It's time to get into the spirit of the season -- tax season, that is. Bah Humbug.
No one enjoys tax season. Most of us wish to spend as little time as possible preparing taxes and getting them out of the "inbox" on the desk. But by putting in a little extra time and effort when considering your investments and how they affect your tax filing, you can save yourself some money.
With that in mind, Dr. Don Taylor,
columnist, walks through some strategies for handling your taxes. It may not make the season festive, but it could end up a little greener.
First, an administrative matter ...
Because April 15 is a Sunday this year, you get an extra day to file your return. Returns must be postmarked by midnight April 16, 2001. Need more time? File
Form 4868, the Application for Automatic Extension of Time to File U.S. Individual Income Tax Return. You'll still have to pay your estimated tax bill by April 16, though, or owe a penalty for late payment. Pay your estimated income tax due by credit card (an expensive proposition), and you can get an extension over the telephone. With an extension you'll have until August 15, 2001, to file your 1040, 1040A, or 1040EZ.
Fund IRA or Roth IRA
If you are eligible to contribute to an IRA or Roth IRA and haven't done it yet for the 2000 tax year, you have until April 16 to fund last year's tax-advantaged retirement account. (Self-employed taxpayers may have more time to fund these accounts.) Think of how smug you'll feel about funding the account at this late date, when stocks are at basement bargain levels. In most years, you would have been better off funding at the beginning of the tax year and then realizing a year's returns on the contribution. So consider funding the current tax year's contribution now, or dollar-cost average this year's contributions over the remaining part of the year through April 15, 2002.
Can't decide between the traditional IRA and the Roth IRA?
IRA vs. Roth IRA
calculator can help you decide. Taxpayers with low current marginal tax rates and a long investment horizon should be better off in retirement with a Roth IRA. These are funded with after-tax dollars, meaning that contributions to a Roth IRA don't reduce your current tax bill. The money grows tax-free when it's withdrawn as qualified distributions in retirement. The higher your current marginal tax bracket, the more sense it makes to contribute to a traditional IRA, so the contributions reduce your current tax bill and taxes are deferred until qualified distributions are withdrawn from the plan. By then, you may be in a lower tax bracket.
Roth IRAs also can be like a change-up pitch in retirement planning. If you are currently contributing to a 403(b) or 401(k) plan and are also eligible to contribute to a Roth IRA, the Roth IRA will provide tax-free qualified distributions in retirement as a counterpoint to the taxable 403(b) or 401(k) distributions.
Re-Characterizing a Roth IRA Contribution or Conversion
As adults, we don't get many opportunities for do-overs. Here's one that could save you some money.
If you converted to a Roth IRA from a traditional IRA last year, it might make sense to undo that conversion. If you transferred $30,000 in assets to a Roth IRA only to see the value of the account fall to $20,000, it would make sense to undo the conversion, so you won't owe taxes on the original valuation of the account. You can also re-characterize a contribution to a Roth IRA.
Re-characterizing and transferring a contribution must take place on or before the date (including extensions) your tax filing is due for the year in which the contribution was made to the first IRA. If you have already filed your 2000 return, you have an automatic six-month extension to re-characterize a contribution or to convert, but you will have to file an amended return. IRS
Publication 590, Individual Retirement Arrangements, is available, but I recommend working with your accounting professional when re-characterizing your Roth IRA. If you do re-characterize, you will have to wait at least 30 days to reconvert back to a Roth IRA.
You can't convert and reconvert an amount during the same taxable year, or, if it's later, during the 30-day period following a re-characterization. If you reconvert during either of those periods, it will be considered a failed conversion.
Springtime Tax-Loss Selling
Investors tend to be optimistic about their investments. No one (except short-sellers) is holding on to their
stock because they're convinced that it's going to zero. It's that optimism about a stock's prospects that pushes tax-loss selling into the fourth quarter for most investors. Also, the fourth quarter is when you get news from your mutual funds about their distributions, and you wind up looking for lackluster stocks in your portfolio to offset that income and capital gains.
Do a little spring cleaning and get rid of those stocks/funds that you meant to sell last year but didn't. It won't help you with your 2000 return, but it can put you ahead of the curve for 2001. If you change your mind about the stock's prospects later, you can always buy it back -- just don't violate the wash-sale rule by buying it back within the 30-day period after the sale.
You can use capital losses in your taxable accounts to offset up to $3,000 (for married couples filing separately, that amount is halved, or $1,500 per spouse) in ordinary income after offsetting any realized capital gains, and the capital losses that you can't use this year will carry forward into future years.