With only about three weeks left to the year, it might not seem like there's much time to do anything to reduce your 2004 taxes. In fact, several important pieces of tax legislation were passed this year. As a result, there are actually quite a few things you can do before the end of this year that could save you a tidy bundle by next April 15... and beyond.
Here are a few of them:
Max out your retirement savings: If you are covered through a plan offered by your employer, call your human resources department or plan contact and find out if your 2004 contributions will hit the legal limit. This year, you can put as much as $13,000 to a 401(k), 403(b) or 457 plan. If you are over age 50, you can add an additional $3,000. Every dollar you contribute means you will pay less income tax.
This of it this way: if you’re in the 25-percent tax bracket, for every additional $100 you contribute, your federal tax bill decreases by $25.00. Your total savings is actually higher when you factor in state tax savings.
If your company makes a matching contribution, at the very least make sure you will have contributed enough to take full advantage of this. I can’t stress enough that this is “free” money. Don’t walk away from it!
Next year the basic employee contribution increases to $14,000. If you can’t afford to defer that much, then bump up the amount coming from your paycheck by a few percentage points. You’ll be surprised how this can add up over time.
While you’ve got H.R. on the phone, ask if you have any money left in your flexible spending account. If your company offers this benefit and you’ve been setting aside money all year, you’ve got to use it or lose it. Consider getting your 10-year-old started on braces before the year is out. Get that physical you’ve been putting off. Tell your spouse to buy new glasses. Or stock up on contact lenses to use up the money in your account. And if you want to avoid being in this predicament a year from now, consider reducing the amount you’re deferring.
Dig out your receipts for large purchases: Starting this year you have a choice of deducting either your state and local taxes or the total amount of sales tax you paid in the past year. If you live in a high tax state (such as Massachusetts or Ohio) you’re probably better off continuing to take the deduction for state income taxes and property taxes.But for residents of states like Florida and Texas, which have no state income tax, the sales tax deduction can significantly reduce your federal taxable income.
John Battaglia, a director with the private client group at Deloitte Tax, LLP says, “Even if you live in a state such as Illinois, which has a 3 percent income tax and minimum sales tax of 6 percent, you could find a situation where you’re better off deducting the sales tax.” For instance, if you bought a new car, you might have paid $2,000-3,000 in sales tax. This could be higher than the income tax you have to pay once you factor in the deductions and credits allowed on your state tax return. At the very least, if you made a major purchase this year, it pays to compare.
I know, I know, you wish you had known this in January so you could have been saving your sales receipts! Not to worry: the I.R.S. is developing tables that will allow you to estimate how much state sales tax you (probably) paid based on your income. (The tables aren’t out yet, but should be available on the I.R.S. website before the end of the year: http://www.irs.gov)
According to Battaglia, you start with “the amount from the table to estimate the amount of sales tax you paid and then you can add additional tax paid on major items like a vehicle or boat.”
If you’ve been feeling guilty about spoiling yourself with a new Beemer, just think of all the sales tax you’ll get to deduct! "Oh, Santa…"
Get charitable with your clunker: If you’re buying a new car and are considering donating your used one to charity, do it before the end of this year. As I wrote two weeks ago, the rules on donating vehicles to non-profit organizations become considerably tougher next year. Instead of getting a donation equal to the fair market value of the car, your deduction is limited by what the charity does with it. If it sells it at auction, your deduction will be the selling price. There’s more paperwork involved as well.
The teacher’s pet tax break is back: If you dipped into your own pockets to buy some of the supplies used in your classroom you can deduct up to $250. This tax break for educators expired at the end of 2003, but it’s been renewed for this year and next. And unlike a lot of other deductions, you don’t have to itemize to benefit from this one.
It doesn’t matter if you work in a private or public school, but you’ve got to log at least 900 hours as a teacher, instructor, counselor, principal or aide.
Ditch your losers: Bite the bullet and stop telling yourself you’ll sell that losing investment once you break even on the price you paid for it. Sure. And one of these years you’re going to fit into that suit you wore to your high school graduation.
It’s time to lock yourself in the bathroom, look at yourself in the mirror and get real. Is it likely you could make up your loss faster if you re-deployed the money in a different investment? If the answer is “yes,” then sell the sucker and move on!
You can use the loss to reduce any gains you have on your investments this year. If there is any excess loss, you can use up to $3,000 worth to reduce your taxable income. Any more than that (remind me why you bought this in the first place?) can be carried forward to future years.
If you really love this investment and think it’s just hit a temporary rough patch, wait 31 days and buy it back. Maybe you’ll get lucky and the price will have dropped even further.
Weight reduction = tax deduction: If you paid to join a weight loss program such as “Weight Watchers” you might be able to deduct the cost. They key is whether you received a doctor’s written diagnosis of “obese.” Expenses associated with losing weight (but not the cost of any food the program requires you to buy) can be added to other medical expenses for 2004, which just might boost your total to more than 7.5% of your adjusted gross income (AGI). To the extent it exceeds this amount, you get a tax deduction.
