Ten Ways to Save on Taxes

Contribute to your 401K or a Traditional IRA.  

You get two tax benefits with these accounts.  Your contributions are before tax with the 401K and tax deductible in an IRA if you are within the income limits (IRA Pub 590).  A pretax benefit and a deduction is basically the same thing except the first in done through your payroll and the other is taken on your tax return. The advantage is an individual in the 25% tax bracket contributing $100 would have an out of pocket contribution of $75.  The other $25 is being put up by Uncle Sam.

The interest or earnings is these accounts grow tax deferred which means you do not have to pay taxes until the money is withdrawn.  Generally there is a 10% penalty for withdrawals prior to age 59 ½. 

Flexible Spending Accounts

Take advantage of flexible spending accounts.  These accounts are set up by your employer and allow you to pay for things like health care expenses, and childcare cost with before tax dollars.  There are limits to how much you can put into these accounts and if you do not use the funds by a certain date you lose them.  

Commuter Benefits

Another employer benefit is commuter benefits.  This allows you to pay for parking and mass transit through payroll deduction with pre-tax dollars.  

Deductions. 

Many people miss deductions that they qualify for.  Certain deductions like the ones above and others: alimony, educator deduction for teachers who buy supplies out of pocket for their class room, moving expenses for job relocation and more.  

Tax Credits.

Tax credits reduce your taxes dollar for dollar.  The energy tax credit which expired 12/31/2007 is not available for your 2008 return but has been reinstated for 2009.  So if you buy new energy efficient exterior doors, windows, insulation, or a high efficiency heater or water heater you can qualify for as much as a $500 credit.  

Tax harvesting investments.

If you sell certain investments at a loss you can write off the losses against the gains plus an additional $3000 (Married filing jointly) against ordinary income. Read Get Rich Slowly's blog on the subject. 

 Hold on to your investment for more than one year because long term capital gains top out at 15% for investments held greater than 1 year.  

Tax Favored Investments

As mentioned above employers sponsored plans and IRA’s are a great way to save on taxes but so are other accounts like education savings accounts and 529 for tuition.  The Roth IRA is a great way to save taxes in the future. See post, "To Roth or not to Roth". 

If you are in a high tax bracket you may be better off investing in tax free municipal bonds versus corporate bonds.  They have lower yields but on a tax equivalent basis you may be better off. 

Charitable donations

Most people donate to charity because they want to help the cause, but if you itemize it is also a deduction on your tax return. You will need to make sure the charity qualifies as one under IRS guidelines. You also want to write a check or use a credit card so you have a record of your donation.  If you are donating clothing or other items, get a receipt. 

Start a family business.

A family business will allow you to pass income to your kids who should be in a lower tax bracket.  You may also take the home office deduction if you use part of your home to run the business.  Pay attention to the rules for the home office deduction because if you take it, you want to get it right.  It is rumored that tax payers taking the home office deduction are more likely to be audited.  That takes us to our last tax saving tip.

Stay organized and keep good records.

Many people lose track of medical expenses, auto miles, charitable donation and other deductions that they could take if they only had the records.  Start a file in January and start putting all tax records for the current year in it.  You can organize it right before tax time.  If you are one of those people that can stay organized then keep separate files for certain deductions (like health care expenses) and credits.  Once you have your records organized and your tax return completed, hold on to them.

You can find out all the details on the above tips at IRS.gov. 

 

Choosing a tax preparer; Do you need a CPA?

One thing that I have learned in my career is that people hate filling out forms.  It can be the simplest form with basic information and people would still pay someone to fill it out.  

The majority of people have simple tax returns and could fill out the forms themselves.  You could purchase software that helps you fill out the forms by interviewing you with questions such as, did you receive a W-2. If you answer yes, the software will then ask you to type the numbers from your W-2 into the program. The program will put the numbers on the correct tax forms. I will put a shameless plug in for the software I use at Happy Returns Tax Service. It cost $19.95 to $24.95  depending on if you use form1040EZ, 1040A or 1040.  It includes Federal, State and e-file.  It is a bargin compared to some of the software on the market and there are no hidden fees.   

Although many people find the tax software great, I find others who get frustrated with software and rather have someone else prepare their return.  There is a good article by John P Cummings, “How to Choose a Qualified Tax Preparer” on the IRS’s website.   

He does a good job of spelling out the qualifications of a Certified Public Account (CPA) and an Enrolled agent (EA).  A CPA can be very expensive even for a basic return.  In my opinion, many people who have a job and some basic investments like stocks, bonds and mutual funds do not need a CPA.  If you own a business, have multiple rental properties or are in complicated investment like; limited partnerships and stock options, then I would suggest you pay the price for a CPA.  

When choosing a professional to prepare your tax return ask for referrals. Avoid tax preparers that claim they can get you the biggest refunds.  I had clients ask me why there refund was larger the pervious year when prepared by another tax professional.  After reviewing the return, I would state that you gave more money to charity the previous year or you had work done to your home that qualified for an energy credit.  Their response is, “No I didn’t”.   Be careful you are still responsible for the return.  

If you are considered a low- and middle-income taxpayer age 60 or older you may qualify for help from the AARP Tax-Aide program.  It has nearly 32,000 volunteers staffing 8,500 sites across the United States. These IRS certified volunteers provide free tax counseling and preparation services. Visit their free AARP Tax-Aide site locator, where you can enter your zip code and receive location addresses, schedules, and other contact information.

Taxes are a frustrating task for many, but if you can find a true professional or good help it can make all the difference.  Happy tax season.   

