End-of-year tax tips pay off

October 01, 2006|By Gail MarksJarvis | Gail MarksJarvis,Tribune Media Services

Now is the time of year to build a fortress around your hard-earned money so that Uncle Sam can't get across the moat when tax time rolls around in April.

Use what's commonly called year-end tax-planning, or forcing yourself to think ahead to tax time.

Once the end of the year passes, it's typically too late to act.

But if you think about your income now, here are some strategies that might make a difference:

Max out 401(k) and IRAs

For the average American, this is the easiest way to cut taxes fast. When you put money into a 401(k), 403(b) or other retirement savings plan at work, you reduce the income that will be taxed that year.

So put away as much as possible. You will benefit two ways: You will cut your taxes this year and build up a nest egg for your future.

This year, the government has raised the maximum people can contribute. While your employer might have somewhat different rules, the federal limit is $15,000 if you are under 50, or $20,000 if you are 50 and over.

You also can be more lavish with your individual retirement account savings if you are 50 and over. Under last year's rules you could stash away $4,500. Now it's up to $5,000, as long as your 50th birthday arrives before year-end.

If you are younger, you are stuck at the $4,000 maximum. But go for it, especially if you have no retirement savings plan at work. You can use a tax-deductible IRA to cut your taxes, and if you stash away $4,000 a year for 30 years and earn an 8 percent return on your money, you could have about $529,600 by retirement.

Before opening a traditional IRA, make sure you meet the rules. For example, if you have a retirement plan at work, top benefits for the IRA phase out when married couples have modified adjustable gross income between $75,000 and $85,000, or between $50,000 and $60,000 if single. For all the rules, check IRS Publication 590 at www.irs.gov.

If you have wanted to open a Roth IRA but have an income that is too high, new tax laws will help. You can open a non-deductible IRA this year and in later years. You won't receive any tax break now. But under a new law, when 2010 rolls around you can pay the taxes on any earnings you've had in that non-deductible IRA, convert it to a Roth IRA and never owe taxes again if you follow the rules.

For retirement savings, you have until April 15 to open a traditional IRA, non-deductible IRA or Roth IRA, but your 401(k) contributions must be made before the end of the year.

Give to charity

If you give money to charity, that's an easy deduction.

This year, however, you will have to be a little more orderly than in the past if you clean the house and give away clothing or household items.

Under new rules, you are going to need paperwork that shows the value of the items you are giving.

In addition, remember that if you donate a car, the value you can deduct depends upon what the charity receives when the organization sells it.

Don't forget that travel, or mileage, connected with your charitable activities can also be deducted, said Chicago certified public accountant Alan Witt.

For seniors who give to charity, there is a new rule that might help. For the first time this year, if you are at least 70 you can give as much as $100,000 in charitable contributions directly out of your IRA.

If you do this, the charitable contribution will be considered part of the distribution you would have normally been required to take from your IRA. So you might reduce the taxes you otherwise would have owed.

When you give this way, you cannot also claim a deduction for charity. But by using this new method of giving, you might position your income so you are more likely to be able to take advantage of other deductions, such as the deduction for medical expenses, said Sid Blum, a financial planner in Evanston, Ill.

Take investment losses and gains

No new rules are connected with gains and losses on investments such as stocks, bonds and mutual funds. But if you have a lousy investment, "now is the time to call on Uncle Sam to share in your pain," said Rande Spiegelman, vice president for personal finance for Charles Schwab.

If you have an investment that is worth less than when you bought it, you will secure a loss if you sell it. That loss can be used to reduce the impact of any gain you have had on a winning investment. If you have no gains to offset, you can use up to $3,000 of loss to reduce taxes on ordinary income this year. And if the loss exceeds $3,000, you can use the extra in future tax years.

Be careful buying mutual funds this time of year: You could be hit with a capital gains distribution. Spiegelman said distributions are probably going to be most noticeable this year in mid- and small-cap funds, energy funds and real estate funds. While you can't be sure about distributions in advance, Spiegelman said when in doubt, consider buying an index fund.

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