For 2010, don't make the mistake of waiting until the end of the year (or tax-filing time) to see what can be done to lower taxes. The following article, the last of a three-part series, discusses everyday actions that taxpayers can take to lower their annual tax bill. See our previous blog postings for parts one and two of this series.
71 Ways to Save on Taxes Now
by Mary Beth Franklin, Senior Editor, Kiplinger's Personal Finance
provided by Kiplinger.com
PART 3 of 3
Don't wait until you file your return to find ways to lower your tax bill. These moves will help you save throughout the year.
Take advantage of tax-free rental income.
You may not think of yourself as a landlord, but if you live in an area that hosts an event that draws a crowd (a Super Bowl, say, or the presidential inauguration), renting out your home temporarily could make you a bundle -- tax-free -- while getting you out of town when tourists overrun the place. A special provision in the law lets you rent a home for up to 14 days a year without having to report a dime of the money you receive as income.
Home buyer's Bible.
Be a packrat with paperwork. Some costs associated with buying a new home affect your "tax basis," the amount from which you'll figure your profit when you sell; others can be deducted in the year of the purchase, including any points you pay (or the seller pays for you) to get a mortgage and any property taxes paid by the seller in advance for time you actually own the home.
Home seller's Bible.
Costs associated with selling -- from the real estate commission to points paid for a seller to property taxes paid in advance for time the buyer actually owns the home -- all reduce your profit on the deal. Sure, most home-sale profit is tax-free these days, but keep track of big basis-boosting improvements in case you get close to the limit.
Pinpoint the "stepped-up" basis of property you inherit.
In most cases, the tax basis of inherited property -- that's the value from which you will figure gain or loss when you sell -- is "stepped up" to the value on the day the previous owner dies. Tax on all appreciation during his or her lifetime is forgiven. Although the estate tax and stepped-up rules on inherited property expired at the end of 2009, Kiplinger’s believes Congress will reinstate the $3.5 million estate tax exclusion and step-up rules retroactive to January 1, 2010. If you inherit assets in 2010, be sure you pinpoint your basis so you don't overpay your tax later. Taxpayers who know about this break save billions of dollars each year.
Don't buy a tax bill.
Before you invest in a mutual fund near the end of the year, check to see when the fund will distribute dividends. On that day, the value of shares will fall by the amount paid out. Buy just before the payout and the dividend will effectively rebate part of your purchase price, but you'll owe tax on the amount. Buy after the payout and you'll get a lower price, and no tax bill.
Check the calendar before you sell.
You must own an investment for more than one year for profit to qualify as a long-term gain and enjoy preferential tax rates. The "holding period" starts on the day after you buy a stock, mutual fund or other asset and ends on the day you sell it.
Keep a running tally of your basis.
For assets you buy, your "tax basis" is basically how much you have invested. It's the amount from which gain or loss is figured when you sell. If you use dividends to purchase additional shares, each purchase adds to your basis. If a stock splits or you receive a return-of-capital distribution, your basis changes. Only by carefully tracking your basis can you protect yourself from overpaying taxes on your profits when you sell.
Mine your portfolio for tax savings.
Investors have significant control over their tax liability. As you near the end of the year, tote up gains and losses on sales to date and review your portfolio for paper gains and losses. If you have a net loss so far, you have an opportunity to take some profit tax free. Alternatively, a net profit on previous sales can be offset by realizing losses on sales before the end of the year. (This strategy applies only to assets held in taxable accounts, not tax-deferred retirement accounts such as IRAs or 401(k) plans).
Tell your broker which shares to sell.
Doing so gives you more control over the tax consequences when you sell stock. If you fail to specifically identify the shares to be sold, the tax law's FIFO (first-in-first-out) rule comes into play and the shares you've owned the longest (and perhaps the ones with the biggest gain) are considered to be sold. With mutual funds, an "average basis" can be used when determining gain or loss; but that alternative isn't available for stocks.
Avoid the wash sale rule.
If you sell a stock, bond or mutual fund for a loss and then buy back the identical security within 30 days, you can't claim the loss on your tax return. The IRS considers the transaction a wash, since your economic situation really hasn't changed. It's easy to avoid being stung by the "wash sale" rule, though. Watch the calendar or, buy similar but not identical securities.
Ask your broker for a favor.
