Jeff Schnepper

The Basics

Last chance to cut your '06 taxes

It's still 2006. But there are a ton of moves you can make now to save money at tax time next April. Here's a rundown.

By Jeff Schnepper

I know, it's only December. And your taxes aren't due until April 15 of 2007. But, you're not really early. You're late!

Your tax planning for your 2006 return should have started last December. It's more complicated this year because tax laws have changed again -- for the 40th year of the last 43 years.

Still, there are moves you can and should make before Dec. 31 to trim your 2006 tax bill.

Let's start with the simple things.

The easy stuff

Charitable deductions. If you contribute to your church, your college, the local dog pound, United Way or organizations contributing to relief for victims of hurricanes Katrina and Rita, make these donations before Dec. 31. And make sure, before you file your tax return, you have a receipt from the organizations that benefit from your generosity.

If you don't have the cash, find out if they can process a donation via credit card. As long as the donation is made by Dec. 31, it's valid as a 2006 deduction. But don't forget that receipt.

Separately, any contributions of clothes or household goods must be in good condition or better to qualify for a deduction. If a single item has a value of $500 or more, an appraisal will now be required. The IRS can deny a deduction for items of minimal value.

Use up your flexible spending account (FSA) dollars. This isn't exactly a tax savings, but, if you don't use the dollars you contribute to the flex plan, you lose them.

The IRS allows purchases made up through March 15, 2007, to count. Your employer can give you a debit card for your FSA spending. You can even pay for nonprescription drugs through an FSA. That eliminates a whole lot of paperwork!

Make your Jan. 1, 2007, mortgage payment on Dec. 31, 2006. Remember to add the extra interest paid to what your bank reports on its Form 1098. They'll get your payment in 2007 and won't report it for 2006. But, you paid it then and it adds to your deduction this year. (The downside is that you can't deduct the payment from your 2007 return.)

Pay your taxes early. If you're paying your own real estate taxes, make any payments due in the beginning of 2007 by Dec. 31. My fourth-quarter real estate tax is due on Feb. 1, 2007. By paying on Dec. 31, I get the deduction a year earlier. (Again, you can't deduct payments made in 2006 from your 2007 return.)

Medical and miscellaneous deductions. Medical expenses and miscellaneous itemized deductions have "floors." For medical expenses, only those in excess of 7.5% of your adjusted gross income (AGI) count. Miscellaneous itemized expenses have to exceed 2% of your AGI to qualify.

If you're going to exceed the floor, accelerate your expenses. Prepay your orthodontist or your tax preparer. Mail your checks on or before Dec. 31. Alternatively, if you're not going to exceed your floors, defer the deductions to 2007. You may exceed your floors then.

Maximize your pension or IRA contributions. These are especially important if you are self-employed. Unless tax rates shoot up, you want to pay your tax "tomorrow" rather than today.

If you're contributing to a retirement plan such as a 401(k) plan or a 403 plan, you can put in $15,000 this year ($15,500 for 2007). If you're 50 or older, you can put up another $5,000 as a catch-up contribution.

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Here's a simple, no-cost way to boost the earning power of your Individual Retirement Account. Click here to play the video.

Make those $12,000 gifts -- if you need to. If you might ever be subject to the estate tax, make your $12,000 tax-free gift before the end of the year.

Make the most from capital gains and losses. This year, the market actually went up! If you have capital gains, remember that any net capital losses over the $3,000 allowed on your 2005 tax return should be carried forward to offset those 2006 gains. If you still have net losses, up to $3,000 may be used to offset ordinary income for 2006.

All net long-term gains are subject to a maximum 15% rate. If you're in the 15% or lower tax bracket, your tax hit is softened to only 5%.

If you're single with taxable income of not more than $30,650, you get the 5% rate. With a standard deduction of $5,150 and a $3,300 personal exemption, you can have as much as $39,100 in gross income and still qualify.

