Continuation: 32 (13-19) Fool-Proof Federal Income-Tax-Saving Strategies
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13. Paid your nest egg with a retirement savings plan. With Social Security benefits being increasingly taxed, you can rely on them less and less for your retirement. If you are an employee, your best single tax-slashing move is to contribute the maximum to an employer-sponsored 401(k) savings plan. Your contributions, as well as their earnings, escape federal and most state and local taxes until withdrawn. If you can’t afford the annual maximum contribution (10,000 in 1998), try to invest at least enough to get your employer’s full matching funds, usually 50 cents for every dollar you kick in, up to 6% of your pretax pay. A bonus: You won’t owe Social Security or FICA tax on the money your employer donates. (For more of Social Security and retirement plans, see “How to Retire Comfortably”).
14. Contribute to an IRA or Keogh plan early in the year. If, like so many taxpayers, you wait until April 15 to claim an IRA or Keogh deduction for the previous year, you’re passing up 15 ½ months of compounding. That’s a big loss. Just watch: If you invest $2,000 on January 1 of every year into an IRA earning 9% a year, you will have $197,150 at the end of 30 years. Wait until April 15 of the following year to invest your $2,000, however, and in 30 years you’ll have only $264,098 –a difference of $33,052. Merely contributing the same amount in the same investment 15 ½ months apart makes a difference of over $1,000 a year. Think how great the difference would be in a Keogh plan for self-employed people where you can invest up to $30,000 a year. Even if you can’t make the full contribution on January 1, invest as much as you can as early as possible. You must open a Keogh plan by December 31 to deduct your contribution for the year; you can wait until tax time to open the IRA for the write-off, though you shouldn’t.
15. Strike tax gold with job benefits. Next to 401(k)s, flexible spending accounts, or FSAs, are an employee’s roomiest shelter, enabling you to pay dependent-care costs and unreimbursed medical expenses with money taken out of your paycheck before federal income tax –and before Social Security tax if you earned less than about $61,000. (Money in FSAs is also free of state and local income taxes, except in New Jersey and Pennsylvania). You and your spouse can each fund a medical care FSA up to the limits set by your employers, generally $2,000 to $4,000; the tax code caps a couple’s contribution to a dependent care FSA at $5,000, though your employer may set a lower limit. The savings: By paying $5,000 of medical bills from an FSA, you could cut your tax bill by nearly $8,100, assuming you are in the 28% bracket.
Working parents with joint incomes of $24,000 or more can come out ahead by forgoing the child-care tax credit and instead paying child-care expenses from an FSA. That’s because the tax credit scales down as your income goes up, while the FSA’s tax-cutting power goes up as your income rises. In the 28% bracket, a couple with one child would save $1,400 in taxes by paying $3,000 for care from an FSA, but they would get only a $480 write-off by claiming the child-care credit.
16. Don’t foot the bill yourself. Persuade your boss to reimburse you for business expenses, even if it means taking an offsetting cut in salary. Why? In order to claim unreimbursed business expenses, their total –plus any other so-called miscellaneous expenses –must exceed 2% of your adjusted gross income. That’s a tough hurdle to jump. For instance, if your income is $60,000, your miscellaneous expenses have to top $1,200. Don’t ask your employer to reimburse you for a car you drive for pleasure, however, or any other expenses that could be judged personal. If you do, your reimbursement will be taxable.
17. Moonlight and rake in some extra tax breaks. Freelancing can open the window to a host of tax breaks. You may suddenly be able to write off expenses that would otherwise have been personal. For instance, if you start writing from home, you can write off a portion of your residence, property taxes, and some utility bills. Plus you can deduct as mush as $18,500 a year for the cost of business equipment you purchase. In addition, once you have self-employment income, you can open a tax-deferred Keogh retirement plan. (for the details about this arrangement, see “How to Retire Comfortably”).
18. Share the cost of a move with Uncle Sam. If you move for work and the distance between your new employment and your old home is at least 50 miles more than the distance between your old job and former home, you can deduct the unreimbursed costs of moving your household goods and your travel expenses, aside from meals. Best of all, you don’t have to be able to itemize deductions to claim moving expenses.
19. Write off business equipment in one year. The law allows you to write off up to $18,500 of the cost of business equipment in a year. You can put this tax break to maximum advantage if you make your business purchases late in the year. For example, if you invest in a $12,000 computer system in November, you can depreciate the system (translation: deduct some or all of its value) and write off $554 for the whole first year, saving $172 in taxes if you are in the 31% bracket. Or you can elect to expense the full $12,000 (that is, claim the full deduction at one time) and save $3,720 in taxes.
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