Tax season is underway, but it may not be too late to lower your tax bill. There are still steps you can take to cut your taxes and increase your refund.
Small Life Changes Make a Big Difference
The first tip to lower your tax bill is this: realize that the IRS changes the tax code, and has rules that “phase in” or “phase out”. The IRS often has specials- almost like the special of the day at your favorite diner- that are temporary and have an expiration date. They also, as needed, amend the tax code and change it mid-year depending on the economic circumstances that are driving the need.
For instance, in 2008, the mileage allowance for reimbursement was 50.5 cents per mile from January 1, 2008 to June 31, 2008; but as gas prices skyrocketed; they changed to 58.5 cents per mile from July 1, 2008 through December 31,2008. Why is it important to understand this? People tend to think of their past experiences as a permanent condition. They also view things that have happened to their siblings or parents, in regard to income taxes, as permanent.
The tax code is a moving, changing document. For example, many people think,
“Well, I’ve never had enough to itemize, so I’ll just take the standard deduction again this year.” Because of that mind set, they may forget some of the components that go into the calculation and not realize that they could get extra tax savings because of a single event or number of small events.
For example, “Mary Jones,” 66 years old, carefully kept track of her medical expenses and taxes for several years. Each year, she would present them to her CPA, only to have him say that itemizing those expenses was a “waste of time,” and to take the standard deduction rather than to itemize. Mary didn’t consider the many things that had occurred since the last time she had tried to itemize when she was 62 years of age:
- At 62, she was working and earning more W-2 wages, so the 7.5% threshold that she had to beat in order for itemization to work was much greater. Now, Mary was retired, and had a part-time job.
- Also, her employer, at the time that she was fully employed, was paying 75% of her health insurance premiums. Since then, she had gone to the part-time job and had lost her employer-paid health insurance.
- She had enrolled in Medicare Part A and had enrolled in Medicare Part B, which was deducting $100 +/- per month from her Social Security check. She had also enrolled in Medicare Part D, which was also deducted from her Social Security. She didn’t write premium checks directly to companies, so she didn’t think of the dollars being deducted from her Social Security by the government as money she had spent.
- She had purchased long-term care insurance and several years later purchased a new car, carrying with it a steep excise tax.
- She had substantial increases in her home’s property tax and at her winter residence property tax, a small mobile home in a park in Florida. Overall, on examination, we realized that at age 66, Mary was over $1,300 above the standard deduction and had been missing substantial tax savings, because of what a CPA had told her four years previous! Moreover, she hadn’t thought about how many little things had changed in her life.
Tax Tip 1
Remember: the tax code constantly changes, so you can’t compare one year to the next. Those changes may represent an opportunity to reduce your tax bill. It is imperative to work with a financial advisor who takes a proactive approach to tax planning, rather than allowing the tax piece of the financial plan to be prepared elsewhere.Indeed, your tax preparation should be a part of your overall financial plan. A good financial advisor, aware of all the year-to-year changes to the tax code, can be your best resource, especially if that advisor offers professional tax preparation.
Tax Tip 2
CD interest penalties are deductible. That’s right; if you have been working with a financial advisor, and have decided on employment of a taxadvantaged investment strategy such as tax-free municipal bonds or tax deferrals in annuities or life insurance products, you may be contemplating moving money from a certificate of deposit or other savings accounts. Often, people delay changing the way their dollars are invested or stored, because there would be a penalty for early withdrawal. They don’t realize that part of that penalty would actually lower their income tax bill on the adjusted gross income: line 30, penalty for early withdrawal.
Tax Tip 3
Another commonly overlooked strategy by those who are near the limit on their itemized deductions is prepaying expenses that are deductible. For instance, if, in 2010, you were planning on spending approximately $10,000 on deductible expenses—health insurance, property taxes, charitable donations, excise taxes, or other itemized deductions—then you could prepay next year’s charitable contributions, next year’s health insurance, and in some cases, even next year’s property taxes. For example, if a person paid all of their 2010 and 2011 expenses at the end of calendar year 2010, $20,000 of paid expenses would allow them to itemize and take greater deductions. Then, in 2011, they would simply claim the standard deduction because they would have no expenses that were on the itemized list. They were prepaid in 2010. This strategy leaves a smart tax payer in an every-other-year posture—one year, double up, file the long form and itemize; the next year, claim standard deductions; the next year, double up and itemize; the next year, take the standard deduction. (In sequence: itemize-standard deduction-itemize-standard deduction.) For people with the proper cash flow and circumstances, this is an excellent strategy for tax savings.
Tax Tip 4
If you have a sizable estate 2012 may be a good year to give some of it away! Last year 2011 and this year 2012 the gifting limit while living is much larger than it’s been it many years, 5 Million Dollars ! Although in 2010 there was no “Death Tax” for any size estate there was still a 1 Million limit on gifting assets while alive. This year could be an advantageous year to set up a trust for grandchildren or to hand over interest in a closely held family business. Who knows, after 2012 what the “powers that be” will allow, but for sure in 2012 it’s a higher gifting amount without taxation than it’s been in a long, long time it’s not likely to stay this way.
