Talk about adding insult to injury! Your paycheck gets shorted all year long, and then mid-April rolls around and you owe even more in–sometimes a lot more. Sure, taxes are a necessary evil and everyone should pay their own way. But why pony up more than your legal share? There are a number of relatively simple tax-planning techniques to use that can actually limit your liability, or at least make it less likely that you’ll have to write another big check next spring.
There is plenty of information out there to help you. All you have to do is find it. A good place to start is with a qualified tax advisor, such as an accountant, tax attorney, or financial advisor. You can also simply pick up a newspaper or magazine around tax time; they’re full of helpful articles and ideas. There are various books and brochures available, and you can even get solid tax advice on the Web. Just type “taxes” into any search engine and get ready for a tidal wave of results.
“The most important thing is to have a plan and not wait until the last minute to execute it,” says Michael Sly, a CPA with Sly & Fiore in Massachusetts. “Spending a little in professional fees for good tax advice can actually help save you hundreds in return.”
For the most part, anything you want to do to limit your tax liability must be done before the end of the tax year. The major exception to that rule is your tax-deferred contribution to an Individual Retirement Account, which can be made right up until the April tax-filing deadline. Most other tax strategies have to be implemented before December 31.
Here are some helpful tactics to consider for the new tax year.
Make sure withholdings from your paycheck are adequate to cover the taxes you owe, but not so much as to create an overpayment. It’s nice to get a tax refund, but that’s money that should have been sitting in your account earning interest. When you fill out a W-4 withholdings form, be sure to use the worksheet and do the calculations properly. You want to have the appropriate amount of tax deducted from your pay. And if you get married or have a child, remember to adjust your W-4. It can make a difference.
Monitor Estimated Taxes
Similarly, if you’re self-employed and pay estimated quarterly taxes, be sure that your payments adequately reflect the amount of income you actually earn each quarter. If you’re doing better than expected, increase your tax payments, and vice versa, so there aren’t any surprises at the end of the year.
Max Out Tax-Deferred Contributions
If you participate in your employer’s defined contribution plan (a 401(k), for example) or have your own plan (a traditional or self-employed IRA), make the maximum allowable contribution–or as much as your budget will allow. These amounts will not be subject to taxation until after you retire.
Use Your Section 125 Savings Accounts
Many employers offer their workers the opportunity to contribute pre-tax dollars to “use-or-lose” accounts for such expenses as childcare and medical/dental treatment. These contributions lower your taxable income and limit the bite of federal, state, social security, and Medicare taxes.
Consider Deferring Compensation
If you’re eligible to receive a year-end bonus of some sort, consider deferring that payment until after the first of the year, especially if you expect to be earning less in the coming year.
Recognize Capital Gains and Losses
Assuming you have both gains and losses from your investments, you may wish to consult your tax advisor (before year-end) and consider a strategy for limiting the taxable effect of both scenarios. And remember, you don’t necessarily have to sell an investment or piece of property in order to incur a capital gain. If you’re invested in mutual funds, for instance, it’s likely that some of them will distribute their capital gains to shareholders, which becomes a taxable event for you.
These are just some of the strategies and techniques, all of them legal, that can help not only limit your tax liability, but also ensure that you don’t overpay. If any of them seem right for you, consult with a tax advisor just to be sure–then go for it. When you really think about it, paying more than your fair share of income tax is like making a non-deductible contribution to the IRS.