KIPLINGER TAX CENTER
TRUSTED ADVICE TO HELP YOU LOWER YOUR TAX BILL
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Once you take advantage of every possible tax-saving opportunity on your 2008 tax return, we can let you in on a dirty little secret: The best chances for savings come before you put pen to paper ... through the actions you take during the previous year at the countless intersections between the tax law and your daily life. The following ideas could prove very valuable to you in the months ahead.
Older families should make these moves throughout the year to keep their bill low at tax time. Here are the areas where you should look for savings:
At work
Car and home
Charitable contributions
Estate planning
Inheritance
Investments and retirement savings
Medical expenses
Rental property
AT WORK
Give yourself a raise. The odds are high that you're having too much tax taken out of your paycheck every payday. The evidence is clear if you have a big refund coming.In 2008, the IRS issued nearly 107 million refunds averaging $2,400. So far this year, the average refund is even more: $2,700.Filing a new W-4 form with your employer (get one from your payroll office) will insure that you get more of your money when you earn it. See our easy-to-use withholding calculator to help you figure how many allowances you should claim. Suggest that your husband or wife do the same. If you're just average, you deserve almost $225 a month extra.
Flex your tax-savings muscle. Be aggressive if your employer offers a medical reimbursement account -- sometimes called a flex plan. It lets you divert part of your salary to an account, which you then tap to pay medical bills. The advantage? You avoid both income and Social Security tax on the money -- and that can save you 20% to 35% or more compared with spending after-tax money.
Don't be afraid of home-office rules. If you use part of your home regularly and exclusively for your business, you can qualify to deduct as home-office expenses some costs that are otherwise considered personal expenses, including part of your utility bills, insurance premiums and home maintenance costs. Some home-business operators steer away from these breaks for fear of an audit. But if you deserve them, claim them.
Time receipt of self-employment income. Those who run their own businesses have a lot of flexibility at year-end. To push the receipt of income into the following year, delay mailing bills to clients until late in December that payment is received after December 31. Or, pay business expenses before January 1 to lock in deductions.
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.
CAR AND HOME
Take Uncle Sam for a ride. You can drive away with a credit that will reduce your tax bill dollar for dollar if buy a gasoline/electric hybrid or qualifying clean-diesel vehicle in 2009. The size of the tax credit depends on how fuel-stingy your new car is, but the savings can range from several hundred dollars to over $3,000.
Convert a vacation home to your principal residence. Until 2009, there was a sweet tax break for folks who sold their homes, claimed tax-free profit and then moved into a vacation property. After they lived in that home for two years, they could sell and claim tax-free profit again ... including appreciation from the days the place was a vacation home. There can still be some real tax benefits to this strategy, but the value will fall over the years. Starting in 2009, a portion of any profit on the sale of a vacation-home-turned-principal-residence will not qualify as tax-free home-sale profit. The taxable portion will be based on the ratio of the time after 2008 the property was used as a vacation home to the total period of ownership. So if you have owned a vacation home for 18 years and make it your main residence in 2011 for two years before selling it, only 10% of the gain would be taxed. The rest qualifies for the exclusion of up to $500,000. Homes owned for a short time prior to a post-2008 conversion fare the worst tax wise.
Use an installment sale of real estate to defer a tax bill. If the buyer pays you in installments, the IRS will let you pay the tax bill on your profit in installments, too. You must charge interest on the deal, and each payment you receive will have three parts: interest (taxable at your top rate), capital gain (taxed at a maximum of 15%) and return of your investment (tax-free).
CHARITABLE CONTRIBUTIONS
Tote up out-of-pocket costs of doing good. Keep track of what you spend while doing charitable work, from what you spend on stamps for a fundraiser, to the cost of ingredients for casseroles you make for the homeless, to the number of miles you drive your car for charity (worth 14 cents a mile in 2009). Add such costs with your cash contributions when figuring your charitable contribution deduction.
