Managing Your Money Wisely

There’s a funny thing about taxes: most people tend to approach them backward.  They sit around between January 1 and April 15 and start sorting through their accumulated paperwork, looking for ways to save.

The problem is that by then it’s too late to take advantage of many of the tax-saving opportunities that do exist.  A smarter way to approach this task is to plan ahead, not behind.  You can be proactive and plan a year-round tax strategy that will yield the lowest possible tax bill when April 15 comes around again.  Sitting down and filling out your return is actually only the last step in such a strategy.The Tax Reform Act of 1986 severely limited the range of tax-saving techniques.  But the 1997 tax law that was created can still pay rewards.  Run through the list of 6 tax-saving ideas that we have researched and gathered around the Net to make sure you’re taking advantage of the opportunities that remain.

1. Don’t wait until it’s too late. Begin tax planning early.  This gives you time to take advantage of strategies that might not be available later in the year because of law changes.  Also, it sometimes takes several months to realize maximum benefits or to implement the strategy.  For example, wait until July to look for a new home and you probably won’t reap any tax benefits until at least October – count on a month or so for house hunting and around two months to close.  That will give you only two or three months of mortgage interest to deduct, costing you thousands of dollars in write-offs.

2. Don’t over-withhold. One of the biggest tax mistakes people make is having the wrong amount of taxes withheld from their paychecks during the year.  Having too much money withheld can be a kind of forced savings plan that transforms into a hefty refund at tax time.  But think about it:  Why should the IRS have its hands on your money all year long instead of you?  If you received a big refund after you filed your last tax return or recently had a baby or bought a house (two occasions that produce tax savings), fill out a new W-4 form at work and revise your withholding allowances on the Deductions and Adjustments Worksheet.

Here’s how doing so can help you:  Take a married couple earning $75,000 who have no house and don’t itemize.  The might plan to take two withholding allowances.  If they have a child and buy a house costing $12,000 in annual mortgage interest and $2,000 in property taxes, however, they will be able to raise the number of allowances from two to eight.  As a result, they will be able to up their biweekly paycheck by about $110.

3. Maintain tax-smart records. Keeping track of your deductible expenses can save you a significant amount of tax dollars.  If you use your car for business, for example, the IRS lets you deduct either a flat 31.5 cents per mile or – if you keep careful records –write off your actual operating expenses.  The business portion of your gasoline, auto insurance, repairs, and other costs could net you hundreds of dollars more in tax savings than the government’s standard mileage rate.

Nowhere is poor record keeping more costly than in an audit.  Without records, the IRS might disallow your write-offs.  Audit-proofing your records means paying by check or credit card (and keeping a receipt) or requesting cash receipts.  If you entertain for business, back up restaurant stubs with notations or diary entries showing the date, place, amount, name of person entertained, and business purpose.

You might think that when Congress in 1997 all but eliminated taxes on the sale of homes, this meant you no longer needed to keep records related to your house for tax purposes.  Well, you are wrong.  It’s true that the 1997 law states that you won’t owe taxes on gains on your principal residence of up to $500,000 if you’re married or $250,000 if you’re single for sales after May 6, 1997.  However, if you’re audited and the IRS wants you to prove that your gains didn’t exceed these thresholds; you’ll need to present documentation.  What’s more, you might be lucky enough to have a profit over those amounts when you sell – especially if you bought a nice home before the 1970s and have held on to it.  So when you do sell, you’ll still want to reduce any taxable gain by adding to your original purchase price the amount you’ve spent on improvements over the years (and have the records to verify it).  You might also need the records to deduct the interest on a refinanced loan.  Bona fide improvements include remodeling your kitchen, adding central air-conditioning, refurbishing a basement, landscaping, and installing a spa.  Repairs, painting, and routing maintenance work do not qualify as improvements, though. 

4. Prepare for the worst. You never know when disaster may strike, but you can be prepared if it happens.  Inventory your valuable possessions, take photographs, or make videotapes and keep them together with purchase records and appraisals in a secure place outside your home, such as in a safety-deposit box or your office.  This way you’ll have proof if a deductible casualty or theft loss occurs.

5. Shift your profitable investments to your kids. If you are ready to sell shares that have appreciated in value, make a gift of them to your child instead.  Your child can then sell the stock, paying tax at his or her rate on the capital gain (the profit from an investment), which is likely of 20% or higher.  Under the new capital gains rules, you are taxed on long-term capital gains at either the 20% or 28% tax rate, even if you’re in the 31%, 36%, or 39.6% bracket.  One exception to these rules:  Collectibles such as art, antiques, and coins aren’t eligible for the new, lower capital gains rates; they’re still taxed up to 28% for long-term gains.  Red alert:  If your children are under age 14, their investment income above $1,300 will be subject to the so-called kiddie tax.  In other words, that amount of income will be taxed at your top rate.

If your investment drops in value, you can sell it for a capital loss and offset up to $3,000 in losses against your capital gains.  This move effectively reduces your capital gains taxes.  If it turns out you don’t have any capital gains, you can offset up to $3,000 in losses against your regular income, known as ordinary income.  You can carry this over to future year’s losses, exceeding $3,000.

6. Don’t pay taxes on income that isn’t taxable. Among the types of income you don’t have to report for taxes:  gifts, inheritances, life insurance proceeds, child support payments, personal injury damages, disability benefits, rental security deposits (unless you don’t refund the money), new-car rebates, and utility company rebates for buying energy-conservation devices.