YOUR TAXES : TAX REFORM : Looking Ahead : Steps you take now can reduce what you will have to pay later.
If you’re the typical American taxpayer, you’re probably up to your eyeballs now with the details of your 1988 tax return--and hating every minute of it. So why should you want to read about your 1989 taxes?
Precisely because the time to begin thinking about your income taxes is before you owe them--not when you sit down to complete the your 1040. So, in that spirit, here are 12 tips from several Southern California financial advisers, accountants and consultants for planning your 1989 taxes--and possibly saving yourself some money.
1. Carefully evaluate your current tax withholding strategy and what it’s accomplishing for you. Pay attention to the amount of any refund you are receiving for 1988, or what you owe. If you are getting back a large sum, you in effect gave Uncle Sam an interest-free loan last year. Sure, it’s nice to get that big tax refund, but it doesn’t make financial sense.
At the same time, be sure to avoid the penalty assessed taxpayers who have not had enough tax withheld from their income throughout the year. The law is straightforward on this score: You either must have withheld an amount equal to 100% of your previous year’s tax or 90% of your current year’s tax obligation. By the way, the state of California enforces the same law on state taxes.
2. Take a hard look at your consumer loans and revolving credit card charges. If you are spending a substantial amount on interest for car loans, department store charges and similar debts, you might be better served paying all the bills off at once with the proceeds from a home equity loan or a home equity line of credit.
Consider the trade off: For your 1989 taxes, just 20% of the interest assessed to your consumer debt is deductible; the deduction slips to 10% in 1990 and is phased out completely in 1991. However, interest payments on the proceeds of most home equity loans are totally tax deductible. You’re paying the same bills, but the tax consequences are radically different depending on your method of payment.
There are a few important warnings: Be careful that your loan fees and other costs don’t offset your tax savings. In fact, you might want to consider a home equity line of credit, for which lenders may not charge points and other loan fees. Shop around before settling on a lender and a loan. Be advised that a home equity loan could call for a balloon payment that might impose a serious hardship. Furthermore, getting a home equity loan should be no excuse to go on a buying spree.
By the way, if a home equity loan isn’t practical for you, pay off your consumer debts as quickly as you can and keep your charge account balances low.
3. If you borrow money from your parents or friends to make a down payment on a new house, make sure it’s in the form of a mortgage. Just 20% of the interest on personal loans is deductible anymore, but 100% of mortgage interest is. Again, same payment obligations but radically different tax consequences.
4. “Bunch” your miscellaneous deductions to accumulate a sum large enough to exceed 2% of your adjusted gross income. And don’t be afraid to borrow expenses from next year. For example, renew business-related magazine subscriptions, prepay membership fees, make business-related purchases, all in a single year so you can accumulate enough to deduct. Of course, next year, you won’t have many miscellaneous expenses at all, but at least you were able to deduct something during one year.
Don’t forget to include all your expenses for business use of your car if your employer does not reimburse you. Advisers say allowable expenses include such obvious costs as insurance but also such items as auto club dues, car washes and registration fees. Be sure to keep detailed records.
5. If you don’t itemize your deductions, or if your miscellaneous deductions will never amount to 2% of your adjusted gross income, consider asking your employer to pay some or all of your business-related expenses directly. You might even propose taking a salary cut in trade. You’ll give up taxable income and gain a non-taxable reimbursement of actual expenses.
6. Research whether you are eligible to make a tax-deductible, tax-deferred contribution to an individual retirement account. If so, make the contribution as early in the year as possible so you will earn as much tax-deferred interest as possible.
Basically, contributions to IRAs are fully deductible on federal income taxes by anyone not covered by a qualified pension plan, regardless of their income. For workers covered by pension plans, the IRA deductions are available to single workers with annual adjusted gross incomes of up to a maximum $35,000 and married couples with a combined adjusted income of no more than $50,000. Single workers may contribute up to $2,000. Married couples with only one working spouse may contribute $2,250; if both spouses work, the total possible tax-deferred contribution is $2,000 each.
7. If you change jobs and receive a lump-sum pension fund distribution, you can roll this disbursement over into a tax-deferred IRA, regardless of whether you are eligible to make the tax-deferred annual IRA contributions discussed above. Be sure to make the rollover within 60 days of receiving the distribution. Otherwise, you will be liable for taxes on the disbursement as well as a possible 10% penalty for early withdrawal of pension funds.
8. If your employer offers a 401(k) plan as part of your benefit package, take full advantage of it. Basically the law allows you to shelter $7,627 this year in a 401(k) account. “It’s one of the last ways to defer taxes on income,” says Margaret Bumcrot of the Downey accountancy firm of Muller, King & Mathys.
Also, check to see if your employer will match your contribution. Many companies are now offering to match at least a portion of employee contributions. These matching contributions are also tax deferred.
9. Consider investing in tax-free municipal bond funds to lower your taxable income. For California residents, there are special California municipal bond funds offering a “double tax-free” advantage because they are exempt from state as well as federal taxes. However, the trade-off for the tax advantage is a lower interest rate than other investments might pay.
10. If you can, defer receiving interest income from your investments until January, 1990. This way, you will have use of the money for the entire year, but will not owe taxes on it until April, 1991.
11. Keep careful records of your stock purchases. If you buy a specific stock over a period of time, you can designate the most “expensive” of your purchases as the lot you are selling, thus lowering your potential taxable gain. You do not have to be limited to a “first in, first out” type of accounting. But your records must be thorough.
12. Taxpayers of all ages should carefully monitor their tax situation as the year proceeds. If you are on the borderline between the 15% and 28% brackets, careful attention to your earnings and potential deductions could make a substantial difference in your tax obligations. For example, if a midyear projection reveals that you might be barely into a higher bracket, a few charitable contributions or redeployment of investments could lower the total tax bite by the end of the year.
