Taxes might not be due until April, but there are a few things you can do before the new year to lower your bill.
Taxes might not be due until April, but there are a few things you can do before the new year to lower your bill. iStockphoto.com
Federal income tax time is still a few months away, but there are some things you can do before Dec. 31 to save money on April 15.
"The biggest thing is, if you have a 401(k) retirement plan at work and you have not yet maxed it out, that is a great way to kick some extra dollars into your retirement account," Mary Beth Franklin, a senior editor at Kiplinger's Personal Finance magazine, tells NPR's Renee Montagne.
What you contribute to the plan is excluded from your income, meaning a lower tax bill. It's also a good move in the long run in terms of building up savings.
For 2011, the maximum you can contribute to a 401(k) is $16,500, or up to $22,000 for those 50 or older. Under some proposed tax plans, the maximum contribution may be lowered to 20 percent of your income or $20,000 — whichever is lower. For an income of $50,000, then, you would only be able to contribute $10,000.
Take advantage of deductions. If you itemize deductions, you can write off either state sales tax or state income tax. For many, it makes more sense to write off the income taxes. But the ability to write off the sales tax may disappear after this year — so if you live in a state without income tax, it might be a good time to make a big-ticket purchase you've been thinking about, and write off the sales tax.
Look at your withholding. If you usually receive a tax refund — and most Americans do — you can claim more allowances on your W-4 form to keep that money in your paycheck. But if it looks like you might owe money when you file taxes in April, it's best to boost withholding now to avoid a penalty. You must pay 90 percent of what you owe in advance to avoid the charge.
Max out your 401(k). If you can afford to contribute the maximum amount to your 401(k) before the end of the year — $22,500 if you're 50 or over, or $16,500 if you're not — you won't have to pay taxes on that amount. And in the long run, it means more retirement savings.
Get the energy-efficient-home credit. If you install windows, doors or insulation to make your home more energy efficient, 10 percent of the cost — up to $500 — can be claimed as a tax credit. The offer expires this year.
Be generous to your family. You can give up to $13,000 tax-free each year, but that amount expires on Dec. 31 and does not roll over to the next year.
Source: Mary Beth Franklin, Kiplinger's Personal Finance
Self-Made Pay Raise
Another interesting way to keep some of your income is what Franklin refers to as giving yourself a pay raise by claiming more allowances on your W-4 form.
"The majority of Americans are just addicted to refunds," says Franklin, who has been writing about year-end tax moves for Kiplinger. "More than 75 percent of Americans give Uncle Sam an interest-free loan, and then they get this refund in the spring."
The amount of taxes withheld from your paycheck ideally should match the amount that you're going to owe when you file your tax return, Franklin says. But many people pay more than they owe through withholding and receive a refund.
This year, the average refund may reach $3,000. Claiming more allowances on your W-4 will mean more money in your paycheck when you earn it, Franklin explains.
Stocks And Home Investments
After this volatile year in the stock market, there are some moves to be made before Jan. 1 to dull the blow if you have an investment portfolio. One classic move Franklin points out is called "harvesting your losses," which applies only to taxable investment accounts — not retirement accounts like IRAs or 401(k)s.
"If you realize you have some losing investments and you choose to sell those before the end of the year, then you can use that to offset some winners, and possibly pay no tax at all," she says.
After matching up those gains and losses, you can use up to $3,000 of excess losses to offset regular income, like salary or IRA distributions.
Another tax credit set to expire Dec. 31, is for remodeling to make one's home more energy efficient. It's the last year the credit of up to $500 is available for purchases of things such as energy-efficient windows, doors and insulation.
Unlike deductions, Franklin notes, credits reduce the amount of taxes you owe (or increase your refund) dollar for dollar, instead of simply reducing the taxable amount. That makes credits an even better opportunity to lower your taxes.