Posted on 12/06/2005 12:10:01 PM PST by BenLurkin
The holidays are here, and you're rushed beyond belief. But before you get too caught up in shopping and cooking and making travel plans, you need to squeeze one more task into your hectic schedule: Set aside some time for a year-end tax review. It could turn out to be a profitable present to your bank account. Spending a few minutes on your taxes now can pay off when you file your return next year. Plus, if you can defuse these 10 potentially explosive tax tasks by Dec. 31, you won't have to call in an accounting bomb squad on April 15.
Get in the giving mood Evaluate your portfolio Let your home help you out Flex your spending account muscle Maximize medical deductions Make early miscellaneous payments Shift incoming income Tend to your retirement Examine expiring tax breaks Check your withholding
1. Get in the giving mood Since the holidays are the time for giving, add your name to your tax gift list by donating to your favorite charity. As long as you itemize, you can deduct gifts of cash or goods to help reduce your tax liability.
This year, giving took on a whole new meaning following Hurricane Katrina's devastation of the Gulf Coast, and lawmakers enacted several new tax provisions to help the area's residents recover. Congress also revised the tax code to include specific tax breaks for folks who provided assistance to storm victims.
The three major Katrina-related philanthropic tax law changes are:
Up to $2,000 in additional exemptions ($500 per person) if you welcomed hurricane-displaced residents (a maximum of four) into your home. An increased mileage allowance (up to 34 cents versus the usual 14 cents per mile) if you used your vehicle to provide assistance to hurricane-relief efforts. Lifting of limits for the latter part of the year on monetary gifts to Internal Revenue Service-authorized charitable organizations. To qualify for the temporary housing deduction, you must have housed evacuees for at least 60 days, so that might be out of reach if you don't already have Gulf Coast guests at your house. If you did, or will, shelter evacuees long enough to qualify, now is the time to get their Social Security numbers, because you'll need that information to claim the tax break.
You still have time to take advantage of the charitable transportation mileage write-off. Usually, you can only deduct philanthropic driving at 14 cents per mile. But the rate was upped for Katrina vehicle volunteers to 70 percent of the higher business mileage allowance. There's just one problem: Depending on when you drove, you might have to make several computations.
The increased rate applies to charity miles on or after Aug. 25, and the IRS took the unusual step of increasing the 2005 business driving deduction rates on Sept. 1. So you'll have to figure the mileage from Aug. 25 through Aug. 31 using the previous 40.5-cents-per-mile business rate, giving you a 28-cents-per-mile deduction for those days. For allowable trips on Sept. 1 and later, use the 48.5-cent business rate, producing a 34-cents-per-mile deduction. And remember that these increased rates only apply to Katrina assistance trips. For any other volunteer transport services, you must use the 14-cents-per-mile amount to figure your deduction.
The abatement of donation amount limits, however, doesn't apply only to hurricane-specific contributions. In most cases, donations are limited to 50 percent of your adjusted gross income, so if your AGI is $30,000 then you can deduct gifts totaling as much as $15,000.
But if you make a lot of money, which is likely if you're giving that much to charity, your total deductions (charitable and other categories) are reduced based on your income. The Katrina tax legislation removes both of these restrictions for all charitable donations made between Aug. 27 and Dec. 31, regardless of the receiving organization's designated cause. So if you stopped giving to your favorite non-hurricane nonprofit because you thought you wouldn't be able to take the tax break, get your checkbook out again before the year ends.
You also have time to donate an auto to charity before the end of the year, but be aware that your deduction might be less than you expected because of tougher vehicle-donation rules that took effect this year. You'll generally still get some tax benefit from giving away your car. Just know exactly what you'll be able to write off.
Don't have a car to give away? Many charities are just as happy to accept run-of-the-mill items, such as clothing and household goods. To keep the Internal Revenue Service happy, make sure you claim the fair market value for your gifts. Bankrate has some work sheets to help you figure the appropriate amount.
