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7 easy tax-saving moves to make now You have until Dec. 31 to make a lot of decisions. Make the right ones, and you save a lot of money. The wrong decisions will cost you. By Jeff Schnepper There are big tax moves you can make that take time and careful planning. Then there are the tax moves that don’t take a lot of time, don’t take a lot of planning but do produce the result we all love: a lower tax bill.
Here are some of the most important and easy ways to slash your 2001 tax bill now. The only trick is that there are deadlines you face. Most are Dec. 31. In a few cases, you can go as late as April 15. So, here are seven useful and easy suggestions on how to minimize the pain. Just remember: there’s a deadline. Bulk up your pension contributions The first investment you should make is in your retirement future and security. So, . . . Every time you put money into your 401(k) or traditional defined-contribution pension plan (with an increased 2001 maximum of $35,000), you’ve reduced your taxes. It’s like a guaranteed first year’s yield equal to your marginal tax bracket. In the 27.5% bracket, an additional contribution of $5,000 is worth an additional $1,375 in tax savings. (For more on this year’s tax bill, see “Inside the new tax cut: See what’s in it for you.”) If you’re in the 27.5% bracket, a contribution of only $1,000 into your pension immediately reduces your taxes by $275. That means that you have an additional $275 to invest, compounding in perpetuity or until you withdraw the money. Not only do you get the increased compounding return, but you also get the benefit of tax deferral. That means that each year you’ll be getting investment returns on “bonus” money that would have been taxed and taken by the IRS had you invested outside your pension. If your company matches any of your contributions, you’ve immediately doubled your money -- risk free -- by those matches. Don’t forget an IRA If you’re not covered by a pension, consider an IRA contribution. Under current law, even if you are covered with a pension, you can qualify for at least a partial deductible IRA contribution if your adjusted gross income is less than $43,000 ($63,000 on a joint return). Alternatively, if you’re young and/or are less concerned with the current year deduction, consider a Roth IRA. Contributions to these accounts aren’t deductible, but they yield tax-free returns forever and are excellent estate planning vehicles. Don’t be scared off pension contributions because of the recent implosion of the stock market. This may be the time to buy – at substantially discounted prices. Alternatively, you don’t have to invest in stocks. If you want to invest more conservatively, you can’t lose with “laddered” investments in U.S. Treasury securities structured to mature with your liquidity needs. What you give, you can take back Back when stocks were only rising, lots of people were “correctly” advised to put appreciating securities in their kids’ names so that the gains would be taxed at their kids’ lower tax brackets. But when these “appreciating” securities began to be worth less than the stamps on the envelopes that contained them, that advice became a land mine. Not only weren’t there any gains to be realized, but the losses were currently worthless to children with no tax liability. Even if they could be carried forward, the losses would first offset only gains that would be taxed at the lowest rates anyway. The answer is to reverse the process. That way, you, in your higher tax bracket, can “enjoy” the benefits of recognizing those losses. If your children are age 18 or older, have them gift the securities right back to you. Then you make the sale and take the losses on your return. The annual gift tax exclusion is $10,000 for 2001. (In 2002, it rises to $11,000.) If you have three children, each can gift back to you $10,000 this year. They can make the same gifts to your spouse, for a total of as much as $60,000 without any gift tax impact. Of cause, that assumes there’s $60,000 left in value in the stock portfolio. Be careful, however: There is a very big minefield to watch for: If the investments have been made in Uniform Gifts To Minors Accounts (UGMA), you’re normally not allowed to gift the money back to yourself. However, if you child is of age (i.e., 18 or older), she can make the transfer. Defer income Tax rates overall are going down this year and next. The 28% rate, which was pretty standard for more than 14 years, falls to 27.5% this year and drops to 27% in 2002 and ultimately hits 25% in 2006. (Absent another tax bill, of course.) That means a dollar of income taxed in 2002 rather than this year not only gives you the benefit of tax deferral, but it saves you a piece of the tax itself. If you’re in the 27.5% bracket, $1,000 received on Dec. 31 creates a $275 liability that has to be paid on April 15, 2002, 3½ months later. If you get the same income the next day, Jan. 1, then the tax is imposed not only at a lower rate -- 27% -- and saves you $5, but it isn’t due until April 15, 2003. So, double your benefit, double your fun. You get both an additional year’s use and