Ten Tax Moves to Make Now
Put more money in your pocket today, and owe less to Uncle Sam April 15th.
By Erin Burt, Contributing Editor, Kiplinger.com
September 22, 2004
No one likes to think about taxes, especially when April 15 seems so far away. But turning your thoughts to your tax bill now could trim your tab when it's time to file.
The end of the year will arrive before you know it -- and there's not a lot you can do to change your liability after that. So take advantage of this lull between busy summer vacations and the frenzied holiday season to maximize your tax benefits and minimize your bill from the IRS.
- Adjust your withholding
- Get organized
- Check flex accounts
- Start a health savings account
- Buy a new business vehicle
- Give to charity
- Start a college fund
- Consider refinancing
- Rebalance your portfolio
- Boost retirement savings
1. Adjust your withholding
Did you get a tax refund last year? Although you probably looked forward to receiving that check, a huge refund is evidence of poor planning. Last year's refunds were padded by 2003's tax cuts, but if you received a few thousand dollars, you essentially gave the government a no-interest loan. That's money you could have put to use throughout the year, by funding a retirement plan or saving for college, for example.
It's not too late to take back what's yours, or catch up your payments to Uncle Sam (underwithholding could land you in hot water, too).
Basically, anyone who receives at least a $500 refund or owes more than 10% of their total tax bill should adjust their withholding. It's also a good idea to check your withholding after any major events that will affect your tax bill, such as getting married or having a child.
For most taxpayers, it all comes down to the number of allowances claimed on the W-4. That's the form on file with your employer that helps determine the amount of tax withheld from your paychecks. Use the IRS Withholding Calculator to estimate your tax bill, check your withholding and find out what adjustments are needed. Then download a new W-4, fill it out and give it to your employer.
2. Get organized
Make filing your taxes a tad less stressful by getting your information in order now. Collect your charitable donation records, medical bills, home business receipts, moving expenses, brokerage account statements and other supporting documents. Sort them into file folders for easy access. As you collect more records and receipts between now and December 31, you'll have a place to put them. And you'll be well organized to handle next year's papers, too.
As you're collecting your broker statements, take this opportunity to figure out how much you've contributed to your IRA or other tax-sheltered accounts this year. Find out whether you have reached your contribution limits and how much you can still sock away to make the most of these savings vehicles.
3. Check your flexible spending account
Review the balance in your medical reimbursement account. These accounts are funded with pre-tax dollars, and any money left in the account at year-end will disappear. If you have a chunk of cash left, use it to buy new glasses, get your teeth cleaned or get a physical. You can even load up on aspirin and decongestants in time for cold and flu season. For a list of acceptable expenses, see IRS Publication 502 Medical and Dental Expenses.
If you have funds left in a child-care account, consider using the money to give your caregiver a year-end bonus. The goodwill you earn will cost you nothing, if the cash otherwise would have been forfeited.
If you don't use a flexible spending account for medical or dependent care consider it. Open enrollment season is right around the corner. Use our worksheet to estimate your potential tax savings.
4. Start a health savings account
If you're already paying for your own health insurance, consider opening a health savings account soon.
To qualify for an HSA, you must be under age 65 and purchase a policy with an annual deductible of at least $1,000 for an individual or $2,000 for a family. This policy must be your only health insurance.
Once the policy is in place, you may set up an HSA and contribute up to the amount of your policy's deductible -- to a maximum of $2,600 for singles and $5,150 for families. If you are 55 or older by the end of the year, you can contribute $500 more than the policy deductible.
Money you put into the account can be deducted on your tax return -- whether you itemize deductions or not.
Best of all, if you open and fully fund your HSA in 2004 but don't spend the all the money, it rolls over to 2005. Earnings grow tax-free, and if you spend the money on medical expenses you can tap the account tax-free, too.
You can dip into your balance anytime, but if you use the money for nonmedical purposes, you'll owe income taxes on the earnings and a 10% penalty (after age 65 the penalty goes away, but you'll still owe income taxes on the earnings).