If you're an investor, look into donating stock that's appreciated in value but no longer fits your investing plan. Instead of selling it, give it to your favorite charity, which can then sell the stock without any tax consequences and use the money for its projects. As for you, you'll sidestep capital gains taxes, plus be able to deduct the asset's market value at the time you made the gift. Just make sure the donated stock is one you've owned for more than a year and that it has gained value while you owned it. It doesn't do you any good to give away a stock that's lost value, since you can't deduct that loss.
2. Evaluate your portfolio A stock loss under different circumstances could be beneficial.
Many investors use the last month of the year to rebalance their portfolios or simply to sell stocks or funds that have turned a nice profit. Remember, though, that your investment savvy will cost you in capital gains taxes. But you can lessen any looming investment tax bill by clearing the financial dogs from your portfolio by Dec. 31.
Rather than hold onto a perennially poor-performing stock in the hope it will recover, sell it at a loss. Sure, it's never easy to take a loss on an investment, but it could actually pay off from a tax standpoint: Uncle Sam lets you net losses against gains. Plus, you can use up to an additional $3,000 in capital losses to reduce taxable ordinary income. If your bad stocks cost you more, you can carry the excess into future tax years.
Did you expand your investment activity to include real estate this year? You're not alone. Flipping residential properties has become a popular, and for many a very profitable, activity thanks to appreciating house values. Some real estate investors, however, might just now discover that their flipping income has produced unexpected tax consequences.
You still have time to offset those gains by using other assets that lost money to reduce the amount of taxable flipping income you earned. It doesn't have to be other real estate to help you out; any asset you sell for a loss will work.
If you haven't yet sold your investment property and you've owned it for less than a year, consider hanging onto it a bit longer. If you own it for 366 days or longer, you'll convert it to long-term capital gains property, meaning that any taxes you owe will be at a lower rate. Plus, if you wait until at least January to take your profit on the property, you'll push the tax consequences into the next year, giving you 12 months (instead of just one) to figure out how to lessen the tax bite.
3. Let your home help you out For most of us, our biggest real estate holding is our house. A principal residence is afforded different tax treatment, including many deductible home costs that you can tweak a bit at the end of the year to your advantage.
Start with your next mortgage payment, due Jan. 1. This actually represents interest for the month of December, so make the payment before the 31st. By accelerating the payment, you get an additional deduction this tax year for the interest paid.
Some tax professionals say you can simply mail this extra mortgage payment by Dec. 31 and have it count. However, if you actually get your payment to the bank by the last business day of the year (or a day or two early), the extra interest will show up on the lender's official paperwork. That means no curious tax examiner will question any difference between the amount you claim on your Schedule A and what your lender reports on the Form 1098 that you (and the IRS) will get in late January with details of your deductible mortgage activity.
Remember, though, that while an early payment will give you 13 mortgage interest amounts to deduct this year, it means that on your 2006 taxes you'll only have 11 (or 12 if you pay a little early next December, too). So before you send off that check, make sure you really need the added deduction on your 2005 return.
The same early-bird approach also applies to deductible property taxes. If your county or municipal tax collector will take your tax payment (or part of it) now, pay it to accelerate the tax benefits. Of course, this only works if you pay real estate taxes yourself, rather than having your lender pay them from an escrow account.
While you're making early property tax payments, don't overlook any other state or local taxes you can pay now and deduct against your upcoming federal tax bill. This works especially well if you pay estimated income taxes to your state treasury. By making the final quarterly payment in December instead of the January due date, you shift the tax benefit into this year.
A word -- actually, three words -- of warning about shifting state tax payments: alternative minimum tax. This parallel tax system was devised more than 30 years ago to guarantee that wealthy filers paid their fair share to the IRS. But nowadays, more middle-class filers are finding the AMT applies to them, in large part because the alternate system isn't designed to keep up with some inflation. Under the AMT, some usually acceptable tax breaks, such as state and local income taxes, as well as real estate and personal property taxes, aren't allowed. Before you shift payment of extra taxes into this year, make sure you won't face an AMT bill where they wouldn't be deductible.
