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Get an Income Tax Refund With 3 Easy Tactics

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Next April, everyone's going to be wishing that they were getting a bigger income tax refund back from the IRS. But if you want to get serious about saving on your taxes, the time to think about it isn't a day or two before you file your return -- it's right now.

If you do the right things, you can cut your tax bill by hundreds or even thousands of dollars. Consider using some of the following simple methods and see how much savings you can get.

1. Contribute to retirement accounts like an IRA or 401(k).
The simplest way to get a tax break is to contribute to a traditional retirement account. For individual retirement accounts, or IRAs, there's not as much time pressure, because you actually have until next April to make a contribution for the current tax year.

But if you're eligible for a 401(k) or other employer-sponsored retirement plan at work, that's where you can pick up some truly colossal savings. The reason is in the contribution limits: 401(k)s let you contribute up to $17,000 this year, compared to just $5,000 for an IRA. Do the math, and you'll see that for someone in the maximum 35% tax bracket, a $17,000 401(k) contribution will give you $5,850 in savings on your taxes.

The rules for 401(k) contributions are different, though, in that you can't get a tax break this year for a contribution you make next year. So talk to your HR representative about boosting your 401(k) contributions before Dec. 31, and you'll see the impact when you file this year's return.

2. Don't fall into the mutual fund trap.
One way to make sure you don't pay more in taxes than you have to is to avoid unnecessary income. If you invest in mutual funds, though, there's a big trap that could jeopardize your tax refund.

Mutual funds don't pay taxes like people or businesses do. When they sell stocks at a profit or a loss, they accumulate the gains and losses throughout the year. Toward the end of the year, if the fund has net recognized capital gains, it has to distribute those gains to its shareholders. If you own the fund, then you have to include that income on your tax return.

If you've owned the fund long enough to have enjoyed the benefits of those gains, then that seems perfectly fair. But the way the tax laws work, even someone who owns shares for a single day right before the record date for the distribution will have to pay tax on the money received -- even though it's really just a return of the money they just invested. And even worse, you have to pay taxes even if you never take the money -- reinvesting it into more shares, as many fund investors do, won't save you.

As an example, look at the American Funds New Economy Fund. With an emphasis on companies at the forefront of innovation and new technologies, the fund has benefited greatly from many of its investments. On the mobile device front, both Apple (Nasdaq: AAPL  ) and Amazon.com (Nasdaq: AMZN  ) have seen impressive year-to-date gains on their respective dominance of the high-end smartphone and entry-level tablet markets. But the fund has also benefited greatly from good calls in the biotechnology space, with Gilead Sciences (Nasdaq: GILD  ) and Alexion Pharmaceuticals (Nasdaq: ALXN  ) both benefiting from successful drugs. Alexion's Soliris, fetching $400,000 per year from patients, has been a lucrative niche for the company, while Gilead just got its Stribild all-in-one combination HIV treatment approved.

With all this success, American Funds anticipates that it will pay out between 1% and 4% in capital gains on Dec. 28. If you buy shares before that date, you'll end up getting taxed on that 1% to 4%. The simple thing to do is to hold off on buying fund shares in taxable accounts until January.

3. Boost tax-deductible expenses and losses.
The other major category of ways to cut your taxes is to accelerate tax deductible expenses and losses. By paying for things in December rather than January, you could be able to write them off this year and save.

Something to keep in mind
The impending fiscal cliff actually changes the normal equation for tax savings this year. In the long run, if tax rates rise next year, you may be better off not doing things to minimize your 2012 taxes, instead saving those deductions for 2013. That's a decision only you can make, depending on your particular situation.

But if saving taxes now is more important, these three tips should get you started. The bigger income tax refund you'll get should make it all worth it.

Investing in Apple has had the unintended consequence of giving investors a big potential tax problem, simply because the shares have run up so far so quickly. But with the stakes so high and the opportunity so huge, the iPhone 5 promises to be a major driver in determining whether Apple is still a buy. So to help investors understand this epic Apple event, we've just released an exclusive update dedicated to the iPhone 5 launch. Claim your copy of our in-depth report on Apple, which includes this important update, today by clicking here now.

Fool contributor Dan Caplinger has no positions in the stocks mentioned above. You can follow him on Twitter @DanCaplinger. The Motley Fool owns shares of Apple and Amazon.com. Motley Fool newsletter services recommend Amazon.com, Apple, and Gilead Sciences. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (2) | Recommend This Article (16)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 20, 2012, at 11:35 AM, QuarkHadron wrote:

    Good article with good recommendations to reduce a person's tax burden, but.... the headline and intro paragraph aren't quite right.

    I never wish for a bigger refund. Indeed, if I get a refund, I consider it a failure on my part.

    I always strive to write a check at income tax filing time.

    I estimate my income and tax bill several times a year and adjust my withholding and estimated payments as necessary to ensure I don't have a refund. I make sure I have a shortage, but within the amount that does not incur a penalty.

    Why? Because any overpayment I've made throughout the year is an interest free loan to the government. I work to maximize my investment income. Why would I want to give out interest free loans?

    So, the recommendations in the article are spot on and all good ways to reduce tax burden - but going a step further with the idea that "the time to think about it isn't a day or two before you file your return -- it's right now," and actively watching your tax burden throughout the year can also free up cash - for investment.

  • Report this Comment On October 26, 2012, at 11:33 AM, hessaw wrote:

    LOve MF articles. But disappointed that long route to cell phone tower site company investment only led to yet another "buy this" conclusion. FOOLISH, I think.

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Dan Caplinger
TMFGalagan

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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