Sent to you by Chris Hunter via Google Reader:
Now that the election's over, all of my friends keep talking about how my taxes are going to change next year. Am I going to pay more, and if so, what can I do to maximize my savings before the calendar year ends?
First of all, most people don't think about their taxes until April rolls around, good on you for planning ahead. We can't know exactly what's going to happen in 2013 just yet, but with the election now over, year-end tax planning is even more important than usual, since we have a better idea of what the newly elected president and congress will do in 2013. With less than two months to go before the new year, here are the main strategies you should consider.
Tax Changes for 2013 That May Affect You
There are a number of tax breaks that are set to expire this year and unless Washington extends them, you might have a higher tax rate next year.
If you're a high-income taxpayer (earning over $200,000 or $250,000 married filing jointly), your taxes will be higher if Congress doesn't extend the Bush-era tax cuts for the highest tax brackets—which are set to expire at the end of 2012. The maximum personal tax rate is currently 35%, but if Congress doesn't extend them (which is a real possibility), the tax rate will revert to 39.6% in 2013. Also, new legislation will increase the Medicare tax on wage income by 0.9% for taxpayers in the higher rate brackets.
What you can do: A classic tax-saving strategy is to defer income until the next year, but if you're in this high tax bracket, you might want to take the reverse approach: Accelerate any bonuses and income you can this year, while the taxes are lower. Photo by Images Money
Low and middle income taxpayers are also facing higher taxes next year, due to the expiration of the 2 percent payroll tax cut and the Earned Income Tax Credit. Additionally, for every dollar you earn over $70,700, the tax rate will be 28 percent, up from 25 percent this year if the Bush-era tax cuts aren't extended. According to CBS, if Congress doesn't do something to get us over the "fiscal cliff" (the possibly disastrous combination of tax increases and spending cuts scheduled for January 2013), the majority of Americans will see some form of tax increase next year (an average of a $3,700 jump in taxes, according to the Tax Policy Center). Because of the ramifications this would have on the economy, however, it's likely Washington will try and avoid it. President Obama has proposed extending the Bush-era tax cuts for those earning under $200,000 or $250,000 joint. Chart by Kapitall
What you can do: This is all up to Washington to address (not just Obama, but the Democrat-controlled Senate and Republican-controlled House of Representatives, you partisans you). As with the high-income owners, if you can control your income (e.g., you're a freelancer and can take on more work), you might plan to try to get more income this year while the tax rate is lower, just in case.
Another strategy is to hold off on deductions (see below) until next year, so you can take advantage of them if your tax rate is higher. For example, wait until next year to make charitable contributions.
For investors, both capital gains and dividends are currently taxed at 15 percent, but that might rise to 20 percent next year and dividends may be taxed as ordinary expenses. With those potential tax increases, you might want to sell investments that have gained a lot in a taxable account, to get that 15 percent capital gains rate while you can. Photo by Advisor Perspectives
Finally, struggling homeowners may want to get their mortgage adjusted as soon as possible, since the Mortgage Forgiveness Debt Relief Act of 2007 may expire at the end of the year. That tax break forgives income taxes on the portion of a mortgage that's forgiven through a principle reduction, short sale, or foreclosure. (See CNNMoney for more info.)
End-of-Year Tax Savings Everyone Should Consider
All that said, there are some things everyone can do before the end of the year to maximize their savings. In general, look for deductions you can maximize now. Whether you take the standard deduction or itemize deductions, you can squeeze out more tax money by paying:
- charitable contributions
- student loan interest payments
- health savings account (HSA) contributions
- traditional IRA or 401(k) contributions
- educator expenses
- moving expenses for a job
- alimony payments
So, for example, if you can afford to make an extra IRA contribution or have been waiting to donate that old jalopy, now's the time to do so to reap the tax savings come April next year.
You can also deduct tuition and fees expenses, but it might be more advantageous to take an education credit instead, which reduces your actual tax bill dollar for dollar. (See IRS Tax Benefits for Education for more info.)
Some deductible expenses are only available if you itemize deductions rather than take the standard deduction. These include:
- medical expenses (you can only deduct the portion of expenses that are above 7.5 percent of your adjusted gross income or AGI)
- miscellaneous deductions (e.g., job-hunting expenses, tax preparation fees, unreimbursed job expenses, and professional dues—but they need to total more than 2 percent of your AGI)
- mortgage interest and real estate taxes
- business expenses
Find out if you're near the threshold by estimating your potential tax refund or bill with TurboTax's free TaxCaster. This can help you decide whether you should get that eye laser surgery done before the end of the year, make an extra mortgage payment, invest in office supplies, and so on.
In 2013, the AGI threshold for medical expenses will jump from 7.5 percent to 10 percent, so it may be especially wise to move medical procedures to this year.
The deductions above are the most common, but there are a few others that may apply to you and are easy to overlook, according to Kiplinger. This includes state sales taxes and home building materials, as well as travel expenses for military reservists.
Defer Income Until Next Year
In addition to accelerating deductions, another classic strategy is to postpone income until next year (and then next year you can apply these strategies again. Isn't this fun?). You'll get your money a month or so later, but pay less in taxes for 2012—useful if you need that money right now for a big purchase, or if you're in another financial bind.
Let's say you're one of the lucky people up for a bonus this year. You could ask HR to not send the check until January 1st so you won't owe taxes on the bonus until 2014. Or, similarly, freelancers can postpone cashing a check from a client until 2013.
Again, whether you should use this strategy depends on your tax rate next year compared to this year, and whether you're tight on money now. Like we said earlier, if you're in the top tier of earners, your taxes may go up next year, in which case you wouldn't want to defer.
The new tax issues aren't exactly light reading, and there's still a lot of uncertainty that can make planning difficult. Your best bet, MSN Money suggests, is to make an appointment with your broker and tax advisor between Christmas and the new year. That's because any changes the government makes to tax laws will likely be finished the week before Christmas. By consulting with your tax adviser at the end of the year, you can get a better sense of how to handle your money to squeeze out the most tax savings.
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