Whether you are flying high with savvy investments, rebounding from recent losses, or still struggling to get off the ground, you can save a bundle on your taxes if you make the right moves before the end of the year.
Before you do anything, consider making income tax projections for this year and next (at least). If your situation is complicated enough, you will need a software program or help from your tax preparer. Once you have the numbers, however, you can see how any actions you take will affect your tax bill each year.
Each year, Congress votes on anywhere from 90 to 100 new tax laws. The tax loopholes and savings below, apply to each new tax year even if the amounts increase from year to year.
1. Defer Income
Most folks on salary don’t have much choice on when they get paid. But if you are one of the lucky ones in line for a year-end bonus, consider asking your employer to give it to you in January. Some companies will be able to help you out, but because of stringent rules, others can’t. If you have consulting income, you might want to delay billing so that you will get paid next year.
Of course, it only makes sense to defer income if you think you will be in the same or lower tax bracket next year. You don’t want to be hit with a bigger tax bill next year if an extra chunk of income could push you into a higher income tax bracket.
2. Take Last-Minute Deductions
Contributing to charity is a noble way to get a deduction. You can make the process easier on yourself if you donate appreciated stock or property rather than cash from the proceeds of a sale. You may be able to give more to the charity, and you avoid paying capital gains. Be sure to give yourself plenty of time because it can take several weeks to transfer the stock or property.
Young taxpayers who may not have itemized deductions before should try bundling miscellaneous deductions such as tax preparation fees, job-hunting expenses, and professional dues to meet the IRS threshold of 2% of adjusted gross income. (Your miscellaneous deductions must add up to more than that, and you only get to deduct the amount above that level.) Paying some of next year’s expenses in December might give you enough expenses to put you over the line.
Accelerating major deductions such as state income taxes, property taxes, and mortgage interest may help anyone, especially during a high-income year. But if your income is too high, there could be a problem.
3. Beware of the Alternative Minimum Tax
Sometimes accelerating deductions can cost you money because you inadvertently trigger the Alternative Minimum Tax (AMT). Originally designed to make sure wealthy people paid their fair share of taxes, the AMT is now affecting the middle class, in large part because of incentive stock options and lower tax rates.
And that can be a particular problem for people who are not used to figuring out sticky tax issues.
The AMT is figured separately from your regular tax liability, and you may have to pay it rather than a lower tax bill if 1) your itemized deductions are too high, 2) you have a large state tax liability, 3) you exercise incentive stock options and hold the shares, or 4) you experience another triggering event.
Calculating your taxes for more than one year may help you avoid the AMT. You may also need to consult your tax adviser to decide when you should exercise incentive stock options or pay certain expenses.
4. Sell Loser Stocks to Offset Gains
With the roller coaster stock market, you may have a mix of winners and losers in your portfolio. If you have a big capital gain, consider selling some of the losers. You can erase your tax liability on the gain with a corresponding loss. Then you can apply a maximum of $3,000 in net capital losses against ordinary income, reducing the amount of income on which you must pay taxes. Any additional losses in excess of $3,000 can be rolled over to subsequent years. (2004)
5. Do a Bond Swap
Bond prices tend to fall when interest rates are rising. It’s very easy to sell a bond — corporate, government, or municipal — and then turn around to buy a similar one. If bond prices are falling, you will have essentially the same investment but with a little more money in your pocket. Your broker should charge you only a small transaction fee to do the swap. But you should be sure that your broker understands how to do these deals.
You also can sell bonds that are down to generate a tax loss.