The end of year can be a mad scramble to buy gifts, go to holiday parties and connect with family. It's understandable why many taxpayers forget year-end tax planning or act with such last-minute haste that they make poor decisions.
By taking time now to examine your personal tax situation and consider next year's prospects, you still can reduce your tax bill. Tax accountants often spend more time with clients in November and December than any other months.
In some cases, this process leads to a decision not to do something immediately.
"We were going to replace windows in our house this year and were all set to find a contractor, but then the energy bill was passed and we decided to wait until next year," said Maggie Doedtman, manager of tax training at H&R Block in Kansas City, Mo. "Anyone considering getting that type of work done should wait until January."
Here's why: Starting in January and for the next two years, you can collect up to $500 in tax credits if you upgrade your home with energy-efficient improvements. If you build a new home with energy-saving features, you can receive up to $2,000 in tax credits.
"If you buy a hybrid car now, you get a deduction of up to $2,000, but if you wait until next year you can get a tax credit of up to $3,400, depending on the hybrid you choose," said Martin Nissenbaum, national director of personal income tax planning for Ernst & Young in New York. "A credit is more valuable than a deduction because it is a dollar-for-dollar reduction in your total tax bill."
You might also decide to postpone investing in a mutual fund just a bit. Many fund families predict they'll be making larger-than-usual 2005 capital gains payouts sometime before Dec. 31.
"If you buy a mutual fund before year end, it's possible you could get a capital gains distribution shortly thereafter and be taxed on gains you didn't enjoy," Nissenbaum said. "Check with the fund company first so you can buy into the fund after that date."
Similarly, if you don't love a fund you own, unload its shares before you're hit with that distribution capital gains tax.
Try to put away as much as you're allowed in your retirement accounts. You can put up to $14,000 in your company 401(k) plan in 2005, and taxpayers over age 50 can put in an additional $4,000. Another 401(k) choice debuts next year.
"Starting in 2006, you'll be able to set up a Roth 401(k) retirement plan at work for the first time," said Jeffrey Kelson, tax partner with BDO Seidman LLP in New York. "As with a Roth individual retirement account, contributions are made with after-tax dollars, so money you take out in retirement won't be taxable to you."
With IRAs, you can contribute for this tax year through April 15, 2006, but you should act sooner. Standard contribution limits on 2005 traditional and Roth IRAs is $4,000, and those 50 or older can put in another $500.
"Because of time value of money, I stress to clients the importance of making IRA contributions as early in the year as possible rather than waiting until just before April 15 of the following year," said Jeffrey Levin, partner in private wealth services for the Holland & Knight law firm in New York. "You get the tax deferral for a longer time period and, when you compound that difference over years, it becomes real dollars."
If you itemize, you can deduct charitable contributions. If you donate appreciated property, in many cases you can deduct full market value, though you may need an appraisal. Save receipts and canceled checks.
A temporary year-end tax incentive for charitable giving was enacted after Hurricane Katrina. "Any cash contribution made to a public charity (not just Katrina-related) through Dec. 31, 2005, isn't subject to the usual limit of 50 percent of adjusted gross income," Doedtman said. "Instead, you can deduct up to 100 percent."
The basic year-end tax move is adjusting timing of income and deductions.
If your income is high, put off receiving any more. You might have a bonus postponed until early next year. Paying your state income tax estimate before Dec. 31 will accelerate your federal deduction. You can pay property taxes early, make an extra mortgage payment, pay your tax preparer for your year-end planning meetings, or have dental work or elective surgery done before year's end.
But you'll need to do a tax projection to see if you're subject to the alternative minimum tax, the controversial system created to ensure all individuals pay some tax. If you're not careful, exercising stock options or investing in municipal bonds could shove you into AMT territory. Compute your regular income tax and the AMT to determine whether to accelerate or defer deductions.
You can make gifts to children or other relatives, being sure to do so before Dec. 31 so the check clears in time. Gifts up to $11,000 per individual needn't be reported.
Finally, take time to review your investments to see whether you should sell some losers before year's end to offset capital gains you've realized. You can deduct capital loss against your ordinary income to a limit of $3,000 in one year. Any excess carries over to the next year.
Andrew Leckey answers questions only through the column. Address questions to Andrew Leckey, "Successful Investing," P.M.B. 184, 369-B Third St., San Rafael, Calif. 94901-3581, or by e-mail at firstname.lastname@example.org.