Reducing taxes step by step
By now, you're aware there's no magic bullet to reduce your taxes. But you can take several steps to reduce your overall tax bill this April. Here are 11 items to consider before filing your federal income tax return:Read Full Story
- Double check your math. It seems obvious, but the IRS cites bad math as one of the most common errors it sees on tax returns. So check your work. Make sure you haven't accidentally transposed any numbers or double reported income. Reporting too much income artificially inflates your tax bill -- and under-reporting can result in penalties and interest.
- Review tax changes for the year. The Tax Code changes every year, sometimes at the rate of more than one change per day. In most cases, these changes mean good things for taxpayers. Don't miss out on new credits, new deductions, and lower thresholds for qualifying for tax breaks. To get an idea of what's new for 2009, check out this post.
- Don't overlook personal exemptions. Sure, you know you can count yourself for the exemption, but what about your niece who's lived with you the entire year? Or the child you pay support for who resides with your ex-wife? Personal exemptions for taxpayers can significantly reduce your tax bill. Find out who qualifies and make sure you've properly included them on your tax return.
- Include your capital losses. We all know to report our capital gains on our tax returns, but did you know you can report your capital losses as well? If your losses exceed your capital gains for the tax year, you can claim the loss on your return of up to $3,000.
- Go back through your records for missed deductions. Don't assume you can't take advantage of itemized deductions. Go back through your records and compare your expenditures to deductions that might apply to you. Don't forget about commonly overlooked deductions.
- Donate to relief for Haiti. While you generally cannot deduct charitable contributions made after the year-end for tax purposes, Congress has added an incentive to get more taxpayers to donate to relief for Haiti. Taxpayers who donate to Haitian relief efforts through qualifying charitable organizations such as the Red Cross through March 1, 2010, may take the donations as deductions on their 2009 tax returns. The regular rules for making charitable donations with respect to valuation and method of donation still apply.
- Contribute to your IRA. Qualified contributions to your IRA will reduce your tax bill, since they're deductible -- but you probably were already aware of that. Did you know, though, that you can make a distribution through April 15, 2010, and still have it qualify as a deduction on your 2009 return? The maximum contribution you can make to a traditional or Roth IRA is the smaller of $5,000 or the amount of your taxable income for 2009; you can split the limit between a traditional and Roth IRA. If you're not working, you can still contribute to an IRA and get the deduction. A nonworking spouse can make a deductible IRA contribution of up to $5,000 for 2009 ($6,000 if age 50 or older as of December 31, 2009) as long as the couple files a joint return, and the working spouse has enough earned income to cover the contribution. In both cases, the employee and employee's spouse are subject to income limits and phase outs. Ask your financial or tax adviser for more information.
- Account for all withholding. This seems simple, but you'd be surprised how many taxpayers overlook withholding. A popular culprit: distributions from retirement accounts or sales of stocks. Double check your forms 1099-R and forms 1099-B: withholding will be reported in box 4. Taxpayers may not be aware that taxes have already been taken out of the proceeds of the distribution, especially if it was a significant withdrawal. I've seen taxpayers miss up to $15,000 in withholding -- and the IRS managed to miss it, too.
- Take a second look at taxes paid. Self-employed persons and taxpayers who have unearned income from rents, partnerships, or investments may be subject to estimated taxes throughout the year. Don't forget about those payments when preparing your return. Including them correctly on your return will result in a lower total come tax time.
- Don't assume penalties are correct. If you're using software to prepare your return -- or doing it by hand -- you may run into situations where a penalty may be assessed when it's not actually due. Two of the most common scenarios: an underpayment penalty when you're actually exempt under the "safe harbor" rules and a penalty for early withdrawal from your retirement account when you may be exempt. These rules can be complicated. If you find you're subject to a penalty, familiarize yourself with the rules or consult with a tax professional. But don't just ignore it -- penalties can run up to 25% of the tax due.
- Adjust your withholding. Okay, this is cheating a little. Adjusting your withholding at the beginning of the year won't actually reduce your total tax due, but it can result in less of a bite at tax time. If you owe a substantial amount (which can also result in penalties and interest if you owe too much), consider increasing the amount withheld from your paycheck. The general rule is the lower the number of allowances claimed on your form W-4, the more will be withheld. Consider dropping an allowance to boost your withholding. The result will be less to pay out of pocket in April.