Summer is the perfect time for fun pursuits, like vacations, cookouts...and tax planning. Okay, maybe you forgot to put tax planning on your summer agenda. But a midyear review is a great way to save tax dollars and time. Here are several suggestions to get you started on your review.
 Your Personal Taxes
- Evaluate the status of dependents.
Are you helping a parent or other relative pay for living expenses such as food and lodging? Midyear is a good time to assess whether you'll meet the five tests for claiming a dependency deduction. Why? Because you have time to increase your assistance to reach the level of providing more than 50% of support.
Tip: Even if you're unable to claim your loved one as a dependent, keep an eye on the amount of support you give. Meeting the 50% rule may still leave you the option of deducting certain costs, such as medical expenses.
- Boost your child care expenses .
The child care credit is a direct reduction of your federal tax liability. You can even keep the cash in the family by paying a relative to watch the kids this summer while you're at work. Two caveats: Your relative cannot be your dependent, and you must be making the payments so you can work.
- Hold onto sales tax receipts.
The sales tax deduction is set to expire at the end of 2005. You can claim the amount in the IRS tables, but having support for actual expenses could result in a larger deduction.
What if you choose not to keep every receipt? You can still increase your deduction by saving paperwork on the big stuff. Here's why: Sales tax on items such as vehicles, boats, homes, and home building materials can be added to the amount in the table. Reminder: You can deduct either the sales taxes or state and local income taxes you pay, not both.
- Set up a health savings account (HSA).
These accounts combine a high-deductible health insurance policy with a tax-sheltered savings account. Establishing one may save tax dollars, because contributions to a health savings account are deductible. Another benefit: Distributions used to pay qualified medical expenses are not taxable.
Tip: For 2005, the amount individuals can put into their HSAs increases to $2,650, and the amount for family coverage increases to $5,250. Those 55 or older can contribute an additional $600.
Your Business
- Establish a retirement plan if you don't already have one.
Examining the choices now gives you time to select the best plan for your business and to get the paperwork completed. Then you'll be set to make contributions as your cash flow allows ¨C and to take the deduction on your 2005 tax return. Another plus: You may be able to claim a credit on this year's tax return for the costs of establishing the plan.
Are your youngsters complaining there's nothing to do over summer vacation? Consider hiring them to help out in your business. Reasonable wages paid for legitimate work is a business deduction. The cash also offers the opportunity for your child to contribute to a retirement account, such as an IRA.
- Pay yourself a dividend if your business operates as a corporation.
The low tax rate on dividends can provide a double benefit: vacation spending money plus tax savings. While you'll want to continue paying yourself a reasonable salary for the work you do, you could also take cash out of your business in the form of dividends.
- Start keeping records for the new ¡°manufacturing deduction.¡±
Don't be put off by the title. Even though it's called a manufacturing deduction, a wide range of businesses can benefit, including architectural services, engineering services, film production, and construction. The new rules, effective for 2005, grant a deduction of up to 3% of profits from qualifying activities. Finding out now whether you'll qualify can let you adjust your estimated payments as well as establish a recordkeeping system to make sure you get maximum benefit
Your Retirement
- Plan your retirement income.
If you're retiring this year, the social security benefits you collect could affect your taxes. Computing the impact early and adjusting your initial start date might be to your advantage.
The same idea applies to distributions from your IRA. If you'll reach age 701/2 by December 31, you're required to start making withdrawals from a traditional IRA. You can take that first distribution by the end of this year ¨C or you can wait until April 1, 2006. The downside of waiting? You'd have two distributions in 2006. Calculate the effect on your income to determine which option provides the most tax benefit to you.
- Adjust your retirement plan contributions.
Are you still making contributions based on last year's numbers? Maximum amounts have increased for 2005. For example, you can now put $10,000 into your SIMPLE plan. Bumping up monthly contributions early lets you spread the increase over the rest of the year.
Remember to add catch-up contributions if you'll be 50 by the end of December. For SIMPLE plans, the additional amount is $2,000, bringing the 2005 total allowable contribution to $12,000.
The 2005 contribution limit for a 401(k) plan is $14,000 with extra catch-up of $4,000 if you're 50 or older. The IRA limit is $4,000 with an extra $500 permitted if you're 50 or older.
Your Investments
- Shift your investment income.
As you plan investment purchases, consider the type of income you'll be receiving from the assets you buy. Then stash them in the proper account to achieve maximum tax savings.
For instance, most dividends are taxed at a 15% rate. But interest is taxed at ordinary income rates, which may be higher. Putting interest-paying bonds into your retirement account while keeping dividend-producing stocks in a taxable account could save money.
- Hold investments long-term.
Dividends aren't the only type of income given more favorable tax treatment. Long-term capital gains (gains on assets held for more than one year) are also taxed at a maximum 15% tax rate. So when you decide to sell a stock or other investment, check your holding period. Consider adjusting your selling date if advisable.
Other Planning
- Do tax planning for upcoming college expenses.
Check out the various tax-favored alternatives.
Section 529 plans include prepaid tuition programs and college savings accounts. Prepaid tuition programs let you buy future tuition credits at today's rates. College savings accounts let you set aside funds in an investment account. No federal tax deduction is permitted for contributions to Section 529 plans, but distributions to pay for college are generally tax-free.
Education savings accounts allow annual contributions of $2,000 a year. Contributions are nondeductible, but tax-free distributions can be made not only for qualified higher education costs, but also for many K-12 expenses. Unlike 529 plans, phase-out rules may prevent higher-income taxpayers from contributing.
Other tax-saving strategies include investing in qualified U.S. savings bonds or saving for college via a Roth IRA.
Tip : If you'll have college expenses this year, factor the credits and deductions available for them into your 2005 tax plan.
- The estate tax is not dead yet¡
So as part of your midyear review, do any updating that's needed to your will and other estate documents.
Tax planning should be a year-round process, but it's especially effective at midyear. Give us a call for guidance in implementing the best moves for your particular situation.
*This tax planning letter provides our clients and friends with information about minimizing taxes. Do not apply this general information to your specific situation without additional details and/or professional assistance. |
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