If you have net capital gains, sell losers to offset those gains. If you have more losers, sell at least enough to get the $3,000 offset against ordinary income. If you have shares of stock pregnant with gains and you don't expect them to appreciate further, sell those shares and shelter the gains with the losses on your losers. Worst case -- pay the maximum 15% tax. You can't go broke taking profits.

New breaks from the new tax laws

We've had two major tax laws in 2006, the Tax Increase Prevention Act of 2005 (signed into law on May 17, 2006 -- maybe somebody should give these guys a calendar) and the Pension Protection Act of 2006.

Here are moves you can make now to take advantage of these laws.

The "kiddie tax" age has been increased to 17. Under prior law, any income above a certain threshold earned by a child under the age of 14 was taxed at the parents' tax rate. Now, this tax is applied to children who are as old as 17 and earn less than $1,700 (in 2006) in interest, dividends, capital gains and other non-wage income.

What to do now to beat the tax? Consider Section 529 Plans, Series EE Savings bonds, qualified dividends and stocks for long-term appreciation. How about T-bills for kids almost age 18?

Tax-free IRA distributions to charities. If you're age 70 1/2 or older, for 2006 and 2007, you can distribute as much as $100,000 directly from your IRA without recognizing any income. You don't get a charitable-donation deduction (unless the distribution was from a Roth IRA), but the distribution does count towards your minimum distribution amount.

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It's intended to ensure the rich pay their share, but this tax hits more Americans every year. Make sure you don't join those bitten by AMT's bite. Click here to play the video.

A modest -- at best -- bit of relief on the alternative minimum tax. More and more middle-income taxpayers are being hit with the AMT each year, which tries to ensure that everyone pays some tax. It is, however, forcing too many people to pay more tax than they probably should. For 2006, the AMT exemption was extended and increased to $62,550 in taxable income for married couples filing jointly and $42,500 for single taxpayer. The exemption had been scheduled to fall in 2006.

A break for reservists called to duty. Military reservists called to active duty can receive payments from their IRAs, 401(k) plans and 403(b) tax-sheltered annuities without having to pay the 10% early distribution tax. To qualify, a reservist must be called to active duty for at least 180 days. Reservists activated after Sept. 11, 2001, and before Dec. 31, 2007, qualify for this relief. If you do qualify and have paid taxes on the withdrawals in prior years, file Form 1040 X to get a refund. You can normally amend up to three years after the due date of the return.

Public safety employees such as firefighters, police and EMS technicians who retire after turning 50 are also exempt from the penalty.

What's ahead

Here's what this year's tax laws will do for you starting in 2007.

Larger contribution limits to retirement plans. The Pension Protection Act of 2006 makes permanent increased limits to retirement plan contributions. So, the $4,000 limit on contributions on IRAs will rise to $8,000 in 2008 and will be indexed to inflation after 2010.

Reduced tax rate on capital gains and dividends extended through 2010. Currently, the maximum rate on long-term capital gains (assets held for more than one year before being sold) and corporate dividends is 15%. For those in the lowest two tax brackets, the rate is 5% through 2007 and then will be 0% in 2008. These rates were extended until 2010.

Likewise, tax breaks on dividend income were extended until 2010. Current tax limits taxes on dividend income to 15%.

Income limitation for Roth conversions disappears in 2010. Under current rules, you can convert your traditional IRA to a Roth IRA only if your income does not exceed $100,000. The same threshold of $100,000 applies to singles and married couples alike. Starting in 2010, anyone can convert IRAs to Roth IRAs. For 2010 Roth conversions, you'll also have the option to pay the taxes due in a single year or spread them over 2010 and 2011.

What to do now? If your income is too high for a current IRA, contribute to a "nondeductible" IRA. Then, in 2010, convert to a Roth.

A big tax break for musicians or songwriters. The sale of music you wrote or the copyright to that music will be treated as the sale of a capital asset, subject to the maximum 15% bracket. That's a substantial savings for those who would have had to pay the tax on ordinary income at rates as high as 35%. This provision is effective as of Jan. 1, 2007, through Dec. 31, 2010.

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