Keeping Income Tax Records

This is the time of year where everyone needs to pay extra attention to there mail.  You will start to receive tax information from your employer, bank, investment companies, mortgage company, and others.  It is important to gather the documents and keep them together so when it is time to prepare your taxes, you have them. Missing one item on your return may subject you to an audit or cause you to pay a tax preparer to file an amended return. 

You need to keep good records for more than filing your taxes. With the federal deficit expected to be at an all time high, the IRS will be cracking down on tax cheats and possibly doing more audits.  If you happen to get audited you want to make sure you have all the documentation for your deductions and credits.  With lending standards tightening and banks requiring more documents to get a loan, having your records organized will make the process that much easier. If you are looking for either tax advice or financial advice providing a few years worth of tax returns will provide the advisor with an easy and quick view of your overall financial picture.  

Many people ask how long they should keep tax returns and records.   Publication 552  suggest that,

“You must keep your records as long as they may be

needed for the administration of any provision of the Internal

Revenue Code. Generally, this means you must keep

records that support items shown on your return until the

period of limitations for that return runs out.

The period of limitations is the period of time in which

you can amend your return to claim a credit or refund or the

IRS can assess additional tax…”

 

This means you should keep records for 3-7 years.  I would suggest you keep a copy of your return forever and dispose of some of the supporting documents after 3-7 years.  If you own property you will want to keep capital improvement records for as long as you own the property and 3-6 years after the property is sold. 

If you own a business, which has different requirements for record keeping you may want to keep records as long as you own a business.  If you want to sell your business the buyer will want to see many years of records.  

That being said, with electronic record keeping I see no reason why people should not keep their records forever.  You can buy a scanner for as little as $20 and scan all your records onto a drive.  Combo fax, scan and print machines are less than $200 and usually come with the software to store the documents electronically.  

The bottom line is that you never know when you will need a document from the past or for what.  Keeping your documents organized and for long periods of time is never a bad idea. 

You may be in for a big surprise

It happens after every down year in the stock market. I start getting calls in February asking; how did I lose X amount of money in my mutual funds but still have to pay long and short term capital gains?

The answer is how mutual funds work. First you can buy and sell the fund and the fund manager can buy and sell stocks within the fund. You buy ABC mutual fund for $10 a share and by the end of the year it is $6 a share. If you never sell your shares you do not realize the loss, which means you can not deduct it on your return. The fund manager of ABC buys a stock for the fund and decided to sell it before the end of the year for a big gain. Unless the fund manager sells another stock at a loss, the capital gain will be passed on to you. You will have to report this gain and pay taxes on it.

What you can do.
Call your mutual fund company or go to their website and ask/look for the estimated short and long term capital gains. If the fund is going to pay a large capital gain and you have a large loss you may want to consider selling the fund so you can write off the loss and not have to pay taxes on the internal gains. It is important that you get out of the fund before the record date. If you own the fund on the record date you will receive the distribution.

If you would like to get back into the fund you need to beware of the wash sale rule. The wash sale rule states that you can not claim the loss of an investment when the same investment was purchased within 30 days before or after the sale date. This simple means you need to wait 31 days to buy it back.

You also want to consider if the fund is closed to new investors. If you sell you may not be able to get back in. Also if you are in funds with sales loads, you want to check the cost of selling and what happens if you want to buy back in. Most likely you will have to pay the load again.

Selling a fund to take advantage of the loss is something that you should consider only after talking to your tax preparer and your financial advisor.

Key IRS Limits Increase for 2009

The IRS has announced changes in key limits for 2009.

There are new limits for both the standard deduction and personal and dependency exemption. 

The personal and dependency exemption will increase to $3,650.

The standard deduction will increase to $5,700 for single filers and $11,400 for married filing jointly.  Head of household will increase to $8,350

The above limits could affect whether or not you should itemize deductions for your 2009  return (filed in 2010).

The annual gift exclusion has increased to $13,000.  This means you can now make a gift of $13,000 without having to file a gift tax form or paying taxes on the gift.

Pension Plan Limits

The 402(g)(3) limits that affect the amount you can save in your 401(k)/403(b) plan has increased to $16,500 and those age 50 and older can contribute an extra $5,500 in 2009. 

Ask your employer if you can fill out a new salary reduction agreement now to take affect in January 2009 so you can spread the new limits throughout the year. 

Roth IRA

The adjusted gross income limitation under Section 408A(c)(3)(C)(ii)(I) for determining the maximum Roth IRA contribution for married taxpayers filing a joint return or for taxpayers filing as a qualifying widow(er) is increased from $159,000 to $166,000. The adjusted gross income limitation under Section 408A(c)(3)(C)(ii)(II) for all other taxpayers (other than married taxpayers filing separate returns) is increased from $101,000 to $105,000.

Traditional IRA

The applicable dollar amount under Section 219(g)(3)(B)(i) for determining the deductible amount of an IRA contribution for taxpayers who are active participants filing a joint return or as a qualifying widow(er) is increased from $85,000 to $89,000.

The applicable dollar amount under Section 219(g)(3)(B)(ii) for all other taxpayers (other than married taxpayers filing separate returns) is increased from $53,000 to $55,000. The applicable dollar amount under Section 219(g)(7)(A) for a taxpayer who is not an active participant but whose spouse is an active participant is increased from $159,000 to $166,000.

Source IRS.gov

 http://www.irs.gov/pub/irs-drop/rp-08-66.pdf