By Kay Bell
Bankrate.com
It's time to play Santa again. This year, put yourself at the top of the tax gift list with these critical year-end moves.
Sure, you're busy right now. But by making some time for taxes before Dec. 31, you'll give yourself a gift that will pay off next year, too, when you file your Form 1040.
Many of the tactics are holiday tax perennials. A few are set to expire at year's end. And all could definitely bring you some much needed holiday and financial cheer.
1. Get in the giving mood. A gift to your favorite charity in December can produce happy tax returns, too. As long as you itemize, you can deduct your donations; this will reduce your taxable income and lower your tax bill.
You have until Dec. 31 to get the check in the mail. You also can put your pledge on your credit card by year's end. Using plastic also could help out holiday money management. Your charged donation will count for 2007 tax purposes, but you won't have to pay the bill until next year.
A few other points to remember in this end-of-year giving rush:
- Make sure the nonprofit has IRS approval. The agency keeps track in Publication 78, which you can search online.
- Get substantiation for your gift. It the IRS ever questions your claim, you must be able to produce a receipt or record (canceled check or charge card statement) verifying your donation of any amount, not just those of $250 or more.
- If you donate household goods, they must be in good or better condition or the IRS could later disallow the claim.
- Auto donations have special deduction rules, depending upon how the charity uses the vehicle. You should get a statement from the nonprofit detailing its plans for the vehicle and how much you can deduct.
You also can donate an asset that's appreciated in value but no longer fits your investment plan. As long as you've owned the asset for more than a year, the charity gets to use as it as needed and you get to deduct the asset's value with no capital gains taxes to worry about.
Older philanthropists also have another option this December. Individuals age 701⁄2 or older can transfer money, up to $100,000 for the 2007 tax year, from an IRA directly to an IRS-qualified charity. By using this approach, an eligible contributor can avoid taxes that normally would be collected on required minimum distributions from the IRA. Unless Congress acts in the next few weeks, this could be the last year that this donation method is available.
2. Assess your assets. Investors typically reassess their portfolios at the end of the year. Some, as discussed earlier, choose to donate appreciated assets. But others are looking to dump disappointing stocks, especially since an asset that has declined in value also offers tax advantages.
If you had a profitable investment year, you can reduce the associated tax cost by unloading any assets that have lost value and using that loss amount to offset capital gains. If you have more losers than gainers, you can use up to $3,000 of your capital losses to reduce your taxable ordinary income.
And if you have even larger losses, you can carry over the amount in excess of $3000 to future tax years. You also might consider hiring a new investment manager.
3. Let your home help you out. Homeownership offers many tax breaks, but you can boost them a bit in December.
Start with your next mortgage payment, due Jan. 1. This actually represents interest for the month of December, so if you accelerate a bit you'll get an additional deduction this tax year for the interest paid.
Some tax professionals say you can simply mail this extra mortgage payment by Dec. 31 and have it count. However, if you actually get your payment to the bank by the last business day of the year (or a day or two early), the extra interest will show up on the lender's official paperwork. That will eliminate any possible IRS questions about different amounts on your Schedule A and the Form 1098 that your lender will send you (and the IRS) early next year.
The same early payment approach also applies to deductible property taxes. If your county or municipal tax collector will take your payment (or part of it) in December, pay it now to accelerate the tax benefits.
4. Eliminate energy excesses. There's still time, but very little, to make some energy-efficient improvements to your house and get a tax gift from Uncle Sam for the effort.
For the last two years, homeowners have been able to claim tax credits under the Energy Tax Incentives Act of 2005. Credits, which reduce your tax bill dollar for dollar, range from $50 for the installation of a whole-house circulating fan to $2,000 for conversion to a solar water-heating system.
Many of the easiest improvements, such as adding insulation, applying window film or replacing drafty doors and windows, are capped; no more than $500 in credits can be claimed for 2006 and 2007 combined. Plus, this is the last year this credit is available.
If you haven't made any residential improvements yet this year or still have some room within the combined credit limit, check into what you can do by Dec. 31 to help improve your residential energy efficiency now and cut your tax bill in April.
5. Focus on fuel efficiency. Tax credits also are available for purchases of hybrid cars, ranging from $250 to $3,000, depending on the make and model. However, the credit phases out for the fuel-efficient vehicles once a carmaker sells 60,000 hybrids.
Honda hit that sales mark this fall, meaning that credits for all its hybrids will be cut in half on Jan. 1, 2008. So if you want one of these vehicles and the best tax benefit, act fast.
"This is an absolute must-do," says attorney Barbara Weltman, who also is an attorney and editor of various J.K. Lasser tax guides. "If you want a Honda hybrid, buy it in December so you'll get twice as much of a tax credit as you would in January."
It's already too late for fans of Toyota and its luxury nameplate, Lexus. The credits for that Japanese automaker's hybrids were eliminated on purchases after Oct. 1.
The IRS keeps a running list of the eligible vehicles and their available credits (or the elimination of them, www.irs.gov) in its "Summary of the Credit for Qualified Hybrid Vehicles."
