Upper-income taxpayers should make these moves throughout the
year to keep their bill low at tax time. Here are the areas where
you should look for savings:
Investments and retirement savings
Give yourself a raise. If you got a big tax refund this year, it
meant that you're having too much tax taken out of your paycheck
every payday. So far this year, the average refund is nearly
$2,800. Filing a new W-4 form with your employer (talk to your
payroll office) will insure that you get more of your money when
you earn it. If you're just average, you deserve about $225 a month
extra. Try our
easy withholding calculator
now to see if you deserve more allowances.
Go for a health tax break. Be aggressive if your employer offers
a medical reimbursement account -- sometimes called a flex plan.
These plans let you divert part of your salary to an account which
you can then tap to pay medical bills. The advantage? You avoid
both income and Social Security tax on the money, and that can save
you 20% to 35% or more compared with spending after-tax money.
Starting in 2013, the maximum you can contribute to a health care
flex plan is $2,500. Use our
to figure out how much you can save.
Change in family = change in flex plan.
If you get married or divorced, or have or adopt a child during the
year, you can change the amount you're setting aside in a medical
reimbursement plan. If you anticipate more medical bills, steer
more pretax money into the account; if you anticipate fewer, you
can pull back on your contributions so you don't have to worry
about the use-it-or-lose-it rule.
Pay child-care bills with pre-tax dollars. After taxes, it can
easily take $7,500 or more of salary to pay $5,000 worth of child
care expenses. But, if you use a child-care reimbursement account
at work to pay those bills, you get to use pre-tax dollars. That
can save you one-third or more of the cost, since you avoid both
income and Social Security taxes. If your boss offers such a plan,
take advantage of it.
Switch to a Roth 401(k).
But if you are concerned about skyrocketing taxes in the future, or
if you just want to diversify your taxable income in retirement,
considering shifting some or all of your retirement plan
contributions to a Roth 401(k) if your employer offers one. Unlike
the regular 401(k), you don't get a tax break when your money goes
into a Roth. On the other hand, money coming out of a Roth 401(k)
in retirement will be tax-free, while cash coming out of a regular
401(k) will be taxed in your top bracket.
Pay tax sooner than later on restricted stock.
If you receive restricted stock as a fringe benefit, consider
making what's called an 83(b) election. That lets you pay tax
immediately on the value of the stock rather than waiting until the
restrictions disappear when the stock "vests." Why pay tax sooner
rather than later? Because you pay tax on the value at the time you
get the stock, which could be far less than the value at the time
it vests. Tax on any appreciation that occurs in between then
qualifies for favorable capital gains treatment. Don't dally: You
only have 30 days after receiving the stock to make the
Stash cash in a self-employed retirement account.
If you have your own business, you have several choices of
tax-favored retirement accounts, including Keogh plans, Simplified
Employee Pensions (SEPs) and individual 401(k)s. Contributions cut
your tax bill now while earnings grow tax-deferred for your
Hire your children.
If you have an unincorporated business, hiring your children can
have real tax advantages. You can deduct what you pay them, thus
shifting income from your tax bracket to theirs. Because wages are
earned income, the "kiddie tax" does not apply. And, if the child
is under age 18, he or she does not have to pay Social Security tax
on the earnings. One more advantage: The earnings can serve as a
basis for an IRA contribution.
Choose the right kind of business.
Beyond choosing what business to go into, you also have to decide
on the best form for your business: a sole proprietorship, a
subchapter S corporation, a C-corp or a limited-liability company
(LLC). Your choice will have a major impact on your taxes.
Don't be afraid of home-office rules. If you use part of your
home regularly and exclusively for your business, you can qualify
to deduct as home-office expenses some costs that are otherwise
considered personal expenses, including part of your utility bills,
insurance premiums and home maintenance costs. Some home-business
operators steer away from these breaks for fear of an audit. But a
new IRS rule that takes effect this year will make it easier to
claim this tax break. Instead of calculating individual expenses,
you can claim a standard deduction of $5 for every square foot of
office space, up to 300 square feet.
Watch start-up costs.
Generally, the costs of starting up a new business must be
amortized, that is, deducted over years in the future. But you can
deduct up to $5,000 of start-up costs in the year you incur them,
when the tax savings could prove particularly helpful. Take our
quiz on savvy start-up moves
Tote up out-of-pocket costs of doing good.
