Tax Saving Strategies:
Max Out Your 401(k) or Similar Employer Plan
Many employers offer plans where you can elect to defer a portion of your
salary and contribute it to a tax-deferred retirement account. For most
companies these are referred to as 401(k) plans. For many other employers, such
as universities, a similar plan called a 403(b) is available. Check with your
employer about the availability of such a plan and contribute as much as
possible to defer income and accumulate retirement assets.
Tip: Some employers match a portion of employee contributions to such
plans. If this is available, you should structure your contributions to receive
the maximum employer matching contribution.
Contribute to an IRA
If you have income from wages or self-employment income, you can build
tax-sheltered investments by contributing to a traditional or a Roth IRA. You
may also be able to contribute to a spousal IRA -even where the spouse has
little or no earned income. All IRAs defer the taxation of IRA investment income
and in some cases can be deductible or be withdrawn tax free. You have time
till April 17th to contribute for previous year.
Tip: To get the most from IRA contributions, fund the IRA as early as
possible in the year. Also, pay the IRA trustee out of separate funds, not out
of the amount in the IRA. Following these two rules will ensure that you get
the most possible tax-deferred earnings from your money.
Give yourself
a raise
If you got a big tax refund this year, it meant that you're having too much
tax taken out of your paycheck every payday. That means IRS is keeping your
money for 1 year, without paying any interest to you. Filing a new W-4
form with your employer will insure that you get more of your money when you
earn it.
Off course, if you want to get a lump sum amount in the form of refund, so
that you can use it for a big purchase, then it is okay.
Avoid or Defer Income Recognition
Deferring the taxability of income makes sense for two reasons. Most
individuals are in a higher tax bracket in their working years than during
retirement. Deferring income until retirement may result in paying taxes on
that income at a lower rate. Additionally, through the use of tax-deferred
retirement accounts you can actually invest the money you would have otherwise
paid in taxes to increase the amount of your retirement fund. Deferral can also
work in the short term if you expect to be in a lower bracket in the following
year or if you can take advantage of lower long-term capital gains rates by
holding an asset a little longer.
Tip: You can achieve the same effect of deferring income by
accelerating deductions-for example, paying a state estimated tax installment
in December instead of at the following January due date.
Defer Bonuses or Other Earned Income
If you are due a bonus at year-end, you may be able to defer receipt of
these funds until January. This can defer the payment of taxes (other than the
portion withheld) for another year. If you're self employed, defer sending
invoices or bills to clients or customers until after the new year begins.
Here, too, you can defer some of the tax, subject to estimated tax
requirements. This may even save taxes if you are in a lower tax bracket in the
following year. Note, however, that the amount subject to social security or
self-employment tax increases each year.
Accelerate Capital Losses and Defer Capital Gains
If you have investments on which you have an accumulated loss, it may be
advantageous to sell it prior to year-end. Capital losses are deductible up to
the amount of your capital gains plus $3,000. If you are planning on selling an
investment on which you have an accumulated gain, it may be best to wait until
after the end of the year to defer payment of the taxes for another year
(subject to estimated tax requirements). For most capital assets held more than
12 months the maximum tax is reduced to 15% for sales after May 5, 2003 and before 2013. However, make sure
to consider the investment potential of the asset. It may be wise to hold or
sell the asset to maximize the economic gain or minimize the economic loss.
Watch Trading Activity in Your Portfolio
When your mutual fund manager sells stock at a gain, these gains pass
through to you as realized taxable gains, even though you don't withdraw them.
So you may prefer a fund with low turnover, assuming satisfactory investment
management. Turnover isn't a tax consideration in tax-sheltered funds such as
IRAs or 401(k)s. For growth stocks you invest in directly and hold for the long
term, you pay no tax on the appreciation until you sell them. No capital gains
tax is imposed on appreciation at your death.
Don't buy a tax bill
Before you invest in a mutual fund near the end of the year, check to see
when the fund will distribute dividends. On that day, the value of shares will
fall by the amount paid out. Buy just before the payout and the dividend will
effectively rebate part of your purchase price, but you'll owe tax on the
amount. Buy after the payout and you'll get a lower price, and no tax bill.
Check the calendar
before you sell
You must own an investment for more than one year for profit to qualify as a
long-term gain and enjoy preferential tax rates. The "holding period"
starts on the day after you buy a stock, mutual fund or other asset and ends on
the day you sell it.
Keep a running tally of
your basis
For assets you buy, your "tax basis" is basically how much you
have invested. It's the amount from which gain or loss is figured when you
sell. If you use dividends to purchase additional shares, each purchase adds to
your basis. If a stock splits or you receive a return-of-capital distribution,
your basis changes. Only by carefully tracking your basis can you protect
yourself from overpaying taxes on your profits when you sell.
