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Get a Jump on Next Year's Taxes

Tracy Byrnes

What? Did you think because you filed your taxes last month that you could just forget about it and look forward to the summer?

Just because tax season has ended and baseball season has begun (as the mother of a little leaguer, it's the longest season ever!), don't be so quick to file away your return and put taxes out of your mind.

I know -- the last thing you want to do is think about your tax return -- especially with the return of warm weather and Roger Clemens (no doubt his accountant is still hard at work).

But your tax return is actually your best planning tool for 2007. Especially if you got a big refund (shame on you for lending Uncle Sam your money) or owed big, your 2006 tax return can help you prevent the same mistakes this year.

So let's walk through some of the line items on your 2006 return and determine where you can make some adjustments.

Wages and Withholdings

Go to line 7 of your Form 1040, your W-2 wages. While your wages are fully taxable, the best way to minimize that tax hit is to max out your 401(k) contributions. I know it's trite, but remember, those contributions come out of your paycheck before your tax bill is calculated. So getting that money out of your paycheck and into your 401(k) could help bring down your taxes due.

For 2006, you can contribute up to $15,500. And if you're 50 or older before Dec. 31, your contributions jump to $20,000. So step up your contributions.

If you got a big refund this year, maybe you weren't having enough withheld. And from an economic perspective, you don't want to give Uncle Sam your money.

Granted, from a psychological perspective, many folks think of their refund as a forced savings account. But if that's the case, then consider having an equivalent amount put into your own savings account each pay period.

Because remember, you're better off having a balance due or breaking even than getting a refund.

So you may need to adjust your wage withholdings for the rest of 2007. You'll need to pull out your W-4 -- Employee's Withholding Allowance Certificate. You remember that form, don't you? You filled it out when you first started your job. You had to add up a bunch of "1s" and somehow your HR department then knew how much money to withhold from your paycheck for taxes.

Well, the form is pretty confusing, so be sure to read Publication 919 -- How Do I Adjust My Tax Withholding? But know this: If you got a big refund, then you want to increase your allowances (or "1s") so less tax will then be taken out of your paycheck. If you owe big, then you'll need to decrease your allowances so that more tax is taken out.

Most people think their allowances are equal to the number of people in their family. But that's not necessarily true. You can take an allowance for anticipated itemized deductions and upcoming losses, too.

So go back over your W-4 to get yourself in better shape in 2007. Better yet, check out the Web for W-4 calculators. For instance, H&R Block's Web site has one. You just drop in a few numbers regarding your tax situation and it will help you determine how many allowances you should take.

Portfolio Planning

Now move on to lines 8 and 9 of your form 1040 -- that's your interest and dividends. Did you pay tax on interest income this year? If so, it might be time to consider readjusting your portfolio holdings.

While fixed income that offers an interest payment used to be the way to go, with interest rates rising, that's not necessarily the case these days. And thanks to the more beneficial tax rates on dividends, equities that offer a dividend might actually leave more money in your pocket.

Remember, any interest you receive from bonds or other savings vehicles is taxed at your regular tax rate, which could be as high as 35%. But a few years ago, President Bush lowered the tax rate on qualified dividends to 15%. So even if the dividend you receive from a stock is smaller than the interest from your bonds, you may actually be able to keep more of it thanks to the lower tax rate. So you may want to consider swapping some bonds for a few dividend-paying stocks.

Then look at line 13 -- capital gains or losses. If you had a lot of capital losses in 2006 and didn't have the capital gains to offset them, you were only able to take $3,000 in net losses on your 2006 tax return. In that case, you probably had to carry your remaining losses forward to 2007.

Remember that to calculate your net capital gain or loss, you must first net your losses against your gains. Once you wipe out your gains, you can only take another $3,000 in losses.

If you have a loss carried forward to 2007 and you might need to sell some holdings or rejigger your portfolio, now is a good time to do it since you can wipe out some of your gains with that loss.

Let's say you had $5,000 carried forward from 2006. Without any gains in 2007, you can take only $3,000 of that loss. The remainder will have to be carried forward again to 2008. But if, instead, you sold some holdings and generated a $4,000 gain, you'll be able to use the whole amount. The $4,000 gain would be wiped out by the $5,000 carried forward loss and you'd still be able to claim the remaining $1,000 net loss on your 2007 return.

So keep that in mind and consider selling some gains before the year is over.

Tackle the AMT Monster Now

Tons of people were thrown into the alternative minimum tax system in 2006 and even more will get hit in 2007 due to a reduction in deductions. For 2007, the government lowered the AMT exemption almost $10,000 and has eliminated credits for child and dependent care expenses, credit for the elderly or the disabled, education credits and residential energy credits against the AMT.

Uncle Sam tinkers with the tax laws every year, and it's important to keep up with these changes, which are available online at the IRS' Web site.

But back to the AMT. First, determine if your alternative minimum tax issues are "chronic."

Your case is "chronic" if you're in AMT for circumstances you really can't change. For instance, you live in an area with high state and local taxes, such as New York or California, you make around $100,000 or you own a home and have kids.

Unless you're willing to move to Texas or Florida or get rid of the kids (wishful thinking), you're stuck until you start making the big bucks and move out of this AMT purgatory.

If you're in AMT because of a particular event or if you know your situation will change in the future, then there's some hope.

Let's say you plan on exercising some incentive stock options in 2007. You can't really say "ISOs" without saying "AMT" in the same breath, so prepare yourself for it.

In that case, try to defer any deductions that you know will be disallowed under the AMT to 2008. For instance, try to pay your December state and local tax bill in January 2008, or consider waiting until next year to take out that home equity loan because that interest is disallowed under AMT. And then try to push off some miscellaneous itemized deductions into 2008 as well.

Those are just some of the things you can do to save yourself from the AMT ogre. But be sure to talk to a professional for more planning suggestions.

So before you get completely sucked into baseball season, do yourself a huge favor and take a quick peek at your 2006 return. Just a few minutes analyzing it now could save you much more than a few dollars next April.