Ready or not, tax season is about to begin. As appealing as it may seem to put off your taxes until April, the sooner you start dealing with the forms you're about to receive, the easier it'll be to find whatever good news you can on your returns.
Much ado about very little
Less than a month ago, millions of taxpayers were worrying about the potential for huge changes in tax laws. Left unchecked, the changes that were initially slated to take effect on Jan. 1 could have produced huge hassles for filing this year's tax returns as well as the prospect for a brand-new tax landscape to deal with in the years to come.
Yet after weeks of fiscal cliff drama, the end result was that for most taxpayers, taxes will stay mostly the same going forward as they have been. With the exception of the long-anticipated loss of the payroll tax reduction, the vast majority of taxpayers will face very few changes in their taxes -- and best of all, lawmakers made permanent fixes to make perennial challenges like the AMT largely a thing of the past.
Here are three tips to make your tax season go as smoothly as possible.
1. Be ready for what you're going to get.
For investors, new rules that change the way that your tax information gets reported have just about fully taken effect. Essentially, the new rules boil down to this: The IRS no longer trusts you to report capital gains correctly, and so it has forced your broker to provide the information the IRS needs to check your work.
In particular, beginning in 2011, IRS rules required brokerage companies to track your cost basis for individual stocks in your portfolio. The same rules applied to mutual funds beginning in 2012, and this year, other types of investments, such as bonds, options, and other securities, will get added to the mix.
In plain English, if you've bought investments since those dates, then your broker must keep information on how much you paid for them. Then, when you sell shares, your broker will calculate exactly what numbers you have to report on your tax return, based on the choices you make regarding a default method for calculating cost basis. Most important, you can't go back and change the method you used -- a common tactic that some investors abused prior to the new rules taking effect.
The new rules can actually be helpful for recordkeeping, but the biggest challenge comes when your broker makes a mistake. In that case, you'll have to go to your broker and have a formal change done. Otherwise, the discrepancies will trigger a potential audit flag at the IRS. So if you sold stocks, ETFs, or mutual funds in 2012, be sure to check the forms you get to make sure your broker got it right.
2. Know how to cut your taxes.
Once you see how much you'll owe on your tax return, you may well want to do anything you can to get that number to be smaller. Unfortunately, a lot of the best tax-cutting strategies don't work after Dec. 31.
One option you do have left, though, is to open an IRA for the 2012 year. Traditional IRAs could let you deduct contributions up to $5,000 -- $6,000 if you're 50 or older. That can produce as much as $1,500 to $1,800 in tax savings, depending on your tax bracket. Just be sure to act by April 15, or else you'll lose your chance at a 2012 IRA.
3. Get a jump on 2013.
As hard as it is to get your 2012 returns done, smart investors are already starting to plan for next April's returns. With new income limits, phaseouts of itemized deductions and personal exemptions, the Medicare surtax, and new 20% maximum tax rates on dividends and long-term capital gains for high-income taxpayers, there's a lot to process.
Among the things to consider are the following:
- Think about moving dividend-paying stocks into IRAs and other tax-favored accounts. Use ETFs and other tax-efficient investments in regular taxable accounts.
- Before taking gains on selling investments, your home, or other assets that create capital gains, consider whether the sale will push your income so high that you're subject to new taxes.
- Plan income and expenses to try to maximize tax benefits. Accelerating income into the current year no longer makes sense for most taxpayers; do what you can to boost your allowable deductions, but be aware that the AMT can render some deductions useless.
Get ready now
Unfortunately, as much as politicians talk about making taxes simpler, things only seem to get more complicated. Don't wait until the last minute; get ready for tax season now, and you'll have a much easier time of it.
Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter @DanCaplinger.