Wednesday, December 23, 2009

Year End Tax Planning

The best motivation for planning your taxes is to legally minimize how much of your money goes to the IRS. Many years ago, Judge Landis of the U.S. Supreme Court declared that everyone has the right to legally minimize his or her taxes. To do this, you need to have an idea of what your income and deductions are now, and what you expect them to be next year. You must then move income and deductions in a way that minimizes what you pay in taxes this year. Sometimes it is worth paying taxes now in order to save even more in taxes next year.

However, ” take the money and run” is a valid alternative. In this case you worry about tomorrow tomorrow. You delay as much income as possible to next year and accelerate as many of your deductions as you can to this year. This way, you pay the least taxes possible.

Step One: Analyze your situation. Will you be paying taxes this year? If so what is your tax bracket? Are you in the 15% bracket or the 35% bracket? If you are in the lower tax bracket you will only get back $15 for every $100 you lay out for a deductible expense. If you are in the 35% bracket then the deduction gets more attractive.

Step Two: Determine where you think you will stand next year. Will you be in a higher or lower tax bracket? With the way the economy went in 2009, many people will have a better year in 2010.

Step Three: Set your goal. Do you want money now or later?

Delaying income is tough when you have a job, a house, and no other tax complications. You get your salary each week and it is hard to push it off to next year. It might happen if you get a year-end bonus that might get paid in 2010. Your interest income or dividends is paid on a set schedule, so you cannot postpone them to next year.

Here are some ways to legally delay income to next year:

· Weigh your options if you are thinking of selling some common stocks. If you have gains, you may want to wait until January to realize them. That way you are not liable for the taxes for a year. If you have losses, then take them this year. However, always make a good investment decision first. If it’s time to sell then don’t worry about the tax consequences.

· If you are self-employed you can delay billing your customers so that you receive the income next year rather than this year. Please note, if you receive the money this year, you are legally required to report it this year. Keeping a drawer full of checks that you get in December and then deposit in January is illegal. You should report all your income in the year you receive it.

Here are some ways to accelerate your expenses

· Pay your mortgage before Christmas. That way the bank will include the interest you normally would pay in January on their annual statement for this year, making it easier to deduct it.

· If you are making donations to your favorite charity, make them by the end of December, rather than in January. If you mail the check on December 31st, you can deduct it on your 2009 tax return.

· If you have a lot of junk, (oops, I mean valuable furniture and other items), you can consider donating them to charity and getting a tax deduction for it. You must get a receipt if it is worth more than $250, and you must provide additional information on your return if it is over $500. Really valuable items might require an appraisal. Be careful, the appraisal might cost more than the tax benefit of making the donation. Generally charities will not value the items for you. They will just say that you gave them seven bags of clothing.

· If you were looking for a job in 2009, keep track of your job search expenses. They can be used as itemized deductions to reduce your taxes. Some examples of these expenses would be the cost of printing your résumé, fees for help in your job search, or hiring a career coach to help your efforts. However, the total must be above 2% of your income to reduce your taxes.

· Often the biggest job search expense is the use of your automobile for your search. Keep track of the mileage for getting to the printer, going to various employment agencies or job fairs, and traveling to interviews. Write it all down to make sure you get the benefit of all the mileage.

· If you pay your real estate taxes yourself rather than through a bank’s escrow account, you can pay them in December rather than January. That way you can deduct them this year.

· Medical expenses must be more than 7.5% of your total income to be deductible. Look at your income and medical expenses and pay any outstanding medical bills this year if you are over this limit. If you are paying for your own health insurance, you should not have a problem exceeding this limit.

Here are some suggestions for the Self-Employed: (These only should be used if you have a good business purpose in spending the money. New “toys” like the newest fanciest computer, don’t make good financial sense.)

· You can write and mail the checks for your business expenses on December 31st and deduct them on your 2009 return. This includes expenses like rent or office supplies.

· Items you charge on a bank credit card can be deducted when they are purchased rather than when you pay the charge card bill. So those office supplies you bought in late December on your Visa card are deductible in 2009. If you charged it on your Staples card, then they are not deductible until you pay Staples. The theory is that Staples has not gotten their money yet so you cannot deduct it.

· Upgrade your equipment. This is only a good idea if it will help you run your business better, lower your future costs, or increase your revenue. Again, fancy toys don’t make financial sense.

Careful tax planning can help you keep some of your money at a time when every dollar counts.

If you pay the dreaded Alternative Minimum Tax (AMT), then you have to be careful what you move deductions from year to year. Generally it does not help you to pay your real estate or other deductible taxes or things like job search expenses in December if you are subject to the AMT. The AMT would take a several blogs to explain. I might tackle it in a future blog.

These are general ideas that can help reduce your taxes. If you plan to implement any of these suggestions, it is well worth it to consult a tax professional.

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