It’s the very last thing you might want to think about during the holidays: tax planning. But don’t let the holidays distract you from improving your tax situation and saving money!
Tax Planning: Why Bother?
Even though you may not file your tax return until April, between now and the end of the year is the time to make sure you qualify for as many 2009 tax breaks as possible.
Tax Planning: What Is It?
Tax planning is a creative process that involves making use of each of the tools in your tax savings toolkit. Your tools take two basic forms: deductions and credits. But what is the difference? Here is a brief rundown:
Deductions (and exemptions) reduce your taxable income. The amount of the deduction is subtracted from your tax liability (the amount of taxes you owe). So the actual dollar value of a deduction depends on your tax rate. For example, if you fall in the 25% tax bracket, a $1,000 deduction would be worth $250.
Credits are much more valuable than deductions. They reduce the amount of tax you owe dollar for dollar. Credits come in two flavors: refundable and non-refundable. Most credits are non-refundable, which means they can reduce your tax debt to zero, but not beyond. But if your tax liability is already $0, a refundable credit will be paid to you as a part of your tax refund. Use direct deposit for the quickest way to receive your refund.
How Do I Start Planning?
IMPORTANT: Keep 3 years worth of tax-related documents (tax forms, receipts, cancelled checks, paycheck stubs, bank statements, credit card bills, medical bills, mileage logs, etc.) for reference and in case of an audit. You can scan the hard copies for easier storage.
Here are a few tips about credits and deductions to get you started:
1. Do you have taxes withheld from your paycheck?
Unless you are self-employed, your employer probably withholds taxes from your paycheck. But have you adjusted your withholding throughout the year? If you are withholding more money than you will owe on April 15, you are merely making an interest-free loan to the government. Why not get your hard-earned money now instead of waiting for a refund?
It is also important to make sure you are having enough money withheld. This is especially true if you are in certain situations (such as married, filing jointly with a working spouse) where you may have to pay back a portion of the Making Work Pay Credit you have already received.
Speaking of paychecks, be sure to see if you qualify for the Earned Income Tax Credit, which is refundable. Don’t be like one of the thousands of taxpayers who qualified in 2008 but did not claim the credit.
2. Did you buy a home during 2009? Still planning to buy one soon?
Good news: the $8,000 tax credit for first-time buyers has been extended into 2010, and a new $6,500 credit for previous homeowners has been added. Both are refundable.
3. Did you lose your job or change jobs?
Unemployment compensation is generally taxable income, but $2,400 of it is tax-free in 2009. You can also deduct the costs associated with finding a new job as well as the expenses of moving to be closer to your new workplace.
4. Are you planning for your retirement?
Retirement planning is also tax planning! Contribute to a qualified plan now and save on taxes. The Saver’s Credit might be worth $1,000 to you. Also, you may want to consider converting your traditional IRA into a Roth IRA.
5. Do you have children you support?
There are several tax breaks to help you: exemptions for dependents, the Adoption Credit, the Child Tax Credit, and the Child and Dependent Care Credit.
6. Do you go to school or support a student?
Depending on your situation, you can choose between deducting $4,000 for tuition and fees, claiming the $2,500 American Opportunity Credit (formerly the Hope Credit), or claiming the $2,000 Lifetime Learning Credit.
7. Do you make charitable contributions?
Donations of cash and property are commonly used for deductions, but by donating appreciated stock you will also avoid paying tax on the appreciation. I personally love this method. You basically receive more bang for your buck.
8. Did you spend money on medical expenses?
You can deduct the amount you spent over 7.5% of your income.
9. Did you buy a car this year?
If you did, great! If you are planning on buying a car next year though, you might want to consider purchasing it before the end of this year. You can deduct the amount of sales tax you pay on up to $49,500 of the price of a new car in 2009. If your new car is a hybrid, you can also claim the Alternative Motor Vehicle Credit.
Take a little time to learn more about these and many other ways to save money on your taxes. Efile.com can help make tax planning simple!