Individual Tax Planning Tips
Defer Recognition of Income and/or Accelerate deductions
Deferring the taxability of income makes
sense for two reasons. Most individuals are in a higher tax bracket in their
working years than during retirement. Deferring income until retirement may
result in paying taxes on that income at a lower rate. Additionally, through the
use of tax-deferred retirement accounts you can actually invest the money you
would have otherwise paid in taxes to increase the amount of your retirement
fund. Deferral can also work in the short term if you expect to be in a lower
bracket in the following year or if you can take advantage of lower long-term
capital gains rates by holding an asset a little longer. You can achieve the
same effect of deferring income by accelerating deductions—for example, paying a
state estimated tax installment in December instead of at the following
January due date.
Bunch Your Itemized Deductions
▪ List of Deductible Medical Expenses
▪ List of Miscellaneous Itemized Deductions
Certain itemized deductions, such as medical or employment related expenses, are only deductible if they exceed a certain amount. It may be advantageous to delay payments in one year and prepay them in the next year to bunch the expenses in one year. This way you stand a better chance of getting a deduction.
Consider Maxing Out Your 401(k) or Similar Employer Plan
Many employers offer plans where you can
elect to defer a portion of your salary and contribute it to a tax-deferred
retirement account. For most companies these are referred to as 401(k) plans.
For many other employers, such as universities, a similar plan called a 403(b)
is available. Check with your employer about the availability of such a plan and
contribute as much as possible to defer income and accumulate retirement assets.
Some employers match a portion of employee contributions to such plans. If this
is
available, you should structure your contributions to receive the maximum
employer matching contribution. Rember to keep a long-term perspective in
deciding whether to saving in a before or after tax account. During
retirement years when the money is withdrawn, will you be in a higher or lower
tax bracket?
If You Have Your Own Business, Set Up and Contribute to a Retirement Plan
If you have your own business, consider setting up and contributing as much as possible to a retirement plan. These are allowed even for sideline or moonlighting businesses. Several types of plans are available which minimize the paperwork involved in establishing and administering such a plan. Ask us about the new Uki(k) retirement plan for single or married couple businesses without any employees.
Contribute to an IRA
If you have income from wages or self-employment income, you can build tax-sheltered investments by contributing to a traditional or a Roth IRA. The maximum allowable deduction is $3,000 per spouse. You may also be able to contribute to a spousal IRA —even where the spouse has little or no earned income. All IRAs defer the taxation of IRA investment income and in some cases can be deductible or be withdrawn tax free. To get the most from IRA contributions, fund the IRA as early as possible in the year. Also, pay the IRA trustee out of separate funds, not out of the amount in the IRA. Following these two rules will ensure that you get the most possible tax-deferred earnings from your money. Please note that high income may restrict allowance of contributions or deductibility of contributions.
Accelerate Capital Losses and Defer Capital Gains
If you have investments on which you have an accumulated loss, it may be advantageous to sell it prior to year-end. Capital losses are deductible up to the amount of your capital gains plus $3,000. If you are planning on selling an investment on which you have an accumulated gain, it may be best to wait until after the end of the year to defer payment of the taxes for another year (subject to estimated tax requirements). Make sure to consider the investment potential of the asset. It may be wise to hold or sell the asset to maximize the economic gain or minimize the economic loss. For most capital assets held more than 12 months the maximum tax is reduced to 15% for sales after May 5, 2003 and before 2009. If your highest marginal tax rate is 10% or 15% then your capital gains rate is only 5%.
Use the Gift-Tax Exclusion to Shift Income
You can give away $11,000 ($22,000 if joined by a spouse) per donee, per year without paying federal gift tax. You can give $11,000 to as many donees as you like. The income on these transfers will then be taxed at the donee’s taxrate, which is in many cases lower. Special rules apply to children underage 14. Also, if you directly pay the medical or educational expenses of the donee, such gifts will not be subject to gift tax.
Give Appreciated Assets to Charity
If you’re planning to make a charitable gift, it generally makes more sense to give appreciated long-term capital assets to the charity, instead of selling the assets and giving the charity the after-tax proceeds. Donating the assets instead of the cash prevents your having to pay capital gains tax on the sale, which can result in considerable savings, depending on your tax bracket and the amount of tax that would be due on the sale. Additionally you can obtain a tax deduction for the fair market value of the property. Many taxpayers also give depreciated assets to charity. Deduction is for fair market value; no loss deduction is allowed for depreciation in value of a personal asset. For contributions of property, whether appreciated or not, you must file an information return on contributions of $501-$5,000, and you need a qualified appraisal on contributions over $5,000 (except for publicly traded securities).
Keep Track of Mileage Driven for Business, Medical or Charitable Purposes
If your drive your car for business, medical, moving, or charitable purposes, you may be entitled to a deduction of 37.5, 14, 14, and 14 cents per mile respectively, using 2004 rates. You need to keep detailed daily records of the mileage driven for these purposes to substantiate the deduction.
Use Your Employer’s Benefit Plans to Get an Effective Deduction for Items Such as Medical Expenses
Medical and dental expenses are generally only deductible to the extent they exceed 7.5% of your Adjusted Gross Income. For most individuals, particularly those with high income, this eliminates the possibility for a deduction. You can effectively get a deduction for these items if your employer offers a Flexible Spending Account, sometimes called a cafeteria plan. These plans permit you to redirect a portion of your salary to pay these types of expenses with pre-tax dollars. Another such arrangement is a Medical Savings Account which is available for some small businesses. Ask your employer if they provide either of these plans.
If Self-Employed, Take Advantage of Special Deductions
You may be able to expense up to $102,000 for 2004, in equipment purchased for use in your business immediately instead of writing it off over many years. Additionally, self-employed individuals can deduct 100% of their health insurance premiums as business expenses. You may also be able to establish a Keogh, SEP SIMPLE plan, Uni(k), or a Medical Savings Account, as mentioned above.
If Self-Employed, Hire Your Child in the Business
If your child is under age 18, he or she is not subject to employment taxes from your unincorporated business (income taxes still apply). This will reduce your income for both income and employment tax purposes and shift assets to the child at the same time.
Take Out a Home-Equity Loan
Most consumer related interest expense, such as from car loans or credit cards, is not deductible. Interest on a home equity loan, however, can be deductible if it is secured by the home. Remember that the interest deduction is limited. Maximum home equity debt allowed for tax purposes is $100,000 ($50,000 if MFS), for main and second homes combined. Additionally, the tax deductible home equity intereest is limited to fair market value of the home minus total home debt. Given these considerations, It may be advisable to take out a home-equity loan to pay off other nondeductible obligations.