The average person avoids thinking about taxes until the April deadline approaches, when it's too late to make changes that can cut your bill.
As 2010 draws to a close it's not too late to take steps to decrease the amount you'll owe the Internal Revenue Service. Here are some tax-planning moves to consider now:
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1. Prepare a Preliminary Tax Return
Using your 2009 return as a guide, prepare a projected Form 1040. Start by estimating your adjusted gross income for 2010 and your allowable deductions. Determine if you will be able to itemize your deductions — do your eligible expenses exceed the standard deduction for your filing status? Lastly, figure out the tax bracket you'll likely fall into for 2010.
The standard deduction for married people filing jointly remains at $11,400 for 2010. The standard deduction for singles and married people filing separately is $5,700, and the amount for the head of a household increases to $8,400. The personal exemption is again $3,650.
2. Consider Postponing Your Income and Boosting Deductions
If you expect to be in the same tax bracket next year, or a lower one, try to put off collecting income until 2011 and rack up as many eligible deductions now instead of waiting until after the New Year. You'll have more expenses to deduct this year and less income to tax at the same or higher rate.
If your income is likely to increase next year and push you into a higher bracket, do the reverse and try to collect as much of your taxable income as possible in 2010 and postpone deductible expenses until 2011. Income received in 2010 will be taxed at a lower rate and deductions claimed in 2011 will provide greater tax savings.
3. Size Up Your Itemized Deductions
It doesn't pay to itemize your deductions unless the total exceeds the standard deduction for your filing status. If you think you'll be able to itemize your deductions on your 2010 Form 1040, try to incur as many deductible expenses as possible this year.
If you won't be able to itemize, postpone any payments that could be deductible until 2011. By deferring these expenses, you'll have more deductions to claim next year.
4. Pay Medical Bills Now
The timing of itemized deductions is especially important when it comes to medical expenses. You can deduct medical expenses only if they exceed 7.5% of your adjusted gross income. If your income totals $70,000 for 2010, you can't deduct the first $5,250 of your medical expenses. If your costs total $6,000, you can claim $750.
In this scenario, if your medical expenses are more than $5,250 and you have enough deductions to itemize, pay your outstanding medical bills before 2011 begins. If your medical expenses are less than $5,250, put off paying any medical bills until 2011.
5. Use Your Credit Card
If you don't have the cash to pay for deductible expenses, consider using a credit card to pay for the items so you can get the deduction for 2010. Eligible expenses charged to bank-issued credit cards are deductible in the year charged, not the year you actually pay it.
However, it's a different story for store-issued cards. If you use a store-sponsored card to buy deductible items at a department store, such as Macy's or Sears, the expenses can't be deducted until the actual charge is paid. So stick to bank cards for end-of-year purchases.
6. Review Your Investments
Look at the investments (including real estate) you sold this year and add up your gains and losses. Separate the totals for your short-term positions (owned for one year or less) and long-term holdings (more than one year). Gains and losses from the sale of inherited property are always considered long-term. Capital-gains distributions received from mutual funds are also classified as long-term.
Do a similar calculation for unrealized "paper" gains and losses for investments you still hold. Consider selling losing investments before the year ends to wipe out any taxable gains. Consider unloading holdings at a profit if your losses exceed the $3,000 maximum current deduction.
7. Consider Mutual Fund Dividends (If Not This Year, Then Next Year)
The law requires mutual funds to distribute net gains from security sales to their shareholders. During the fourth quarter, fund managers calculate their net gains for the year and distribute it through dividends to shareholders. The shareholders will pay federal and state income taxes at the special capital gain rates on these distributions. After a distribution is made, the value of the fund's shares drops.
If you buy shares of a fund for $10,000 on Dec. 1 and the fund issues a $1,000 capital gain dividend on Dec. 15, your shares will be worth $9,000 on Dec. 16. You had no real gain or income, but you must pay tax on the $1,000 distribution.
If you want to purchase fund shares during the final months of the year, wait until after the distribution is issued and the fund's value drops. It might be too late for you to address your mutual fund dividends this year, but it's something to keep in mind for next year.
8. Don't Forget the Alternative Minimum Tax
While these strategies may reduce your "regular" taxes, they may backfire if you're subject to the dreaded Alternative Minimum Tax (AMT).
For those who qualify for the AMT, medical expenses are only deductible if they exceed 10% (not 7.5%) of your adjusted gross income. Taxes, investment and job-related expenses aren't deductible at all. If you usually pay the "regular" tax but anticipate having to pay the AMT for 2010, consider postponing any potentially deductible expenses until 2011, when you may not be subject to the AMT.
The AMT rates are 26% or 28%. If for 2010 you are in the 28% or higher bracket for "regular" taxes and you will pay AMT at the 26% rate, you may want to claim as collect income as possible 2010. The additional income will be taxed at 26%.
As you consider these tax planning tips, keep in mind that certain strategies will help some people more than others. It is a good idea to discuss your year-end plans with your accountant before taking action.
And remember: Your first criteria for evaluating any financial transaction should always be economic — taxes are second.
- adjusted gross income