Empty-nesters 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.
to figure out how much you can save.
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
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.
Switch to a Roth 401(k).
If your employer offers the new breed of 401(k), seriously consider
opting for it. Unlike the regular 401(k), you don't get a tax break
when your money goes into a Roth, but younger workers are often in
lower tax brackets ... so the break isn't so impressive anyway.
Also unlike a regular 401(k) money coming out of a Roth 401(k) in
retirement will be tax-free at a time you may well be in a higher
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.
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.
Save energy, save taxes. Congress extended a $500 tax credit for
energy-efficient home improvements, such as new windows, doors and
skylights, through 2013. Be advised, though, that $500 is the
lifetime maximum, so if you claimed $500 in energy-efficient
credits before this year, you can't claim this credit. There are
also restrictions on specific projects; for example, the maximum
you can claim for new energy-efficient windows is $200.
Think green. A separate tax credit is available for homeowners
who install alternative energy equipment. It equals 30 percent of
what a homeowner spends on qualifying property such as solar
electric systems, solar hot water heaters, geothermal heat pumps,
and wind turbines, including labor costs. There is no cap on this
tax credit, which is available through 2016.
Second homes can offer a vacation from taxes.
If you're trying to figure whether you can afford a second home,
remember that you'll get some help from the IRS. Mortgage interest
on a loan to buy a second home is deductible just as it is for the
mortgage on your principal residence. Interest on up to $1.1
million of first- and second-home debt can be deducted. Property
taxes can be written off, too. Things get more complicated -- and
perhaps more lucrative -- if you rent out the place part of the
year to help cover the bills.
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 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.
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 (worth 14 cents a mile). Add such
costs with your cash contributions when figuring your charitable
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).
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.
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.
Help your children earn a 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, who are often the least
able to afford such contributions. Parents can help, however, by
giving an adult child (who can not 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.
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