Making time for year-end tax planning during the busy holiday season may sound like bad timing, but it may save you bundles of cash come April 15th. However, in order to make full use of these tax-saving tips, be sure to visit your tax professional before year’s end. Once January 1st rolls around, there’s little else you can do but pay up.
Be prepared for AMT.
First off, keep an eye on the Alternative Minimum Tax. Initially developed to ensure the wealthy were shouldering their share of the tax burden, the Alternative Minimum Tax is a parallel tax system which flips many of the standard tax rules on their head. Although recent legislation will mean fewer Americans get hit with AMT this year, before you begin tallying your deductions, determine if you will be paying AMT. Many of the deductions you plan on taking may actually drive you into the AMT trap.
Meet with your tax professional in November or December.
Even if you didn’t pay AMT last year, you may get hit with AMT if you earn between $200,000 and $500,000. And of course, if you were hit with AMT last year, you will probably be hit harder this year. Consult with your tax professional before the end of the year to determine the best tax plan, especially if you think you might have to pay AMT.
Plan your deductions.
If you don’t fall into the AMT trap, manage your income and deductions to your benefit. If you expect to make more money next year, you may want to accelerate income into this year to take advantage of your lower tax bracket. Defer your deductions until next year to offset some of next year’s tax burden.
Do the opposite if you expect to earn less next year. Defer income into next year and accelerate deductions into this year. For example, ask your employer if you can receive your bonus in January. To increase your deductions, make your fourth quarter estimated state tax payment prior to year’s end, and use it as an itemized deduction this year.
Offset capital gains with losses.
Next, check your capital gains. Before January 1st rolls around, you may want to offset your capital gains by realizing some losses. Depreciated securities may not hurt you as much as you think. Net losses of up to $3,000 are deductible against ordinary income. Additional losses can be carried forward in future years.
Save for retirement.
If you have extra cash on hand, consider making a last-minute contribution to your 401(k), 403(b), or 457 plans. Contributions to these plans directly reduce your taxable income. These employer-sponsored plans allow you to defer up to $15,000 this year. If you are over age 50, you are also eligible for a $5,000 catch-up contribution.
You may also be able to make deductible contributions to your IRA, even if you currently participate in an employer-sponsored retirement plan. This year, contribution limits are $4,000 with an additional catch-up contribution of $1,000 if you are over 50. These benefits are phased out between $75,000 and $85,000 for couples filing jointly ($50,000 – $60,000 for individuals). Keep in mind that contributions to your IRA can be made up until tax day.
If you do not participate in an employer-sponsored retirement plan, contributions to your traditional IRA may be tax-deductible, regardless of your income level.
And don’t forget, contributing to an employer-sponsored retirement plan or to an individual retirement account may make you eligible for a saver’s tax credit in addition to reducing your taxable income. A credit of 10%-50% (capped at $1,000 per person) is given for contributions to a retirement plan. The lower your income, the higher your tax credit. Taxpayers filing jointly with an AGI of $50,000 ($25,000 for individuals) or less are eligible.
Fund your HSA.
If you contribute to a Health Savings Account, your contributions will further help you to reduce taxable income. You may contribute up to the amount of your annual plan deductible but not more than $2,700 for individuals ($5,450 for families) this year. Account holders age 55 and above can make an additional $700 contribution in 2006. Best of all, you can take an above-the-line deduction for your contribution.
Open a Virginia 529 college savings account.
Many of our clients contribute to 529 college savings plans for their children or grandchildren. Contributions in some states (like Virginia) can qualify for a state tax deduction if made before the end of the year. These accounts work similarly to Roth IRAs. Although contributions to these plans are made with after-tax dollars, the accounts grow tax-free. All withdrawals for qualified higher education expenses (including tuition, books, room and board) are tax-free.
In Virginia, 529 account holders can receive a state tax deduction (up to $2,000) for contributions. Larger contributions can be carried forward and deducted in future tax years.
Support your favorite charity.
If you plan on itemizing your deductions, consider making an end-of-year contribution to your favorite charity. And remember, gifts don’t have to be in the form of cash. Consider giving highly-appreciated stock or land. Charities pay no capital gains tax on either stock or land gifts.
Additionally, the Pension Protection Act of 2006 will allow you to give $100,000 tax-free from your IRA to your favorite charity. The one caveat: you must be 70 1/2 years of age or older. These qualified charitable distributions will satisfy required minimum distributions but are only available to taxpayers in 2006 and 2007.
We advise our clients to meet with their tax professional in November or December to review their tax plan before year’s end. Tax planning is complex and time consuming. So, make an appointment with your tax professional before the real tax season hits.
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