Where What When

Year-End Tax Planning

Tax Advice

Well, another tax season is rolling around. When it comes to taxes, timing and planning can be very significant. So here are some pointers.

A new energy bill that takes effect after December 31 will provide tax savings for items like new windows, home improvements, and the purchase of an alternative-fuel car. So you might want to push these items off till after January 1.

If you have sold stocks for a profit, you should consider selling the losers you are holding. You can buy them back but must wait 30 days to do so.

Every tax return is allowed to claim a fixed amount as a deduction. This is $10,000 for marrieds and $5,000 for singles. However, you can “itemize” your deductions if this will add up to more. The items you can deduct are state taxes paid, real estate taxes paid, mortgage interest, charity, and sometimes medical and job expenses. Actually the government allows you to deduct sales taxes instead of state income taxes if you prefer. There are tables to help you calculate this number. If you are itemizing your deductions, make sure that these are paid before the year’s end. For example, give charity and pay state income taxes before December 31.

The best way to give charity is to donate appreciated stock. You get a deduction for the fair market value of the stock even though you paid less. And by all means, clean out your old stuff and get a tax deduction for Goodwill donations.

Certain deductions will not help those who are paying the alternative minimum tax. This parallel tax system limits deductions for various items, including children and state income taxes. This additional tax can hit hard with a big surprise.

You can pay January’s mortgage early in order to deduct an additional month’s interest. Make sure your real estate taxes are paid up.

If you have had high medical expenses and will be able to deduct these items, then try to pay more medical expenses before year’s end. This includes just about anything that is needed for your health: doctors, dentists, therapists, etc. It can include special educational expenses for learning disabilities and travel for medical needs. Nursing home expenses as well as some premiums for long-term care insurance are deductible. In addition, if you have made deposits into a “cafeteria plan,” check the rules about deadlines, because there is a “use or lose” aspect to these plans. If you don’t use the money set aside for medical expenses by the deadline, it is forfeited.

If you are planning a wedding this winter, keep taxes in mind, as being married can increase or decrease your taxes. However, what was known as the “marriage penalty” has been greatly reduced.

College tuition paid qualifies for various tax deductions, all of which have limitations. What I sometimes see is people who spend a lot on tuition one year and then nothing the next year. For example, if your daughter is in seminary, make sure that your last tuition payment is made in 2006 so that you get tax benefits for next year as well. Paying all of it in 2005 could result in a loss of $1,500 on your 2006 tax return.

Putting money into pensions is one of the most popular tax saving devices. If you have a pension plan at work, it is important to participate. Even if you don’t, you can still contribute to your own fund, called an IRA. You have until April 15, 2006 to pay into your IRA, and it will still count for 2005. Only one spouse has to work to enable both spouses to contribute to an IRA. In addition, there are two kinds of IRAs. The new kind is called a Roth IRA. Deciding which is better for you will require some calculating and forecasting.

You can deduct up to $2,500 in student loan interest and up to $6,000 in child care expenses, and even expenses for moving if needed for a job change. Time your payments for maximum savings. For example, let’s say that a couple will incur $7,000 in childcare expenses in one year and $5,000 the next. For the first year, you will not get a benefit from $1,000 of your payments. It would be advantageous to delay paying $1,000 into year two in order that you will be able to claim the two-year total of $12,000.

If not enough income taxes were withheld, have your employer withhold more before the end of the year, and it will be deemed to be on time.

If you are a low earner with children, you can receive the earned income credit. Make sure your investment income is below $2,700, or you will be completely ineligible.

Some employees have to spend money for job-related expenses. These expenses provide a larger savings if deducted by the employer. An important strategy is to reduce your “salary” and create an expense account. For example, if your compensation is $50,000 per year, out of which you, the employee, have to spend $2,000 on expenses, a good approach would be to negotiate for $48,000 in wages and $2,000 for expenses. Make sure you save all receipts and submit them to your employer. This will result in reducing your taxable income from $50,000 to $48,000. The same approach is good for health insurance premiums.

If you are near a “cliff,” some creative ideas can help. A cliff is when your income goes up and your deductions really drop off. For example, if you earn under $160,000, you can deduct $2,000 in college education. If you earn over that, you cannot. If you put one dollar in an IRA, you will be back under the limit and you will save $800 on income taxes. Not bad for a dollar. Another example involves the credit for retirement savings. A couple earning $32,000 could save $749 by putting $1,000 into an IRA. That means that you put $1,000 into your retirement account, yet it only cost you $251out-of-pocket. Asking an employer to hold off on bonuses until 2006 can be very effective as well. Those for whom 2005 is the determining year for college scholarships and Pell grants have all the more reason to implement these suggestions.

Social security benefits are tax free – if your income is on the low side. Don’t push it up by selling stocks or making IRA withdrawals. These can have a snowball tax effect!

Ultimately, the simplest of all deductions is for your children. Each family member provides a deduction for $3,200. You can deduct other relatives in certain situations. In addition, you get a $1,000 reduction in taxes for each child under 17. This is a full $1,000 in savings – a “tax credit” not a tax deduction.

Some good news: If you sell your house for a profit, the first $500,000 in profit is tax free.

Let me stress that all of the above items come with rules, details, and limitations. It is important that you are thorough and get good advice. Don’t assume anything on your own. I have seen people buy a house believing they will save a lot on taxes only to discover that the savings are smaller than they assumed.

With good planning, hopefully, you can effectively implement these suggestions.

Top

Article List - December 2005