7 Ways to Shrink This Year's Tax Bill

By Jeff Schnepper

People don’t plan to fail -- they fail to plan. But you won’t be caught in that trap, not this year. We’ve got a few months left, and we’re going to use them to minimize the taxes you have to pay come April 15.

There are plenty of things you can and should do to trim that bill, and many of them must be done before Dec. 31. That’s when the Internal Revenue Service closes our books for us. So, don't forget your good planning. You don't want to wait a year to get all your tax breaks.

While the number of actions you could take is probably infinite, the actions basically fall into what I call my Top Seven for Tax Heaven strategies. Here they are.

1. Maximize your pension contributions

I don’t care whether you have a 401(k) or a traditional defined-contribution pension plan. Make sure that these are the first investments you fund. Every time you put money into these plans, you’ve reduced your taxes. A $1,000 pension contribution in the 28% bracket immediately reduces your current tax due by $280. That means that you’ll have an additional $280 to invest, compounding in perpetuity or until you withdraw the money.

In addition to the increased compounding return you’ll be earning, you’ll be getting the benefit of tax deferral. That means that each year you’ll again be getting investment returns on “bonus” money that would have been taxed and taken if you had invested outside your pension.

If your company matches any of your contributions, you’ve immediately doubled your money -- risk free -- by those matches. Unless you’ve found that chicken that lays the golden eggs, you’d be looking hard and long to match the returns on a pension with matching features.

If you’re not covered with a pension, or if you are and can qualify, consider an IRA contribution. Under current law, even if you’re covered with a pension, if your adjusted gross income is less than $42,000 ($62,000 on a joint return), you can qualify for at least a partial deductible IRA contribution.

Alternatively, if you’re young and/or are less concerned with the current year deduction, consider a Roth IRA. These accounts aren’t deductible, but they yield tax-free returns forever and are excellent estate planning vehicles.

2. Organize your capital gains and losses

If you’re an investor, this is a way to limit taxes two ways. You can control which investments you sell for capital-gains purposes. And you can use losses from other investments to offset the gains.

If you have any losses on stocks, funds or bonds and you don’t see them coming back, sell now. My general rule of thumb is that if I wouldn’t buy the stock at its current price today, and I have a loss, it’s time to sell. Offset these losses with the sale of assets, with gains, which you think have run their course.

By offsetting gains with your losses, those gains come to you tax-free. You can offset other income with losses in excess of gains to the extent of $3,000 per year. Any excess will be carried forward to the next year.

If you have tax-free bonds that have decreased in value as interest rates increased, consider a municipal-bond swap. That’s a strategy where you sell your “loss” bonds and buy equivalent, but not identical, bonds to replace them. You will have maintained your risk exposure and yield, but, because the bonds are not the same, you avoid the wash-sale rules and get to deduct your loss on the original sale. You still get your full principal at maturity, and the same cash flow from interest payments, but you save on your taxes. It’s a win -- a win for everybody except the IRS.

3. Make your charitable contributions now

If you itemize, your charitable donations are deductible to your church or synagogue, your college, the United Way and Habitat for Humanity. Just get the job done by Dec. 31. You don’t have to give via check, either. You can charge your charitable contributions. If the charge was made in December, it's allowed as a 2000 deduction -- even if you don’t pay the credit-card debt until 2001.

Don’t forget your non-cash contributions of old clothes, furniture, equipment, and so on. The wholesale fair-market values of those goods are allowable tax-deductible donations. The Salvation Army offers free valuation guidelines, or you can compute the value using a program from listed at the left of the screen at bigwriteoff.com. In any case, make sure you get a receipt. Remember, if you’re audited, no receipt means no deduction.

4. Watch your floors

I don’t mean to look down when you walk and try not to trip. (Although that’s not a bad idea, in and of itself.) What I’m talking about here are the minimum “floors” you have to exceed before you can deduct certain expenses.

For example, medical expenses are allowed as deductions only to the extent that they exceed 7.5% of your adjusted gross income. That means that if you have an adjusted gross income of $100,000, the first $7,500 in medical expenses doesn’t count.

Now is the time to review your income and medical expenses to date to see if you qualify for such a deduction. Some medical expenses can be either accelerated or deferred -- such as elective surgery and orthodontia. If you’re going to exceed the minimum floor, then accelerate these medical expenses, because they’re going to be allowed. In other words, get that hernia fixed, or pay for the braces for your son’s teeth.

If not, then defer your date with the surgeon until next year, when you’ll again have the opportunity to exceed the minimum floor.

The same concept applies to miscellaneous itemized deductions such as investment expenses, employee business expenses, job-hunting expenses and tax-preparation expenses. They’re only allowed to the extent that their sum exceeds 2% of your adjusted gross income.

If you’re going to exceed the floor, accelerate those expenses. Prepay investment fees, subscribe and pay for investment publications in December, mail a check to your favorite accountant on Dec. 31 for tax preparation next March/April. Alternatively, if you’re not going to hit the floor, defer these expenses until next January. Otherwise, from a tax perspective, they’re wasted. . .

5. Defer income

If you’re in the 28% bracket, $1,000 received on Dec. 31 mandates a $280 payment by April 15, 2001 -- three and a half months later. If you receive the same income the next day, Jan. 1, then the $280 in tax isn’t due until April 15, 2002. You get an additional year’s use and returns on those dollars before they have to go to the IRS.

Some certificates of deposit (CDs) only credit interest at the end of the year. Since you’re on the cash basis (you report income when received and deduct expenses when paid), any interest “earned” this year won’t be taxable until credited . . . next year.

As a self-employed individual, I take my vacation the last two weeks in December. Since the office is closed, there’s nobody to receive checks during that period of time. So they become taxable income when I get back, in January 2001.

In addition, I send my November and early December bills out right before I leave. That move insures that the dollars that my invoices generate don't arrive until next year and escape current year taxation.

Understand that deferral doesn’t mean I won’t pay the tax on those dollars. It just gives me an interest-free loan from the IRS. I’ll be happy to pay later . . . so long as I currently have the use and yield from those dollars today.

6. Prepay expenses

This is the opposite side of the coin from deferring income. Here are some examples:

If you’re paying state estimated tax, your fourth-quarter payment is usually due in January 2001. But if you pay it on Dec. 31, you get to deduct it this year rather than next year.

Property taxes work the same way. My fourth-quarter property tax is due Feb. 1, 2001. By paying that on Dec. 31, I accelerate the deduction into this year.

Apply the concept to your home mortgage. Your Jan. 1 payment is for the use of the money for the month of December. Pay on Dec. 31, and you have an additional month’s interest to deduct if you itemize.

Watch this one: Your bank’s computers will normally not record this payment and the interest in time to include it on your end of the year statement (Form 1099). You may have to run an amortization schedule and add the incremental interest to their sum.

Similar to the deferral strategies, these acceleration techniques don’t decrease the total tax you’ll have to pay over your lifetime. But they do give you the expanded use of the money, and the time value of any yield. In any case, my general rule of thumb is to take the tax deductions now . . . life is short, and who knows what tomorrow may bring.

7. Convert personal expenses into business expenses

If you’re in business, hire your kids.

Even if you’re not self-employed, consider employing them on a non-deductible basis so they qualify for a Roth contribution.

If you’re self-employed, consider a home office. Look for ways to convert dollars that you’re spending anyway into allowable, deductible, business expenses.

These strategies assume you are going to be in the same or a higher tax bracket next year. If for some reason your bracket is going to decrease (job change, retirement, substantial stock market losses, etc.), then you may want to reverse the techniques to minimize your tax outflow.

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