returns on those dollars before they have to go to the IRS. Plus, you get to keep more of those dollars as well! Some certificates of deposit (CDs) only credit interest at their maturity date. Since you’re on a cash basis for tax purposes (You report income when received and deduct expenses when paid.), any interest “earned” this year won’t be taxable until credited…next year. As a self-employed individual, I take my vacation the last two weeks in December. Since the office is closed, there’s nobody to receive checks during that period of time. So they become taxable income when I come back, in January 2002. In addition, I send my November and early December bills out right before I leave. That insures that the dollars those invoices generate don’t arrive until next year and escape current taxation. This is deferral, not evasion. I’m going to have to pay the tax on this income. It just gives me an interest-free loan from the IRS. I’ll be happy to pay, but later, thank you very much. Meanwhile, I’m enjoying the use and yield from these dollars today. Prepay expenses This is the opposite of deferring income. We’re going to get the economic benefit of the time value of the money. With lower tax rates, we’re also going to get to keep more dollars today at the higher rates than next year when those rates go down. Here are some suggestions: Estimate state tax payments: If you’re paying state estimated tax, your fourth-quarter payment is usually due in January 2002. Make the payment on Dec. 31 and deduct it this year. Prepay your property taxes. This is advice I offer again and again. My fourth-quarter property tax is due on Feb. 1, 2002. I pay that one on Dec. 31 as well. Think home mortgage. Your Jan. 1 payment is for the use of the money in December. Pay on Dec. 31, and you have an additional month’s interest to deduct. Watch this one: Your bank’s computers will normally not record this payment and the interest in time to include it on your end of the year statement (Form 1098). You’ll probably have to run an amortization schedule and add the incremental interest to the bank’s sum. Make your charitable contributions now. If you don’t have the cash, charge the donation. The deduction is allowed in the year of the charge, not in the year of the credit card payment. If you don’t have cash or credit, contribute old clothes, furniture or equipment. Then deduct their fair market value. The Salvation Army offers a free valuation guideline, or you can compute the value using a program from Bigwriteoff.com. (See link at left.) Remember to get a receipt. Picture dead presidents on those receipts…No receipt means no deduction, especially if you’re audited! Watch your floors I don’t mean just look where you’re walking. I’m talking about the minimum “floors” you have to exceed before you can deduct certain expenses. For example, medical expenses are allowed as deductions only to the extent they exceed 7.5% of your Adjusted Gross Income (AGI). So if you have an AGI of $100,000, your first $7,500 in medical expenses doesn’t count. The same concept applies to miscellaneous itemized deductions such as investment expenses, employee business expenses, job-hunting expenses and tax preparation costs. They’re only allowed to the extent their sum exceeds 2% of your AGI. The strategy, with all “floor” expenses, is to accelerate or defer them into years when you do expect to exceed the minimums. Think elective surgery or orthodontia. Consider prepaying your accountant in December for March/April tax preparation. Prepay investment fees or any qualifying employee business expenses (union dues, business gifts etc). If you’re going to exceed these floors, accelerate the expenses. You’ll get not only the time value of the accelerated deduction, but the added kick from the rate reduction as well. If you’re not going to make the floors, defer the deductions into a year where you might. They’re of no use to you this year anyway. Don't lose your benefits If you signed up with your employer’s salary reduction or cafeteria plan you’ve made a very savvy tax move. Now, all your medical expenses can be “tax deductible” without regard to the 7.5% floor, or even if you don’t itemize! But your salary reduction election is normally irrevocable. It’s a use-it-or-lose-it situation. If you have a balance in your plan, make sure you use up you available dollars before year-end. This is the time to:
Alternatively, or in addition (if you want to increase your chances of getting other benefits), use those tax-free dollars to hire a maid to clean the house. Remember, these are dollars that you’ve already given up, except to use them as provided by your plan. Use them, and it’s like getting the goods and services for free. Leave a balance and it’s like you’ve thrown out the money. These strategies assume you were going to generate about the same dollars this and next year. If your bracket were to increase next year due to a promotion or a fat raise, it would be prudent to review the impact of that change on your tax planning. In many cases, it might then become appropriate to reverse some of the techniques suggested.
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