Although all citizens are supposed to pay taxes to support the common good, no one is required to pay extra, yet that is what a lot of us do.
Here are a few ideas we have used over the years to save money on taxes.
Research potential deductions when the tax laws for the year are known.
Our wonderful Uncle likes to meddle in our lives by trying to encourage certain behavior through granting tax deductions. If you are needing to purchase something anyway, you may as well get the deduction for it. For instance, in 2011 their were some hefty credits for going green – if you installed energy efficient windows, siding and etc. you got a nice little bit of it back. Of course, this only makes sense if you need to do it anyway.
So, do the research and plan your expenditures for the year to maximize tax credits and deductions.
Manage deductions, gains and losses.
If you itemize, or think you will, it may be beneficial at times to hold off on contributions which can be deducted and make 2 years worth of deductions in a single calendar year. Do this when you won’t have enough in just one year to make a difference on your taxes.
Controlling when you take capital gains or losses on investments is also a good tax management strategy. For instance, knowing that there is a good chance that capital gains will be taxed at a higher rate next year, we went ahead and took some of those gains this year instead of waiting. If you are wanting to shed losing stocks, think of timing the sale to maximize use of the loss.
Do your own tax return.
Although we now use an accountant due to the complexity of our financial lives, we did our own taxes for years and almost always filed the 1040 long form with all of its various attachments (and we’ve never been audited).
At the time, I didn’t realize what we were saving in dollars. Because we have two businesses and have also had to calculate the Alternative Minimum Tax for about a decade, we hired an accountant. He does our personal return which has one of the businesses included as schedule C and he does our llc on its own return. He is good, but he charges what I think is a lot. We usually end up paying between $1000 to $1200 a year for these two returns (four actually as he does the state returns as well), prep of estimated taxes and advice for the coming year.
If your situation is simpler you could go to one of those tax prep places that you see set up in Walmart, or being advertised by those folks walking up and down the street dressed like the Statue of Liberty. Accounting Web claims that (as of 2010) you can get one of these outfits to do your federal and state return for $200 – $300. However, in my unprofessional opinion, if your situation is simple enough to use these kinds of services, you can do your own taxes. We did ours for decades.
Throughout the year, we would collect anything tax related, including donations, deductions (real estate and property taxes paid, charitable donations, gains and losses on sales of assets and etc) and file it in a tax folder for the year. After all the tax forms arrive in the mail box, we took a day to read the annual booklet put out by our friend the IRS and then did and double checked the calculations.
It’s really not that hard if your financial life is straightforward, you just have to look out for possible deductions and credits so that you don’t miss out.
Caveat: the tax code is more complicated now than when we did ours and there are more options for having others do your taxes. I bet there are a lot of accountants and tax preparers out there who would disagree that you can or should do your own taxes! Even if you do have your taxes done, you still need to check what is given back to you – it is your responsibility.
File on time.
Don’t pay a penalty for late filing.
Don’t overpay throughout the year.
It’s not cool to get a big tax refund. That means you have been loaning your money to the US government interest free all year! Don’t do it. Sure you’ll have to maybe chuck in estimated tax payments 4 times a year, but that doesn’t take long to do.
Donate don’t sell.
If you are in a high enough tax bracket and are itemizing deductions, it may be more beneficial to donate those garage sale type items instead of selling them. They may be worth more in deductions than you could get by selling, plus, you avoid the hassle of the sale. Be sure to keep good records and abide by the valuation guidelines put out by the IRS. Pictures could help as well.
Keep good records.
Keep receipts and all other records that support your tax return and make sure they are organized so you will understand them if you get audited 5 years from now.
Invest tax free.
Instead of putting money into taxable accounts, we put a portion of our investments in totally tax free things, such as municipal bonds.
Invest tax deferred.
Of course, contribute to your tax deferred, company matched 401K or Roth IRA accounts (although you pay now, you save big later with Roths).
Use pretax dollars.
If you can set up a flexible spending account or a health spending account and your situation assures that you will use the monies, do it. Pay your childcare costs pretax as well as your out of pocket health expenses. Just don’t forfeit the money at the end of the year.
Give your money away.
Huh? Why give money away? We are trying to save money on taxes. Like all other tax breaks, this one only makes sense if you want to give money anyway.
If you have an estate big enough and you want to pass it along to someone else, and can afford to give up the money now instead of at your death, you can save significant taxes on it. You can give thousands of dollars away each year without paying gift taxes (yes you heard me, the giver pays the taxes). This is called the annual gift tax exclusion amount and it is set for $13,000 for 2012. By giving some each year, you move money out of your estate that would otherwise be taxed at egregious rates (it has been as high as 55% of the amount of your estate over the exclusion amount).
You can also pass a certain amount ($5 million dollars in 2012) free of gift or estate taxes when you die. Any amount you give each year that exceeds the annual gift tax exclusion amount is added in to a lifetime gift amount and reduces the estate tax exemption amount your estate is allowed when you die.
Make your hobby a real business.
You very likely will benefit from higher allowed expense deductions than you do with a hobby. However, the IRS wants to see a profit in about 3 out of 5 years!
What do you think of these tips? What tips do you have to legally save money on taxes?