Got kids? The $1,000 Child Tax Credit, which was slated to drop to $700 next year, has been extended through 2010.
Got kids in college? Don’t overlook the tuition deduction. If you meet the income requirement, this year and in 2005 you can deduct a maximum of $4,000 in higher education expenses if your AGI doesn’t exceed the income limits: $65,000 for single filers and $130,000 for Married, joint filers.
If your income is too high to qualify for this, there’s also a limited deduction of $2,000. This is available to single filers whose AGI is $80,000 or less and married, joint filers with AGI of $160,000 or less.
Both of these higher education tax breaks expire after next year.
If your college student has a 529 plan and also receives a scholarship, you can withdraw an amount equal to the scholarship from the 529 without getting hit with a 10 percent penalty (you’ll still owe income tax on any gains). Now the same terms are extended to the Coverdell Education Savings Account.
Got laid off? Add up your job-hunting expenses. They fall under the category of “miscellaneous itemized expenses.” (Examples of other expenses which fall into this category include tax preparation fees and job-related education costs.) If the total comes to more than 2 percent of your AGI, the excess is deductible.
Get married! Your excuse for delaying the wedding —”We’ll pay more income tax if we get married this year.”— just disappeared. According to CCH, a major provider of tax and information software, The Working Families Tax Relief Act of 2004 short-circuited scheduled reductions in tax breaks for those who file jointly. Principal federal tax analyst, Mark Luscombe, says in 2005 the standard deduction for couples will continue to be twice what it is for a single tax filer. And the amount in both cases is going up.
In addition, the 10 percent and 15 percent brackets will expand next year for all taxpayers. If you file “married, joint” this means nearly $6,000 more income will be taxed at 15 percent instead of 25 percent, according to CCH. That will save you $600 in federal tax.
Pony up your property tax payments: Pay your 2005 local property taxes this month instead of in January and you can take them as a deduction against your 2004 income. (Assuming, of course, you are not opting to take the sales tax deduction instead.)
The whole point is to accelerate your deductions into this year and postpone receipt of money that’s owed to you until next year in order to reduce your “taxable” income.
Ach der AMT! Scrap the previous paragraph if you have the misfortune of being subject to the Alternative Minimum Tax. You may have heard that Congress finally got around to tackling the AMT mess this year when it passed the “Working Families Tax Relief Act.” Don’t hold your breath. ‘People may be assuming it’s been fixed,” says Deloitte’s Battaglia. “Basically the Act just extended the higher exemption amount another year.”
In other words, another “bandaid” instead of a real cure. Granted, it’s a very big bandaid. In fact, according to CCH’s Luscombe, this single item in the Working Families Tax Relief Act “will have a bigger impact” on taxpayers (translation: save more taxes) than any other provision.
Still, the bottom line is, if you fell into AMT purgatory in 2003, chances are you’ll land there again this year.
As regular readers of this column know, the Alternative Minimum Tax was introduced decades ago to make sure extremely wealthy Americans couldn’t avoid paying any income tax by investing in clever tax shelters. But since the AMT income limits aren’t adjusted for inflation, more and more middle class taxpayers are getting snagged. Especially those who pay a lot of state income and property taxes.
That’s because when you calculate your income according to the AMT rules, you’re not allowed to deduct these amounts.
(P.S. Opting for the sales tax deduction instead won’t help you. In fact, some tax analysts say it could actually make things worse.)
With the AMT You also don’t get the usual personal exemptions. So people with large families get hurt because the exemptions for themselves and their children disappear.
If you think you’re going to fall into the AMT this year, there’s no sense in pre-paying property taxes because you lose that deduction. You’re better off pushing potentially deductible items into 2005. Then pray that Congress finally settles this once and for all. (As a backstop, write your Congressional representative and let him/her know how you feel about this issue!)
Business owners should buy new equipment now: If you’re thinking of upgrading your computers or need a new piece of machinery, paying for it by Dec. 31 allows you to take a bigger deduction on your 2004 business taxes.
You can write off up to $100,000 in qualified “Section 179” expenses this year. (This increases to $102,000 next year thanks to an inflation adjustment.) But the additional “bonus depreciation” that’s available on top of that disappears at the strike of midnight on New Years. You’ll still get to write off investments made after that, but at a slower rate.
Speaking of taxes, someone who has renewed my faith in the caliber of people who work at the infamous Internal Revenue Service is retiring: Don Roberts, head of the I.R.S. Media Relations office in Washington, D.C. To give you an idea of the kind of guy Don is, he returned my phone call yesterday... around 6 p.m. Not the time you usually think government folks knock off work.
During the past few years, as the tax code underwent one major change after another, Don made sure all of my questions were answered — either by his staff or by himself personally — and in a way that made it possible for me to in turn explain the impact to you. He also had a sense of humor. I wish him all the best and thank him for leaving big shoes for his replacement to fill.
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