It's never too early to take steps to reduce your tax bill. Here are 10 tax savings tips that can help you reduce your 2006 tax bite.
1. Invest in dividend-paying stocks.
Because of the favorable 15% tax rates on dividend income, holding stocks that pay dividends can reduce your taxes immediately. This might make such investments more attractive than other cash-generating securities, such as bonds, or even holding other stock investments that don't pay dividends.
2. Hold stocks long-term.
Dividends aren't the only type of income recently given favorable tax treatment. Long-term capital gains (gains on assets held for more than one year) are also taxed at no more than 15%. So when you decide to sell a stock, consider your holding period, and remember the tax savings allowed for long-term gains will allow you to reap significant tax benefits.
3. Dispose of
How about those shares that have completely fallen off the radar? Perhaps the company is in bankruptcy or has been de-listed. Your worthless stock could result in a capital loss, which could be used to reduce your other income or to offset other stock gains. The good news is that you have plenty of time to take the steps necessary to actually sell the stock to a qualified relative, take the loss on your personal tax return, and still keep the stock in the family, just in case it ever amounts to anything in the future.
4. Maximize your after-tax cost of borrowing.
If you have car loans, credit card loans, or other loans on which the interest is generally non-deductible, consider paying off these loans with a home equity loan or home equity line of credit (commonly called a HELOC) on which the interest is generally deductible. Not only will you convert non-deductible interest into a tax deduction, you'll likely also reduce your overall interest rate on these loans. Be careful: You're putting your home at risk with this move. But for many taxpayers, the tax savings is well worth the risk.
5. Save for your retirement.
Make sure to take advantage of the more liberal contribution limits to tax-deferred retirement accounts. By contributing to your employer-sponsored retirement plan -- such as a 401(k), 403(b), or 457 plan -- you'll reduce your taxable income and defer taxes on the earnings until you take future distributions. With the 2006 contribution limits raised to $15,000 for most plans, you could slash your tax bill simply by saving for the future. And don't forget: If you're age 50 or older in 2006, you can make an additional $5,000 "catch-up" retirement contribution.
6. Go solar.
This new tax provision for 2006 allows you to claim a credit for 30% of the cost of installing solar water-heating, photovoltaic, or fuel-cell equipment in your home, up to $2,000 total. No credit is allowed for equipment used to heat a swimming pool or hot tub.
7. Make your home energy-efficient.
Also new in 2006, you may claim a lifetime credit of up to $500 for making qualifying energy-saving improvements to your home. Qualifying expenditures include installation of certain energy-efficient insulation materials, exterior windows and doors, electric heat pumps, and central air conditioning. The credit is 10% of the cost of qualifying materials; for window installations alone, it's limited to $200 total.
8. Use your employer's flexible spending account (FSA).
Signing up for your employer's FSA will generally allow you to turn non-deductible expenses into income-reduction vehicles, saving taxes on that income immediately. And with the new "grace" rules, the FSA is much less of a "use it or lose it" proposition.
9. Buy an energy-efficient car.
In yet another of the new energy provisions, the purchase of a qualifying vehicle will allow you to claim a tax credit. This credit is available for a variety of alternative-fuel vehicles, with new hybrid vehicles eligible for a tax credit up to $3,400, depending on their fuel-efficiency. However, this credit is limited to the first 60,000 vehicles sold per auto manufacturer after Jan. 1, 2006.
10. Refinance points.
Have you recently refinanced your home? Did you pay any points? Or did the new loan wipe out a prior loan on which points were charged, points that you were expensing over the life of that old loan? Make sure that you don't overlook the deduction for points and how it impacts you and your taxes.
These aren't the only items that will allow you to reduce your 2006 taxes immediately. Don't hesitate to review the tax articles linked above. The end of 2006 is fast approaching; take steps to lower your taxes while you can.
When he's not dealing with tax issues, Roy Lewis is 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. The Motley Fool has a disclosure policy .