By Kay Bell • Bankrate.com
The surest way to tax savings is through tax planning, but you don't necessarily have to hire a financial adviser as a guide. There are several steps you can take yourself to reduce your tax bill:
Think about retirement
Today's contributions to retirement accounts will definitely mean more comfortable tomorrows down the road. Even better: Putting money into such accounts also can help reduce your current tax bill.
Thanks to new pension laws, you have more retirement options.
Start at the office. If you have a 401(k) check with your payroll office about when and how you can boost your contributions. Many companies allow you to easily change the percentage of your pay that you have automatically deposited into your company plan. Adding a bit more before Dec. 31 will reduce your 2006 taxable income amount.
If you're not yet participating, find out when you can enroll. Companies have an open season, typically in the fall, when workers can sign up for this benefit. If you have a major life event, such as a marriage, divorce or birth of a child, you can make 401(k) changes then to accommodate those changes.
For 2006, federal law allows you to contribute up to $15,000 to a 401(k), $20,000 if you're age 50 or older. Those same amounts are the starting point for 2007 but will be adjusted upward slightly to account for inflation. The IRS will announce next year's specific limits in late 2006.
Even if you have a 401(k) at work, consider opening an IRA or contributing to an existing account. Your choice of a traditional IRA or a Roth account depends upon your individual financial situation. In some cases, contributions to a traditional account are deductible from current taxes; with a Roth, you'll get to eventually withdraw the money tax-free.
The key to an IRA is to take full advantage of these tax-favored accounts. Sure, you can wait until the April filing deadline (the 16th in 2007, because next April 15 falls on a Sunday) to contribute to your IRA for the 2006 tax year. But the earlier you put into the account, regardless of whether it's a Roth or a regular plan, the greater the power of compound earnings.
You can save up to $4,000, or $5,000 if you're 50 or older, in either type of IRA in both 2006 and 2007.
Embrace energy and tax savings
During the last few years, rising fuel prices have resulted in tax enticements from Uncle Sam that are designed to encourage Americans to save on energy, too.
Are you considering making some home improvements? If you choose energy-efficient upgrades that are approved by the IRS, you can pay for some of the home work with the tax credit you'll get.
These credits, which range from large-scale solar power projects to things as simple as replacing windows or adding insulation, began in January 2006. But you don't have to rush at the end of the year to get the tax break. The credits are available in 2007, too. So look into the tax-break requirements and potential reward before you start any remodeling.
Take the same sort of energy-conscious approach if you're thinking of buying a new set of wheels.
Drivers who choose energy-saving hybrid vehicles can now get a credit on their tax return. The exact amount depends on what kind of IRS-approved auto you buy and when you purchase it. So before you head to the dealership, be sure you have the latest data, such as this Bankrate.com story, to ensure you get the vehicle you want and the maximum available tax credit.
Examine your investments
It's always a good idea to periodically evaluate your investment portfolio. It's especially important when it comes to your taxes.
If you sold any holdings during the year and made a profit, you'll owe taxes on that money. You can reduce or possibly eliminate that tax bill by selling corresponding assets on which you'll take a loss by Dec. 31.
In the coming year, as you look to rebalance your investments, make sure you choose assets that pay qualified dividends. Thanks to tax-law changes several years ago, and just extended through 2010, certain dividend payments will cost you less in taxes. They are taxed at the same rate as long-term capital gains, which for most investors is 15 percent, compared to the ordinary income rates which go as high as 35 percent.
Less income means less tax
The year might be winding down, but there is still time to trim your eventual 2006 tax bill by reducing your taxable income.
If you have control over your income, put off receiving payments until January.
If you itemize, you also can lower your taxable income by increasing your deductions. Make deductible payments due in January, such as the year's first mortgage payment and its associated interest in late December.
Generosity also can produce tax rewards. Charitable donations generally are tax deductible in the year made. So any gifts you make to qualified nonprofits by Dec. 31 can reduce your 2006 income.
If any of those donations are clothing or household items, make sure you follow the new IRS guidelines. The tax agency now requires that any such property donations be in "good" or better shape or your deduction will be disallowed. Tax attorney Donna LeValley, who also edits the annual "J.K. Lasser" tax guide, suggests that in addition to making a list of the items, take a photograph. You can store a digital image on your computer with the list, she notes, and it will be handy if a tax examiner asks about the donation.
If you miss the December donation deadline, don't worry. The charitable contribution deduction rules will still be around for 2007. But effective Jan. 1, 2007, so will another new requirement that you get receipts for all your gifts, regardless of how small. Previously, such documentation was required only if you gave $250 or more to a charity.
You don't have to turn in the receipts when you file your return, but you will need them if the IRS asks questions. Start 2007 with a new file for charitable gift acknowledgements so you won't have to worry about tracking down the information if the need arises.
Rely on good records
Because of the new requirements, this might be the year to set up a systematic record-keeping system.
It doesn't have to be elaborate. In fact, for many people the simpler the better. An accordion file folder for receipts and investment statements or a filing cabinet drawer if you have a lot of areas to track will work fine.
Computer-based tax filing programs also help many taxpayers keep track of the records they need year after year. The added bonus of these systems is that you don't have to worry about all the loose tax papers.
The key is to set up a system that you'll maintain. Any record tracking method is worthless if you don't use it. But one that you use will definitely help you implement your tax saving strategy and cash in on it at filing time.
Freelance writer Kay Bell writes Bankrate's tax stories. She blogs daily at Don't Mess with Taxes from her home in Austin, Texas
