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Tax-Savvy Steps Right After the New Year If you think your tax bill is chiseled in stone at the end of the year, think again. It is true that many money-saving options evaporate by January 1. On New Year's Day, your options to defer income or accelerate deductions become much more limited, but there is a lot you can do to make the tax-filing season cheaper and easier.

Some strategies can help you lower your taxes, sometimes by thousands of dollars. Some save time and money when you are preparing your tax return. Other strategies help you avoid costly penalties and interest for both federal and state taxes. All in all, the 10 steps will lower your blood pressure while keeping money in your pocket.

  1. Contribute to Retirement Accounts
    If you have not already funded your retirement account, do so by April 15. That is the deadline for any kind of IRA, deductible or not. If you have a Keogh or SEP, though, and you get an extension, you can wait until your extension deadline to put money into those accounts.

    Making a deductible contribution will help you lower your tax bill this year. Plus, your contributions will compound tax-deferred. It is hard to find a better deal. If you put away $3,000 a year for 20 years in an investment with a 10% return, your $60,000 contribution will grow to $189,000. The same investment in a taxable account would grow to only $136,000.

    To qualify for the full annual IRA deduction, you must not participate in a company retirement plan or earn less than $45,000 for singles and less than $65,000 for married couples.

    In 2003, the maximum IRA contribution you can make is $3,000 ($3,500 if you will be age 50 or older by the end of the year), and self-employed persons saw an increase in the maximum annual addition to SEPs and Keoghs to $40,000.

    A non-deductible Roth IRA contribution also can be valuable. Although you pay taxes on the contribution, you pay no taxes on the withdrawals. With enough time, your investment will outpace even the traditional IRA. To contribute the full $3,000 to a Roth IRA, you must earn less than $95,000 a year if you are single or $150,000 a year if you are married. Unfortunately the earnings figures are still the same.

    Savings: Your savings will vary. If you are in the 27% tax bracket and make a deductible IRA contribution of $3,000, you will save $810 in taxes the first year. Over time you will save thousands, depending on your contribution, income tax bracket, and number of years you keep the money invested.

  2. Make a Last-Minute Estimated Payment
    If you did not pay enough to the Feds during the year, you may have a big tax bill staring you in the face on April 15th. What is worse is that you also may face significant interest and penalties.

    How could that happen? Withholding on your paycheck may be out of whack or you may have received a big gain from selling stock. According to IRS rules, you must pay 100% of last year's tax liability or 90% of this year's. If you made more than $150,000, you have to pay more than that 110% of last year's tax liability. If your tax payments were a bit light, you may be stuck.

    You can erase any penalties and interest for the fourth quarter by making an estimated payment by January 15th. The IRS, however, will assume that you should have made estimated payments all year long. If so, you will be charged some penalties and interest for earlier quarters, if you did not send any estimated payments in back then, but if your income windfall arrived in the fall, you can file Form 2210 Underpayment of Estimated Tax, to avoid extra charges.

    A note of caution: try not to pay too much. It is better to owe the government a little rather than to expect a refund. After all, the IRS charges around 6% interest on underpayments, which is better than the average credit card, but the IRS does not give you a dime when it borrows your money.

    Savings: Interest and penalties on tax underpayments.

  3. Organize your Records
    Good organization may not cut your taxes, but there are other rewards, and some of them are financial. For many, the biggest hassle at tax time is getting all of the documentation together. This includes last year's tax forms, this year's W-2s and 1099s, receipts, and so on.

    If you really want to make tax season go smoothly, use a program like Quicken throughout the year so you have easy access to all the information you need. Weary of clients who dump piles of paper into grocery bags, tax preparers are the first to urge people to get their records in order. Yes, you can pay them to sort through the debris, but there are much better uses for their time.

    How do you get started?
    • Keep all the information that comes in the mail in January, such as W-2s, 1099s, and mortgage interest statements. Be careful not to throw any tax-related documents out even if they do not look very important.
    • Collect receipts and information that you have piled up during the year.
    • Group similar documents together; putting them in different file folders if there are enough papers.
    • Enter the amounts from all these documents into a computer program like Quicken for quick totals and make a printout for your tax preparer.
    • Make sure you know the price you paid for any stocks or funds you have sold. If you don't, call your broker before you start to use TurboTax or before you see your tax preparer. Know the details on income from rental properties, and do not assume that your tax-free municipal bonds are completely free of taxes. Having this type of information at your fingertips will save you another trip through your files - or your piles.

    Savings: $300 to $400 with your tax preparer and hours of your time right off the bat. Plus, you are likely to sail through an audit - with fewer assessments and penalties - if you have documentation on hand.

  4. Find the Right Forms
    You will not find all of them at the post office and library. Instead, you can go right to the source online. View and download a large catalog of forms and publications at the Internal Revenue Service's Web site at www.irs.gov or have them sent to you by mail.

    You can search for documents by number or date back to 1992.

    The IRS will also send you to a private site that lists state government sites where you can pick up state forms and publications.

    Savings: Hours of your time and the hassle of running around town.

  5. Itemize
    It is easier to take the standard deduction, but you may save a bundle if you itemize, especially if you are self-employed, own a home, or live in a high-tax area. It is worth the bother when your qualified expenses add up to more than the 2003 standard deduction of $4,750 for singles and $7,950 for married couples filing jointly.

