Avoid a Big Tax Refund
Keep more money in your pocket, and less in Uncle Sam’s, in 2009.
You think you love getting a tax refund. What’s not to like about found money? But a refund is really just the return of a year-long, interest-free loan that you extended to your spendthrift Uncle Sam. You can do much smarter things with that money, like putting it into a retirement plan or a college savings fund. So if you will be receiving a 2008 refund of more than a few thousand dollars and you’re an employee, adjust your withholding at work. If you’re self-employed, lower your quarterly estimated tax payments accordingly.
Nitty Gritty
Withholding news: Making Work Pay Tax Credit
If your 2009 income will be less than $75,000 ($150,000 if you’re married and will file jointly), be sure your tax withholding has been properly adjusted for the new Making Work Pay Tax Credit you’re entitled to receive this year. This credit of up to $400 for singles and $800 for couples should be reflected in the amount of taxes taken out of your paycheck. But you may need to submit a revised W-4, especially if you’re married (your employer wouldn’t know your spouse’s income) or you’re holding down multiple jobs.
Save More in Your Retirement Plan
Plan now for a comfier future later.
If you are not maxing out your employer-sponsored, tax-deferred retirement plan, you’re missing out on the single best opportunity to save on taxes. I know that the idea of saving more may be impossible in today’s rough economy. But if you can squeeze just an extra percent or two out of your paycheck and pour that cash into the plan, you’ll reduce your taxable income and your ’09 tax bill. Doing so might also bring your income under certain thresholds that will let you qualify for bigger tax breaks you’d otherwise miss, such as personal exemptions, itemized deductions, an individual retirement account, the Child Tax Credit, the Child and Dependent Care Credit, and the Hope and Lifetime Learning Credits for college.
For Example
The prize for contributing to a 401(k)
Here’s an example, courtesy of Research401k.com. Say you’re a single person earning $50,000 and in the 25 percent tax bracket. Without making a 401(k) contribution, you might owe $12,500 in taxes this year. By contributing $4,000, you’d reduce your taxable income to $46,000 and might instead owe $11,500 in taxes. Essentially, the government lends you $1,000 to invest for your future, and you don’t have to pay the loan back until you withdraw the money from the 401(k) in retirement.
Look Into Muni Bonds and Funds
Lower your taxable income with tax-free savings choices.
If you have money in interest-earning, checking, or saving accounts; CDs; money-market funds; or taxable bonds or bond funds, you’re adding to your tax liability. You may want to consider moving some of that cash to tax-free municipal bond funds. (I’m a fan of Vanguard funds, like the Vanguard Intermediate-Term Tax-Exempt Fund, VWITX.) At the moment, yields on munis are unusually high compared with taxable investments, which means you will earn considerably more, after taxes, in munis. To see how much more in your particular case, use this taxable-equivalent yield calculator. Just be aware that the sweet yields on munis come with some extra risk, since there’s always a possibility that a few bond issuers won’t make their payments. Historically, that risk is pretty slim, but it’s not zero, especially in a recession.
Lower Your Mutual Fund Taxes
Keep your 2009 tax liability down.
How is it possible that your mutual fund that dropped 30 percent in value last year still socked you with a taxable distribution? Well, this is one of the most aggravating features of a managed mutual fund — it can lose money and still saddle you with a tax liability. As a fund buys and sells assets throughout the year, investors are on the hook for the taxes on those transactions. You may even be taxed on gains the fund incurred before you owned it.
One way to limit the damage before you buy a fund is to ask the fund company if it will be making a distribution soon. If the answer is “yes,” hold off buying until afterwards. Or you might invest in funds with low turnover ratios, such as index funds, since they’ll be less likely to throw off taxable distributions. A turnover ratio below 10 percent is generally tax-efficient (a fund’s annual report will show its turnover rate). Morningstar’s Fund Screener tool can help you find low-turnover stock funds.
Technically Speaking
Investing in tax-managed mutual funds
One class of mutual funds, tax-managed funds, is all about keeping your tax liability low. They do this in different ways ― keeping turnover low, avoiding dividend-paying stocks, and selling losers, to name a few. Some tax-managed funds own stocks; some own stocks and bonds. Morningstar and Yahoo! Finance’s Mutual Funds Center can help you find them.
Keep Better Tax Records
Get all the write-offs you deserve.
Organizing your tax records better could not only lower your tax liability, it may help you get rid of the tax-filing headache sooner. Create a file called “Taxes 2009” and throughout the year toss into it business receipts; bank, brokerage, and mutual fund statements; W-2s; 1099s; property tax bills; and mortgage interest statements. And keep track of your purchase price, commission, and sales price for any investment transactions in 2009.
The Legalese
Filing an extension
If you’re having trouble getting your ’08 taxes done by April 15, you can file Form 4868 and get an automatic six-month extension of time to file to October 15. Keep in mind, however, that this extension does not give you more time to pay any taxes due. You’ll owe interest on any amount not paid in by the April deadline, plus a late payment penalty if you haven’t covered at least 90 percent of your total tax by then.
If you can’t pay all your taxes due by April 15, file your return by the deadline anyway and pay in as much as you can, to avoid penalties and interest. Also, call the IRS (800-829-1040) to discuss your payment options. The agency may be able to give you a short-term extension to pay, an installment agreement, or an offer in compromise. More than 75 percent of taxpayers eligible for an Installment Agreement can apply using the Online Payment Agreement application at IRS.gov.
