Summertime and the tax saving is easy

By Kay Bell
Bankrate.com

Summer is here, but you can't take a vacation from tax planning if you want to save money next filing season.

The good news this year is that so far Washington has kept its hands off the tax code as it applies to individuals. There are no mid-2004 tax changes or partial-year computations. The tax laws that were in effect in January are the ones we're still working with this summer.

So with that bit of tax continuity in mind, here's a look at some moves you can make now that could help cut this year's tax bill.

What you make affects what you pay
Inflation adjustments instituted on Jan. 1 have already helped many taxpayers. While the six tax brackets remain the same, ranging from 10 percent to 35 percent, slightly larger amounts of income are now taxed at lower rates. For example, in 2003 single filers making $70,000 saw part of their money taxed at 28 percent; this year, the maximum applicable tax rate to their salaries is 25 percent.

But you could cut the coming tax bill even more by reducing your taxable income. That doesn't mean you need to march into the boss's office and demand a pay cut. But you should visit with the company's benefits director to discuss 401(k) plan options.

Contributing to a 401(k) is a win-win strategy. The money you add goes into your account before federal taxes are figured on your salary. And by contributing, you not only cut your current tax bill, but you boost your retirement stash. Plus, some companies match a portion of employee contributions.

If your company offers such a plan and you're not participating, find out from your human resources office how -- and how soon -- you can get into the program. If you've already enrolled, increase your contribution to the maximum your budget will allow.

What about individual retirement accounts? If you don't have a retirement plan at work, this is a definite must. Depending on the type of plan, you may be able to deduct your contributions to a traditional IRA or forgo the deduction so that your eventual withdrawals will be tax-free (with a Roth account). Whatever your choice, this year you can put in up to $3,000, or $3,500 if you're 50 or older.

"A lot of folks wait until they prepare their returns in April to make IRA contributions," observes Gregg Wind, a certified public accountant and owner of Gregg R. Wind and Associates in Los Angeles. "But if you have the cash flow, it's easier to fund the account during the year, $250 a month, rather than come up with the $3,000 all at once. You also get the benefit of dollar cost averaging in spreading out your contributions."

Plus, the sooner you put any money in the account, the sooner it starts earning and, notes Wind, "the power of compounding is astounding."

Adjusting other assets
Midyear also is a good time to reassess all of your asset holdings, especially in light of the continued benefits of the 15 percent long-term capital gains and qualified dividend tax rates.

"People should look at the mix of their investment portfolios," says Michael Joyce, president of Michael Joyce & Associates, with offices in Richmond, Va., and Bethlehem, Pa. "A lot of people have money in taxable and tax-deferred accounts."

Joyce, who also is chairman of the National Association of Personal Financial Advisors' board of directors, notes that the lower investment taxes mean that some owners of equities should consider restructuring their holdings.

This is particularly true for owners of traditional IRAs or 401(k)s. The IRS doesn't get its cut of these accounts until the money is withdrawn at retirement, when the taxes are assessed at the taxpayer's ordinary income rate.

Where such a retirement account contains dividend-paying stocks, it might make sense to switch to interest-bearing assets, since interest income already is taxed at the higher ordinary income rates. The dividend-producing assets can then go into a regular investment account where the tax rate is only 15 percent (or less).

Of course, Joyce adds, all tax and investment moves depend upon each individual's situation. Be sure that the dividend-paying security you opt for does indeed qualify for the new rate. Some funds call their payments dividends, but the distributions are technically interest in the IRS's eyes. Others do pay dividends, but the shareholder still isn't eligible for the lower rate because of the way the company handles its taxes.

So double-check with your financial adviser before making any changes and remember that the lower investment income rates are only temporary. Without further Congressional action, they're set to expire in 2009.

Pay Uncle Sam only what you owe
You might be able to come up with some extra cash to put toward a nest egg or a hot stock if you're paying the appropriate amount of payroll taxes. With our pay-as-you-earn tax system, that means that a worker sometimes needs to adjust paycheck withholding so that tax payments match actual tax liability.

With six months of pay stubs in hand, look at how much has been taken out so far. Then project that amount over the rest of the year. If it's close to what your last tax bill was and you've had no substantial change in your lifestyle, that's great.

But if it looks like the amount will be substantially different (either more or less), or you've gotten married, had a child or bought a house, you should change the number of exemptions you claim on your W-4.

 

 

 

 

 

 

 

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