Taxpayers can save on their bill for '06, but they'd better hurry
By Kathleen Day
By Kathleen Day
If tax season seems too far off to be worth the worry, think again.
With the end of the year approaching fast, taxpayers have a shrinking window of opportunity to qualify for breaks that can reduce their overall tax bill come filing time.
This tax year, people can save in a variety of ways — by giving financial gifts, selling mutual fund shares at the right time or putting aside money for college — provided they act by Dec. 31. A few breaks are just temporary measures, including a one-time phone tax refund and credits for making energy-saving home improvements.
Financial planner James G. McGrath is following his own money-management advice by installing energy-efficient windows in his Rockville, Md., home, an expenditure of several thousand dollars that will knock $200 off his tax bill in April.
"If you're going to do it anyway, this year's a good year to do it," he said of the benefit, which will expire next year unless Congress renews it.
Ideally, tax planners say, everyone should be thinking year-round about how to minimize payments to the government. But the rest of us know most people are either too busy to do that or think the only thing worse than paying taxes is trying to figure them out.
"We prefer to do our tax planning in February and March, so you can think about it all year rather than scurry about in the last few months," said Barton Francis, partner in the personal financial services group at PricewaterhouseCoopers LLP, an accounting firm. "You have more time and typically more options if you address this earlier."
Before racing over the next several weeks to seek out those breaks, Francis said, people first should estimate how much they would owe in taxes if they did nothing more.
To do that, calculate taxes under what planners call the "regular" tax code. Then run the numbers under the dreaded alternative minimum tax, or AMT, a parallel system created by Congress nearly 40 years ago to ensure that wealthy taxpayers paid at least some federal income tax.
Whichever number comes out higher is the tax owed, absent a strategy to whittle that number down. You need to know which system you fall under to know which tax-saving strategy to choose.
Because the AMT has not been adjusted for inflation, it snares more middle-class taxpayers each year, making the pursuit of tax breaks ever more important. Jackie Perrins, an investment specialist in the D.C. office of J.P. Morgan Private Bank, warns that even small tax increases can erode income gains in periods such as this one, when interest rates earned on investments are relatively low.
Taxpayers determined to seek tax breaks without a planner's advice should make sure they understand how each potential benefit fits their particular situation before deciding to use it. Moreover, they need to understand the differences between deductions, exemptions and credits. Deductions and exemptions reduce the amount of income that will be taxed. A credit, on the other hand, is an amount you subtract after you have figured out your tax bill: It will either directly boost your tax refund or cut what you owe.
Those who go it alone should consider using a computer program — Intuit's TurboTax and H&R Block's TaxCut are two of the most popular — that can quickly run tax scenarios under regular rules and under the AMT, and figure out the impact of various credits or deductions.
Whether you do your own taxes or rely on professional help, if you're planning to take any credits or deductions next season, make sure you save all the paperwork that's needed to back them up. The IRS expects taxpayers to keep records, including canceled checks and receipts from charities, to show the breaks are justified.