Although you may have until April 15, 2011, to file your 2010 tax return, your tax preparation should start in the current year. Getting a start on your tax planning before the New Year begins can help you to maximize benefits and minimize taxes. In this article, we provide some tips that can help you make the best of the upcoming tax season.

Tutorial: Personal Income Tax Guide

1. Use Withholdings From Retirement Plan Distributions To Pay Estimated Taxes
You may be required to pay estimated taxes to the IRS to avoid a penalty for underpayment of taxes. In particular, you may be required to make an estimated tax payment if 1) you expect to owe at least $1,000 in tax for 2010 after subtracting your withholding and credits, and 2) amounts withheld from your salary and other taxable income during the year is less than the smaller of the following:

  • 90% of the taxes you will owe for the current tax year
  • 100% of the taxes you owed for the previous tax year. This may be increased to 110% if your adjusted gross income exceeds certain amounts.

Generally, estimated tax payments must be made on a quarterly basis by the end of each quarter of the year. However, an exception applies if the amount is withheld from income you receive on an ad-hoc basis. For instance, if your IRA distribution is processed later in the year and you have taxes withheld from that distribution, this will be enough to meet your estimated tax requirements because these withholding amounts are treated as if they were withheld throughout the year. (For more on estimated tax, see IRS Publication 505.)

The following tables can be used to determine your estimated taxes for 2011:

Schedule X - Single
If taxable income is over: But not over: The tax is:
$0 $8,700 10% of the amount over $0
$8,700 $35,350 $870.00 plus 15% of the amount over $8,700
$35,350 $85,650 $4,867.50 plus 25% of the amount over $35,350
$85,650 $178,650 $17,442.50 plus 28% of the amount over $85,650
$178,650 $388,350 $43,482.50 plus 33% of the amount over $178,650
$388,350 no limit $112,683.50 plus 35% of the amount over $388,350
Schedule Y-1 - Married Filing Jointly or Qualifying Widow(er)
If taxable income is over: But not over: The tax is:
$0 $17,400 10% of the amount over $0
$17,400 $70,700 $1,740 plus 15% of the amount over $17,400
$70,700 $142,700 $9,375 plus 25% of the amount over $70,700
$142,700 $217,450 $27,735 plus 28% of the amount over $142,700
$217,450 $388,350 $48,665 plus 33% of the amount over $217,450
$388,350 no limit $105,062 plus 35% of the amount over $388,350
Schedule Y-2 - Married Filing Separately
If taxable income is over: But not over: The tax is:
$0 $8,700 10% of the amount over $0
$8,700 $35,350 $870 plus 15% of the amount over $8,700
$35,350 $71,350 $4,687.50 plus 25% of the amount over $35,350
$71,350 $108,725 $13,867.50 plus 28% of the amount over $71,350
$108,725 $194,175 $24,332.50 plus 33% of the amount over $108,725
$194,175 no limit $52,531 plus 35% of the amount over $194,175
Schedule Z - Head of Household
If taxable income is over: But not over: The tax is:
$0 $12,400 10% of the amount over $0
$12,400 $47,350 $1,240 plus 15% of the amount over $12,400
$47,350 $122,300 $6,482.50 plus 25% of the amount over $47,350
$122,300 $198,050 $25,220 plus 28% of the amount over $122,300
$198,050 $388,350 $44,584.50 plus 33% of the amount over $198,050
$388,350 no limit $105,095 plus 35% of the amount over $388,350

2. Making Charitable Donations
If you plan to make a charitable donation, bear in mind that you must itemize your deductions in order to receive related tax benefits. Individuals who take a standard deduction are not eligible for those benefits. (To read more, see Deducting Your Donations.) The following tips apply to charitable donations:

  • Only actual contributions are deductible; therefore, if you pledged an amount during the year, only the amount that you actually contributed during the year is usually counted for that year. If you want to donate cash and do not have the cash immediately available, you may use your credit card to finance the donation. Of course, you should use your credit card for this purpose only if you are sure you will be able to pay off that balance within a short period, preferably before it incurs interest.
  • Effective for tax years beginning after August 17, 2006, cash contributions to qualified charities must be supported by a dated bank record or receipt.
  • Effective August 17, 2006, charitable donations of clothing and household items are not deductible unless the property is in good used condition or better.

(For more on charitable donations, see IRS Publication 526 and 561.)

3. Offset Gains Against Losses
If you want to deduct losses on stocks that have depreciated, be sure to liquidate those stocks in time to ensure the trades settle by year-end. These losses can come in handy if you have considerable gains on other stocks, as the deductible losses from depreciated stocks that you sell can be used to reduce the taxes you owe on those gains. Tax experts recommend selling winning stocks with long-term capital gain and losing stocks with short-term capital gain to maximize tax benefits. (To learn more on this, see Selling Losing Securities For A Tax Advantage.)

4. Fund A Retirement Plan
If you need additional deductions to reduce the amount of taxes you will owe for the year, consider making contributions to your retirement accounts. This will work for Traditional IRAs, but only if you are eligible to receive a deduction for the contribution. If you are neither an active participant, nor married to someone who is an active participant, then your Traditional IRA contribution is deductible. If you or your spouse is an active participant, then your eligibility to deduct your contribution is determined by your modified adjusted gross income (MAGI) and your tax filing status. (See Traditional IRA Deductibility Limits for information about deducting IRA contributions when you and/or your spouse participate in an employer sponsored plan.)

