With the calendar soon flipping over to Jan. 1, now is the time to make those last-minute tax moves that will take a bicuspid out of your annual tax bite. Here are a few suggestions.
Contribute to your favorite charity
If you've held appreciated stock 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 you'll still be able to deduct the full value of the stock. You win, your charity wins, and the only loser is Uncle Sam. (But he doesn't really mind, which is why this tax break has been written into the law.)
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 don't forget about the contributions you will make by check. You need to give the check to the charity (or at least mail it out) before the end of the year for this deduction to "stick." It doesn't matter that the charity may not actually cash (or even receive) the check until next year. The key is that you deliver it to the charity before the year expires.
The same goes for donating an auto or boat or other large item to a charitable organization. But with the changes to the law in 2005, you'll want to make sure you follow all of the rules and substantiation requirements so you can actually get the deduction you desire.
Remember also that a deduction for charitable contributions has merit only if you are planning on itemizing your deductions on Schedule A. If you're a "standard deduction" filer, you should still keep charity in your heart, but Uncle Sam won't help you out with a tax break.
Clean up your portfolio
You might own stocks that are no longer appropriate for your portfolio. And those stocks might also be in a loss position. You can sell these shares, take the loss, and use that loss to offset the sale of gainers (and even long-term capital gains from mutual funds) in the current tax year. Once you've used your losses to offset your gains, you can use up to $3,000 in losses to offset your other income. That'll save you tax dollars right now. But even if you do have long-term stock gains, don't fret too much, since the maximum tax rate on these gains is only 15% -- or less, depending on your marginal tax bracket.
Realize that for any stock or mutual fund sale, the trade date, not the settlement date, is the controlling factor for tax purposes. There are very few trading dates left in the year, so if you want to clean out your portfolio and realize some losses, you must get it done soon.
Dispose of worthless stock
How about those stubs you own that have completely fallen off the radar? Perhaps the company is in bankruptcy or has been delisted. You might have some worthless stock on your hands that could result in a capital loss.
But the term "worthless" is a technical one from a tax standpoint. It means more than just the bottom dropping out of a stock or a suspension of trading. You might be able to use a few tricks to get these shares sold before the end of the year, even if those shares are no longer traded on any market. If done correctly, you can realize the loss this year but still keep the stock in the family, just in case it comes back from the dead.
Use your credit card
If you have year-end deductible expenses (such as business, medical, or rental expenses, charitable contributions, miscellaneous itemized deductions, state taxes, or virtually any allowable deduction), 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. 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 contributions. If you have the right 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.
Prepay your state and/or local taxes
If you believe that your tax bracket next year will be no higher than it is this year, and you won't be bothered by any alternative minimum tax (AMT) issues, consider making those state and 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 Dec. 31 and take the federal tax deduction this year? And why not make it by credit card? Many states allow for the payment of state taxes by credit card, so again, you can secure your deduction in 2005 but not actually pay the bill until sometime in 2006. Sweet!
This doesn't apply solely to people who have fourth-quarter estimated tax payments to make in January. If you are a W-2 wage earner and expect a state or local tax balance due, you can use a state/local prepayment voucher and make your tax payment before the end of the year. But before you leap, make sure to look at your AMT position. If you find yourself in the AMT zone, prepaying your state taxes will not result in any additional federal tax savings.
Again, you will benefit from this move only if you itemize your deductions. If you're a standard deduction filer, prepayment of your state taxes won't get you a tax deduction.
Make business purchases now
If you're a business owner, consider buying those big-ticket items before the end of the year. That could include virtually any business asset, such as computers, furnishings, or a business vehicle. I certainly don't advise spending money just for the sake of spending it before the end of the year -- we'll leave that to the government. But if you need business assets to improve your efficiency, or you're thinking about making those purchases early next year anyway, make 'em now and take advantage of the liberal depreciation rules that will likely allow you to deduct those purchases immediately, without the actual hassle of depreciation.
Teachers -- shop now!
Educators can take a deduction for up to $250 spent on classroom materials. But this tax break will end at midnight this Dec. 31. It was previously scheduled to expire at the end of 2003 but was extended.
Teachers aren't the only ones eligible for this break. Teacher aides, counselors, and even principals can claim it, as long as they work at least 900 hours in a K-through-12 public or private school. Even better, you don't have to itemize to take this break. It's available directly at the bottom of the long Form 1040, and the amount you claim helps reduce your income amount, which means a lower tax bill. All you have to do is purchase $250 worth of classroom supplies by the end of the year.
Deduct sales taxes
Taxpayers who itemize their deductions will be able to choose whether to deduct state and local income taxes or claim a deduction for sales taxes. But not both.
The sales-tax break obviously will help residents of states without income taxes, but every taxpayer should give this deduction a close look. In some cases, state income tax rates may be low enough to make the sales-tax deduction more valuable. And, as a bonus, you are allowed to supplement the "standard" amount of sales-tax deductions if you bought a vehicle or boat this year. But act quickly, since this deduction is also set to expire at the end of 2005.
I know you're busy this time of the year, but don't let these tax-reduction moves pass you by!
Roy Lewis lives in a trailer down by the river and is a motivational speaker when not dealing with tax issues. 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.