The best time to think about saving on your taxes is when taxes are the last thing you want to think about.
That, my friend, is right now. Your 2003 tax return contains valuable information for designing a serious plan for saving on taxes during 2004.
It also provides the opportunity to admit your mistakes and learn from them.
Don't you feel like a bigger person already?
That return won't help you one bit if it's stuck in a desk drawer, a folder or a shoe box and forgotten until early next year, when it's too late to do anything about your situation except moan and groan.
Carefully go down each line of your completed return. First, look to see if you overpaid in taxes. If you did overpay, change how much is being withheld from your salary at work. Getting a refund isn't a good deal at all: You're getting your own money back without interest.
"Some people say their refund pays their property taxes, but it's better to save instead and take control," said Barbara Steinmetz, certified financial planner with Steinmetz Financial Planning in Burlingame, Calif. "If in one unusual year you don't get a refund, how will you pay your property taxes then?"
Your compensation income also is important because it helps determine what you can do to lower the taxable amount for 2004.
A great way to decrease that amount is to maximize your contributions to your company 401(k) plan. In 2004, the maximum is $13,000, up from $12,000 in 2003. There's another $3,000 allowable if you're going to be age 50 by the end of the year, and that amount is up from $2,000 last year. Make those adjustments now, not later.
"If you're an executive employee, ask your company about entering into a non-qualified deferred compensation arrangement in order to defer some of your compensation to future years and avoid current tax," said Martin Nissenbaum, national director of personal income tax planning for Ernst & Young in New York.
Reconsider your entire investment mix. For example, putting money in tax-exempt bonds now will have much more impact on your tax bill than if you wait until a couple of months before year's end, as many investors do. Then it's too little, too late.
Interest income is taxed as ordinary income subject to tax rates of up to 35 percent, while qualified stock dividends are taxed at a maximum rate of 15 percent. That change took place retroactively at the beginning of last year. However, the many people who didn't adjust investment portfolios to take advantage of the lower dividend rate should do so right now, Nissenbaum advised.
"The first thing I always look at is capital loss carryovers, which many clients don't bother to think about until November, when they're deciding whether to sell a stock before year end," said Steve Pierson, tax partner with BDO Seidman LLP in Chicago. "Consider it earlier in the year, since that same stock might have been higher in value or peaked at some point, and as a result you could have made a much better investment decision."
Capital losses are used first to offset capital gains. If there are no capital gains, or capital losses are larger than the capital gains, you can deduct the capital loss against your other income up to a limit of $3,000 in one year. If your overall capital loss is more than $3,000, the excess carries over to the next year.
The modest capital gains rate of 15 percent (or 5 percent for those in the 10 percent or 15 percent tax brackets) provides a great opportunity if you have a stock that's going up in value and you need to liquidate some investments, Pierson noted.
Envision what you'd like your 2004 tax return to look like. Are you anticipating higher income from another source? Would you be better off taking some losses? Act accordingly.
"Think about bunching your deductions," advised Maggie Doedtman, senior tax research and training specialist with H&R Block in Kansas City, Mo. "If you were close to being able to itemize in 2003, think about accelerating payments in 2004 to get deductions such as charitable contributions and medical expenses into this year."
If you're considering exercising incentive stock options this year, do a projection to see whether it would throw you into the alternative minimum tax, Doedtman warned.
The alternative minimum tax is an extra tax some Americans must pay on top of regular income tax. Although intended to prevent high-income individuals from using tax benefits to pay little or no tax, each year the alternative minimum tax reaches more people. Congress is studying ways to correct this, but for now you must do your homework to see whether it may affect you this year.
Andrew Leckey is a Tribune Media Services columnist.