It's not too late to reduce your tax bill

December 06, 1992|By Randy Smith | Randy Smith,Knight-Ridder News Service

PHILADELPHIA — Philadelphia--Quick, the tax man cometh.

No use wringing your hands in January over steps you could have taken this year to shelter income from the Internal Revenue Service's bite.

If you haven't already done it, now's the time for tax planning to maximize deductions and pay no more than necessary.

The timing of income and expenses, contributions to retirement plans and charity and how you manage investments can substantially affect your tax bill. And tax planning could be especially important this year, given the likelihood that Congress will increase taxes next year.

President-elect Clinton, for example, is proposing to raise tax rates to 36 percent, from 31 percent, for families making more than $200,000 and individuals making over $150,000.

People who can choose when they receive bonuses or other income "should consider accelerating income into 1992 to take advantage of potentially lower tax rates," the Coopers & Lybrand accounting firm said in a post-election analysis. Deductions "should be delayed until next year, when they have the potential to achieve greater tax savings."

To be sure, the wealthy, corporate executives and business owners have more to gain from tax planning.

Most people can't control when they get the bulk of their income -- salary, bank interest or stock dividends. It all adds to the current tax bill, due April 15.

Still, middle-income families can take steps to lighten the burden.

It could be as simple as making contributions to a 401(k) retirement plan or tax-deductible Individual Retirement Account, which reduce taxable income. Bunching uninsured medical bills

into a single year could help meet the IRS' stiff threshold for allowing deductions.

Or it could involve selling bad investments this year to create a loss that will balance taxable gains on other investments.

Starting this late in the year limits the benefits of tax planning, most of which accrue over time.

"The biggest mistake people make is waiting until the end of the year," said Paul Montgomery, a financial planner at Montgomery Associates in Exton, Pa. "They should start planning early in the year, when they're filling out tax returns for the previous year and records are handy."

Mr. Montgomery recommends reviewing taxes every three months.

Here are some effective ways to reduce taxes:

* Retirement plans.

Contributions to 401(k) plans are deducted from salary before taxes, so they reduce taxable income. Employees can contribute up to 20 percent of gross pay, up to a maximum of $8,728 in Suppose a person making $45,000 in taxable income contributes 10 percent, or $4,500, to a 401(k) plan. The contribution reduces current taxes by $1,260, based on a 28 percent tax rate.

It's a cheap way to save. Every $100 contribution reduces your withholding by $28, so net pay drops by $72.

But many eligible people say they can't afford to contribute. They get no tax benefits and risk shortchanging their retirement.

The solution could be to start small. "Start with 2 percent and Bease it up each year. When you get a raise, dedicate it to the 401 (k)," said Judith Lau, president of Lau & Associates, a Wilmington, Pa., financial planning firm.

* State and local taxes. You can deduct all state and local income taxes this year by paying them before Dec. 31. Pay in advance taxes due on non-wage income, such as interest, rather than paying them early next year.

* Medical and miscellaneous deductions. Strict limits make it tough for most people to claim these deductions. You can deduct only the portion of uninsured medical expenses exceeding 7.5 percent of adjusted gross income. Miscellaneous expenses must exceed 2 percent.

Suppose you have heavy medical or dental expenses this year that are likely to meet the 7.5 percent threshold. If so, any additional expenses this year would be tax deductible.

"Pay off the kid's orthodontist and schedule any planned medical work or surgery before December 31, so you'll get the deduction," Mr. Montgomery said.

By bunching two years' expenses into a calendar year, you're less likely to waste deductions.

The same is true for miscellaneous expenses. Be sure to deduct unreimbursed employee business expenses, such as a vehicle mileage allowance that doesn't fully cover operating costs.

* Balance capital gains and losses. If you sold investments this year, you don't want to end up with a big taxable gain. Nor do you want big losses, since you can deduct only $3,000 of losses from ordinary income in any one year.

"You always want to match gains and losses," said Michael Kennedy, tax partner-in-charge at Coopers & Lybrand.

If you own stocks that are performing poorly, you could sell them at a loss to balance gains on other investments. Similarly, investors with losses are usually better off taking an offsetting gain by Dec. 31, Mr. Kennedy said. You can buy back the stock, but you must wait 30 days to avoid losing the deduction.

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