4. Flex your spending account muscle Do you have a flexible spending account at your job? Does it still have money in it? Does your benefit year operate on a calendar basis? If you answered "yes" to all of these questions, then you're running out of time to maximize this valuable fringe benefit.
Flexible spending accounts allow workers to put away pretax cash to help pay out-of-pocket child or dependent care expenses or uncovered health costs. Not only can these accounts help you meet extra costs, the account contributions are taken out of your paycheck before taxes are calculated.
These accounts are particularly beneficial when you can use them to pay for medical expenses that don't add up to the percentage-of-income threshold (more on this coming up in tip 5). Plus, the IRS has decided that you now can spend account money on over-the-counter medications.
But there's a downside. In most cases, if you don't use your account money in the benefit year that it's contributed, it can't be carried over to the next year. The IRS has OK'd a spending account grace period, but it's up to your company to decide whether to offer the extension.
While your eventual tax bill won't be affected if you don't spend all your flexible account money by the end of this (or your benefit) year, failure to do so means you'll waste this tax-advantaged option. So don't lose it, use it!
5. Maximize medical deductions If you don't have a flexible spending account, some of your medical costs still could reduce your tax bill as long as you get the treatments by Dec. 31.
The key to lowering your tax bill by deducting itemized medical and dental expenses is to have enough of them. IRS rules say you can't count these costs unless they exceed 7.5 percent of your adjusted gross income. If you make $50,000 that means you get no tax benefit until your medical costs exceed more than $3,750.
You still have time to reach the earnings cutoff. If you've been putting off that elective surgery and can afford it, schedule the procedure before the year's end to bump up your medical bills to the deductibility threshold.
The eligible expenses must be those not covered by any insurance or other reimbursement plan, such as the tip 4-discussed flexible spending account. And make sure there's a solid medical reason for the procedure. Cosmetic nips and tucks don't count here!
But you can include any dependent's medical treatments, as well as the installation costs of special, doctor-prescribed therapeutic equipment or medically necessary improvements to your home. And if you must travel for medical treatments, you can deduct the drive (at 22 cents per mile for any trips this month), along with any parking and tolls you paid along the way.
6. Make early miscellaneous payments By now you've probably realized that with many tax issues, timing is everything. That's certainly the case with miscellaneous deductions that could help you cut your tax bill.
As with medical expenses, miscellaneous costs, such as union or professional dues, job-related educational expenses and subscriptions to business publications, must meet a percentage of your adjusted income to count. In this case, it's 2 percent. If you're near the threshold this December, prepay some of these expenses. Buy the uniform you were going to get in January, extend your business-journal subscription another year or pay the registration fee for that job-related computer class you plan to take in February.
By bunching these expenses and paying them early, you could amass a large enough amount to deduct. If you're a bit strapped for cash to make so many early payments, consider paying them by credit card. You'll still get the potential 2005 tax deduction, but won't have to pay until next year when the bill arrives. Just make sure you can pay off your charge card account in full so that you don't face the added cost of interest charges.
Here again, though, remember the AMT we talked about in tip 3. Miscellaneous deductions aren't allowed if you have to calculate your taxes under the alternative method.
7. Shift incoming income Paying your credit card bill next year might be easier if you are expecting a year-end commission or holiday bonus, but can have it deferred until 2006.
Why would anyone delay getting extra income? It could be a good idea when the added money would bump you into a higher tax bracket this filing year or you're sure you'll be in a lower tax bracket next year. In these cases, and if you can afford to wait a few weeks for the cash, talk to your employer soon about the logistics of postponing the payment until early next year.
Deferring income is a bit easier if you have your own business, either as your main source of income or as a supplement to your salaried job. In this case, if your December cash flow is fine, send out your final 2005 invoices in early January. Look at it as a holiday gift to yourself, to reduce your taxable income, and one to your customers, who'll have one less bill to pay.
