Seven year-end financial moves that could lower your tax bill
These strategies may save you a bundle when Uncle Sam comes knocking April 15.
The holiday season has arrived, so deck the halls, hang the mistletoe, and make sure to act on a few lessons from last year's tax return.
Even though taxes for 2007 aren't due until April 15, 2008, tax experts say now's the time – before Jan. 1 – to make the financial moves that can lead to big savings on tax day.
"After the end of the year and before April 15, just about the only thing you can do to help out your tax situation is to fund your deductible IRA [individual retirement account] or something like that," says Mark Luscombe, principal analyst for CCH, a publisher of tax-related information in Chicago. "But there's loads of stuff you can do before year-end."
As the countdown to 2008 begins, opportunities still beckon for those who can fit a little tax planning into their hectic year-end schedules. Here are seven moves that tax experts recommend doing before midnight on New Year's Eve:
1. Maximize retirement contributions
Workers with a 401(k) or 403(b) retirement savings plan benefit on multiple levels by steering cash now into those coffers, according to Barbara Steinmetz, a financial planner with tax expertise in San Mateo, Calif. Whatever goes into those vehicles, she explains, comes off one's adjusted gross income (AGI). Hence, those who take this step have lower taxable incomes than they would otherwise.
Plus, workers whose employers provide a matching contribution are, by funding their accounts, making sure they don't leave free money on the table. And maximizing one's retirement contributions increases the likelihood of having enough money on hand down the line for a comfortable retirement.
"If you can lower AGI, you could be affecting other numbers," such as medical deductions, which are calculated as a percentage of AGI, Ms. Steinmetz says.
2. Get a jump on deductions
Deductions don't just happen. Ideally, they result from well-planned expenditures during a particular tax year, says William Stromsem, director of the tax division for the American Institute of Certified Public Accountants, a New York-based professional association. He notes that a few well-targeted expenses this month can soon bode well during tax season.
For instance, a small-business owner may be planning to buy a new computer system or a new truck. By making such a purchase before Jan. 1, this taxpayer can almost immediately begin reducing how much he or she owes in taxes by taking the capital expense as a deduction on a 2007 tax return.
Situations vary, but CCH's Mr. Luscombe notes this rule of thumb: If something is listed as an eligible deduction or credit on a schedule 1040 form from the Internal Revenue Service (IRS), and it's already on an individual's to-do list, then it's worth considering as a December action item.
3. Give now, save later
Taxpayers with a soft spot for a relative, friend, or charity would do well to get their checkbooks out soon.
That's because they can give as much as $12,000 to any individual before Dec. 31 and do so without triggering a penalty. Likewise, donations made to charity before that date are deductible on a 2007 tax return. Donors should always request receipts, even for small amounts, and save them in the event of an IRS audit.
This year, persons over the age of 70-1/2 have particular reason to consider being charitable in December. A soon-to-expire provision in the tax code allows people in this age range, who are by law making withdrawals from their IRAs, to reduce their AGI by forgoing some of that IRA income and requesting that it instead go directly to charity. For those who intend to be charitable anyway, Luscombe says, doing so with IRA funds often makes good sense. This provision expires Dec. 31.
4. Consider selling stock
Investors can use losses to offset taxable gains that they may have accrued on other investments. Hence, if someone plans to unload certain underperforming investments, then doing so before Jan. 1 could be a strategy that pays off. Those whose losses exceed capital gains may in some cases use the excess losses to reduce their earned income (i.e., from salary or wages) by as much as $3,000.
But remember: To realize these benefits, investors need to sell at a loss. And that may not be a worthwhile move if a stock is poised to rebound.
Also, full-time students age 23 and under might in certain cases want to sell stocks before year's end, Luscombe says. The reason: In 2008, they'll start getting taxed on investment income at their parents' tax rates.
5. Say 'no' to income, 'yes' to bills
Minimizing one's income before Dec. 31 can be wise, Mr. Stromsem says, if a person doesn't expect to be in a higher tax bracket next year. The logic: By delaying receipt of payment until 2008, one also delays payment of taxes on that income for more than a year and can let the money earn interest or serve other purposes in the meantime.
To act on this strategy, workers expecting a year-end bonus might ask managers to issue payment after Jan. 1. Similarly, anyone who does direct billing of customers might want to wait until early in 2008 to demand receivables. Conversely, a taxpayer can get an extra deduction by prepaying in December a property tax bill that's not due until January.
But this strategy, too, comes with a caveat. It merely postpones the inevitable tax hit, and it stands to increase one's tax liability in the year to come.
"You have to keep in mind what the effects may be not only on this year but also the opportunities for next year," Steinmetz says. If you prepay property taxes this year, she notes, "next year, you're going to be one [property tax deduction] short."
6. When bracing for winter, go green
Homeowners can save on tax bills as well as utility bills if they make particular green investments before Jan. 1. That's because a range of energy-saving improvements, such as adding certain types of insulation or windows, qualify for a soon-to-expire $500 tax credit. (Unlike deductions, which reduce the amount on which a person pays taxes, credits are subtracted directly from one's tax bill.)
Before taking the plunge, Stromsem says, homeowners ought to check with a tax preparer or the IRS to make sure the desired project qualifies for a credit. If it does, then it could pay to act before January. This move might make sense, Stromsem says, "if you were going to buy storm windows anyway."
7. Keep an eye on Congress
Congress reconvenes this week and lawmakers could tinker with the tax code before their Christmas recess, or even pass legislation in 2008 that would be retroactive for the 2007 tax year.
With many provisions set to expire both this year and in the near future, Congress just might make a few moves with immediate implications, says Mark Steber, vice president of Jackson Hewitt Tax Service, a tax preparation firm based in Parsippany, N.J.
"There's certainly a lot brewing [in the Capitol], from alternative minimum tax to tax credit modification," Mr. Steber says. "We don't know what's going to happen, but it'll happen late. People need to pay especially close attention this year because [new laws] may put more money in their pockets."