12 tax moves to make before the year ends

12 tax moves to make before the year ends

12 Smart Year-End Tax Moves

Year-end tax planning takes on new urgency this year.

Although current tax rates are scheduled to remain in effect through 2012, anything could happen as Congress and the White House grapple with ways to shrink the federal budget deficit.

"Take all the deductions you can this year because next year is up in the air," advises Philip Liberatore, a certified public accountant in La Mirada, Cal.

With a little investment of time now, year-end tax planning may reward you with a bigger refund next April, or even some cash right now.

Feed Your 401(k)

A good place to start is with your 401(k) or similar employer-based retirement plan. Money you contribute to your plan (if it's not a Roth) is excluded from your income, lowering your tax bill.

If you're not yet on track to max out your contributions by year-end, you can direct some extra dollars to your retirement plan during your last few pay periods. This year, workers can contribute up to $16,500 to employer-based plans. Workers 50 and older can contribute up to $22,000.

Although only a small percentage of workers contribute the maximum amount to their retirement plans, you may want to take full advantage of this tax-saving maneuver and step up your contributions this year and next. One tax-reform proposal would scale back maximum 401(k) contributions to 20% of income or $20,000 per year, whichever is less. So if you earn $50,000 a year, for example, your maximum 401(k) contribution would be $10,000.

Do-It-Yourself Pay Raise

When you file your tax return each year, the amount of tax withheld from your paycheck or submitted through estimated quarterly tax payments ideally should match the amount of tax you owe. In reality, that seldom happens.

The majority of Americans are addicted to refunds. More than 75% of U.S. taxpayers give Uncle Sam an interest-free loan year after year. This year, the average refund may break $3,000 -- that's $250 per month. Wouldn't you prefer to get your money when you earn it rather than waiting a year for a refund? There's an easy fix. Just file a revised Form W-4 with your employer. The more "allowances" you claim on the W-4, the less tax will be withheld.

If your current financial situation is similar to last year's, just use our Tax Withholding Calculator. Answer three simple questions (you'll find the answers on your 2010 tax return) and we'll estimate how many additional allowances you deserve -- and how much your take-home pay could rise.

However, this tool won't be much help if your tax situation has changed since last year because, for example, you got married, have a new baby or switched jobs. In that case, you might want to give the more-complicated IRS online withholding calculator a whirl.

Penalty-Proof Your Return

But if you expect that you'll owe money when you file your 2011 tax return next spring, you can avoid an underpayment penalty by boosting your withholding now.

You needn't pay every penny of the tax you expect to owe. As long as you prepay 90% of this year's tax bill, you're off the hook for the penalty. Or you can escape its reach, in most cases, by prepaying 100% of last year's tax liability. However, note that if your 2010 adjusted gross income topped $150,000, you'll have to prepay 110% of last year's tax liability to avoid a penalty.

Taking these steps to boost your withholding at year-end will shield you from an underpayment penalty on your 2011 return no matter how much you actually owe when you file your return.

If you have both wage and consulting income and expect to owe money on your tax return, you'll do better by boosting the taxes withheld from your last few paychecks rather than trying to make up the shortfall with your final estimated quarterly payment, due January 17, 2012.

Taxes that are withheld are treated as if they were spread out evenly throughout the year, so that approach sidesteps an underpayment penalty; the estimated-tax-payment approach does not.

Save Taxes by Selling Losing Stocks

Scour your taxable investment accounts for candidates to sell by year-end. You can harvest the losses to offset investment gains, plus shield up to $3,000 of ordinary income from taxes. Don't forget to check your 2010 tax return for excess investment losses that you can carry over to reduce your 2011 tax bill.

Investments held for more than one year and sold at a profit qualify for the 15% long-term capital gains rate, as do qualified dividends. But this year and next, taxpayers in the two lowest income-tax brackets can take advantage of a 0% capital gains rate and sell assets at a profit tax-free. To qualify, your 2011 taxable income can't exceed $34,500 for individuals or $69,000 for married couples. (Any gains that lift your taxable income above those thresholds are taxed at 15% like everyone else's.)

If you hate to part with a favorite stock or fund, you can repurchase it at any time. Although the "wash sale rule" discourages you from buying a substantially identical stock or fund that you sold at a loss within 30 days either before or after the sale, there are no time restrictions for buying a security that you sell at a profit. Repurchasing a stock or fund at its current price will establish a new, higher cost basis, which will result in a smaller taxable gain or a larger tax-deductible loss when you sell it.

Max out Deductions

Taxpayers who itemize deductions can choose between writing off their state income taxes or their sales taxes in 2011. In most cases, income taxes will provide the bigger tax break.

But if you live in a state with no income tax, or you buy a big-ticket item such as a car or boat by December 31, you may be better off deducting sales taxes.

And unless Congress acts this year or next, the ability to write off sales taxes will disappear after 2011.

Enjoy writing off the full value of your mortgage interest and other itemized deductions while you can. In the past, high-earners had to reduce the amount of write-offs they could claim, but those restrictions were lifted in 2010. There's talk in Washington about restricting itemized deductions for high earners as part of a tax reform plan to simplify the system and raise revenue.

You may even want to accelerate some deductible expenses, such as paying your January mortgage, your 2012 real estate taxes or fourth-quarter estimated state income taxes in December so you can add them to your itemized deductions for 2011.

But beware: If you are vulnerable to being hit with the alternative minimum tax, you'll need a different year-end game plan. The what? Learn more about the AMT in our next slide.

AMT: The Tax Everyone Loves to Hate

The AMT is a parallel tax system developed more than 40 years ago to ensure that the very wealthy paid at least some income tax.

You figure your taxes twice -- under the regular tax rules and under the AMT -- and pay whichever is higher.

