This time of year, now through the first quarter of next year, you will see articles offering year-end tax planning tips. Tax planning tips can increase income in future years, so be careful. Many tax tips often involve accelerating deductions, deferring income, or last-minute charitable deductions (the first three following tips).
For example you may be compelled to make a large charitable contribution this year by December 31st. However if you could be in a higher tax bracket next year because your income is going up because of a substantial raise or bonus, you would have been better off to make the contribution next year. Some may say this is heartless, but I say just the reverse. If you pay less in taxes because of good planning, your will be better off financially and able to give more in the future.
If you have volatile income, before you use the tax savings tips here and in other articles, you may want to run projections for this year and next. A good accountant will run these calculations for you, but understand that tax law changes from year to year and from one administration to the next can often make predicting tricky.
1. Defer income
If you are able to defer income, such as commissions and bonuses until next year, you might be able to pay lower income taxes this year. However, you must consider what your income and taxes will be next year to be sure that you are not actually increasing your taxes.
2. Accelerating deductions
Accelerating major deductions such as state income taxes, property taxes, and mortgage interest may help anyone, especially during a high-income year. If you don’t think your personal income tax bracket will be higher next year, and you’re not affected by the alternative minimum tax, you can make state and/or local tax payments before the end of this year so you can take a deduction this year.
3. Charitable Contributions
Consider making chartable deductions before the end of the year to receive a deduction. You must make the contribution by 12/31/2007.
Donate appreciated property such as real estate or stock instead of the proceeds of the sale. You may be able to receive a deduction for the value of the contribution without paying tax on the growth portion resulting from a sale, then a gift. If you intend to transfer appreciated property, begin early since it will take several weeks to make the change.
4. Alternative minimum tax traps
Many people face large AMT bills compared to previous years. Be warned if you have larger than usual medical expenses, non-federal income and real estate taxes, or miscellaneous itemized deductions; or if you have exercised large stock options, to name a few.
Year-end tax planning strategies can backfire under AMT. Be very careful accelerating some deductions and exercising stock options at year end. See a tax professional for information on your specific tax situation.
5. Be careful when investing new money in mutual funds at the end of the year
Call the mutual fund and find out when the distribution date is. You may want to purchase after the distribution date to avoid owing taxes on fund shares that you owned only for a short period of time and had little to no gain.
6. Contribute the maximum to retirement accounts
Contribute the maximum allowable to employer-sponsored defined contribution retirement plans, such as profit sharing, 401(k), 403(b) and 457(b) plans. This not only provides an excellent tax deduction, but it also helps you to plan for your future retirement.
You may want to contribute to an IRA; up to $2,000 is fully deductible if you did not participate in a company-sponsored retirement plan or if your income falls below certain levels.
If you are self-employed, you can contribute more to a pension plan than into an IRA. You have until December 31 to set up the plan.
7. Investment Losses
If your investment portfolio has stock that has depreciated in value and is worth less than when you originally purchased it, you may want to consider selling it. You may be able to use that loss to offset capital gains and ordinary income.
Be careful though; investment decisions should not just be for tax purposes. Make sure that you do your research before selling any investment. Some people react too quickly when investments lose value; others sometimes hold on too long. If you decide to sell and invest in something new, make sure that you examine your portfolio to ensure that you have the right mix of investments to match your investment profile, risk propensity and asset allocation model.
8. Save for College
Consider contributing to your child’s college savings into a 529 plan. The contributions are not deductible on your Federal return, but parents may be able to write off contributions up to a certain dollar amount on their state income tax return. Log on to SavingforCollege.com to find out information about your state.
9. Home Improvements
Here is a great deal. How about saving energy and the environment, lower utility bills, increase the value of your home and save on taxes – all at once. Projects for the home’s shell (insulation, windows, sealing) and heating and cooling may qualify for a one time tax credit of $500. However you are running out of time, since they must be in place by the end of 2007. So while crawling around your attic looking for ornaments, think of adding insulation. If you made home improvements over the last couple of years, be sure to dig up your records; you may already be eligible.
Before moving forward on one of these projects, make sure that you get full information about these and other energy efficient tax incentives from The Tax Incentives Assistance Project at http://www.energytaxincentives.org/. There you will find more information about Home Shell and Heating & Cooling as well as Hybrid Passenger Vehicles and Solar Energy Systems.
10. If self-employed, buy equipment and supplies
Have you been putting off buying needed business equipment and supplies, or do you know that you will soon need them? Now may be the time to invest in your business and save taxes as well. Business tax can be complex; therefore it may be wise to first call your accountant prior to large purchases.
11. Give gifts to children
When you give to friends and family, it is usually not taxable to the recipient or the giver. Many people do not realize though if that gift exceeds $12,000 per person it is taxable to the giver, and at a high rate. Therefore, if you intend to give anyone more than that amount, you could give some this year and some next. The second tip is that you and your spouse can both give $12,000 per person, doubling the amount not subject to tax. Be sure to consult your legal and tax advisor prior to making all gifts.