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End of Year Tax Planning

Plan now for the coming tax filing season and it will save you time and money. There are three sets of actions you can do to improve your tax situation before the end of the current year. You need to reduce your taxable income, maximize your allowable credits and minimize the bottom line payment if you will owe.

Reduce your taxable income

The first thing is to identify actions that will reduce you taxable income. In no way does this mean hiding income or creating deductions. You want to find actions that will move income to future years, move carryovers forward from prior years, or increase adjustments and deductions.

  • If you have a 401K at work or have an IRA, consider moving excess emergency funds or tighten your budget so you can make some contributions by the end of the year and defer some income to futures year or with a Roth IRA avoid the income altogether.
  • Take advantage of your employer’s flexible spending account to pay medical expenses with before tax dollars. Usually there is an enrollment period, so this may be an item for next year. If you would have had the expenses anyway, you can pay them with pre-tax dollars.
  • Look at your prior year returns and be sure to gather any carryover capital losses, itemized deduction contribution limit carryovers, Net Operating losses carry forward and other items you were not able to take because of IRS limits, but allow you to take in future years.
  • If you are saving for a child’s college education, consider contributing to a state sponsored Section 529 plan where the state will give a deduction for contributions usually up to $2,000.
  • If you are investing in bond mutual funds, consider funds where a high percentage of Municipal Bonds are from your state. Muni Bonds are not taxable on a federal return, but most states require you to add back interest from bonds that are not their state. Look for funds with a high percentage of funds from your state.
Maximize your allowable credits

Credits are reductions to your tax liability and can be big tax saving items. The stimulus bills congress passed in the last few years opened up some new credits and expanded others.

  • The education credit was expanded so you can get up to 40% of the American Opportunity credit refundable. This means you don’t need to owe taxes to get it. If you thought you could only get the credit for the first two years that also changed. Review this valuable credit for this tax year.
  • Review your stockbroker’s statement looking for foreign taxes paid. The taxes paid to another country can be taken as a credit against your United States tax liability.
  • If you purchased a vehicle which qualified for various electric car credits, gather the manufactures papers you received when you purchased to include with your tax papers and as a reminder to take this significant credit.
Minimize or eliminate your final taxes owed

Now that you’ve done everything you can to reduce your taxable income and maximize your credits, you need to access if you will still have a balance owned. One key reason to do this is if you have not paid enough estimated taxes or had sufficient withholding, you may owe penalties. Also you will have to come up with cash and it may come at a time when you have to borrow to pay or go into what I call a ‘Tax Man Loan’. More on that later.

If you do end up owning more than 10% of your tax liability, find a way to pay some of it down by the extension date. First before the original tax due date; file an extension to avoid a 5% a month penalty for not filing and paying. Pay any amount you can with the extension and every month until the extension due date. You can do it online or by sending in funds with the extension. Every dollar you pay on your account will reduce the large amount later and reduces any interest and penalty especially if you have not paid at least 90% of your total tax liability. If all of this still has left you with a big tax bill, you will be into a big ‘Tax Man Loan’. This is when you are paying interest and penalties at ½ percent and 5% percent a month while your account has a balance.

If you have done your planning and you have a refund coming, you’ll want to file as soon as you can. The moment you get your W2 or other tax documents you’ll be ready. With the almost immediate receipt of a refund with direct deposit, you will have the cash you need. Bottom line is as someone has said something like - Plan to succeed so you do not succeed at failing.

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