When you start thinking about pumpkins, turkeys and holiday travel, it’s a good time to think about taxes, too. That’s because the moves you make between now and New Year’s Day can cut the income tax bill you might face on April 15.
“It’s a shame to leave money on the table when you can save a few dollars by planning now,” says David Sands, an income tax partner with Buchbinder Tunick and Co., a New York accounting firm. “You really should start by early in November.”
This is an especially important year for devising a year-end tax strategy, because many provisions and tax breaks expire or change after 2009. Here’s how to make sure you grab the goodies in time.
1. Know where you stand
Determine your marginal income tax rate and whether you will be subject to the alternative minimum tax for 2009. This knowledge will help you manage possible deductions to your best advantage.
To find your marginal tax bracket (the percentage you’ll pay on your last dollar of income, or save on the last dollar of a deduction), download the 2009 tax tables in a publication called IRS Revenue Procedure 08-66.
If you had to pay the alternative minimum tax (AMT) last year, there’s a good chance you will again this year. The AMT was originally designed to keep high-income people from avoiding taxes. But it’s triggered in 2009 for people earning more than $46,700 ($70,950 for married filing jointly).
Normally, taxpayers save themselves money by deferring income into the next tax year and accelerating deductions into the current year. But the high-rate AMT kicks in when you claim more than a certain amount of “tax preference” items—including state and local income taxes, property taxes, and personal exemptions for family members—for your income level. To avoid this tax, it could be to your advantage to declare more income in 2009 or delay some optional deductions until 2010.
2. Steer your assets clear of taxes
Unless you’re subject to the AMT, defer income whenever possible. That may mean asking the boss to hold your bonus check until January (if you’re lucky enough to get one in this tough year.) It also means acting soon to plow as much as possible into your 401(k), your deductible health savings account (HSA) and your traditional tax-deferred IRA, if you have one. You have until your taxes are due, typically April 15, to make your HSA and IRA contributions for 2009. In 2009, you can contribute as much as $5,000 to an IRA; you can make an additional $1,000 “catch-up” contribution if you are 50 or older.
Rethink your IRA distribution. If you’ve been taking mandatory minimum distributions from your tax-deferred retirement accounts, you’re allowed to skip them in 2009. That’s a one-year break that Washington gave retirees back a year ago when the ailing stock market had cracked their nest eggs. Mandatory distributions return in 2010. It’s generally good to avoid taking distributions you don’t need, as that allows you to continue deferring taxes and keeps the money invested longer. But if you’ve had a very low earnings year in 2009 and expect your tax rate to rise in future years, it would be better to take your regular distribution or even more this year and pay the lower tax rate, advises Sands.
If you’ve lost money on stocks or stock funds that you’ve held for more than a year, you can sell them and “harvest” the capital losses. You can use those losses to offset capital gains and up to $3,000 in ordinary income. And you probably will have capital gains this year, even if your stocks have fallen from their peak values and you haven’t sold anything. The broad stock market is up about 20 percent in 2009, and mutual funds by law must distribute their annual gains before the end of the year. You’ll probably receive that money as reinvested stock shares, but you will be taxed on it.
One more word to the wise: It’s usually a bad idea to make a new mutual fund purchase in November or December until after the fund has made its capital gains distributions for the year. If you buy in the day before the distribution, you have to declare it and pay taxes on it, even if you haven’t been in the fund long enough to enjoy the gains.
Consider converting your traditional IRA to a Roth. You contribute to a Roth IRA with money that has been taxed, and no tax is levied on the funds withdrawn, as long as they’re used for retirement. But Roths have been off limits to individuals and couples earning more than $100,000, and people who could contribute had to pay taxes right away on funds they were converting from a traditional IRA.
In 2010, both of those rules ease. Anyone can convert an IRA to a Roth, and the resulting tax burden can be spread over two years—2010 and 2011. Savers who think they want to make this move in 2010 can make one more contribution to their tax-deferred IRA in 2009, so that there’s more to transfer next year.
3. Make your spending tax-savvy
If you intend to buy a car, motorcycle, light truck or motor home, act before the year ends. Last winter’s stimulus bill included a tax deduction for the state and local sales and excise taxes you’d pay on a new vehicle costing up to $49,500. You’ll get a deduction even if you don’t itemize, as long as you earn less than $135,000 ($260,000 for couples filing jointly).
Also, a few hybrid vehicles made by Ford and Mercury still qualify for tax credits through March, says Robin Christian, a senior tax analyst with Thompson Reuters.
Of course, you may find it’s more economical to keep driving your old car, or to buy a used car that’s not eligible for the deduction.
Give your babysitter a bonus and see the dentist. “Employees can give themselves an extra raise” by making sure they use up every last dollar sitting in their company health care and dependent care spending accounts, advises William E. Massey, a senior tax analyst at Thomson Reuters. Typically, they have until Dec. 31 to spend the tax-deferred funds or forfeit them, though some employers offer a grace period until March 15 of the following year. Qualified health expenses usually include discretionary items like eyeglasses, dental visits and even over-the-counter medications. Dependent care funds can be used for children or an aging parent who is legally your dependent.
Get a tax credit for buying energy-efficient items like replacement windows, insulation and water heaters. The credit is for 30 percent of the purchase price, up to $1,500, and it’s available through 2010. To make sure your purchase qualifies, check the Department of Energy’s list.
Charitable gifts are tax-deductible, but that’s not much help to those of you who don’t itemize your deductions. In 2009, if you are 70 1/2 or older, you can distribute up to $100,000 directly from your tax-deferred IRA to a charity without paying tax on the distribution. That gift cannot additionally be claimed as a charitable tax deduction, however.
Make extra payments in 2009 for deductible expenses you ordinarily would pay early next year. Good candidates are your estimated state income tax payment, an extra mortgage payment, and your property tax bill.
Some expenses are deductible only if they exceed 2 percent of your adjusted gross income. Many tax advisers recommend “bunching” these deductions into every other year, to maximize their benefit. The IRS website has a list of allowed deductions—investment fees and expenses, safe deposit box rental fees, job-related expenses and more. That includes tax planning fees, too, so if you ask your accountant for a quick review of your taxes now, you can write those charges off, too.
Linda Stern is a freelance journalist who writes about taxes and other financial issues. She lives in Maryland.