Year End Income Tax Guide (Part 1)
Part of the hard truth we all have to accept includes death and taxes. Even Mr. ToughMoneyLove can take only such much hard truth so I choose not to write about death. That leaves taxes. This being December, it’s time to think about last minute tax strategies for 2008 and begin our tax planning for 2009. I have put together a few tax planning “highlights” (or “lowlights” depending on your attitude about taxes) for you to think about. These are arranged in no particular order of importance so you might want to scan all of them to find something that may be relevant to your situation.
Alternative Minimum Tax (AMT) planning. You are at risk of being subject to the AMT if you:
- Claim multiple dependency exemptions.
- Have significant state income tax deductions.
- Claim an unusually large deduction for unreimbursed employee business expenses or miscellaneous expenses.
- Have large medical expenses.
- Have large capital gains.
- Exercise incentive stock options.
If any of these apply to you, consult your tax advisor about last minute strategies for avoiding an AMT hit for 2008.
Tax credits for fuel-efficient vehicles. For hybrid cars and SUVs weighing less than 8,500 pounds, there are two available tax credits: (1) a fuel economy credit worth ranging between $400 and $2,400, depending on the fuel economy in the city; and (2) a conservation credit ranging between $250 and $1,000, based on estimated lifetime fuel savings. Unfortunately, all allotted tax credits for Toyota and Lexus vehicles have phased out completely. Honda hybrid vehicles are now eligible for only partial credits.
Deduction Bunching and Income Acceleration. The general rule is that you want to delay paying income taxes as long as possible by accelerating deductions into the current tax year and delaying income into the next tax year. That general rule may not apply this year to taxpayers in the upper tax brackets. Obama and the Democrats are coming after you. Those upper brackets may get bumped up substantially as early as 2009. So look into your own crystal ball as to whether you should actually accelerate income into 2008 (bonuses, etc.) to escape the higher 2009 tax brackets and thereby lower your cumulative 2008-2009 tax obligations.
On the deduction side, some taxpayers never get to deduct things such as medical expenses because only those medical expenses that exceed 7.5% of adjusted gross are eligible. If you have a Health Savings Account (HSA) or qualified Health Reimbursement Arrangement (HRA) in your employer’s cafeteria plan, you should consider a “deduction bunching” strategy by combining medical expenses into a single next tax year so that the combination exceeds the 7.5% AGI limit. Again, run the numbers or ask your tax advisor if this will work for you but be sure you ask before you make your final medical expense payment and reimbursement decisions for 2008.
Paying off the Mortgage. If you are in a high net worth situation and have some cash available to pay off that mortgage, you should reconsider your previous decision to invest that cash instead. This is particularly the case if many of your itemized deductions are being “phased out” on your tax return due to your income. That phase out renders your mortgage interest deduction much less valuable because you are only receiving a tax benefit to the extent that your interest payments exceed your standard deduction ($10,900 for a married couple.) Think about it hard. In this market, paying down the mortgage may be your best investment.
Documenting Charitable Deductions. Make sure you have the required documentation for all cash contributions to charity for 2008 (bank records or acknowledgement letter from the charity.) The IRS is really clamping down on this. Also, if you are like me and have donated cars or boats to charity, you will need a written appraisal if the value exceeds $5,000. The worst part of a vehicle donation is that if the car is valued over $500, you can only deduct what the charity received when they re-sold your car. (You didn’t think they were actually going to drive your clunker, did you?)
Heroes Earnings Assistance and Relief Tax Act of 2008. If you are a veteran (thanks for your service by the way), this law treats combat pay as earned income ( for purposes of the earned income tax credit). The law also reservists with six months active duty to take distributions from 401(k) and certain other retirement plans without incurring penalties.
Tax Underpayment Penalties. I have been caught on this one. No more. To avoid penalties for underwithholding or underpayment of estimated income taxes, you need make estimated payments equal to 90% of your 2008 year tax liability or 100% of what you paid in 2007. If the AGI on your 2007 return was more than $150,000 ($75,000 if married filing separately), the percentage is actually 110% of 2007 taxes paid or 90% of your 2008 tax obligation, whichever is lower. Run your numbers now and if you have underpaid or under-withheld, see if you can do a little catching up before year end. Otherwise, the IRS is going to hit you with a penalty. Believe me – it hurts.
You know what? Mr. ToughMoneyLove is already suffering from “tax fatigue” so I am going to end here and call this “Part 1″ of my year end tax guide. Come back (probably tomorrow) or subscribe (link below) for Part 2. I hope you will find something that will allow you to keep more income in your pocket and less of it transferred to all of those bailout recipients. That’s my goal as well.
By the way, a good way to get a quick “look see” as to how some of these tax issues might affect you is to run your 2008 numbers through some tax prep software (such as Turbo Tax). Even Quicken can be used to do some basic tax planning. Then if you find something that is over your head in complexity, call your tax advisor.
Update: Here is Part 2 of my Year End Income Tax Guide.