There's time to make sure your 2003 tax refund is larger

PERSONAL FINANCE

November 23, 2003|By EILEEN AMBROSE

EIGHT MILLION more taxpayers are expected to receive refunds this tax season. And the news gets better: The average refund for those filing by April will be 29 percent higher.

That's according to TaxBrain, an online tax service, which estimates that 108 million federal tax returns will qualify for refunds for 2003 returns. The average refund will be $2,552, up from $1,974 on 2002 returns.

The main reason is the tax law signed in May. It reduced income tax rates retroactive to January, but the tables used by employers to withhold taxes from paychecks weren't changed until July, experts said.

So, unless workers adjusted their withholdings to reflect the changes, they overpaid taxes for the first six months of the year.

"The biggest windfall will be those going from 27 percent [tax rate] down to 15 percent," said Eric Hayes, a senior tax analyst with TaxBrain, who estimates that 10 millions households fit that description.

You can sit back, file next year and wait for your refund, or try to do better. There's still time before the year's up to squeeze in deductions or make adjustments to bump up your refund.

The typical year-end tax strategy is to defer income and accelerate deductions. For example, ask an employer to postpone a bonus into the new year, or pay estimated state income taxes in December instead of January and deduct them on 2003's return.

This is still good advice, but filers should be aware that some of the steps to reduce taxes can backfire and trigger the alternative minimum tax, or AMT.

If you haven't heard of the AMT, you could be in for an ugly surprise. Basically, you pay regular income tax or AMT, whichever brings in more money for Uncle Sam. AMT was designed decades ago to trap the rich who avoided taxes through lots of deductions, but more middle-income families are being ensnared because the tax wasn't adjusted for inflation.

And with regular income tax rates falling while the AMT's rates stay the same, the chance of coming under AMT increases, said James McGrath, a financial planner for Financial Strategies in Rockville.

"The AMT is going to bite more people," said McGrath, who suggests filers do a rough calculation first to figure if AMT might be a problem.

The AMT formula doesn't allow the same deductions as regular income tax. For example, AMT doesn't allow deductions for state taxes.

If AMT isn't a concern, here are strategies to reduce taxes:

Retirement accounts. Contributing to a 401(k) or similar plan reduces taxable income because money goes into the plan before taxes are paid on it.

Contribution limits to 401(k)s rose this year, so if you haven't increased your savings, there's time to put away more and keep taxes down.

This year, younger workers can contribute up to $12,000 in a 401(k). Those 50 and older can salt away up to $14,000.

If you're not covered by a retirement plan at work or you meet certain income limits, you're eligible for a traditional individual retirement account that allows you to deduct contributions. The maximum contribution for IRAs this year is $3,000 for younger workers, and $3,500 for those 50 and older. IRA contributions for 2003 can be made up until April 15th.

IRA conversions. With a traditional IRA, you will pay ordinary income tax on withdrawals. With a Roth IRA, money goes in after taxes are paid on it, but earnings can be withdrawn tax-free in retirement. With the drop in income tax rates, it's a good time to convert a traditional IRA to a Roth, said Bob Scharin, editor of RIA's Practical Tax Strategies . To convert to a Roth, your income must be lower than $100,000, he said.

Capital gains. Taxes shouldn't dictate what's in your portfolio. But if you're thinking of dumping losers or taking profits by selling winners, there are tax benefits to doing it now.

You can offset capital gains recognized from investments with losses. If losses exceed gains, you can deduct up to $3,000 against ordinary income. Any extra losses can be deducted in future years.

The tax law this year reduced the rate for long-term capital gains - investments held longer than a year- from 20 percent to 15 percent for those in higher tax brackets. The rate dropped to 5 percent for those in the 10 and 15 percent brackets. These rates apply to investments sold after May 5.

Another way to take advantage of lower rates is to give appreciated securities to children or elderly parents with low incomes, Scharin said. They can sell the securities and be taxed at the 5 percent rate. But if a child is under 14 at the time the securities are sold, he or she will be taxed at the parents' rate.

Teaching supplies. Recognizing that teachers often pay for school supplies out of their own pocket, Congress created a small tax break for them. Teachers from kindergarten through high school can deduct up to $250 spent this year on books and supplies, and they don't have to itemize to get the deduction, said Scharin.

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