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| The Basics | Tax planning is a year-round game; start now
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Whew! Teachers get to keep a nice break
Our Congress just loves learning; 2005, like 2004, has plenty of benefits for kids and education.
If youre a teacher, you get one special benefit. You can deduct as much as $250 of your classroom expenses from 2005 without itemization or reduction.
This applies if you are a teacher, instructor, counselor, principal or aide and worked in kindergarten or through grade 12.
This nice little tax break was supposed to die in 2004, but Congress reinstated the provision to apply to both 2004 and 2005. So, enjoy. And hope the break is renewed for 2006.
Enjoy the lower rates
Nobody has started to tinker with tax rates yet this year. Enjoy them. Our tax rates are the lowest I can remember -- and Ive been around for a while. Compare our 2005 rates to those only four years ago.
| Tax rate changes between 2001 and 2005 | | 2005 | 2001 | % change from
2001 to 2005 | | 10% | 10% | 0.00% | | 15% | 15% | 0.00% | | 25% | 27.5% | -9.09% | | 28% | 30.5% | -8.20% | | 33% | 36% | -8.33% | | 35% | 39.1% | -10.49% |
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In addition, amounts in each bracket are automatically increased for inflation. The combination of larger brackets and lower marginal rates -- especially for upper-income taxpayers -- has put more dollars in your pocket in the last few years and will continue to do so.
The practical effect of the change is this: If you and your spouse file jointly and had taxable income of $80,000 in 2001 and expect the same in 2005, your federal income tax bill drops from $16,350 to $13,330 -- a savings of $3,020.
If your taxable income is $150,000, the tax bill falls from $36,822.50 to $31,731.50, a savings of $5,091.
And thats starting with taxable income. When you add in all the new deductions and expanded credits, there should be a lot more money in our pockets after tax than three years ago.
Lets put that in perspective. In early 2004, a Congressional Budget Office study showed the typical American household had a smaller income tax burden in 2001 than in any other year back to 1979. 2001 is now our high tax year!
Enjoy it while you can. Does anyone believe the rates wont be moving higher? Congress and the White House seem to be intent on proving that the big bang theory really works. The cash to pay for increased defense and other spending has to come from somewhere.
Some tax-planning moves for 2006
Defer income if you can. Lets say we dont expect tax rates to rise in 2006. The betting is they'll at least stay constant for a while. If you don't have to take the income in calendar 2005, defer it into 2006. That way, the income is off your 2005 tax return. Postpone the pain.
Use the tax laws to minimize any stock market pain. Yes, the markets up, but, as the past few weeks have shown, it is still volatile. So, you may have some investments that have generated deductible losses while others have (hopefully) major gains. You can use your losses to offset any gains. On a net basis, all capital losses, regardless of whether theyre short or long term, offset capital gains on a dollar-for-dollar basis. You can use $3,000 of net capital losses in excess of capital gains to offset ordinary income. Any excess left over can be carried forward to 2006.
But watch out for the wash-sale rules. The IRS disallows losses on securities sold if substantially identical securities are bought within 30 days before or after the loss sale. Best case: Buy 31 days later.
Bunch your medical expenses if you can. Only medical expenses in excess of 7.5% of your adjusted gross income are allowed as deductions. So, if your adjusted gross income is $100,000, you get no deduction for the first $7,500 of your medical expenses. But there are some medical expenses you can defer or accelerate, depending on whether you expect to exceed this floor. Elective surgery, orthodontia or the payment of your medical insurance premiums can all be advanced or postponed to meet your minimum floor.
Miscellaneous itemized deductions. These are only allowed to the extent they exceed 2% of your adjusted gross income. If youre going to exceed the 2% floor, then accelerate your deductions. Prepay your accountant in 2006 to do the tax return that you dont have to file until April 2007. Renew and pay for your investment publications before the end of the year. If you dont have the cash, charge these expenses. The charges are allowed in the year of the charge, not when you actually pay your credit card bill.
Accelerate payments that can produce tax deductions. If you write your January 2007 mortgage check or the check for your property taxes on or before Dec. 31 2006, you can claim the interest deduction or real estate tax deduction in 2006.
Get the most out of non-cash charitable contributions. Give your old clothes, furniture, equipment, etc. to your church, synagogue, Salvation Army or Goodwill before Jan. 1, 2007 and take a deduction for the fair market value. Make sure you get a receipt: No receipt means no deduction.
Plan your tax payments. An MSN Money survey on taxes found that more than 53% of the respondents expected a refund of more than $1,000. Thats a whole lot of money left interest-free with the IRS.
You want a big refund? Send me your money. Id be happy to send it back to you, interest-free, prior to April 15.
Otherwise, shoot for the safe harbors -- 90% of the current years total tax or 100% of your prior years total tax (110% if you prior years adjusted gross income was more than $150,000). Hit those targets and, no matter how much you owe next April 15, there wont be any interest or penalties if you timely pay the balance.
Adjust your withholdings to meet these targets. If you expect to pay next year, put the withholding difference in a money market account. At least then, youll be picking up any interest.
Plan for the alternative minimum tax
This awfully mean tax has been destroying my clients refunds this year. What can be done?
If you expect to be hit by the AMT, reverse many of your typical planning strategies. Defer, rather than accelerate, those items that arent allowed as deductions for the AMT. Such expenses include taxes, employee business expenses, investment expenses, job search expenses, etc.
The AMT is a flat 26%/28% tax. If youre normally in a higher bracket than that, accelerate your income. Such income will then be subject to the lower AMT rates. For more on this, see "Don't get bitten by this Awfully Mean Tax."
Meanwhile, the U.S. tax law is going to change. Congress is considering a Value Added Tax (VAT) or even a consumption tax. Plan your tax year under current rules. But keep on eye out and watch here for updates. The law will change. And, when it does, MSN Money will be here to guide you through the new rules.
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