Many people think taxes are simply a chore, something to attend to once a year. Anyone with that attitude is probably leaving money on the table, whereas those who plan ahead to avoid paying unnecessary taxes are the real winners.
The only way you can control your tax issues is to review them throughout the year. Was your refund too large? Are you lending Uncle Sam your money interest-free? Did you have a large balance due with some penalties attached? Did you fail to take a credit or a deduction because you didn’t know about it — or, worse, didn’t maintain the appropriate records? Now is the time to look forward to next year, so you don’t make the same mistakes again. But it takes thought, planning, and attention.
Many tax-related matters are important components of any investing strategy. For example, how long you hold a stock or security makes a difference given the lower taxes on long-term gains. Your cost basis for various securities may have to be adjusted on various occasions. If you’re making a charitable donation, giving stock could help you come out ahead, in tax terms.
Even if you’re not an investor, a number of tax issues should be important to you. More and more taxpayers are getting nicked by the Alternative Minimum Tax. If you were one of them, consider actions now that will reduce your AMT bite. And what about all of the recent tax changes? Are you familiar with how you can make them work to reduce your taxes? Concerned about an audit? Perhaps you should be.
In short, you should have at least a working knowledge of numerous tax issues. Leaving things to a tax pro at the end of the year is just fine, but that tax pro can’t follow you around to help you with your daily financial, investment, and tax decisions. It’s ultimately up to you to take some of the teeth out of your annual tax bite.
Here are a few items you should consider to jump-start your tax planning.
Invest in dividend-paying stocks. Because of the favorable 15% tax rates on dividend income, holding stocks that pay dividends can reduce your taxes immediately. This might make such investments more attractive than other cash-generating securities, such as bonds.
Hold stocks for the long term. Dividends aren’t the only type of income with favorable tax treatment. Long-term capital gains (gains on assets held for more than one year) are also taxed at a maximum 15% tax rate. So when you decide to sell a stock, consider your holding period and remember that the tax savings allowed for long-term gains will allow you to reap significant tax benefits.
Reduce your income. Make sure to take advantage of the more liberal contribution limits to tax-deferred retirement accounts. By contributing to your employer-sponsored retirement plan — such as a 401(k), 403(b), or 457 plan — you’ll reduce your taxable income, and you won’t pay taxes on your savings and earnings in the account until you take distributions. You can slash your tax bill just by saving for the future. And don’t forget: If you’re 50 or older, you can make an additional $5,000 “catch-up” retirement contribution.
Deductions and credits for non-itemizers. Just because you don’t itemize your deductions, that doesn’t mean there aren’t other deductions available to you that you can use to reduce your taxes. Deductions for alimony or student-loan interest that you’ve paid, as well as job-related moving expenses, medical insurance for the self-employed, and penalties for early savings withdrawal are all available to you, as are the new college tuition deduction and deductions for self-employment taxes — regardless of whether you itemize your deductions or not. There are also many tax credits available, such as the Hope and Lifetime Learning credits, the retirement contribution credit, the foreign tax credit, the adoption credit, and the dependent-care credit. If you qualify, all of these credits (and more) can be used to reduce your taxes without itemizing your deductions, so make sure to check your eligibility for any or all of them.
Charitable contributions. Thinking about donating that old car of yours? It’ll get you a great deduction and will also provide funds for a charitable organization to do good works, but make sure you follow the new rules regarding the deductions dealing with autos and other property. They are much more stringent than they used to be.
Refinance points. Have you recently refinanced your home? Did you pay any points? Or did the new loan wipe out a previous loan on which points were charged and you were expensing over the life of that old loan? Make sure you don’t overlook the deduction for points and how it affects you and your taxes.
Overlooked deductions. Make sure you don’t overlook many of the deductions available to you and your family. The more you become familiar with the law, the more you can tug on those tax loopholes and pull them wide enough for you to jump through.
Hire family members. If you’re an unincorporated business owner, consider putting your kids or other lower-income family members on the payroll. Doing so allows you a double-dip tax savings of both income and self-employment taxes. Your kids won’t have to pay any Social Security/Medicare (FICA) taxes on their wages if they’re younger than 18, and they won’t be subject to federal unemployment taxes if they’re younger than 21.
Even if you have a million other things to do, don’t let your tax planning slip through the cracks. Starting your tax planning now not only helps reduce your taxes but also puts you in control of your entire financial situation. Start now. Be diligent.