Here are several ways to reduce 2007 tax bill

From avoiding the alternative minimum tax to reducing capital gains

Your Money

February 25, 2007|By Gail MarksJarvis | Gail MarksJarvis,Your Money

What's done is done. It cannot be undone until tax time next year.

So if you aren't liking the way your taxes are turning out for 2006, you can plan ahead so you have a better chance to secure a more palatable outcome for 2007.

With the hard lessons of 2006 fresh in your mind, you may spot some common tax-saving measures that might make your return less alarming at this time next year. Consider these:

Adjust your withholding.

Nothing hurts worse than having to dig into your pocket to come up with cash for Uncle Sam.

If you have underpaid your taxes during the year by $1,000 or more, you could be subject to a penalty.

Often, underpaying can be corrected for the future by re-evaluating what you are withholding from your paychecks. Try one of the withholding calculators on the Internet. There's one at www.irs.gov. Then adjust your W-4.

If you received a giant refund, you have not won the tax battle, either. Uncle Sam earned interest on your money throughout the year and then simply returned it to you without paying any interest.

If you had a large refund, recalculate your withholding; then change your W-4 and invest the extra money so you can be as smart as Uncle Sam about earning interest.

Avoid the alternative minimum tax.

If you ended up falling into the dreaded AMT territory this year, make sure you do everything you can to avoid it in the future.

That may not be possible, but Deloitte Tax Private Client Services suggests doing a self-diagnosis so you realize whether you are in the high-risk group. Then you might be able to make shifts that will help you avoid the AMT.

If you are in a state or city with high sales taxes or property taxes, that puts you at a disadvantage. But Deloitte says to watch out for what you can control.

Among the easiest: Invest more money in a 401(k) plan and do not invest in what are called "private activity municipal bonds," or bonds that finance projects such as sports stadiums and hospitals, rather than direct government services.

Be careful of any large capital gain on stocks, bonds, mutual funds or real estate, because it can raise your state and local taxes and trigger the AMT. Beware of home-equity loans, and be conscientious about how you exercise stock options.

See a certified public accountant for advice on options, and also a multiyear approach to the AMT.

Reduce capital gains.

When you sell an investment (stocks, bonds, mutual funds, real estate) and make money on it, you owe capital gains taxes. But you can cut this in the future if you plan to hunt all year for losing investments and sell them, too. Those losses will help you cut the gains from the winners.

Say you are holding a stock, and the company is acquired for cash. Your gain is $5,000, and the money is in your brokerage account. So look at your other investments. Are they disappointments?

If you sell losers that declined a total of $5,000 since you bought them, at tax time you would owe Uncle Sam nothing for your $5,000 gain.

There's another way to keep capital gains down - and it can be especially helpful to families paying for college with stocks, bonds or mutual funds.

Tax planners suggest giving the assets to children older than 17. When they sell the investments, their income is usually so low their capital gains tax is generally just 5 percent, rather than their parents' 15 percent.

But before doing this make sure the student does not qualify for financial aid. Any investment held or sold by the student will slash grants colleges give them. Your first step: Try a financial aid calculator at www.smartmoney.com. Click on Personal Finance and College Planning.

Put investments in the right place.

If you have money sitting in a savings account, or investments in brokerage accounts or mutual fund companies, they probably are subject to taxes.

You can insulate that money by stashing as much as possible in accounts that aren't taxed. Use a 401(k) plan at work to the maximum - $15,500 this year, or $20,500 if 50 or older. Put up to $4,000 per person ($5,000 if you are 50 or older) in an individual retirement account or Roth IRA.

And save for college in 529 plans or Coverdell education IRAs.

If you are self-employed or have a small business, evaluate Simple IRAs, SEP (Simplified Employee Pension Plan) IRAs or solo 401(k) plans. Depending on your income, you could invest as much as $45,000 in a SEP or 401(k), said Bob Scharin, tax analyst for RIA, a provider of tax information and software.

Anything you earn on investments in these accounts won't be taxed while the money stays in the accounts. With Roth IRAs and college savings plans, the money won't be taxed when withdrawn either if you follow the rules. Find the rules at www.irs.gov.

Retirement investing.

As you approach retirement, Deloitte tax planners say it might be more advantageous to have some stocks outside of IRAs, rather than in them, if you are in one of the higher tax brackets.

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