Mine your portfolio for
tax savings
Investors have significant control over their tax liability. As you near the
end of the year, tote up gains and losses on sales to date and review your
portfolio for paper gains and losses. If you have a net loss so far, you have
an opportunity to take some profit tax free. Alternatively, a net profit on
previous sales can be offset by realizing losses on sales before the end of the
year. (This strategy applies only to assets held in taxable accounts, not
tax-deferred retirement accounts such as IRAs or 401(k) plans).
Tell your broker which
shares to sell
Doing so gives you more control over the tax consequences when you sell
stock. If you fail to specifically identify the shares to be sold, the tax
law's FIFO (first-in-first-out) rule comes into play and the shares you've
owned the longest (and perhaps the ones with the biggest gain) are considered
to be sold. With mutual funds, an "average basis" can be used when
determining gain or loss; but that alternative isn't available for stocks.
Avoid the wash sale
rule
If you sell a stock, bond or mutual fund for a loss and then buy back the
identical security within 30 days, you can't claim the loss on your tax return.
The IRS considers the transaction a wash, since your economic situation really
hasn't changed. It's easy to avoid being stung by the "wash sale"
rule, though. Watch the calendar or, buy similar but not identical securities.
Ask your broker for a
favor
The law allows investors to deduct a loss on a worthless security, but only
if you can prove the stock is absolutely worthless. If you own stock you're
sure isn't coming back, ask your broker to buy it from you for a nominal
amount. You can then report the sale and claim your loss.
Think twice about
selling stock for a profit if you're subject to the AMT
Although long-term capital gains benefit from the same 15% maximum rate
under both the regular tax rules and the alternative minimum tax, a capital
gain can effectively cost more than 15% in AMT-land. The special AMT exemption
is phased out as income rises so, for example, a $1,000 capital gain can wipe
out $250 of the exemption, effectively exposing $1,250 to tax. That means your
tax bill rises by more than $150 for that $1,000 gain.
Pay tax sooner rather
than later on restricted stock
If you receive restricted stock as a fringe benefit, considering making
what's called an 83(b) election. That lets you pay tax immediately on the value
of the stock rather than waiting until the restrictions disappear when the
stock "vests." Why pay tax sooner rather than later? Because you pay
tax on the value at the time you get the stock, which could be far less than
the value at the time it vests. Tax on any appreciation that occurs in between
then qualifies for favorable capital gains treatment. Don't dally: You only
have 30 days after receiving the stock to make the election.
Minimize the bite of
the "kiddie tax."
The rule that taxes a child's income at the parents' rate now covers
children up to age 19, or up to age 24 if the child is a full-time student. You
can minimize the damage by steering a child's investments into tax-free
municipal bonds or growth stocks that won't be sold until the child turns 19,
or 24 for full-time students.
Use the Gift-Tax Exclusion to Shift Income
You can give away $13,000 ($26,000 if joined by a spouse) per donee, per
year without paying federal gift tax. You can give $13,000 to as many donees as
you like. The income on these transfers will then be taxed at the donee's tax
rate, which is in many cases lower.
Note: Special rules apply to children under age 18. Also, if you
directly pay the medical or educational expenses of the donee, such gifts will
not be subject to gift tax.
Invest in Treasury Securities
For high-income taxpayers, who live in high-income-tax states, investing in
Treasury bills, bonds, and notes can pay off in tax savings. The interest on
Treasuries is exempt from state and local income tax. Also, investing in
Treasury bills that mature in the next tax year results in a deferral of the
tax until the next year.
Consider Tax-Exempt Municipals
Interest on state or local bonds ("municipals") is generally
exempt from federal income tax and from tax by the issuing state or locality.
For that reason, interest paid on such bonds is somewhat less than that paid on
commercial bonds of comparable quality. However, for individuals in higher
brackets, the interest from municipals will often be greater than from higher
paying commercial bonds after reduction for taxes. Gain on sale of municipals
is taxable and loss is deductible. Tax-exempt interest is sometimes an element
in computation of other tax items. Interest on loans to buy or carry
tax-exempts is non-deductible.
Give Appreciated Assets to Charity
If you're planning to make a charitable gift, it generally makes more sense
to give appreciated long-term capital assets to the charity, instead of selling
the assets and giving the charity the after-tax proceeds. Donating the assets
instead of the cash prevents your having to pay capital gains tax on the sale,
which can result in considerable savings, depending on your tax bracket and the
amount of tax that would be due on the sale. Additionally you can obtain a tax
deduction for the fair market value of the property.
Tip: Many taxpayers also give depreciated assets to charity.
Deduction is for fair market value; no loss deduction is allowed for
depreciation in value of a personal asset. Depending on the item donated, there
may be strict valuation rules and deduction limits.
Keep Track of Mileage Driven for Business, Medical or Charitable Purposes
If you drive your car for business, medical or charitable purposes, you may
be entitled to a deduction for miles driven. You need to keep detailed daily
records of the mileage driven for these purposes to substantiate the deduction.