If you own your own a business, consider establishing a retirement plan for that business. Depending on the type of plan and your compensation for the year, you may be able to contribute and deduct up to $49,000 for 2010. In addition, you may be eligible to claim a deduction for plan-related expenses.

(For information about retirement plans for small business owners, see Plans The Small Employer Can Establish and Tax Credit For Plan Expenses Incurred By Small Businesses.)

5. New Exemption Amounts for AMT
You may be required to pay alternative minimum tax (AMT) if your taxable income is more than a certain amount. The AMT is in addition to your regular income tax, and it eliminates many of the deductions and tax credits for which you are eligible. For 2011, the exemption amounts have been increased to the following:

  • Single: $48,450
  • Married filing jointly or surviving spouse: $74,450
  • Head of household: $48,450
  • Married filing separately: $37,225
  • Check with your tax professional to determine whether certain transactions, such as Roth IRA conversions, will affect whether you are subject to AMT. This will help you to determine whether it's best to defer certain transactions. Furthermore, late Congressional action may alter the amounts listed for 2011.

    6. Check If You Are Eligible For Free Expert-IRS-Tax Assistance
    One of the organizations within the IRS is the Taxpayer Advocate Service. This organization offers free assistance to individuals who fall into one of the following categories:

  • The individual can no longer provide for basic necessities such as housing, transportation or food because of IRS actions.
  • The individual owns a business and is unable to meet basic expenses such as payroll because of IRS actions.
  • The individual has experienced a delay of more than 30 days to resolve a tax-related problem.
  • The individual has not received a response from the IRS by the date promised.

If you need to speak with a Taxpayer Advocate, you may call the Taxpayer Advocate Service toll free at 1-877-777-4778. Additional information about the Taxpayer Advocate Service, including mailing address for your local representative, is available in the IRS Publication 1546.

7. Check Your Address With The IRS
Every year, the IRS reports tens of thousands of refund checks that can't be delivered because of bad addresses. Incorrect addresses will not only result in failure to deliver any refund by mail, but could also result in you missing important communications from the IRS. If you are eligible for a tax refund, consider having the amount sent directly to your account by direct deposit. You can even split your refund into three accounts, including your IRA. Regardless of how you have your tax refund sent to you, you should still check to make sure the IRS has your correct address on file.

8. Gather All Tax-Related Documentation
Gather all your related tax documentation and categorize where possible. This includes receipts for charitable donations, receipts for medical expenses, amounts paid for estimated taxes and amounts paid for educational expenses. This will make it easier for your tax preparer to complete your tax return. If you are not sure whether something should be included, add it to the pile anyway and have your tax preparer make a determination as to whether it can be used for tax purposes.

9. Consider A Flexible Spending Account
When signing up for your benefits at work, either during open enrollment or when you become eligible for benefits, consider whether signing up for a flexible spending account (FSA) could be beneficial to you. Under a flexible account program, funds are taken from your paycheck on a pretax basis, which reduces your taxable income, and are refunded to you when you submit the appropriate claim forms to your benefits department. The following example is a high-level explanation of how it works:

Assume the following:

  • Your taxable salary is $100,000 per year.
  • You pay $4,000 per year for childcare out of pocket. This is paid with funds that have been taxed already.
  • You participate in a dependent care FSA and have your employer deduct the $4,000 from your paycheck and credit it to your FSA. This reduces your taxable income to $96,000, which means you now pay less taxes.
  • You submit a claim, along with the required receipts or documented proof of expenses, and the $4,000 is refunded to you.
  • Result: Your $4,000 is tax-free.

There are two kinds of FSAs, dependent care and healthcare. Dependent care is used for expenses incurred through caring for certain dependents. Up to $5,000 can be contributed to each account, but take care not to contribute more than you will use, as these accounts come with a ‘use-it-or-lose-it rule. Also, check with your employer to determine which expenses are covered under the FSA. Starting in 2011, participants cannot use FSA funds to purchase OTC drugs. (For more insight on these accounts, read Healthcare FSAs Increase Your Disposable Income.)

10. Lesser-Known Deductibles
There are several deductible items that many people are unaware of that you can watch out for. For example:

  • You can deduct certain expenses incurred for a job search in your present occupation, even if you do not get a new job. However, you cannot deduct the expenses if they were incurred while looking for a job in a new occupation, if you are looking for a job for the first time, or if there was a substantial break between the end of your last job and your subsequent job search.
  • You can deduct the depreciation of your home computer if you use it to produce income.
  • You can deduct the depreciation for a computer or cellular telephone if you use it for work and it is required by your employer.

Some tax benefits are not as obvious as others and special rules may apply in order for you to receive these deductions; therefore, it is important that you allow your tax professional to help you make the right determination. (Find out what deductions you could be missing out on in 10 Most Overlooked Tax Deductions.)

Preparation is the key to having a tax season that is free of frustration and mistakes. It also helps to make sure that you receive all of the tax benefits for which you are eligible. Being prepared also helps to eliminate the risk of having to file an amended return, or of receiving a notice of amendment from the IRS. Usually, a notice of amendment means your refund is being reduced, or the amount of taxes you owe is being increased. Avoid the surprises by working with a competent tax professional.

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