Tuesday, March 11, 2008

Savvy Tips for Tax Season

The following are some important but often overlooked concepts from Dennis McCafferty writing for USAA Magazine. I threw one of my own in at the end in regards to investing in individual stocks. Whether you prefer to do your own taxes or not, at least the following ideas should jog your memory and save you some money. I prefer to do my own taxes for a couple of reasons. 1) It is a great learning experience, and allows me to stay engaged with my finances, and 2) I am a finance geek!

Just Do It: Some 10 percent of taxpayer file after April 15, according to Cohesive, a tax-preparation and planning firm in California. But they might as well dump their money on the street. “At least 98 percent of the clients who come to us late pay more taxes,” says Cohesive founder and owner Karla Dennis, enrolled agent. “In several instances, we point out missing deductions, but there’s simply no time to gather the needed documentation to support them.” Bottom line here is start early. Don’t wait until the last minute.

Make Tax-Savvy Investments: Two relatively conservative investments can help give tax relief. A municipal bond fund is similar to a taxable bond fund, but all of the bonds in the fund are issued by a state, city or local government, and the fund generates income that is not subject to U.S. income tax. Some funds hold only bonds issued in one state, and if you live in that state, produce income that is exempt from both federal and state income taxes. This type of investment typically is suitable for someone in a higher tax bracket. A fixed annuity is a guaranteed investment. Similar to a certificate of deposit, or CD, a fixed annuity will pay a set, fixed interest rate. Depending on the annuity, the interest rate may reset or fluctuate periodically. From an income tax standpoint, the perk is that you will not pay income tax on the earnings until you withdraw them from the annuity.

Give and Receive: Donating old clothes, tools, books and items collecting dust to qualified charities may entitle you to a charitable contribution deduction. A recent change in the rules now requires that in order to take the deduction you must get documentation of the donation from the recipient organization, which also must be eligible for tax-deduction donations. “Most clients forget that non-cash donations are eligible,” says Ronald Park, managing partner of a Texas based accounting firm. “Cleaning out the closet once a year can save you not only space, but money.”

Deduct Moving Expenses: If you’re a member of the armed services, you probably know you’re entitled to deduct unreimbursed moving expenses. But make sure you do it. Civilians generally need to meet certain time and distance requirements to deduct moving expenses, but if you’re active duty and you move, those requirements can be waived.

Be Smart About College Savings: Many savings plans don’t have great tax advantages. If college savings is the primary goal for any savings account you open for a child, a 529 plan or Coverdell education savings account might be the best bet. “Forget savings accounts and bonds,” says Beth Wiggins, a Texas certified public accountant with tax and accounting firm BKD LLP. “Income from these accounts may be taxed at the parents’ tax rate until the child is 24. Instead, focus entirely upon college savings plans, such as Coverdell accounts or 529s, where earnings are never taxed if used for educational expenses.”

I’m going to add one of my own that wasn’t mentioned in the article, but can help defray some of your losses if you invest in individual stocks, while minimizing the taxes you will pay on your winners (if you choose to sell).

Hold Your Winners, Sell Your Losers: This idea runs contrary to what “feels good.” Mainly because you tend to think your losing stocks will “come back.” However, research shows routinely that you should do the opposite. Selling a winning stock before the one year mark means you’re going to pay short-term capital gains taxes (often taxed as ordinary income). Instead, hold your winners for the long run, and avoid this substantial penalty. On the flip side, sell your losers and write-off the loss. Take the deduction as long as you can swallow the psychological pain. I’ve done this before on a terrible decision I made a couple of years ago. Long story short, at least I got a tax deduction after the stock lost 80% of its value.

More tips from USAA here


Cameron Schaefer said...

great advice Brian, it's amazing how easy it is to put off taxes, but the fact is they really don't take that much time. it's funny how little people try to learn about taxes...it's a shame because there's lots of ways to keep your money in your own pockets if you take the time to learn.

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