There is very little you can do after December 31st to reduce your taxes for the current year. So, take stock of your tax issues before the end of the year to see what you can do about them... how you can pay Uncle Sammy only your fair share... and not a penny more.
We'll look at some year-end tax-saving moves that could help you reduce your tax bill. Hopefully one (or more) of these tips will allow you to take a bicuspid out of your tax bite. Here we go...
Contributions to your favorite charity: If you have appreciated stock that you've held for more than one year, you might want to keep the cash in your pocket and donate the stock. You'll avoid paying tax on the appreciation, but will still be able to deduct the full value of the stock. You win, your charity wins, and the only loser is Uncle Sammy.
If you still love the stock and want to maintain a position in the shares after your charitable contribution, you can simply buy new shares in the company. Your charity will be able to assist you with this transaction, and it can really be a great deal for all involved.
Use your credit card: What was that? I thought the Fool was all about getting out of debt? Well, you're absolutely correct. We're not talking about running up your credit card unnecessarily, but if you have year-end deductible expenses (such as business expenses, medical expenses, miscellaneous itemized deductions, etc.), you can use your credit card to make the purchase this year, take the deduction this year, and pay your credit card bill next year.
You see, when you pay with a credit card, the IRS considers the expense deductible in the year that the charge is incurred, not necessarily when you pay the credit card charge.
In fact, going back to the first tip, you can even find charitable organizations that accept credit cards for charitable contributions. If you have the right credit card, you can receive a 30-day "float" that amounts to an interest-free use of the bank's money if you pay it off when the bill comes.
Convert ordinary income into long-term capital gain income: Remember that the long-term capital gains tax rate is a preferred rate. While the tax rate on ordinary income can reach as high as 39.6%, your maximum capital gains rate will only be 20% (and some might pay a capital gains rate as low as 10%). So, when at all possible, try to convert ordinary income and gains into long-term capital gains.
This can be done by simply only selling stock that you've held for more than one year. However, there is another little trick that those of you still investing in mutual funds might find interesting. If you have a mutual fund (that you've held for longer than one year) that you expect will pay out a substantial amount of regular dividends (which are taxed at your normal tax rate), you might want to sell those shares immediately prior to the payout date.
Why? Because the share price of the mutual fund will generally drop by approximately the amount of the dividend. So, if you sell the fund before the payout date, you'll lose the dividend, but you'll get the higher sales price on your shares, which will be treated as long-term capital gains to you. Abracadabra! You've just converted ordinary income into long-term capital gain income, and will pay taxes at a lower rate.
We certainly don't advocate doing this on a whim. But, if you have a mutual fund that you were thinking about getting rid of soon anyway, dumping it before the dividend payout date could save you a few (or even several) tax dollars.
Prepay your state and/or local taxes: If you believe that your tax bracket next year will be no higher than this year, and you won't be bothered by any alternative minimum tax issues, consider making those state/local tax payments before the end of this year. After all, you're going to owe the money anyway, right? So, why not make those payments before December 31st and take the federal tax deduction this year?
You might think that this strategy only applies to people who have fourth-quarter estimated tax payments to make in January, but it really doesn't. If you are a W-2 wage earner and expect a state/local tax balance due, even you can use a state/local prepayment voucher and make your tax payment before the end of the year.
In Part II, we discuss a few more tax-saving ideas.
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