11 Steps for Reducing Your Taxes
- 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 and 2010 was no exception. Some changes, like the AMT patch, weren't pushed through until the end of the year. 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 2010, 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; about a third of all taxpayers itemize. Go back through your records and compare your expenditures to deductions that might apply to you.
- Make a year end donation. You still have a few days in 2010 to make a charitable donation that qualifies as a charitable deduction. Qualifying donations made by the end of the year can reduce your taxable income. You can't deduct the value of donated services, but you can deduct goods and cash.
- Contribute to your IRA. Qualified contributions to your traditional IRA will reduce your tax bill, since they're deductible. Even better, you can make a contribution at any time before Tax Day (April 18, 2011) and it will still qualify as a deduction on your 2010 return. It's important to note that contributions to Roth IRAs are generally not deductible and rules for making a Roth contribution are a bit different for 2010. 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 this year (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.
Preparing and filing your tax return can take up a lot of time, which means you may be in a rush to simply get it done. But flying through your return can mean costly mistakes: bad math, missed exemptions, overlooked deductions and credits, inaccurate penalties and more. Take the time to go back through your return with this checklist, step by step, and make sure you've covered your bases. A thoroughly checked tax return will give you some peace of mind and likely means a lower tax bill. That's worth a few extra minutes of your time, isn't it?