ESTATE PLANNING
Protect your heirs. Be sure beneficiary designations for your IRAs and 401(k)s are up to date. If your IRA or 401(k) goes to your estate rather an a designated beneficiary, unfavorable withdrawal rules could cost your heirs dearly.
Death and taxes. Someone who is terminally ill may want to sell investments that show a paper loss. Otherwise, the "tax basis" of the property -- the value from which the heir will figure gain or loss when he or she sells -- will be "stepped-down" to date-of-death value, preventing anyone from claiming the loss. If you want to keep property, such as a vacation home, in the family, consider selling to a family member. You get no loss deduction, but it could save the buyer taxes later on.
INHERITANCE
Pinpoint the stepped-up basis of property you inherit. In most cases, the tax basis of inherited property -- that's the value from which you will figure gain or loss when you sell -- is "stepped up" to the value on the day the previous owner dies. Tax on all appreciation during his or her lifetime is forgiven. If you will inherit assets in 2009, be sure you pinpoint your basis so you don't overpay your tax later. Taxpayers who know about this break save billions of dollars each year.
Roll over an inherited 401(K). A recent change in the rules allows a beneficiary of a 401(k) plan to roll over the account into an IRA and stretch payouts (and the tax bill on them) over his or her lifetime. This can be a tremendous advantage over the old rules that generally required such accounts be cashed out, and all taxes paid, within five years. To qualify for this break, you must name a person or persons (not your estate) as your beneficiary. If your 401(k) goes through your estate, the old five-year rule applies.
INVESTMENTS AND RETIREMENT SAVINGS
Check the calendar befor 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.
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. 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.
Scour your portfolio for paper losses. Never make investment decisions solely for tax reasons, but the prospect of realizing a money-saving tax loss might be the impetus you need to unload a loser. If you incur losses during the year, ask yourself if it's time to take some money off the table by selling stocks or mutual funds that have enjoyed healthy run-ups in value. Offsetting losses could make your gains tax-free.
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.
Beware of Uncle Sam's interest in your divorce. Watch the tax basis -- that is, the value from which gains or losses will be determined when property is sold -- when working toward an equitable property settlement. One $100,000 asset might be worth a lot more -- or a lot less -- than another, after the IRS gets its share. Remember: Alimony is deductible by the payer and taxable income to the recipient; a property settlement is neither deductible nor taxable.
Time claiming Social Security benefits. If you stop working, you can claim benefits as early as age 62. But note that each year you delay -- until age 70 -- promises higher benefits for the rest of your life. And, delaying benefits means postponing the time you'll owe tax on them.
Dodge a 50% tax penalty. Taxpayers over age 70˝ are required to take minimum withdrawals from their IRAs each year. Failing to do so subjects them to one of the toughest penalties in the tax law: The IRS claims 50% of the amount that should have come out of the account. Your IRA sponsor can help pinpoint the amount of the required payout.
MEDICAL EXPENSES
Keep careful records of medically necessary improvements. To the extent that such costs -- for adding a wheelchair ramp, for example, lowering counters or widening a doorway or installing hand controls for a car -- exceed any added value to your home or vehicle, that amount can be included in your deductible medical expenses.
Crank in the value of deducting long-term care premiums. As you shop for long-term care insurance, remember that a portion of the cost is deductible. The older you are, the more you can write off. For employees, this is a medical expense, which means it only saves money if your medical expenses exceed 7.5% of your adjusted gross income. If you're self-employed, you avoid the 7.5% restriction and get this deduction even if you don't itemize.
RENTAL PROPERTY
Stay actively involved in rental real estate. Generally, anti-tax-shelter legislation prevents losses from real estate investments from being deducted against other kinds of income. But, if you are actively involved in a rental activity, you can deduct up to $25,000 of such losses ... if your adjusted gross income is less than $100,000. You don't have to mow grass and unclog toilets to qualify as actively involved; but you should make sure you're involved in setting rents and approving tenants and management firms.
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