Is it really already time to talk about taxes?
Sorry, but it is. Taxes aren’t just an April game. There are a number of ways to decrease your tax bill for 2012, but these plans need to be put into action before year-end, and with Thanksgiving early this year, it’s easy for people to get caught up in the holiday hoopla and miss the opportunity.
What is the first tip you have?
My favorite tip not only lowers your tax bill but also involves adding to your savings—and that’s to increase your 401(k) contribution. For people under the age of 50, the limit for 2012 is $11,500 and some people over 50 may be able to contribute an additional $5,500 if their plan allows “catch up” contributions, for a total of $17,000. The higher limit for people closer to retirement age is to help build their savings faster as they have fewer years left in which to save. Also, be sure you are at the very least socking away enough money to receive any matching your company may offer. That’s free money and it’s crazy to leave it on the table. Remember, every single dollar you are able to add to your 401(k) contribution is a dollar that you won’t pay taxes on this year. And each of those dollars is added to the principal of your retirement savings—which over the long-term can greatly increase your nest egg, especially when considering the effect of compound interest over the lifetime of your investment. There is an urban legend that Albert Einstein once called compound interest “the most powerful force in the universe.” Whether it’s true or not, they are words to live by—and it’s hard to argue with Einstein. This is the time for your listeners to make a visit to Human Resources and increase their contribution as much as possible—before the end of the year— to save on this year’s tax bill and make the most of their retirement plans.
What about those who have already maxed out their 401(k) plans or simply can’t afford to contribute more this year? Any tips for them to save on taxes?
Absolutely. If you are one of the lucky people who will get a year-end bonus payable before December 31 of this year, request your employer to pay you in January to have those earnings attributed to your 2013 earnings instead of 2012.
How about a tax tip for homeowners? It’s been another rough year for them.
I do have a tip for homeowners. You might want to consider sending in your January 2013 mortgage payment before the end of this year, allowing you to deduct the interest on this year’s tax return. Here’s an example: Let’s say you have a $150,000 mortgage at a 5% interest rate and you pay $625 per month in interest. You could save an extra $156 in 2012 by paying your mortgage now (assuming a 25% tax bracket). One thing to keep in mind is that like my tip about deferring a year-end bonus payment, these are deductions you’re taking now and won’t be able to take again next year.
Anything tax considerations that apply specifically to students?
Yes. The American Opportunity Tax Credit was a centerpiece of the 2009 stimulus bill. The new education tax break expanded the existing Hope Credit, providing a credit of up to $2,500 of the cost of qualified tuition and related expenses, and up to 40% ($1,000) of the credit is refundable. This means you can get it even if you owe no tax. The full credit is available to individuals whose modified adjusted gross income is $80,000 or less (or $160,000 or less for married couples filing a joint return). The credit is phased out for taxpayers with incomes above these levels.
The American Opportunity Credit was originally supposed to end in 2010, but it was extended through 2012. However, this could be the credit's last year. Congress is looking for ways to cut the federal deficit, and allowing tax breaks to expire is an easy way for them to save money. If you have eligible education expenses, be sure to claim the American Opportunity Credit while you can.
Other timely advice?
Take a look at your stock portfolio and consider dumping some of the losers. A capital loss is the result of selling an investment at less than the purchase price or adjusted basis. The key point is that capital losses are only losses after you sell them. You may wince at a stock sitting in your portfolio with a deflated price, but it doesn't do you any tax good until you sell it. The good news is that while the investment may have been a bust, you can recoup a percentage of a true loss from the taxman. This is one of the best deductions available to investors. A capital loss directly reduces your taxable income, which means you pay less tax, and it makes for a nice consolation prize.
Another timely tip: Don’t forget about your flexible spending account at work. Many people participate in these plans, which allow an employee to set aside a portion of earnings to pay for qualified medical expenses. It’s great to set aside that income tax-free, but these plans adhere to strict “use it or lose it” rules, and a study released this month found that only 16 percent of flexible spending account users actually contribute the right amount. If you have tax-deferred money left in your account, schedule an annual check-up, go buy those extra pair of glasses and get that dental work you’ve been putting off or you will lose that money.
Anything else you’d like to add?
Yes. Charitable giving is a great way to decrease your tax bill because many contributions are 100% deductible provided you don’t receive anything in exchange. (Direct donation to the Red Cross for Hurricane Sandy victims? 100% deductible. Dinner gala for the local non-profit theatre? Not so much.) Now is the time to donate to a charity if you want to claim that deduction on your 2012 return. You’ll also need to be able to prove that you donated this year, so make sure you get receipts and keep them somewhere safe. Pledges to donate do not count.
Another tip for tax-smart philanthropy: If you have owned shares in a mutual fund, stock or other security for more than one year and the investment has appreciated, you can donate it as a gift and deduct the full market value of the investment on the date of the gift. For example, if you bought shares of a stock for $10 more than a year ago and those shares are now $20 each, you can donate two shares (or $40) to a charity, having only paid $20 out of pocket—and you won’t have to pay any taxes on your capital gains. Be sure to get a receipt from the organization you choose to donate to, as a cancelled check isn’t enough for the IRS.