8. Tend to your retirement Give yourself a holiday gift of future financial security by starting or adding to retirement savings accounts. In many cases, you get an immediate tax break and begin building a nest egg sooner.
If you're eligible to participate in your company's 401(k) retirement plan and its rules allow you to enroll now, do it. If you're already contributing, think about upping the amount. The money you contribute reduces your taxable income.
Since it's so late in the tax year, your increased retirement account contributions probably won't help you cut your coming tax bill, but you'll definitely have a head start on reducing next year's taxes.
This strategy also applies if you work for yourself, either full time or as a side business. While you can wait until next year to establish some self-employment retirement plans (e.g., a SEP-IRA), if you opt for a Keogh or solo 401(k), both of which offer you more generous contribution limits, Dec. 31 is the last day you can set up these plans.
9. Examine expiring tax breaks Tax law changes over the last few years have produced a patchwork of various tax breaks that take effect and disappear at different times. Absent congressional action to extend them, 2005 could be the last year for three popular tax deductions:
Educator expenses, State sales taxes and Tuition and fees.
If you're a teacher or other qualified public or private school employee, you still can deduct up to $250 spent on classroom materials. Even better, you don't have to itemize to take this break. It's available directly at the bottom of the long Form 1040, and the amount you claim helps reduce your income amount. Less income usually means a lower tax bill. All you've got to do is buy $250 worth of classroom supplies by Dec. 31.
Taxpayers who itemize still will be able to choose between deducting state and local income taxes or sales taxes on 2005 returns. This obviously will help residents of states without income taxes, but every taxpayer should give this deduction a close look. In some cases, state income-tax rates may be low enough to make the sales-tax deduction more valuable. The IRS provides tables for each state with the deductible sales tax amount you can claim so you don't have to rush around now looking for all of your old receipts. A bonus: You can add the amount of sales tax on the purchase of a vehicle or boat to the prefigured table amount to arrive at a bigger deduction. So if you're planning on buying a new car and think the sales-tax deduction could help you, consider buying it by Dec. 31 since this break is not yet guaranteed beyond that date.
Also set to expire is the $4,000 write-off for college tuition and fees. Limitations on expenses and income restrictions do apply, so make sure you can claim this tax break. If you find it will help you, or a dependent planning to continue higher education next year, look into paying the upcoming semester's bills before the end of this year.
10. Check your withholding Finally, stop giving Uncle Sam free use of a portion of your hard-earned money. Most of us pay the bulk of our annual tax bill through payroll withholding, and it's important that the amount be as accurate as possible.
If you don't have enough taxes taken out of your paycheck, you could end up owing the IRS at tax-filing time. Worse, you could face penalties and interest if the shortfall is more than $1,000.
Going too far the other way with your withholding is not a good idea, either. Sure, over-withholding means you'll get a refund check when you do file. But that also means that the federal government, instead of you, has had access to your cash all these months. If you had been collecting the cash, you could have stashed it in a savings account or CD (Bankrate can help you find the highest rates), where it would have earned a little bit of interest and provided you with some extra money to spend on holiday gifts.
Making adjustments to your withholding is easy. If you find that too much tax is being taken out, put cash back in your pocket by increasing allowances on your W-4 to reduce withholding. If you're not having enough withheld, you can prevent a huge tax bill on April 15 by reducing allowances or even telling your boss a specific extra dollar amount you want withheld.
Your payroll manager office should have a new W-4 you can fill out, or you can download one from the IRS site. The key is to get the changes made before your last paycheck of the year is issued.
But even if you're too late to do anything about 2005 withholding, it's still a good time to look at what adjustments you should make for the coming year. This is especially important if circumstances in your life have changed -- you got married, had a child or bought a house. All of these affect your taxes and can be accounted for through payroll withholding.
And when the changes show up on your paycheck, you've got a head start on making sure that 2006 is a better tax year.
Time for a trip to goodwill to donatethe kiddies summer clothes and last years too-small snow suits.
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