Keep track of what you spend while doing charitable work, from what
you spend on stamps for a fundraiser, to the cost of ingredients
for casseroles you make for the homeless, to the number of miles
you drive your car for charity (at 14 cents a mile). Add such costs
with your cash contributions when figuring your charitable
Put away your checkbook.
If you plan to make a significant gift to charity in 2010, consider
giving appreciated stocks or mutual fund shares that you've owned
for more than one year instead of cash. Doing so supercharges the
saving power of your generosity. 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. However, don't donate stocks or fund
shares that lost money. You'd be better off selling the asset,
claiming the loss on your taxes, and donating cash to the
Be creative with your generosity.
A charitable-remainder trust can avoid capital gains taxes on
appreciated assets, allow you to receive income for life and
receive a tax deduction now for a charitable contribution that will
be made after your death. A charitable-lead trust can avoid taxes
on appreciated assets, earn an immediate tax deduction and still
provide an inheritance for your heirs later. A donor-advised fund
can earn you a tax deduction for the full value of appreciated
assets now, even though you don't have to determine the recipients
of your generosity until later years.
Use a Roth to save for college.
Sure, the "R" in IRA stands for retirement, but because you can
withdraw contributions at any time tax- and penalty-free, the
account can serve as a terrific tax-deferred college-savings plan.
Say you and your spouse each stash $5,000 in a Roth starting the
year a child is born. After 18 years, the dual Roths would hold
$375,000, assuming 98% annual growth. Up to $180,000 -- the total
of the contributions -- can be withdrawn tax- and penalty-free and
any part of the interest can be withdrawn penalty-free, too, to pay
Save for college the tax-smart way.
Stashing money in a custodial account can save on taxes. But it can
also get you tied up with the expensive "kiddie tax" rules and
gives full control of the cash to your child when he or she turns
18 or 21. Using a state-sponsored 529 college savings plan can make
earnings completely tax free and lets you keep control over the
money. If one child decides not to go to college, you can switch
the account to another child or take it back.
Roll over an inherited 401(k).
A recent change in the rules allows a beneficiary of a 401(k) plan
to roll over the account into an IRA and stretch payouts (and the
tax bill on them) over his or her lifetime. This can be a
tremendous advantage over the old rules that generally required
such accounts be cashed out, and all taxes paid, within five years.
To qualify for this break, you must name a person or persons (not
your estate) as your beneficiary. If your 401(k) goes through your
estate, the old five-year rule applies.
Investments and Retirement Savings
Check the calendar before you sell.
You must own an investment for more than one year for profit to
qualify as a long-term gain and enjoy preferential tax rates. The
"holding period" starts on the day after you buy a stock, mutual
fund or other asset and ends on the day you sell it.
Don't buy a tax bill.
Before you invest in a mutual fund near the end of the year, check
to see when the fund will distribute dividends. On that day, the
value of shares will fall by the amount paid. Buy just before the
payout and the dividend will effectively rebate part of your
purchase price, but you'll owe tax on the amount. Buy after the
payout, and you'll get a lower price, and no tax bill.
Mine your portfolio for tax savings.
Investors have significant control over their tax liability. As you
near the end of the year, tote up gains and losses on sales to date
and review your portfolio for paper gains and losses. If you have a
net loss so far, you have an opportunity to take some profit tax
free. Alternatively, a net profit on previous sales can be offset
by realizing losses on sales before the end of the year. (This
strategy applies only to assets held in taxable accounts, not
tax-deferred retirement accounts such as IRAs or 401(k) plans).
Avoid the wash sale rule.
If you sell a stock, bond or mutual fund for a loss and then buy
back the identical security within 30 days, you can't claim the
loss on your tax return. The IRS considers the transaction a wash
because your economic situation really hasn't changed. It's easy to
avoid being stung by the "wash sale" rule, though. Watch the
calendar, or buy similar but not identical securities.
Think twice about selling stock for a profit if you're
subject to the AMT.
Although long-term capital gains benefit from the same 20% maximum
rate under both the regular tax rules and the alternative minimum
tax, a capital gain can effectively cost more than 20% in AMT-land.
The special AMT exemption is phased out as income rises so, for
example, a $1,000 capital gain can wipe out $250 of the exemption,
effectively exposing $1,250 to tax. That means your tax bill rises
by more than $150 for that $1,000 gain. More about the
AMT, the Tax We Love to Hate
Consider tax-free bonds.
