Smooth The Wrinkles

Tax returns contain valuable information that can help develop better strategies for saving and investing.

Your Money

April 10, 2005|By Andrew Leckey

Out of sight, out of mind. Once you kiss your completed 2004 income tax return goodbye, it instantly becomes the last thing on your mind.

But that's not being smart about your personal saving and investing.

Your return holds valuable information that can help you formulate a more efficient financial strategy. Carefully examine every line, acknowledging mistakes and vowing not to repeat them.

Contrary to popular opinion, receiving a tax refund is not a good thing. You've basically received your money back without interest, which is not much of a deal. So if you overpaid in taxes last year, reduce the amount being withheld from your salary at work. Then make sure that change goes into effect.

"Don't accept that your W-2 will be correct just because your employer prepares it, because I find mistakes in them all the time," said Barbara Steinmetz, certified financial planner with Steinmetz Financial Planning in Burlingame, Calif.

"Always verify all changes that you've requested in your contributions to be absolutely sure that the payroll department actually made them."

Your 2004 compensation income is a starting point for lowering your 2005 taxable amount. An easy way to decrease that is by maximizing your contributions to your company 401(k) retirement plan. Make the adjustment now.

For this year, the maximum contribution to a 401(k) has been raised to $14,000, with an additional $4,000 if you're age 50 or older. Company matching can make this even sweeter.

In addition, the contribution to an individual retirement account has been raised to $4,000, with an additional $500 if you're 50 or older.

"If you pay your own business expenses as part of your employment and they are shown on your W-2, they are only deductible if you itemize," said Martin Nissenbaum, national director of personal income tax planning for Ernst & Young in New York. "You might ask your employer to reduce your salary and give you an expense account, because it will be more beneficial from a tax perspective."

Interest income is taxed as ordinary income in the taxpayer's bracket, while capital gains on stock are taxed at a rate of 15 percent (or 5 percent for those in the 10 percent or 15 percent tax brackets), noted Nissenbaum. So consider moving some investment money from your interest-bearing bank account into a dividend-generating stock such as a utility.

Keep track of all your investments and how they're performing. Many investors don't. Unload the underachievers that you think have weak prospects.

"Look at your 1099s and brokerage statements to see where your gains and losses were and decide if your investments are where you want to be," advised Maggie Doedtman, manager of tax training with H&R Block in Kansas City, Mo. "Capital gains are still taxed at a favorable rate, and you can use this to structure this year's sales."

Losses on assets owned for at least a year are considered long-term capital losses and are used to offset long-term gains. If your losses exceed your gains, you can apply up to $3,000 in losses each year to offset ordinary income. Losses above that annual limit can be carried into subsequent tax years.

This is an excellent time to re-evaluate your investment mix. For example, too much of your investment income might be taxable. Putting money into tax-exempt bonds now will have more impact on your tax bill than if you wait until a couple of months before the end of the year, as so many investors do.

Understand your investments from a tax perspective.

"Most people completely overlook the tax accounting for their mutual fund, whose dividends and capital gains are taxed even if they remain inside the fund," said Joseph Votava, CFP, CPA and tax attorney with Nixon Peabody LLP in Washington. "If you plan on selling, you'll need to add the capital gains and dividends reinvested by the fund to buy additional shares to the original price paid for the fund to come up with your cost basis."

There's a significant change for this year involving a popular charitable contribution.

"If you donate a car or boat or aircraft to charity, the amount of the contribution now depends on what the charity does with it," Nissenbaum said. "If the charity sells it, your deduction is what it was sold for, while if it keeps it for its own use, you receive a deduction for the car's fair market value."

Traditionally, it is a smart tax move to bunch your deductions. If you were close to being able to itemize for last year, consider accelerating payments this year to be sure to get deductions such as charitable contributions and medical expenses.

You should watch out for the alternative minimum tax, an extra tax that about 3 million Americans must pay on top of regular income tax. Intended to prevent high-income individuals from using special tax benefits to pay little or no tax, the AMT reaches more and more people each year. It generally affects taxpayers with incomes between $100,000 and $300,000.

"Some deductions are not allowed under the AMT," Votava said. "So if you find yourself subject to it, you'll want to reverse the typical tax planning of accelerating deductions and deferring income."

Andrew Leckey is a Tribune Media Services columnist.

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