Tax planning is a year-round process. However, if you haven't done everything you can to minimize your tax burden, don't despair. As the year winds down, here are some steps you can take to cut your tax bill.
Max Out Your Retirement Contributions
If you work for a company that offers a retirement plan with salary deferral features, such as a 401(k) plan or 403(b) plan, take a look at how much you're on track to contribute to your account this year.
For 2009, your maximum salary deferral contribution is $16,500. Anyone aged 50 or older by December 31, 2009, can make additional catch-up contributions of $5,500 for 2009. You have until the end of the year to increase your salary deferrals if you haven't been contributing at the maximum rate throughout the year. Salary deferral contributions made on a pretax basis reduce your taxable income for the year. (To find out more about these contributions, read Making Salary Deferral Contributions - Part 1 and Part 2.)
Are you self-employed? Assuming you have no non-owner employees who work for your business 1,000 hours or more per year, consider setting up a self-employed 401(k) plan by December 31, 2009. With these tax-advantaged retirement accounts, self-employed individuals can contribute $16,500 plus 20% of their adjusted net profit or 25% of W-2 wages, up to a total of $49,000 for 2009. For individuals 50 or older by the end of the year, the maximum contribution increases to $54,500. (To read more, see IRA Contributions: Deductions and Tax Credits, Tax-Saving Advice For IRA Holders, 401(k) Plans For The Small-Business Owner.)
Time Your Expenditures
For tax purposes, most peopleuse the cash basis of accounting, which means that you can claim a deduction based on the date you pay your bills. For payments made by check, the date the check is mailed determines deductibility. Items paid with credit cards are deductible in the year the transaction is charged to your account. As the year winds down, you need to decide whether to pay for certain items prior to December 31, 2009, or wait until after New Year's Day.
If you're a homeowner, consider sending in your January 2010 mortgage payment early enough so that it will be processed prior to December 31, 2009. By sending in your payment a few weeks early, you can deduct the interest portion of that payment a full year earlier. (To learn more, read The Mortgage Interest Tax Deduction.)
And if you'll be itemizing your deductions this year, certain expenses are deductible to the extent that they exceed a percentage of your adjusted gross income (AGI). For instance, you can deduct medical expenses that exceed 7.5% of your AGI, and miscellaneous itemized deductions, including investment fees and unreimbursed employee business expenses, that exceed 2% of your income. If you meet either of these thresholds, consider paying other outstanding bills before December 31, 2009. (To find out more yearly tax tips, check out Money Saving Year-End Tax Tips.)
Gifts To Charities
Donations to charities are deductible as itemized deductions. Prior to December 31, clean out your closets and donate your clothing and household items to a charitable organizations, as you can deduct these "non-cash" contributions based on their fair market values. Don't forget to get a receipt, and be sure to list the goods you donate, including the condition of each item. Under the new rules, only non-cash contributions in "good or better" condition count.
For gifts of money, making your donation by credit card before December 31, 2009, allows you to deduct the donation on this year's return, even if you don't pay your credit card bill until 2010. However, if you do pay by credit card and don't pay off the bill at the end of the month, remember that you will be paying interest on your donation – in effect, paying money to donate money. So, if it isn't worth the tax deduction, be very hesitant to use this method of payment for donations.
Finally, you always have the option of donating appreciated investments to charities. You get to claim your deduction based on the value of the assets donated, without paying any capital gains taxes on the appreciation. (Keep reading about donations in Deducting Your Donations, It Is Better To Give AND Receive and The Christmas Saints Of Wall Street.)
Pay Enough Taxes
If you are required to pay estimated taxes for the year, now is the time to take a look at your withholding tax to date and instruct your employer to take out additional taxes from your salary if you haven't had enough taxes withheld during the year. This will help to avoid getting hit with a penalty for underpayment of estimated taxes. Unfortunately, money is always tighter during the holiday season, so if you can't pay for the extra tax now, it may make sense to wait and be hit with the tax later.
Generally, you are required to make estimated tax payments for 2009, if:
- you expect to owe at least $1,000 in tax for 2009 after subtracting your withholding and credits and
- you expect your withholdings and credits to be less than the smaller of:
- 0% of your current year's tax liability or
- 100% (110% for people whose AGI exceeds a certain amount in 2008, depending on their tax filing status) of the prior year's tax liability.
(For more information, check out IRS Publication 505.)
Another way to cut your tax bill is to prepay your projected state tax shortfall if you'll be itemizing your deductions and will not be subject to the alternative minimum tax.
Sell Your Losers
Do you own any investments in your non-retirement accounts that have decreased in value? If so, consider selling some of your losers - your capital losses can offset the taxes owed on capital gains realized during the year, including capital gain distributions from your mutual funds. You can then claim up to $3,000 ($1,500 if you are married filing separately) in additional capital losses against your wages and other income. Any additional losses are carried forward to next year. Just make sure to wait at least 31 days before buying back a security sold at a loss, or the IRS may disallow the loss under the wash sale rules. (To find out more ways to cut your taxes, read Common Tax Questions Answered and Tax Tips For The Individual Investor.)
The Last Step
Before finalizing your year-end strategies, evaluate whether you'll save any taxes by postponing 2009 income or deductions into 2010 or by accelerating 2010 income or deductions into 2009 where possible.