Painless Year-End Tax Planning

By Martin Brown

Year End Tax PlanningThe only thing worse than owing income tax, is owing no tax at all. The point being, no income: no tax. Not a great situation to find yourself in, and one that more people are confronting this year than in many years past.  But, if you owe tax, here are some tips for year end tax planning.

Despite the gloomy economic news, the greater truth is that tens of millions of us are employed. And particularly for the growing ranks of the self-employed, December 31st is an important deadline for doing something to change the income tax bill that comes due for each of us on April 15.

Not all of our tax realities are set in stone. As of the last calendar day of the current year, you can, for example, make Individual Retirement Account contributions during the early months of the new year (provided the account is opened during this calendar year.) Those contributions can reduce your previous year’s tax bill, but most of your options to mitigate your income tax for this year will close at the end of this month, so here are some important items to remember if you want to keep more of your money from winding up in the hands of Uncle Sam:

Painless Year-End Tax PlanningThe number one path to pain-free tax savings is to acquire a deductible or tax credit item using a low interest or no interest deal prior to the last day of the year.
An example of this would be purchasing a new home computer, printer, and other business equipment through one of many zero payment plans that retailers are offering now. You get depreciation on a portion of your purchase for the entire year, which gives you an income deduction, even though the purchase was made at the very end of the year.

Another approach is to sell depressed stock(s).
If you bought stock at $30 a share in January that today is worth $5 per share, you can sell the holding and take the loss against gains that you have made. All you need to do is wait 31 days before repurchasing the same stock. You cannot, for example, sell on December 31, and buy back on January 2nd.

Also, remember that capital losses, offset gains. You can’t make $25,000 doing a side business, say running a small catering service, and write stock losses off against that income.

You can save on gift and estate taxes by giving up to $12,000 to as many individuals as you wish, but like other tax year benefits it does not accumulate over the years, in other words, use this allowance during the calendar year, or lose it forever.

Prepay your mortgage interest.
This is generally the easiest trick of all. Your home mortgage is, as I’m sure you know, deductible from your total income. Prepay your January mortgage. Or if your particularly flush with funds, your February house note before the end of December, and the additional interest on those payments will be applied to your 2008 home interest deduction.

Many people wait until the first of January to make their mortgage payment and needlessly forfeit a no-brainer deduction bonus. You might say, “well it counts against next year’s income so why should I care.” But here’s why you do it: the income you have this year is the only reality, next year, God forbid, you may not need the extra deduction! Pass on the option now, and you don’t get the opportunity back again.

And on the subject of energy tax credits, beware that some energy tax credits for items ranging from hybrid auto purchases to home insulation appear and disappear, so know the facts on all such opportunities before making a decision.

For example, there is a tax credit of up to $500 on insulation for your home—but that happens in 2009. In other words, that’s an item you will want to put off until after the first of the year. If you do it in 2008, it’s of no tax benefit at all.

Finally, remember two very important rules:

First, there is a big difference between a tax credit and a tax deduction.
A deduction goes against your income. If your taxable income, for example, is $52,000, and you have a $1,000 charitable deduction, your taxable income is now $51,000.  Of much greater value is a tax credit. Because if you have a total tax bill of $3,800, and you have a $500 tax credit; your tax due is now reduced to $3,300. An income deduction varies in value depending on your overall income, but a tax credit is like cash in your pocket provided you owe income tax, and most of us do.

Second, tax rules change more often than the weather, so keep up with it.
You don’t have to hire a CPA or a tax attorney necessarily, but the more complex your particular income issues are the more cautious you want to be about making any assumptions about what is and what is not deductible. Simple stuff like home mortgage interest and home office equipment purchases pretty much reoccur annually, but one-time deductions and tax credits go in and out of fashion. So at a minimum, sit down and do a little research.

The taxman cometh to all those who earn; so the more you learn now the less you will owe later!

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