‘Tis the Season to Lower Your Tax Bill

by | Nov 25, 2005 | Cash Flow, Weekly Column

In the last couple of weeks, we’ve seen an increasing number of television commercials featuring sleigh bells and fluffy fake snow. The Sunday paper is stuffed with advertising inserts to help us find the perfect gifts. Obviously, it’s that time of year again.

Time to start thinking about tax strategies.

Right now is the season to see if there is anything you need to do before the end of the year to lower your tax bill. It may be too late in the year to implement some strategies, but you can put them in place for next year.

The first strategy for reducing your taxes is simple: pay attention to the basics. Make sure you claim the right number of personal exemptions, figure your taxes at the correct rate, and claim all the deductions to which you are entitled. Some of these might include the child tax credit, education expenses, state taxes, or charitable contributions.

Have you contributed the maximum allowed to an IRA or to your employer’s 401(k) plan? If you don’t have an IRA, you have until April 15 of next year to open one for this year. Plus, take a look at the amount being withheld from your paycheck. Please think about reducing your withholding if you’ve been getting a large refund every year. That “bonus” is nothing but an interest-free loan to Uncle Sam. Put the same money into an IRA or savings account instead and let it earn interest for you.

If your financial affairs are more complex, there are additional ways to save on taxes. These involve three basic strategies: arranging to receive more of your income from sources that are taxed at lower rates, direct deductions, and reducing FICA taxes.

Long-term capital gains (those on property you have owned for at least a year) are currently taxed at a lower rate than ordinary income. Dividends on stocks are also taxed at a lower rate than is interest. You don’t want to over-emphasize the tax aspect in making investment decisions, but do keep those factors in mind if you need to make changes in your investment portfolio.

The second and third tax-saving strategies apply if you own your own business, even a small, part-time one. Again, remember the basics, and be sure you deduct anything that is a legitimate business expense. This might include use of your car, an office in your home, or travel expenses. Your business might pay medical insurance or other benefits for its employees, including you.

Another often-overlooked method of saving taxes is to reduce FICA deductions. If you are self-employed, you pay both the employee and employer share of taxes for Social Security and Medicare. That is a 15% deduction. However, FICA is not charged on dividends or rents. So many owners of small businesses incorporate, then take out part of their earnings as dividends rather than salary. Of course, if you do this, you will receive less Social Security income when you retire. If you take the tax savings and invest it for retirement, however, in most cases you will be better off.

Please keep in mind that these are basic strategies. Some of them might not apply to you, and there is no room in one short article to do more than introduce them. Plus, of course, the tax laws change from year to year.

If you think some of these approaches might work for you, I’d strongly recommend that you consult a tax preparer, preferably a CPA if your situation is at all complicated. Do-it-yourself is wonderful for many things, but trying to keep up with the federal tax code is not necessarily one of them.

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