How to Reduce your Taxes Next Year (part 1)
If you have not already done your tax planning for next year, now is the time to start. A little forward planning could save you substantial tax dollars come tax season next year. Click here to read or watch more IRS Help resources. Here are some suggestions:
1. Pay no more than you should
This year, the average refund received by taxpayers exceeds $2,000 and next year, the amount is anticipated to be more than $3,000 i.e. $250 per month. Could you do with an extra $250 per month? Well, one way to ensure you can get it is to ensure the amount of taxes withheld from your salary matches your tax liability. The IRS has an online Withholding Calculator that can help you estimate the amount of taxes you owe.
Once you have determined your tax liability, file a revised Form W-4 with your employer. The more “allowances” you claim on the W-4, the less tax will be withheld. This is assuming your current financial situation has not changed from last year’s.
On the other hand, if you expect that you’ll owe money when you file your 2011 tax return next spring, you should increase your withholding now to avoid any underpayment penalty. One rule of thumb is to prepay 90% of this year’s tax bill in withholding for next year. Or if you want to be really safe, prepay 100%. But if your 2010 adjusted gross income topped $150,000, you should prepay 110% of last year’s tax liability to avoid a penalty.
If you increase the taxes withheld from your last few paychecks it will be taken as spread out throughout the year. This is wiser than trying to make up the shortfall with your final estimated quarterly payment, due January 17, 2012 because the estimated-tax-payment approach does not prevent an underpayment penalty.
2. Max out your 401s
Contributions to employer based retirement plans like the 401(k) lower your tax bill. You can contribute more towards your retirement plan the rest of this year. This year, you can contribute up to $16,500 to employer-based plans. If you are 50 years old and older, you can contribute up to $22,000.
No one knows what the tax structure for next year will be. One proposal for 401s is that the maximum 401(k) contribution will be 20% of your income or $20,000 per year, whichever is less. So save as much as you can and lower your taxes at the same time.
3. Sell off loss making shares
If you have made profit from your overall share portfolio, consider selling off the shares that are making losses to offset some of your profits and shield up to $3,000 of ordinary income from taxes. You should also check your 2010 tax return for excess investment losses that you can carry over to reduce your 2011 tax bill.
Alternatively, if your annual gross income does not exceed $34,500 (for individuals) or $69,000 (for married couples), you can sell your shares without having to pay capital gains tax. But if your profit increases your taxable income above those thresholds, then you will be subject to the usual 15% capital gains tax.
I shall continue with more steps to take to reduce next year’s taxes in my next article. Stay tuned.