There's an added tax bonus for all car buyers, regardless of whether you go for an environmentally friendly hybrid or a gas-guzzling sports car. If you itemize and opt to deduct sales taxes instead of income taxes, you can add the sales tax paid on your new wheels to the table deduction amount that the IRS provides.
6. Maximize medical expenses. Itemizing taxpayers can increase their deduction amount by claiming eligible medical and dental expenses. The big problem with this tax break is that the expense amount must exceed 7.5 percent of your adjusted gross income. That means, for example, a taxpayer earning $50,000 must accumulate medical costs that exceed $3,750.
If you're close to that limit, look at ways to get over the hurdle in the next few weeks. Have you been putting off elective surgery? Schedule the procedure before the year's end to bump up your medical bills to the deductibility threshold.
You also can count any dependent's medical treatment, as well as the installation costs of special, doctor-prescribed therapeutic equipment or medically necessary improvements to your home. And if you must travel for medical treatment, you can deduct the drive at 20 cents per mile for any trips this month (or the previous 11 months), along with any parking and toll costs you paid along the way.
7. Make more miscellaneous payments. While you're spending medical money, consider upping your miscellaneous payments. You can claim these costs, such as union or professional dues, job-related educational expenses and subscriptions to business publications, on your Schedule A, too.
But like the medical claims, miscellaneous costs also must meet a percentage of your adjusted income to count. In this case, it's 2 percent.
If you're near the threshold this December, prepay some of these expenses. Buy the uniform you were going to get in January, extend your business journal subscription another year, pay the registration fee for that job-related computer class you plan to take in February.
8. Keep an eye on the 'kiddie tax'. The so-called "kiddie tax" was designed to keep parents from placing assets in child's name to avoid higher taxes. Under the law, a youngster's first $850 of investment income is tax free; the next $850 is taxed as the youth's usually lower income (10 percent to15 percent) and capital gains tax rates (5 percent).
Earnings in 2007 of more than $1,700, however, are taxed at the parent's highest tax rate (15 percent on long-term capital gains and dividends; up to 35 percent on short-term gains and ordinary income) until the child reaches a certain age, at which time the youth's typically lower rate takes effect. For the last several years, lawmakers have been hiking the trigger age, thereby collecting more tax money from the parents to whom the holdings' tax consequences apply. And in 2008, even more families are going to face kiddie tax consequences.
"The kiddie tax age has been rising in recent years and in 2008 it will apply to children up through age 18 or fulltime students up to 23," says Bob D. Scharin, RIA senior tax analyst from Thomson Tax & Accounting.
If your youngster will be in that new kiddie tax age range next year, you might want to consider selling appreciated properties by Dec. 31. You don't have to sell all appreciated assets now, but do dispose of enough to safely keep next year's earnings below the earnings threshold, which goes up slightly, to $1,800.
"That way, the capital gains will be taxed at the child's own capital gains tax rate, probably 5 percent, rather than at the parents' rate," says Scharin.
9. Shop for your classroom. Teachers and other school employees can deduct up to $250 spent on materials to make the learning experience better for students. In addition to classroom teachers, this tax break can be claimed by teacher aides, counselors, even principals, as long as they work at least 900 hours in a public or private school for kids in kindergarten through grade 12.
Even better, the deduction is claimed directly on the long Form 1040. There's no Schedule A itemizing to worry about. All you've got to do is buy $250 worth of classroom supplies by Dec. 31.
Because the deduction amount is relatively small, most teachers probably have already reached the limit, says Scharin. But if you haven't, now's the time to do a little extra tax-break spending.
10. Ramp up retirement contributions. Give yourself a holiday gift of future financial security by starting or adding to retirement savings accounts. Some taxpayers could get a direct deduction on their next return. All who start or add to the account will begin building a nest egg sooner.
If you're eligible to participate in your company's 401(k) retirement plan and its rules allow you to enroll now, do it. If you're already contributing, think about upping the amount. The money you contribute reduces your taxable income, and that should help lower your eventual tax bill.
This strategy also applies if you work for yourself, either full-time or have a side business to supplement your salaried job. Dec. 31 is the last day you can open a Keogh or a solo 401(k) retirement plan. These savings vehicles are the self-employed equivalents of corporate retirement programs and will help whittle down the taxable amount you brought in via your own enterprise.
Even if your year-end retirement account contributions aren't enough to substantially cut your 2007 tax bill, adding to them now will definitely give you a head start on reducing next year's taxes.
Finally, remember that every tax situation is unique. While these 10 tax moves might help many filers, evaluate your financial and tax circumstances carefully before taking action. In some cases, it's possible that some tax moves might be more beneficial if postponed until 2008. Learn about such instances in the Bankrate feature "4 tax moves NOT to make in 2007" posted below.
Editor's Note: Freelance writer Kay Bell writes Bankrate's tax stories from her home in Austin, Texas. She also blogs about taxes at Bankrate's Taxes: Eye on the IRS and her personal blog, Don't Mess With Taxes.
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