The madness of April 15 is over, but don't be so quick to file away your tax return: It's actually your best planning tool for 2005.
Whether you got a big refund (shame on you for loaning Uncle Sam your money) or owed big, your 2004 tax return can help you prevent the same mistakes this year.
All you need to do is walk through your 2004 return line by line and determine where you can make some adjustments.
Keep Your Own Wages
Start with 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. 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 2005, you can contribute up to $14,000. And if you're 50 or older before Dec. 31, your contributions jump to $18,000. So step up your contributions.
Then look at your withholdings. If you got a big refund, maybe you were having too much withheld. And from an economic perspective, you don't want to give Uncle Sam your money.
"You are better off having a balance due or breaking even than getting a refund," says Martin Nissenbaum, national director of income tax planning at Ernst & Young.
Granted, from a psychological perspective, too, many folks think of it 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.
So you may need to adjust your withholdings for the rest of 2005. You'll need to pull up
Form 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 somehowyour HR department then knew how much money to withhold from your paycheck for taxes.
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 the family," says Nissenbaum. 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 2005. Better yet, check out the Web for W-4 calculators;
H&R Block offers one, for example. You just drop in a few numbers regarding your tax situation and it will help you determine how many allowances you should take.
Tweak That Portfolio
Then move on to lines 8 and 9, 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 offered 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 ordinary 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.
Say you had a lot of capital losses in 2004 -- maybe you sold some
at a loss, to name three widely held losers of last year. But if you didn't have the capital gains to offset those losses, you were only able to take $3,000 in net losses on your 2004 tax return. In that case, you probably had to carry your remaining losses forward to 2005.
Remember: 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.
So if you have a loss carried forward to 2005 and you might need to sell some holdings or rejigger your portfolio, now's 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 last year. Without any gains in 2005, you can take only $3,000 of that loss. The remainder will have to be carried forward again to 2006. 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 2005 return.
Prepare for That Wretched AMT
I know -- that's an understatement. But you need to get a jump on this monster now. So first determine if your alternative minimum tax issues are "chronic," says Nissenbaum.
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 -- like New York or California -- you make around $100,000, you own a home and you have kids.
Unless you're willing to move to Texas or Florida or get rid of the kids, 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 2005. You can't really say "ISO" 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 2006. So try to pay your December state and local tax bill in January 2006, consider waiting until next year to take out that home equity loan -- since that interest is disallowed -- and try topush off your miscellaneous itemized deductions 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.
Save Your Receipts
Finally, if you have a big purchase coming up, like a car or a wedding, be sure to start saving all your receipts. You may be better off deducting your sales tax instead of your state and local income tax in 2005, so keep your documentation just in case.
I know the last thing you want to be thinking about is next year's tax return, but making a few adjustments now might make you much happier next April.
As originally published, this story contained an error. Please see
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