End of Year Tax Planning

Tax planning takes on some urgency this year, as Congress and the White House try to get a grip on the federal deficit.

Max out your 401(k)

Money you contribute to your plan (if it’s not a Roth) is excluded from your income, lowering your tax bill.  If you’re not on track to max out your contributions by year-end, you can direct some extra dollars to your retirement plan during your last few pay periods. This year, workers can contribute up to $16,500 to employer-based plans.  Workers 50 and older can contribute up to $22,000.

 

Win with investment losses

Review your taxable investment accounts for stocks or mutual funds to sell by year-end.  You can use the losses to offset investment gains, plus up to $3,000 of ordinary income from taxes.  Don’t forget to carry over, onto your 2011 tax return, any losses not deducted in 2010.

 

Don’t lose with winners

Be careful if you intend to buy mutual funds before year’s end.  Sometime in December, many funds pay out dividends and capital gains that have built up during the year, and the payout goes to investors who own shares on ex-dividend date.  It might sound like an easy way to get a whole year’s worth of income.  That’s not how it works, though.  You would get the payout, but at the same time, the share price falls by exactly the same amount.

 

Max out deductions

Enjoy writing off the full value of your mortgage interest and other itemized deductions while you can. In the past, high-earners had to reduce the amount of write-offs they could claim, but those restrictions were lifted in 2010. There’s talk in Washington about restricting itemized deductions again.  You may want to accelerate some expenses, such as paying your January mortgage, or estimated state taxes in December so you can add them to your itemized deductions for 2011.  But beware: If you are may be hit with the AMT, you’ll need a different year-end game plan.

 

Give to Charity

This is a great time of year to clean out your closets and garage, but you can write off donations to a charitable organization only if you itemize deductions.  A few bags full of gently used clothes and household items can add up to hundreds of dollars in tax deductions, but valuing those donations can be difficult. (Try Turbo Tax’s free tool.)

If you plan to make a significant gift to charity this year, consider giving appreciated stocks or mutual fund shares that you’ve owned for more than one year.  Doing so boosts the savings on your tax return. Your charitable-contribution deduction is the fair-market value of the securities on the date of the gift, not the amount you paid for the asset, and you never have to pay tax on the profit.

 

Upgrade Your Home

This is your last chance to claim a tax credit for making energy-efficient improvements to your principal residence.  The home-energy tax credit expires at the end of this year.  It is worth 10% of the cost of new windows, doors, skylights, insulation, and heating and air conditioning systems, up to a maximum $500 credit (but no more than $200 can be allocated to new windows).  You must install the upgrades by December 31 in order to claim the credit, but you can’t claim it for 2011 if you already took advantage of $500 or more of energy tax credits in previous years.