The law allows investors to deduct a loss on a worthless security, but only if you can prove the stock is absolutely worthless. If you own stock you're sure isn't coming back, ask your broker to buy it from you for a nominal amount. You can then report the sale and claim your loss.
Think twice about selling stock for a profit if you're subject to the AMT.
Although long-term capital gains benefit from the same 15% maximum rate under both the regular tax rules and the alternative minimum tax, a capital gain can effectively cost more than 15% in AMT-land. The special AMT exemption is phased out as income rises so, for example, a $1,000 capital gain can wipe out $250 of the exemption, effectively exposing $1,250 to tax. That means your tax bill rises by more than $150 for that $1,000 gain.
Pay tax sooner rather than later on restricted stock.
If you receive restricted stock as a fringe benefit, considering making what's called an 83(b) election. That lets you pay tax immediately on the value of the stock rather than waiting until the restrictions disappear when the stock "vests." Why pay tax sooner rather than later? Because you pay tax on the value at the time you get the stock, which could be far less than the value at the time it vests. Tax on any appreciation that occurs in between then qualifies for favorable capital gains treatment. Don't dally: You only have 30 days after receiving the stock to make the election.
Minimize the bite of the "kiddie tax."
The rule that taxes a child's income at the parents' rate now covers children up to age 19, or up to age 24 if the child is a full-time student. You can minimize the damage by steering a child's investments into tax-free municipal bonds or growth stocks that won't be sold until the child turns 19, or 24 for full-time students.
Consider tax-free bonds.
It's easy to figure whether you'll come out ahead with taxable or tax-free bonds. Simply divide the tax-free yield by 1 minus your federal tax bracket to find the "taxable-equivalent yield." If you're in the 33% bracket, your divisor would be 0.67 (1 - 0.33). So, a tax-free bond paying 5% would be worth as much to you as a taxable bond paying 7.46% (5 Ã· 0.67). A bond swap may pay off. It's a fact of life: As market interest rates rise, bond values fall. If you have bond that have lost value, consider a bond swap. You sell your losers, cash in the tax loss and invest the proceeds in higher-yielding bonds to maintain your income stream.
Use Treasury bills to defer taxes.
Interest on three- and six-month Treasury bills is taxed in the year it is paid. So, buying a T-bill that matures in 2011 means you don't have to report the income until you file your 2011 return in 2012. Remember, Treasury interest is completely exempt from state or local taxes, too.
Death and taxes.
Someone who is terminally ill may want to sell investments that show a paper loss. Otherwise, the "tax basis" of the property -- the value from which the heir will figure gain or loss when he or she sells -- will be "stepped-down" to date-of-death value, preventing anyone from claiming the loss. If you want to keep property, such as a vacation home, in the family, consider selling to a family member. You get no loss deduction, but it could save the buyer taxes later on.
Time claiming Social Security benefits.
If you stop working, you can claim benefits as early as age 62. But note that each year you delay -- until age 70 -- promises higher benefits for the rest of your life. And, delaying benefits means postponing the time you'll owe tax on them.
Dodge a 50% tax penalty.
Taxpayers older than 70½ are required to take minimum withdrawals from their IRAs each year. Failing to do so, subjects them to one of the toughest penalties in the tax law: the IRS claims 50% of the amount that should have come out of the account. Your IRA sponsor can help pinpoint the amount of the required payout. is available More on the ins and outs of the minimum withdrawals.
Keep careful records of the cost of medically necessary improvements.
To the extent that such costs -- for adding a wheelchair ramp, for example, lowering counters or widening a doorway or installing hand controls for a car -- exceed any added value to your home or vehicle, that amount can be included in your deductible medical expenses.
Include travel expenses in medical deductions.
In addition to the cost of getting to and from the doctor, you can deduct up to $50 a night for lodging if seeking medical care requires you to be away from home overnight. The $50 is per person, so if you travel with a sick child to get medical care, you can deduct $100 a day. As with other medical expenses, you get a tax benefit only to the extent your expenses exceed 7.5% of adjusted gross income.
Crank in the value of deducting long-term-care premiums.
As you shop for long-term care insurance, remember that a portion of the cost is deductible. The older you are, the more you can write off. For employees, this is a medical expense which means it only saves money if your medical expenses exceed 7.5% of your adjusted gross income. If you're self-employed, you avoid the 7.5% haircut and get this deduction even if you don't itemize.
