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| The Basics | Last chance to cut your 2005 tax bill
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The clock's running out on 2005. Before you put on your party hat, check these 10 ways to substantially lower this year's tax bill.
By Jeff Schnepper
In the waning hours of 2005, before you put on your party hat, grab this last chance to save money on your taxes. Besides the lower tax rates, a bigger child tax credit and other goodies you'll enjoy from the new tax law, theres more you can and should do. Once you slide into 2006, theres not much you can do to reduce your 2005 taxes. So, heres a list of what has to be done now.
Get generous! Make those last minute charitable contributions. As I have said before, if ever there was a year to contribute, it's 2005. Normally, charitable contributions are limited to 50% of your adjusted gross income and are subject to an overall itemized deduction limit. However, all charitable contributions are excluded from both these rules. But, if you don't make them by Dec. 31, youll lose the tax break.
You can charge a contribution on a credit card and still get the deduction. And this is good to know: If you did a lot of driving for Hurricane Katrina relief, you can deduct up to 70% of the current business allowance. Since Sept. 1, 2005, thats 70% of 48.5 cents, or 34 cents per mile.
Low on cash? You can charge a contribution on your credit card and deduct it in the year of the charge -- even if you actually pay your bill next year.
Used up your credit line? Empty your closets and visit the Salvation Army. The value of non-cash contributions can also be deducted. Make sure you get those receipts. If youre audited, no receipt means no deduction.
While I'm on the topic of being generous, if you live in a state where there's no income tax, buy more stuff. Because 2005 will be the last year you can deduct sales taxes -- unless Congress extends that provision. If you live in a state with a low state income tax, take a look at which -- the sales tax or income tax -- will give you the bigger deduction. For more, check here.
A warning, however: watch out for how the deduction might pull you into the Alternative Minimum Tax (AMT).
Bulk up your retirement nest egg. If youre contributing to a 401(k) or related retirement plan, always max your contributions to the extent theyre matched by your employer. Even if you have to borrow to pay your other expenses, a 100% match is an immediate 100% return on your money. Even credit card companies dont charge that much.
If you can, put the maximum the law allows into your retirement fund. This year you can shelter as much as $14,000 in a 401(k) and $4,000 in an IRA.
If youre age 50 or older, you can sock away another $4,000 in your 401(k) and another $500 in your IRA as catch-up contributions. Congress figured you have only 15 or less years to age 65 retirement, and it wanted you to be able to build up your fund of tax advantaged dollars.
If youre self-employed and want to contribute to a Keogh Plan, (Profit Sharing or Money Purchase Plans), you must establish that plan by Dec. 31. Youll have until the due date of your return, including extensions, to fund the plan. But, it must be set up by the end of 2005, or you get NO deduction.
Empty your Flexible Spending Account. These are use it or lose it accounts. In years past, if the money isnt spent by the end of the year, you lose it. This year, your employer may let you take until March 31, 2006 to empty the account.
To be on the safe side, act now. That means its time for new glasses, contact lenses, or laser surgery to repair your vision. Pre-pay your orthodontist. Stock up on drugs. (Take that smile off your face!) You can even use your FSA for non-prescription drugs. If your employer sets it up, you can even use a debit card to make your purchases. Makes the paperwork a lot simpler.
Related news and commentary on MSN Money
Review your investments. It's been a mediocre year for U.S. stocks. Sell your losers now. Use that loss to offset capital gains or as much as $3,000 in other income. Any excess losses are carried forward to future years.
This year, you may actually have capital gains. Dont forget to claim any unused losses from prior years on this years return.
Consider a municipal bond swap. Thats where municipal bonds in your portfolio that have gone down in value are sold. They are then replaced with other municipal bonds of like quality, coupon, par value and yield.
Done right, you get equal or greater income with equivalent quality and maturity. You also get a tax deduction for the loss on your sale. Sounds like a good deal to me.
Accelerate your interest deductions. Make your Jan. 1 mortgage payment on Dec. 31. Use an amortization program to compute the added interest you paid.
That payment wont be received by your bank until 2006. So, the 1098 the lender will send you for 2005 wont include your extra payment. You should add that amount to line 11 on your Schedule A.
A warning: If you make the payment in 2005, you can't make the deduction in 2006. So start planning on how to find an equal deduction.
Accelerate your real estate tax deductions. If youre paying your own real estate taxes, in many cases, your fourth quarter 2005 tax is due early in 2006. In my case, the tax is due on February 1.
By paying by Dec. 31, Ive taken the deduction a year earlier. The tax saving is the equivalent of an interest free loan from the IRS in perpetuity. But, beware the Alternative Minimum Tax (AMT). Taxes that are deducted increase your exposure to this special tax. Never accelerate tax payments if youre going to be hit by the AMT. If you think this is a possibility, check with a tax professional now.
Accelerate your deduction for state income taxes. Your fourth quarter estimated state income tax is normally due by Jan. 15. Pay it half a month earlier, and you get the deduction a whole year earlier.
If youre going to be in a lower tax bracket next year, consider overpaying your state income tax. Youll get the deduction in 2005 and any payments in excess of your actual tax (your state refund or credit for 2005) will be income in 2006. Youll not only get the time value of the money, but the difference in the rates as well.
But dont forget that AMT trap I already mentioned. The AMT is expected to hit perhaps as many as 5 million people this year, nearly four times the number affected in 2000.
Invest in your kids future. Contribute into a Coverdell Education Account or Section 529 College Savings Plan for your kids or even your own school expenses.
Withdrawals from these tax advantaged accounts for qualified educational expenses can come out tax free. You can use Coverdell dollars for pre-college expenses as well.
In some states, contributions into these plans may be deductible or create state income tax credits. Check out the College Savings Plans Network, Saving for college.com or TIAA-CREFs Independent 529 Plan web site for details.
And check two articles by my colleague Liz Pulliam Weston:
Keep an eye on your floors. Some expenses have to exceed a minimum floor before they are allowed as deductions. Medical expenses have to exceed 7.5% of your Adjusted Gross Income (AGI) and Miscellaneous Itemized expenses have to exceed 2% of your AGI.
Make the calculations now. If you exceed these floors, accelerate your expenses. Prepay your doctor/dentist for 2006s work. Prepay a months worth of health insurance. Buy a computer and printer if theyre to be used for business or investment purposes.
Renew and pay for your investment subscriptions. Technically, the IRS frowns on multiple year renewals deducted in a single year. But, you should be safe with a one-year renewal.
I do tax returns. Many of my clients send me a check on Dec. 31. They deduct the payment in 2005. I receive and report the income in 2006.
If you dont see yourself beating these floors, stop spending! Hold off your expenses until January. You might be able to exceed the minimums in 2006.
If youre self employed, the 2% floor doesnt apply to you. Your deductions are allowed above the line. That means you can get them in addition to the Standard Deduction (or your itemized deductions if greater). That means stock up on supplies and other allowable business deductions now!
Look, its your money. Tax planning takes effort and time. But the rewards are more tax free dollars in your pockets. Its time well invested. But, its time running out.
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