Because the AMT disallows common deductions, such as state income taxes and property taxes, more of your income is taxed. Residents of high-tax states, such as California, New Jersey and New York, are particularly vulnerable to the AMT. So are taxpayers with large families because the AMT also disallows personal exemptions, worth $3,700 apiece in 2011 for you, your spouse and each of your children.

If it looks like you might be snagged by the AMT in 2011, don't prepay state and local taxes that you won't be able to deduct.

Upgrade Your Home

This is your last chance to claim a tax credit for making energy-efficient improvements to your principal residence. The home-energy tax credit expires at the end of this year.

It is worth 10% of the cost of new windows, doors, skylights, insulation, and heating and air conditioning systems, up to a maximum $500 credit (but no more than $200 can be allocated to new windows).

You must install the upgrades by December 31 in order to claim the credit, but you can't claim it for 2011 if you already took advantage of $500 or more of energy tax credits in previous years.

An even bigger credit is available to homeowners who install renewable-energy equipment, such as geothermal heat pumps, solar panels and small wind turbines, in their primary residence or vacation home by the end of the year. You can claim a credit for 30% of the cost, including installation, with no limit. This credit is good through 2016.

Don't Buy a Tax Bill

Be careful if you intend to buy mutual funds before year's end.

Sometime in December, many funds pay out dividends and capital gains that have built up during the year, and the payout goes to investors who own shares on what's known as the ex-dividend date. It might sound like a savvy move to buy just before that day so you get a whole year's worth of income.

That's not how it works, though. Yes, you'd get the payout, but at the time of the payout, the share price falls by exactly the same amount. If you get $2 a share in dividends, for example, the share price drops by two bucks. In effect, the fund is simply refunding part of your purchase price.

But the IRS doesn't see it that way. You have to report the payouts as income on your 2011 return -- and pay taxes on them -- even if the money is automatically reinvested in extra shares. (The tax threat does not apply to mutual funds held in 401(k) plans or other tax-deferred retirement accounts.)

Before you buy shares for a nonretirement account in December, check the fund company's Web site to find out exactly when the dividend will be paid.

Give to Charity

This is a great time of year to clean out your closets and garage, but you can write off donations to a charitable organization only if you itemize deductions. A few bags full of gently used clothes and household items can add up to hundreds of dollars in tax deductions, but valuing those donations can be difficult. (Try Turbo Tax's free tool).

If you donate a used car worth more than $500 to charity, your deduction will be limited to the amount the organization receives when it sells it. But you may be able to claim a bigger deduction based on the vehicle's fair-market value if the charity uses it to deliver meals, for example, or gives it to a needy individual. The charity will list the vehicle's sale price, or whether an exception allowing a higher deduction applies, on Form 1098-C, which you must attach to your tax return.

Send cash donations to your favorite charity by December 31 and hang on to your canceled check or credit card receipt as proof of your donation. If you contribute $250 or more, you'll also need an acknowledgment from the charity.

Give Really Big to Charity

If you plan to make a significant gift to charity this year, consider giving appreciated stocks or mutual fund shares that you've owned for more than one year. Doing so boosts the savings on your tax return. Your charitable-contribution deduction is the fair-market value of the securities on the date of the gift, not the amount you paid for the asset, and you never have to pay tax on the profit.

Taxpayers age 70½ must take annual minimum withdrawals from their IRAs or pay a steep penalty -- 50% of the amount they failed to withdraw. But this year you can direct up to $100,000 of your IRA distribution to a charity and exclude it from income. Although you can't claim a charitable deduction for the donation, reducing your adjusted gross income could make you eligible for other income-related tax breaks.

And if you, like Warren Buffett, believe you're not paying enough taxes, Uncle Sam will gladly take more. You can make a contribution to reduce the federal deficit. Your gift is tax-deductible.

Make Your Family Happy

The clock is ticking on the very generous estate and gift tax exclusions that allow you to give up to $13,000 this year to any number of recipients -- and a total of $5 million over your lifetime -- without owing any federal gift tax. The $5 million lifetime exclusion expires at the end of 2012, and Congress may decide to reset it at a lower level.

While the $5 million lifetime exclusion is irrelevant for all but the wealthiest Americans, your annual $13,000 gift exclusion disappears forever if you fail to use it by the end of each year. A husband and wife can jointly give away up to $26,000 per recipient this year tax-free (but you will have to file gift tax Form 709 to make a record of your joint gift, even though no gift tax is due.)

Say you want to help your newly married son and his wife buy a house. You and your husband could give the newlyweds up to $52,000 this year tax-free -- $26,000 each to your son and your daughter-in-law. And if you're feeling really generous, you could do it all over again on January 1, 2012.

Spend Down your Flex Plan (If You Need To)

If you're thinking of cleaning out your 2011 flexible spending account to avoid the "use it or lose it" rule, remember that starting this year, you can't use flex funds to pay for over-the-counter medicines, such as aspirin, ibuprofen or allergy meds, without a prescription (except for insulin).

But that restriction does not apply to other, nonprescription medical items, such as crutches, contact-lens solution or bandages. (For a list of what is allowed by law, see IRS Publication 502.) The same rules on eligible purchases apply to health savings accounts.

In most cases, you have until March 15, 2011, to use your 2010 funds, but some employers still adhere to the December 31 deadline for using the money or forfeiting the balance. Check with your employer to verify your plan's deadline.

If you're about to sign up for a flex account for 2012, keep in mind that it will be the last year before a congressionally mandated $2,500 limit goes into effect in 2013. (Currently, there is no statutory limit, and many employers set limits above $2,500.) Consider signing on for a larger-than-usual spending amount for 2012 with the plan of accelerating some medical expenses, such as eye laser surgery or tooth veneers.

12 tax moves to make before the year ends