Tax Tip 5
It is not uncommon for some taxpayers to not be in a tax bracket at all, because they have money in tax-free or tax-deferred vehicles, collect Social Security, and have low fixed expenses. Yet those people often still have some IRA monies. People under the age of 70 not required to take their RMDs are allowed to leave money in IRAs and simply enjoy being at the zero bracket. Those people, however, often could have taken hundreds, even thousands of dollars out of their IRAs or deferred accounts and continued to pay zero tax. If you’re working with a proactive financial advisor, they may suggest a “what if” tax return in the month of December to determine how much actual income you are going to be reporting. If there are a few hundred dollars or more left that you could earn and still pay zero tax, it makes sense to take those dollars from IRA and either rolls them into a Roth IRA, or simply re-categorize those assets, expose them to the possibility of taxation, avoid paying the tax, and restore them in any non-IRA.
Tax Tip 6
For those people with capital gains from sales of stock or from mutual fund distributions, many know that they can offset those gains with a loss, but few actually sit down and do the annual exercise. It is a good idea to meet with a financial advisor or broker to look at your losses. By selling those losing assets, you can offset your other investment gains and end up with an equivalent of no capital gains. Many people would rather not sell their underperforming assets, because they believe they’re about to “come back” and wouldn’t dare wait the 31-day waiting period to repurchase the same asset as an allowable purchase. However, many people don’t realize that an ETF (Exchanged Traded Fund) is in a different asset class than a mutual fund, and many ETFs are comprised of many of the same assets as their mutual fund counterparts. For instance, someone invested in the Vanguard S&P 500 mutual fund could sell that fund at a loss and buy the Vanguard S&P 500 ETF the next day without violating the 31-day rule. There are other nuances to changing asset classes that must be considered, but the point is clear: in December, compare your investment winners and losers and plan accordingly.
Tax Tip 7
De-characterization of Roth rollovers. Many people have converted monies from an IRA to a Roth IRA, and have also inherited taxable IRAs from a relative who has passed away. This leaves them exposed to an unintentional tax bill. If you rolled money to a Roth during the year, the IRS will allow you to “unroll” that Roth back to regular IRA under certain circumstances. So, don’t feel that because you’ve converted money to a Roth IRA, and then had another tax anomaly take place, that you’re stuck with that conversion. Once a year, you can “un-Roth” money back to an IRA to undo a taxable event.
Tax Tip 8
Another special tax deduction that has been extended to 2012 is the Capital Gains Tax Rate. Many people believe that the Capital Gains Tax Rate is 15%, because that’s what they paid the last time they sold an investment at a gain. For instance, if Mary sold stock in 1998, she may have paid 15% capital gains on the federal level, and then an additional tax on the state level, making it unattractive to sell other stocks with large gains. However, the Capital Gains Tax Rate is not 15%; it is on a sliding scale based upon what your actual personal tax rate is. In 2012, if you are in the 10% tax bracket, then you might be able to sell a stock or other appreciated asset and pay 0% capital gain. That’s right; the minimum Capital Gains Tax Rate for 2012 is zero. For many people who primarily have Social Security income, which is not taxable up to a certain income limit, and perhaps a small pension or IRA income stream, it is not uncommon for them to be in the 10% or 15% tax bracket. Those people could sell highly appreciated assets this year, and pay no capital gains tax whatsoever. Single taxpayers with no more than 34,500.00 and joint filers with up to 69,000.00 are getting a last chance to take some non taxable profits in 2012. ALSO don’t forget if you sell a stock at a gain there is NO 30 DAY RULE! You could repurchase the same stock the next day; the 30 day rule is if you take tax losses…NOT profits! Selling a profit but still paying no tax means a free step up in cost basis after 2012 it’s not likely there will be a zero capital gains rate again. Carpe Diem!!
Tax Tip 9
When you find an error in your tax work for a particular tax year, you may have more than just that year to worry about. If an error was made, it is often carried forward from previous years, so look at the previous year’s return as well. Even if there’s an error in your favor, amend those returns. Form 1040X can be used to go back up to three years. Many people are afraid to ask for errors to be corrected. Many taxpayers believe, irrationally, that the IRS will look for other things “to get even” for filing for an additional refund. This is simply not the case. If you underreported deductions, or over reported income and subsequently paid too much tax, the IRS is happy to refund from prior years.
Tax Tip 10
One thing that almost everyone you speak to agrees on is the fact that in the future, 2012 and beyond, Tax Brackets and Tax Rules and Laws are going to be changing and becoming more and more of an issue. If your financial planner, insurance planner or other trusted advice giver is not giving you advise from a Tax Perspective than you may want to reconsider your choices. The IRS placed in force new rules in 2009 that mandates tax prepares to take Continuing Education Courses and Pass Exams which before 2009 was not required. Also IRS “letter audits” are on the rise and the US is still in financial trouble. If your current advisor says, “Don’t let the tax Tail wag the dog “as a response to tax planning questions ….Fire Them ! They are side stepping a major factor on your future financial security!