    Many deductions are well known, such as ones for mortgage interest and charitable gifts. Taxpayers, however, sometimes overlook miscellaneous expenses, which are deductible if they tally up to more than 2% of adjusted gross income when they are combined. These deductions include tax preparation fees, job-hunting expenses, business car expenses, and professional dues. You can also deduct medical expenses if they reach 7.5% of adjusted gross income.

    Savings: Possibly thousands of dollars.

  6. Consider a Home Office Deduction
    The rules were loosened in 1999 so that people who did not qualify for the home office deduction in previous years can now take the deduction. People who have no fixed location for their businesses can claim a home office deduction if they use the space for administrative or management activities. Doctors, for example, who consult at various hospitals or plumbers who make house calls can now qualify. As always, you must use the space exclusively for business.

    Many taxpayers have avoided the home office deduction because it has been regarded as a red flag for an audit. If you legitimately qualify for the deduction, however, there should be no problem.

    You are entitled to write off expenses - such as rent, utilities, insurance, and housekeeping - associated with the portion of your home where you exclusively conduct business. A middle-class taxpayer who uses a home office and pays $1,000 a month for a two-bedroom apartment could easily save $1,000 in taxes a year. People in higher tax brackets with greater expenses can save even more.

    There is a tax trap here, however. If you who own your home, you may have to pay taxes on part of the capital gains when you sell. It pays to run the numbers before taking the deduction.

    Savings: A typical deduction easily can run into thousands of dollars.

  7. Provide Dependent Taxpayer IDs on Your Return
    On your return, plug in Taxpayer Identification Numbers - usually Social Security Numbers - for your children and other dependents. Otherwise, the IRS can deny the personal exemption of $3,050 for each dependent and the $600 child tax credit for each child under age 17.

    Be especially careful if you are divorced. Only one of you can claim your children as dependents, and the IRS has been checking closely lately to make sure spouses are not both using their children as a deduction.

    Of course, if you make enough money, the benefits disappear anyway. The 2003 phaseout range for the personal exemption begins at $209,250 for married couples filing jointly and $174,400 for heads of households.

    The child tax credit begins to phase out at $110,000 for married couples filing jointly and at $75,000 for heads of households.

    After you have a baby, be sure to file for a Social Security card right away so that you have the number at tax time.

    Savings: Hundreds, possibly thousands of dollars, depending on the number of dependents and your income.

  8. File and Pay on Time
    Actually, you only need to pay on time.

    The IRS does not really care when you file that is, as long as you fill out extension Form 4868.

    If you still owe money after Tax Day, the IRS will charge you around 6% annual interest as well as a half percent penalty per month. If you didn't bother to extend, the IRS also will slap you with a steep late filing penalty of 5% a month, which tops out at 25%.

    Savings: Interest and penalties.

  9. File Electronically
    Electronic filing works best if you expect a refund, because the IRS processes electronic returns faster than paper ones, you can expect to get your refund three to six weeks earlier. If you have all your documents in order, go ahead and file electronically in mid-January using software like one of the TurboTax® programs. If you have your refund deposited directly into your bank account, you will wait even less time.

    There are other advantages besides a fast refund. The IRS checks your return to make sure that it is complete, which increases your chances of filing an accurate return. Less than 1% of electronic returns have errors, compared with 20% of paper returns. The IRS also acknowledges that it received your return, a courtesy you do not get even if you send your paper return by certified mail. That means you protect yourself from the interest and penalties that accrue if your paper return gets lost.

    If you owe money, you can file electronically and then wait until April 15th to send in a check along with form 1040-V. You also may be able to pay with a credit card, or you may use direct debit, but expect to pay a credit card service charge of as much as 2.5%. With direct debit, you may delay the debiting of your bank account until April 15th.

    Savings: Peace of mind.

  10. Find a Tax Advisor
    Products like Quicken TurboTax or Quicken TurboTax for the Web can handle the most complex returns with ease (and allow you to file your taxes electronically for a faster refund), but you may feel uncomfortable doing your taxes on their own, especially when they are complicated enough to demand the 1040 long form and a number of added schedules. If so, it may be time to find a tax preparer. Any good preparer should save you at least as much as the fee. You may also gain valuable advice on how to reduce your taxes for the coming year, but do not wait until the last minute.

    Ask friends and family for recommendations. Ask about credentials and professional designations. There are two designations to look for in a tax preparer. Enrolled agents (EAs) have passed rigorous IRS exams and are certified to represent clients in tax court. CPAs, or certified public accountants, have also passed several examinations and are licensed to practice by the state.

    Interview your top candidates to see if you feel comfortable with them. Do they have the expertise for your specific situation? And will they be available for questions after tax season is over? Finally, ask if the preparer has errors and omissions insurance.

    When you first meet to talk about your taxes, be prepared to talk about your personal life. Your preparer is not just being nosy. Personal details can have important tax implications. Are you planning to get married or divorced? Are you looking to buy a house? Such life events show up on your tax return as dollars and cents.

    The more organized you are, the more time your tax preparer can spend lowering your taxes. Some tax preparers suggest that you use a program like Quicken TurboTax or TurboTax for the Web, then bring the results to a tax preparer to see if there are any areas where they can find extra deductions.

    Savings: At least the price of admission.

OTP SIG3