Upper-income older families 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.
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
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
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
Pay back a 401(k) loan before leaving the job.
Failing to do so means the loan amount will be considered a
distribution that will be taxed in your top bracket and, if you're
younger than 55, hit with a 10% penalty, too.
Cut compensation, boost dividends.
Principals in closely held businesses may want to shift part of
their compensation from salary (which is taxed in their top
bracket) to dividends (which is taxed at a maximum 15% rate). This
can pay off if the corporation is in a low tax bracket, so the loss
of the deduction for dividends paid is more than offset by the
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.
Time receipt of self-employment income.
Those who run their own businesses have a lot of flexibility at
year-end. To push the receipt of income into the following year,
delay mailing bills to clients until late December so that payment
is received after December 31. Or, pay business expenses before
January 1 to lock in deductions.
Pay estimated taxes ... or not.
If you receive significant income not subject to withholding --
from self-employment or investments, for example -- you probably
need to make quarterly estimated tax payments to avoid an IRS
penalty. But, if withholding will equal 100% of your 2012 income
tax bill (or 110% if your income was over $150,000), you don't need
to make estimated payments ... no matter how much extra income you
make this year.
Convert a vacation home to your principal residence. Until 2009,
there was a sweet tax break for folks who sold their homes, claimed
tax-free profit and then moved into a vacation property. After they
lived in that home for two years, they could sell and claim
tax-free profit again ... including appreciation from the days the
place was a vacation home. There can still be some real tax
benefits to this strategy, but the value has fallen. A portion of
any profit on the sale of a
vacation-home-turned-principal-residence will not qualify as
tax-free home-sale profit. The taxable portion will be based on the
ratio of the time after 2008 the property was used as a vacation
home to the total period of ownership.
Make the most of tax-free home-sale profit.
Up to $250,000 of home-sale profit is tax free ($500,000 if you are
married and file a joint return) if you own and live in the house
for two of the five years leading up to the sale. If you are
bumping up on the limits, consider selling and buying a new home to
start the tax-free clock ticking again. There is no limit on the
number of times you can claim tax-free profit on the sale of a
Don't underestimate the cost of home-equity debt.
Generally, interest on up to $100,000 of debt secured by your home
can be deducted, no matter what you use the money for. But if you
are among the growing number of taxpayers subjected to the
alternative minimum tax (AMT), home-equity debt is only deductible
if the loan was used to buy or improve your home.
Use an installment sale of real estate to defer a tax
If the buyer pays you in installments, the IRS will let you pay the
tax bill on your profit in installments, too. You must charge
interest on the deal, and each payment you receive will have three
parts: interest (taxable at your top rate), capital gain (taxed at
a maximum of 20%) and return of your investment (tax-free).
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 , 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,
and you never have to pay tax on the profit.
Give away an IRA.
After age 70½, you must withdraw a minimum from your IRA each year,
even if you don't need the money. You can meet that obligation by
directing that up to $100,000 go directly to a charity. You don't
get a deduction, but you don't have to pay taxes on the payout,
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.
Protect your heirs.
Be sure beneficiary designations for your IRAs and 401(k)s are up
to date. If your IRA or 401(k) goes to your estate rather an a
designated beneficiary, unfavorable withdrawal rules could cost
your heirs dearly.
Death and taxes.
Someone who is terminally ill may want to sell investments that
show a paper loss. Otherwise, the "tax basis" of the property --
the value from which the heir will figure gain or loss when he or
she sells -- will be "stepped-down" to date-of-death value,
preventing anyone from claiming the loss. If you want to keep
property, such as a vacation home, in the family, consider selling
to a family member. You get no loss deduction, but it could save
the buyer taxes later on.
Give it away. Money you give away during your lifetime won't be
in your estate to be taxed at your death. That's one reason there's
also a federal gift tax. The law allows you to give up to $14,000
to any number of people in 2013 without worrying about the gift
tax. If your spouse agrees not to give anything to the same person,
you can give $28,000 a year to each individual. If you have four
married kids, for example, and you give $28,000 to all eight
children and in-laws, you can shift $224,000 out of your estate
gift-tax free each year.
Investments and Retirement Planning
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.
Scour your portfolio for paper losses.
Never make investment decisions solely for tax reasons (that's
called letting the tax tail wag the investment dog), but the
prospect of realizing a money-saving tax loss might be the impetus
you need to unload a loser. If you incur losses during the year,
ask yourself if it's time to take some money off the table by
selling stocks or mutual funds that have enjoyed healthy run-ups in
value. Offsetting losses could make your gains tax-free.
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. If you use an online
brokerage, send an email directing which shares should be sold and
ask for a response confirming receipt of your request.
Ask your broker for a favor.
The law allows investors to deduct a loss on a worthless security,
but only if you can prove the stock is absolutely worthless. If you
own stock you're sure isn't coming back, ask your broker to buy it
from you for a nominal amount. You can then report the sale and
claim your loss.
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).
A bond swap may pay off.
It's a fact of life: As market interest rates rise, bond values
fall. If you have bonds that have lost value, consider a bond swap.
You sell your losers, cash in the tax loss and invest the proceeds
in higher-yielding bonds to maintain your income stream.
Think twice about selling stock for a profit if you're
subject to the AMT.
Although long-term capital gains benefit from the same 15% 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.
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.
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.
Time claiming Social Security benefits.
If you stop working, you can claim benefits as early as age 62. But
note that each year you delay -- until age 70 -- promises higher
benefits for the rest of your life. And, delaying benefits means
postponing the time you'll owe tax on them.
Dodge a 50% tax penalty.
Taxpayers older than 70½ are required to take minimum withdrawals
from their IRAs each year. Failing to do so, subjects them to one
of the toughest penalties in the tax law: the IRS claims 50% of the
amount that should have come out of the account. Your IRA sponsor
can help pinpoint the amount of the required payout.
More on the ins and outs of the minimum
Keep careful records of the cost of medically necessary
improvements. To the extent that such costs -- for adding a
wheelchair ramp, for example, lowering counters or widening a
doorway or installing hand controls for a car -- exceed any added
value to your home or vehicle, that amount can be included in your
deductible medical expenses.
Include travel expenses in medical deductions. In addition to
the cost of getting to and from the doctor, you can deduct up to
$50 a night for lodging if seeking medical care requires you to be
away from home overnight. The $50 is per person, so if you travel
with a sick child to get medical care, you can deduct $100 a day.
Starting in 2013, you get a tax benefit only to the extent your
expenses exceed 10% of adjusted gross income, or 7.5% if you're 65
Crank in the value of deducting long-term-care premiums.
As you shop for long-term care insurance
, remember that a portion of the cost is deductible. The older you
are, the more you can write off. For employees, this is a medical
expense which means it only saves money if your medical expenses
exceed 10% of your adjusted gross income (7.5% if you're 65 or
older.) If you're self-employed, you avoid the haircut and get this
deduction even if you don't itemize.
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 event 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 you 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.
Stay actively involved in rental real estate.
Generally, anti-tax-shelter legislation prevents losses from real
estate investments from being deducted against other kinds of
income. But, if you are actively involved in a rental activity, you
can deduct up to $25,000 of such losses ... if your adjusted gross
income is less than $100,000. You don't have to mow grass and
unclog toilets to qualify as actively involved; but you should make
sure you're involved in setting rents and approving tenants and
Use a tax-free exchange to acquire property.
By trading one rental property for another, for example, you avoid
the capital gains taxes you'd incur if you sold the first property
... leaving you with more to invest in the second.
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
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.
See All Tax Savings Strategies