Year-end tactics can cut your tax bill
You've done a great job at work this year, and the boss wants to reward you with a bonus. Say thanks and politely ask if the check can be mailed after Jan. 1, says tax expert Jim Seidel.Skip to next paragraph
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Stalling income is a tried-and-true way for people to try to knock down their income-tax bills. As this tax year winds to a close, it's important to consider it along with a useful counterpart - accelerating expenses.
This could be as simple as making an extra house payment that includes deductible interest, contributing to a charity before year-end, or even making an early property-tax payment.
As for timing such payments, now is good, but Mr. Seidel, a senior tax analyst at New York tax-advisory service RIA, says that you can wait until Dec. 31, because a check or credit-card payment is considered as made this year even if it does not clear until next year. Just make sure the check is good, he says. And you might want the Postal Service to provide you with an inexpensive proof of mailing.
These tax strategies are known as "bunching" - lumping expenses into a given year, or moving income around to the extent possible in order to bulk up deductions.
"Take a look at your expenses and see if you can shift them one way or another," suggests Seidel.
Bunching can come in especially handy for itemized deductions such as medical expenses or that grab bag of "miscellaneous" deductions - tax-preparation fees, unreimbursed employee expenses, job-hunting costs, or the use of your home for business, etc. Both of these require itemization and have floors.
For medical expenses, they have to exceed 7.5 percent of your adjusted gross income (AGI), and 2 percent for miscellaneous deductions. Sometimes this requires long-range planning, such as paying for orthodonture work, while at other times a single visit to the dentist, for example, will help push you over the limit.
The general rule is to bring expenses into 2002 and push income to 2003, but Seidel says there are exceptions. If you expect your income to rise enough to put you into a higher tax bracket next year, he says you'll want to push expenses into 2003.
While 2002 has not been a year of sweeping overhaul to the tax code, education, at least, gets some new tax breaks that may be worth investigating. The deduction for college expenses is up to $3,000, says Martin Nissenbaum, national director of personal income tax for Ernst & Young.
It's not the same as the Hope Scholarship or Lifetime Learning Credit, and can't even be claimed if either of those tax breaks is invoked. But it can help blunt the impact of rising college costs.
Anyone paying down student loans can deduct the interest even without itemizing.
The deduction phaseout limit rises dramatically, too: Joint filers can now have $130,000 of AGI - compared with modified AGI of $75,000 last year - before they completely lose this deduction (singles lose it at $65,000).
Starting this year, schoolteachers can claim a $250 deduction for any classroom supplies they purchase (schoolteacher couples can claim $500). In years past this expense was lumped into miscellaneous deductions, where it was subject to limitations, but now it can be taken without itemizing. "It's certainly better than nothing," says Mr. Nissenbaum.
On retirement issues, there's a little help, too. The maximum annual contribution allowed on IRAs has risen to $3,000 (from $2,000), with a $3,500 maximum for anyone age 50 or higher.
Nissenbaum also reminds taxpayers that if they have any winning stock picks that they are considering selling, they should first scour their portfolio to see whether they can offset any gain with a loss from selling a soured investment. If you're up $6,000 on investment A and have a $5,000 loss in investment B, for instance, selling B will reduce the tax burden on A to just $1,000 of capital gains. That tactic really amounts to bunching, only with stocks and mutual funds.
While the amount of loss - rather than your income - governs write-offs on capital gains, most other deductions phase out as your taxable income rises.
Then there are "cliff" deductions, such as the college-expense write-off. You can claim it if your modified AGI is $130,000 ($65,000 for singles). Earn just $1 more and the entire deduction is lost.