November 10, 2006
If you're like me, you're stunned to find that the Thanksgiving holiday is right around the corner. Christmas songs will soon be in the air, and before you know it, we'll be celebrating another new year. The time has come to take one final look at your financial situation and make your last-minute moves to minimize your tax bill for the year. Here is a very brief overview of some steps you might want to consider before the ball drops in Times Square.
- Be energy-efficient: You can claim a credit of up to $2,000 for installing solar water-heating equipment in your home. You can also claim a credit of up to $500 for making various energy-saving improvements such as energy-efficient heat pumps, air conditioning, insulation materials, and exterior windows and doors. Additionally, the purchase of a qualifying alternative-fuel vehicle could provide you with a tax credit of up to $3,400.
- Flexible spending account (FSA): Maximizing your employer's FSA will generally allow you to decrease your taxable income while simultaneously paying for otherwise non-deductible expenses. And with the new "grace rules," an FSA is much less of a "use it or lose it" proposition.
- Beware of the new "kiddie tax" rules: The age limit for the imposition of kiddie taxes on a child's unearned income has been recently increased from 14 to 18. Take time to review these rules and make changes to allow for the reduced payment of the kiddie tax now and in future years.
- Retirement contributions: Maximize the contributions to your employer's tax-deferred savings plan, thereby saving taxes immediately and deferring taxes on earnings in your account. Also, don't overlook your IRA contributions (either Roth or traditional).
- Charitable contributions: If you've held appreciated stock for more than one year, consider donating those shares, rather than making similar cash donations. You'll avoid paying taxes on the stock appreciation but can claim the full fair market value of the stock as a charitable deduction.
- Purchase business assets: If your business will soon require additional computers, furnishings, or even transportation equipment, make those purchases before the end of the year to take maximum advantage of the Section 179 expensing election.
- Plan for retirement: If you don't have a retirement plan, consider setting one up before the end of 2006, even if you don't have to actually fund the plan until 2007. In fact, there are federal tax credits for some of the costs of setting up a new retirement plan. And don't overlook a Simplified Employee Pension (SEP) plan, which does not have to be established or funded until 2007.
- Use your credit card: Even a cash-basis business (as most are) can deduct expenses purchased with a credit card on the date of the charge, not necessarily when the credit card payment is made. So if you find that you need business supplies or equipment before the end of the year, and you're short of cash, don't be afraid to charge and deduct it this year.
- Defer income and accelerate deductions: For cash-basis taxpayers, consider sending out your invoices late in December, so that the payment isn't received until the following year, thereby deferring current taxes. You should also stock up and pay for office supplies and other office items before year's end, including paying any outstanding bills or prepaying business expenses.
- Lower taxes on dividends: You might find that the more favorable tax rates now in place on dividends (15% or 5%, depending on the circumstances) might make dividend-paying stocks more attractive than ever. You'll want to be careful, though, since there are holding-period restrictions on those dividend payers, and not all dividends are given the favorable tax rates.
- Offset gains and losses: If you decide to rebalance your portfolio before the end of the year, or if you simply decide to sell some shares at a profit, don't forget the pent-up power of your capital losses. If you find that you have more losses than gains, you can deduct as much as $3,000 of those losses in one year. You'll have to carry forward any losses in excess of $3,000 against future gains or future ordinary income. But don't overlook the wash sale rule, which requires you to defer your loss if you purchase a "substantially identical" security within the period beginning 30 days before and ending 30 days after the date of the loss sale.
- Long-term capital gains: To be eligible for the lower (again, 15% or 5%) capital-gains tax rates, you must hold the capital asset being sold for more than one year. So when selling or otherwise disposing of your stocks, bonds, investment property, rental property, or other capital assets, pay close attention to your holding period. If you find that your holding period is less than one year, consider putting off the sale until later.
These are but a few of the many moves you can make to reduce your taxes before the end of the year. Don't overlook them.
When he's not dealing with tax issues, Fool contributorRoy Lewisis a motivational speaker who lives in a trailer down by the river. He understands that The Motley Fool is all about investors writing for investors. You can take a look at the stocks he owns, as long as you promise not to ask him which stock to buy. He'll be glad to help you compute your gain or loss when you finally sell a stock, though.