See, Health Savings Account Answers for more details on these plans. For a list of companies that offer these accounts, including details about their fees and interest rates, visit HSA Insider.
5. Buy a new business vehicle
A new full-size truck or SUV purchased for your business could drive home a nice tax break. A recent tax change, affectionately known as "the Hummer loophole," lets you "expense" or deduct the full cost of a business vehicle that weighs 6,001 pounds or more (when loaded) as a business expense right away, rather than taking limited-depreciation write-offs over a number of years. The amount currently eligible for expensing is $102,000 a year, more than enough to cover not just the $50,000 Hummer H2 but even a $90,000 Porsche Cayenne Turbo.
If you have your eye on a hefty SUV, don't dawdle. The Senate has already passed a bill to slash the maximum amount eligible for expensing to $25,000 for SUVs that weigh up to 14,000 pounds. The House of Representatives is expected to go along, although it is unclear whether it will get around to passing the bill before then November election. Pickups aren't targeted by the bill.
6. Give to charity
Don't wait for the crunch of the holiday season to clean out your closets and make way for the new. Do it now and save yourself a double dose of hassle. Take those old clothes and toys -- or even the old clunker in the driveway -- and donate them to charity. Make sure you get a receipt or keep a record of your donations and their estimated value. If you itemize deductions, a $1,000 donation translates into $250 in savings if you're in the 25% tax bracket.
You might also consider donating securities or other appreciated assets to charity. If you own a stock that has increased in value since you've owned it, you can get a double tax break: You can deduct the market value of the stock when you donate it, and not worry about paying capital gains taxes because you didn't sell the shares.
7. Start a college plan
Twenty-four states and the District of Columbia give a state tax deductions for contributing to their 529 college savings programs. You'll fund these accounts with after-tax dollars, but your money will grow tax-free -- which means you don't have to mess with reporting capital gains on your tax return. Several 529 plans have no set contribution limit. Find out more about your state's plan.
8. Consider refinancing -- again
If you refinanced a year or two ago, check the rates again. Today's national average on a 30-year fixed-rate loan is now around 5% and adjustable rate mortgages are lower still. If refinancing makes sense for you, replacing a loan you refinanced earlier by year end can lock in tax savings. Points paid on refinancing are only deductible over the life of the loan. But when you refinance again, you deduct the remaining undeducted portion of points from the previous refinancing all at once.
9. Rebalance your portfolio
It's important to check your investment allocations to make sure they are still in line with your goals. Over time, one group of investments will outperform the other -- say, large-cap growth stocks versus bonds -- throwing your allocation out of whack. To restore it, you need to sell shares of one type and buy the other.
When rebalancing assets in a taxable account, consider selling some stocks at a loss to offset any capital gains.
First, you'll subtract short-term losses from short-term gains (investments held one year or less), then subtract long-term losses from long-term gains (investments held longer than one year). Then use any remaining losses to offset any remaining gains in the other category.
You can also deduct up to $3,000 against other kinds of income, such as salary (if you have more losses than gains). Any losses beyond $3,000 are carried over to the next year. You continue this process every year until you've finally deducted all your losses.
10. Boost your retirement savings
Contributing to a 401(k) is a great way to lower your taxable income -- without taking a paycut. Your contributions are subtracted from your salary before taxes. That means there's less salary to tax. If you're already participating in a 401(k), take it to the max. You can sock away $13,000 in your account this year ($16,000 if you're 50 or older by the end of the year).
You can also save up to $3,000 in a Roth or tax deductible IRA, or $3,500 if you're over age 50, up from just $2,000 a few years ago.
If you have self-employed income, you can also set up a SEP IRA and contribute up to 25% of your net self-employment income (up to a maximum of $41,000). The contribution cuts your taxable income dollar for dollar. If you set up another kind of retirement plan for your business by December 31, such as a Keogh or solo 401(k) plan, you have until the due date for your return to make 2004 contributions.