Tax season might be the last thing on your mind as the holiday shopping season approaches, but there are easy steps to take before the end of the year to maximize your income return for 2011.
"Things need to be done by year’s end," says Lynn Mayabb, certified financial planner and senior managing advisor at BKD Wealth Advisors. "Many of the deadlines for things like transactions in investment accounts, offsetting earlier gains and more must be done by Dec. 31, and they take time to process."
For this and planning purposes, it’s best to take care of the tax items you can before the holiday rush.
No. 1: Charitable Donations
When it comes to making charitable donations at the end of the year, there are several ways to claim it on a tax return, according to Certified Financial Planner Margaret Starner.
To avoid paying a capital gains tax, Starner says individuals can donate appreciated assets if they have them available. "If you were ever to sell it or give your stock away, you avoid paying a tax on that.”
For donors over the age of 70, donating tax free from your IRA is an option for gifts up to $100,000. This can be helpful, according to Starner, because Medicare premiums are income based. "If you are giving away directly from your IRA, that never shows up as income on your tax return.”
If you are giving a large donation, Starner suggests creating a donor fund that will space out the gifts over the course of several years. This is a great way to have the donation appear to be all in one year so you can claim the write off this year.
No. 2: IRA Contributions and Conversions
Starner recommends maximizing IRA and pension contributions as soon as possible, even though you have until the following April to claim them. Mayabb says only one deposit must be made before tax day in April to have the contribution count for 2011, however contributing before year’s end will have consumers better prepared when creating a tax estimate.
Starner adds younger people should consider a Roth conversion even though it will make their taxes higher. “You get no deductions, but the investments grow tax-free."
For example, she says an 18-year-old working his or her first summer job should absolutely start contributing to a Roth IRA, because of the of the growth advantages it offers.
"You're in such a low tax bracket you can be compounding tax-free for 50 years," she says. "The more years you have for it to be tax free, the better."
Mayabb says many of her clients will do a rough draft of their income taxes to what a ROTH conversion can save them, and they find it can almost fund an IRA out of the refund they are getting.
No. 3: Plan Major Payments Strategically
Taxpayers who have many deductions in relation to their income may be hit with a higher tax rate next year through the alternative minimum tax, according to Starner. The government requires taxpayers to compute deductions in two ways, she explains, one with deductions and one disallowing deductions, to see which is higher. The higher tax rate is what you will pay for the year.
"The most common deductions to lose are your mortgage, income on home and state income tax," she says. "It's tragic when you have all of these expenses and can't deduct them."
When making major payments, like your property tax bill, plan strategically. Some opt to pay two years of real estate property tax in one year, so that they can minimize their tax the next year.
"Think, will this put me into alternative minimum tax territory?" Starner advises. "Once you have more deductions, planning becomes more important."
No. 4: Consider a 529 Savings Plan
For those with a 529-college savings plan, Mayabb suggests making a contribution before the end of the year.
There is a Dec. 31 deadline for contributions if you want to claim it as a tax credit. This deadline is for those looking to open a 529 or contribute to an existing savings plan, she says