Double your family's estate tax break.
If yours is among the minority of families that has to worry about the federal estate tax, realize that planning ahead can save your heirs a fortune. A simple plan employing what's called a "by-pass trust", for example, can double from $3.5 million to $7 million the amount you can pass tax-free to the next generation. Although the estate tax and stepped-up rules on inherited property expired at the end of 2009, Kiplinger’s believes Congress will reinstate the $3.5 million estate tax exclusion and step-up rules retroactive to January 1, 2010
Give it away.
Money you give away during your lifetime won't be in your estate to be taxed at your death. That's one reason there's also a federal gift tax. The law allows you to give up to $13,000 to any number of people in 2010 without worrying about the gift tax. If your spouse agrees not to give anything to the same person, you can give $26,000 a year to each individual. If you have four married kids, for example, and you give $26,000 to all eight children and in-laws, you can shift $208,000 out of your estate gift-tax free each year.
Choose the right kind of business.
Beyond choosing what business to go into, you also have to decide on the best form for your business: a sole proprietorship, a subchapter S corporation, a C-corp or a limited-liability company (LLC). Your choice will have a major impact on your taxes. Hire your children. If you have an unincorporated business, hiring your children can have real tax advantages. You can deduct what you pay them, thus shifting income from your tax bracket to theirs. Since wages are earned income, the "kiddie tax" does not apply. And, if the child is under age 18, he or she does not have to pay Social Security tax on the earnings. One more advantage: the earnings can serve as a basis for an IRA contribution.
Watch start-up costs.
Generally, the costs of starting up a new business must be amortized, that is, deducted over years in the future. But you can deduct up to $5,000 of start-up costs in the year you incur them, when the tax savings could prove particularly helpful.
Avoid the hobby-loss rules.
There's a heads-the-IRS-wins-tails-you-lose rule if the IRS determines your activity is a hobby rather than a for-profit business. You still have to report any earnings as income, but there are restrictions on deducting expenses and you can't deduct a loss. To avoid this problem, run your activity in a business-like manner, including having a separate bank account and having business cards printed.
Time receipt of self-employment income.
Those who run their own businesses have a lot of flexibility at year-end. To push the receipt of income into the following year , delay mailing bills to clients until late in December that payment is received after December 31. Or, pay business expenses before January 1 to lock in deductions.
Don't be afraid of home-office rules.
If you use part of your home regularly and exclusively for your business, you can qualify to deduct as home-office expenses some costs that are otherwise considered personal expenses, including part of your utility bills, insurance premiums and home maintenance costs. Some home-business operators steer away from these breaks for fear of an audit. But if you deserve them, claim them.
Cut compensation, boost dividends.
Principals in closely held businesses may want to shift part of their compensation from salary (which is taxed in their top bracket) to dividends (which is taxed at a maximum 15% rate). This can pay off if the corporation is in a low tax bracket, so the loss of the deduction for dividends paid is more than offset by the owner's savings.
Stash cash in a self-employed retirement account.
If you have your own business, you have several choices of tax-favored retirement accounts, including Simplified Employee Pensions (SEPs) and individual 401(k)s. Contributions cut your tax bill now while earnings grow tax-deferred for your retirement.
Pay estimated taxes ... or not.
If you receive significant income not subject to withholding -- from self-employment or investments, for example -- you probably need to make quarterly estimated tax payments to avoid an IRS penalty. But, if withholding will equal 100% of your 2009 income tax bill (or 110% if your income was over $150,000), you don't need to make estimated payments ... no matter how much extra income you make in 2010.
Take Uncle Sam shopping for your new business vehicle.
It may not be the greenest of strategies, but if you need a new vehicle for your business, realize that Congress offers special tax incentives if you buy a heavy sports-utility vehicle or a pick-up. While the first-year write-off for most business cars is limited to around $12,000, you can "expense" much more if you buy a heavy SUV or pick-up truck for your business.
Buy a hybrid, take Uncle Sam for a ride.
You can drive away with a tax credit if you buy a gasoline/electric hybrid or qualifying clean diesel vehicle in 2010. The size of the credit depends on how fuel-stingy your new car is, but the tax savings can range from several hundred to over $3,000.
Brummet & Olsen, LLP is ready to help you with your tax situation. Please feel free to contact our office at (630) 986-0540 to set up an appointment to discuss your particular circumstances.