It's easy to figure whether you'll come out ahead with taxable or
tax-free bonds. Simply divide the tax-free yield by 1 minus your
federal tax bracket to find the "taxable-equivalent yield." If
you're in the 33% bracket, your divisor would be 0.67 (1 - 0.33).
So, a tax-free bond paying 5% would be worth as much to you as a
taxable bond paying 7.46% (5/0.67).
Keep a running tally of your basis. For assets you buy, your
"tax basis" is basically how much you have invested. It's the
amount from which gain or loss is figured when you sell. If you use
dividends to purchase additional shares, each purchase adds to your
basis. If a stock splits or you receive a return-of-capital
distribution, your basis changes. Only by carefully tracking your
basis can you protect yourself from overpaying taxes on your
profits when you sell. A new IRS rule requires financial services
and brokerage firms to report to the IRS the cost basis for stocks
purchased on or after January 1, 2011 and mutual funds purchased on
or after January 2, 2012. They'll also provide you with this
information, which should make it easier for you to avoid costly
mistakes when you sell. For older shares, though, you'll still need
to track your basis to avoid overpaying taxes on your profits.
Tell your broker which shares to sell.
Doing so gives you more control over the tax consequences when you
sell stock. If you fail to specifically identify the shares to be
sold, the tax law's FIFO (first-in-first-out) rule comes into play
and the shares you've owned the longest (and perhaps the ones with
the biggest gain) are considered to be sold. With mutual funds, an
"average basis" can be used when determining gain or loss; but that
alternative isn't available for stocks.
Beware of Uncle Sam's interest in your divorce.
Watch the tax basis -- that is, the value from which gains or
losses will be determined when property is sold -- when working
toward an equitable property settlement. One $100,000 asset might
be worth a lot more -- or a lot less -- than another, after the IRS
gets its share. Remember: Alimony is deductible by the payer and
taxable income to the recipient; a property settlement is neither
deductible nor taxable.
Watch the calendar at your vacation home.
If you hope to deduct losses attributable to renting the place
during the year, be careful not to use the house too much yourself.
As far as the IRS is concerned, "too much" is when personal use
exceeds more than 14 days or more than 10% of the number of days
the home is rented. Time you spend doing maintenance or repairs
does not count as personal use, but time you let friends or
relatives use the place for little or no rent does.
Take advantage of tax-free rental income.
You may not think of yourself as a landlord, but if you live in an
area that hosts an even that draws a crowd (a Super Bowl, say, or
the presidential inauguration), renting out your home temporarily
could make you a bundle--tax-free--while getting your out of town
when tourists overrun the place. A special provision in the law
lets you rent a home for up to 14 days a year without having to
report a dime of the money you receive as income.
Fund a Roth for you child or grandchild.
As soon as a child has income from a job -- such as babysitting, a
paper route, working retail -- he or she can have an IRA. The
child's own money doesn't have to be used to fund the account (fat
chance that it would). Instead, a generous parent or grandparent
can provide the funds, or perhaps match the child's contributions
dollar for dollar. Long-term, tax-free growth can be
Minimize the bite of the kiddie tax.
The rule that taxes on a child's income at the parents' rate now
covers children up to age 18. You can minimize the damage by
steering a child's investments into tax-free municipal bonds or
growth stocks that won't be sold until the child turns 18.
Help your children earn credit for retirement
This credit can be as much as $1,000, based on up to 50% of the
first $2,000 contributed to an IRA or company retirement plan. It's
available only to low-income taxpayers, though, who are often the
least able to afford such contributions. Parents can help, however,
by giving an adult child (who cannot be claimed as a dependent) the
money to fund the retirement account contribution. The child not
only saves on taxes but also saves for his or her retirement.
Tally adoption expenses. Thousands of dollars of expenses
incurred in connection with adopting a child can be recouped via a
tax credit, so it pays to keep careful records. The credit can be
as high as $12,970. If you adopt a special needs child, you get the
maximum credit even if you spend less.
Pay child-care bills with pre-tax dollars.
After taxes, it can easily take $7,500 or more of salary to pay
$5,000 worth of child care expenses. But, if you use a child-care
reimbursement account at work to pay those bills, you get to use
pre-tax dollars. That can save you one-third or more of the cost
because you avoid both income and Social Security taxes. If your
boss offers such a plan, take advantage of it.
See All Tax Savings Strategies