Avoid a Big Tax Refund
Keep more money in your pocket, and less in
Uncle Sam’s, in 2009.
You think you love getting a tax refund. What’s not to like about found money? But a refund is really
just the return of a year-long, interest-free loan that you extended to your
spendthrift Uncle Sam. You can do much smarter things with that money, like
putting it into a retirement plan or a college savings fund. So if you will be
receiving a 2008 refund of more than a few thousand dollars and you’re an employee, adjust your withholding at work. If
you’re self-employed, lower your
href="http://www.irs.gov/businesses/small/article/0,,id=110413,00.html">quarterly estimated tax payments
accordingly.
Nitty Gritty
Withholding news:
Making Work Pay Tax Credit
If your 2009 income will be less than $75,000 ($150,000 if
you’re married and will file jointly), be
sure your tax withholding has
been properly adjusted for the new Making Work Pay Tax Credit
you’re entitled to receive this year. This credit of up to $400 for
singles and $800 for couples should be reflected in the amount of taxes taken
out of your paycheck. But you may need to submit a
href="http://www.irs.gov/pub/irs-pdf/fw4.pdf">revised W-4, especially if
you’re married (your employer wouldn’t know your spouse’s income) or
you’re holding down multiple jobs.
Save More in Your Retirement
Plan
Plan now for a comfier future later.
If you are not maxing out your
href="http://moneywatch.bnet.com/retirement-planning/article/check-out-the-best-401ks-/277183/">employer-sponsored,
tax-deferred retirement plan, you’re missing out on the single
best opportunity to save on taxes. I know that the idea of saving more may be
impossible in today’s rough economy. But if
you can squeeze just an extra percent or two out of your paycheck and pour that
cash into the plan, you’ll reduce your taxable income and your
’09 tax bill. Doing so might also bring your income under certain
thresholds that will let you qualify for bigger tax breaks you’d
otherwise miss, such as personal exemptions, itemized deductions, an individual
retirement account, the
href="http://moneywatch.bnet.com/saving-money/article/limbo-your-way-to-lower-taxes/277132/">Child
Tax Credit, the Child and Dependent Care Credit, and the Hope and Lifetime
Learning Credits for college.
For Example
The prize for
contributing to a 401(k)
Here’s an example,
courtesy of Research401k.com. Say
you’re a single person earning $50,000 and
in the 25 percent tax bracket. Without making a 401(k) contribution, you might
owe $12,500 in taxes this year. By contributing $4,000, you’d reduce your taxable income to $46,000 and might instead
owe $11,500 in taxes. Essentially, the government lends you $1,000 to invest
for your future, and you don’t have to pay
the loan back until you withdraw the money from the 401(k) in retirement.
Look Into Muni Bonds and Funds
Lower your taxable income with tax-free savings choices.
If you have money in interest-earning, checking, or saving
accounts; CDs; money-market funds; or taxable bonds or bond funds,
you’re adding to your tax liability. You may want to consider moving
some of that cash to tax-free municipal bond funds. (I’m a fan of Vanguard funds, like the Vanguard
Intermediate-Term Tax-Exempt Fund,
href="http://finance.bnet.com/bnet/?Page=CHART&Ticker=VWITX">VWITX.) At the moment, yields on munis are unusually high compared with taxable investments,
which means you will earn considerably more, after taxes, in
href="http://moneywatch.bnet.com/investing/article/best-buys-on-bonds/279238/">munis.
To see how much more in your particular case, use this
href="http://www.finance.cch.com/sohoApplets/TaxEquivYield.html">taxable-equivalent yield calculator. Just
be aware that the sweet yields on munis come with
some extra risk, since there’s always a
possibility that a few bond issuers won’t make their payments.
Historically, that risk is pretty slim, but it’s
not zero, especially in a recession.
Lower Your Mutual Fund Taxes
Keep your 2009 tax liability down.
How is it possible that your mutual fund that dropped 30 percent
in value last year still socked you with a taxable distribution? Well, this is
one of the most aggravating features of a managed mutual fund — it
can lose money and still saddle you with a tax liability. As
a fund buys and sells assets throughout the year, investors are on the hook for
the taxes on those transactions. You may even be taxed on gains the fund
incurred before you owned it.
One way to limit the damage before you buy a fund is to ask the
fund company if it will be making a distribution soon. If the answer is
“yes,” hold off buying until
afterwards. Or you might invest in funds with low turnover ratios, such as
index funds, since they’ll be less likely to
throw off taxable distributions. A turnover ratio below 10 percent is generally
tax-efficient (a fund’s annual report will
show its turnover rate).
href="http://screen.morningstar.com/FundSelector.html">Morningstar’s Fund Screener
tool can help you find low-turnover stock funds.
Technically Speaking
Investing in
tax-managed mutual funds
One class of mutual funds, tax-managed funds, is all about
keeping your tax liability low. They do this in different ways ― keeping
turnover low, avoiding dividend-paying stocks, and selling losers, to name a
few. Some tax-managed funds own stocks; some own stocks and bonds.
href="http://www.morningstar.com/">Morningstar and
href="http://finance.yahoo.com/funds">Yahoo! Finance’s
Mutual Funds Center can help you find them.
Keep Better Tax Records
Get all the write-offs you deserve.
Organizing your tax records better could not only lower your tax
liability, it may help you get rid of the tax-filing headache sooner. Create a
file called “Taxes 2009” and
throughout the year toss into it business receipts; bank, brokerage, and mutual
fund statements; W-2s; 1099s; property tax bills; and mortgage interest
statements. And keep track of your purchase price, commission, and sales price
for any investment transactions in 2009.
The Legalese
Filing an extension
If you’re having trouble getting your
’08 taxes done by April 15, you can file Form 4868 and get an
href="http://www.irs.gov/pub/irs-pdf/f4868.pdf">automatic six-month extension of time to file
to October 15. Keep in mind, however, that this extension does not give you
more time to pay any taxes due. You’ll owe
interest on any amount not paid in by the April deadline, plus a late payment
penalty if you haven’t covered at least 90 percent of your total tax
by then.
If you can’t pay all your
taxes due by April 15, file your return by the deadline anyway and pay in as
much as you can, to avoid penalties and interest. Also, call the IRS
(800-829-1040) to discuss your payment options. The agency may be able to give
you a short-term extension
to pay, an installment agreement,
or an offer in compromise. More than 75 percent of taxpayers eligible for an
Installment Agreement can apply using the
href="http://www.irs.gov/individuals/article/0,,id=149373,00.html">Online Payment
Agreement application at IRS.gov.