Take Advantage of Your Employee's Benefit Plans to Get an Effective
Deduction for Items Such as Medical Expenses
Medical and dental expenses are generally only deductible to the extent they
exceed 7.5% of your Adjusted Gross Income. For most individuals, particularly
those with high income, this eliminates the possibility for a deduction. You
can effectively get a deduction for these items if your employer offers a
Flexible Spending Account, sometimes called a cafeteria plan. These plans
permit you to redirect a portion of your salary to pay these types of expenses
with pre-tax dollars. Another such arrangement is a Health Savings Account. Ask
your employer if they provide either of these plans.
Pay child-care bills
with pre-tax dollars
After taxes, it can easily take $7,500 or more of salary to pay $5,000 worth
of child care expenses. But, if you use a child-care reimbursement account at
work to pay those bills, you get to use pre-tax dollars. That can save you
one-third or more of the cost, since you avoid both income and Social Security
taxes. If your boss offers such a plan, take advantage of it.
Ask your boss to pay
for you to improve yourself
Companies can offer employees up to $5,250 of educational assistance
tax-free each year. That means the boss pays the bills but the amount doesn't
show up as part of your salary on your W-2. The courses don't even have to be
job-related, and even graduate-level courses qualify.
Check Out Separate Filing Status
Certain married couples may benefit from filing separately instead of
jointly. Consider filing separately if you meet the following criteria:
- One spouse has large medical
expenses, miscellaneous itemized deductions, or casualty losses.
- The spouses' incomes are
about equal.
Separate filing may benefit such couples because the adjusted gross income
"floors" for taking the listed deductions will be computed
separately. On the other hand, some tax benefits are denied to couples filing
separately. In some states, filing separately can also save a significant amount
of state income taxes.
If Self-Employed, Take Advantage of Special Deductions
You may be able to expense up to $500,000 in 2011 for qualified equipment
purchases for use in your business immediately instead of writing it off over
many years. Additionally, self-employed individuals can deduct 100% of their
health insurance premiums as business expenses. You may also be able to
establish a Keogh, SEP or SIMPLE plan, or a Health Savings Account, as
mentioned above.
If Self-Employed, Hire Your Child in the Business
If your child is under age 18, he or she is not subject to employment taxes
from your unincorporated business (income taxes still apply). This will reduce
your income for both income and employment tax purposes and shift assets to the
child at the same time.
Take Out a Home-Equity Loan
Most consumer related interest expense, such as from car loans or credit
cards, is not deductible. Interest on a home-equity loan, however, can be
deductible. It may be advisable to take out a home-equity loan to pay off other
nondeductible obligations.
Don't underestimate the
cost of home-equity debt
Generally, interest on up to $100,000 of debt secured by your home can be
deducted, no matter what you use the money for. But if you are among the
growing number of taxpayers subjected to the alternative minimum tax (AMT),
home-equity debt is only deductible if the loan was used to buy or improve your
home.
Keep track of the cost
of moving to a new job
If the new job is at least 50
miles farther from your old home than your old job was,
you can deduct the cost of the move ... even if you don't itemize expenses. If
it's your first job, the mileage test is met if the new job is at least 50 miles away from your old home.
You can deduct the cost of moving yourself and your belongings. If you drive
your own car, you can deduct 16.5 cents per mile for a 2010 move, plus parking
and tolls.
Bunch Your Itemized Deductions
Certain itemized deductions, such as medical or employment related expenses,
are only deductible if they exceed a certain amount. It may be advantageous to
delay payments in one year and prepay them in the next year to bunch the
expenses in one year. This way you stand a better chance of getting a
deduction.
Tally job-hunting
expenses
If you count yourself among the millions of Americans who are unemployed,
make sure you keep track of your job-hunting costs. As long as you're looking
for a new position in the same line of work (your first job doesn't qualify),
you can deduct job-hunting costs including travel expenses such as the cost of
food, lodging and transportation, if your search takes you away from home
overnight. Such costs are miscellaneous expenses, deductible to the extent all
such costs exceed 2% of your adjusted gross income.
Pay back a 401(k) loan
before leaving the job
Failing to do so means the loan amount will be considered a distribution
that will be taxed in your top bracket and, if you're younger than 55 in the year you leave your job, hit
with a 10% penalty, too.
Deduct interest paid by mom and dad
Until recently, parents had a good reason not to help their kids pay off
student loans. If the parents were not liable for the debt, then no one got to
deduct the interest. Now, however, when parents pay it's treated as if they
gave the money to the real debtor who then paid off the loan. The child gets
the tax deduction, as long as the parents can't claim him or her as a
dependent, even if he or she doesn't itemize.
Make the most of the
tax-free home sale profit
Up to $250,000 of home-sale profit is tax free ($500,000 if you are married
and file a joint return) if you own and live in the house for two of the five
years leading up to the sale. If you are bumping up on the limits, consider
selling and buying a new home to start the tax-free clock ticking again. There
is no limit on the number of times you can claim tax-free profit on the sale of
a home.