Year End Tax Tips

It’s that time of the year again. The holidays are here, and we’re all thinking about which gifts to buy, holiday menus, and how we’re going to pay for it all! We become so involved with the holidays that we forget that it’s also the time of the year to maximize our tax returns. It only takes a little time and some good habits to maximize your tax return.

First, get organized. Get a large envelope or folder and keep it where you sort through your mail every day. Place every piece of mail that says “important tax documents enclosed” into that envelope – keep in mind that all your relevant tax information doesn’t arrive in your mailbox on the same day. This will make your life so much easier, and your tax preparer much happier. You won’t be searching for everything right before the tax deadline in April.
Next, make sure you keep your last pay stub of the year. We all know that we’ll need it for our tax return, and yet all together too many of us relearn every year that getting a reprint from the payroll section can be a painful experience. It has all the tax information not on your W-2 such as union and association deductions, political donations, 401(k) and deferred compensation contribution amounts, and other valuable tax deduction information. It’s one your best sources of tax deductible items.

We’re all in the spirit of giving during the holiday season. So this is a great time to give to your favorite charity. But remember this is the holiday season. People who work at these charities are busy and as distracted by the holidays as we are. So before you write that check, call the charity and ask them if you can donate using a credit card (as long as you pay it off when the bill comes in). If you write a check, there’s a chance it won’t be cashed by the end of the year, and you could miss out on the deduction. If you’re donating clothing, make sure it’s usable. The Pension Protection Act of 2006 stipulates that everything must be in “good used condition or better.”

Does your company offer a 401k plan or a deferred compensation plan? This is the time to make sure you put as much as you can afford into the plan. These plans are tax deferred, so you pay no taxes until you use the money. This is a great way to save money for retirement, and to reduce your gross taxable income. If you can save $100,000 in one of these plans over the course of a career, that could translate into $1000 a month of income for one hundred months.

If you prepay some of your 2008 bills in 2007, you’ll get to write them off this year. If you are a homeowner, you can make your January mortgage payment in December, giving them one more month of interest to deduct.

Do you plan on sending your children to college? A 529 plan is a great way to save for this expense. Your money grows tax-deferred and earnings on your withdrawals are exempt from federal income tax when used for qualified education expenses. Many states allow parents to write off contributions up to a certain dollar amount. New York State, for example, allows each parent to deduct $5,000 from state income taxes ($10,000 for a married couple filing jointly). If you don’t know if your state offers a 529 plan deduction, ask your tax advisor or check out savingforcollege.com. This site is a great resource for understanding these plans.

If you contribute to a Flexible Spending Account, check on your balance and use up any remaining money. Pre-tax funds contributed to an FSA can be spent on eligible expenses incurred during the tax year. For Medical FSAs, this would be a good time to find those receipts for co-pays and deductibles, to stock up on regularly used prescriptions, or get a routine physical or dental exam. Non-prescription and over-the-counter medications qualify for reimbursement from a medical FSA. Funds not spent by the end of the year are forfeited to the plan administrator, unless your agency adopted the “grace period,” which ends March 15th of the following year. Check on those rules before the end of the year, and plan to act accordingly.

Most of all, organization is the key to maximizing your tax return. Every January start a new file for the new tax year. It’s easy to do. Each time you incur a job or business related expense like uniforms, equipment, etc., take the receipt and file it away. Being organized can save you hundreds of dollars a year on your return.

Good Debt vs. Bad Debt

Good Debt
The concept of good debt is a fairly simple one. Anything that will be worth more than the initial loan at the loan’s end can be considered good debt. A mortgage on a home is a good example. Historically over long periods of time, real estate appreciates in value. After all, it’s the only thing that they can’t make more of. Depending on your income and other factors, the interest on mortgage loans and real estate taxes can be tax deductible. Improvements to your home may also be tax deductible, so hold on to those receipts! The interest on a home improvement or home equity loan may also be tax deductible.

This may be a better way of financing a major purchase such as a new car. The interest on auto loans generally isn’t tax deductible. But many people have gotten themselves into trouble by taking too much equity out of their homes with equity loans. I have an associate that took so much equity out of his home that when he needed to sell it, the cumulative value of the loans was worth more than the current market value of the home. As always, talk to your tax advisor before making any decisions.

If you are unsure about how much mortgage debt you can handle, many banks incorporate mortgage calculators into their websites. Bankrate.com has one of the most comprehensive loan and mortgage calculators I’ve come across. It’s great for auto and home equity loans too.

An education loan can be another example of good debt. Taking and paying for classes that will help increase your income can be thought of as good debt. I’m not saying don’t take that philosophy class you’ve dreamed about all your life, but earning a degree in a field related to your profession usually means that you’ll make more money over your lifetime.

Remember, taking on so much good debt that you can’t pay it is not good, and in fact, essentially becomes bad debt.

Bad Debt
There are many things that can be interpreted as bad debt. Generally speaking, it’s debt on something that decreases in value over time. You’ve heard that a new car can be worth much less as soon as you drive it out of the dealer’s lot. I know many of us love our cars, but realistically, cars are consumable items. Just like a paper cup, you use it and dispose of it – albeit after a much longer period of time than a person possesses a paper cup. Unless you purchase a rare or exotic car, you’re financing a depreciating item, which can substantially raise the overall cost of the vehicle. So that seven-year car loan is a bad idea.

This concept of financing consumables also applies to credit cards. Think about the things you have purchased over the years with your credit card – vacations, clothing, that romantic dinner at your favorite eatery, and that new flashlight from that police equipment catalog that arrived in the mail. Have any of those items increased in value? I don’t think anything I’ve purchased with my credit card has made me money. And credit card debt can be deadly. I’ve seen interest rates at more than 20 percent. If you pay $100 a month on $5,000 of credit card debt at 15 percent interest, it will take you six and a half years to pay it off, at a final cost of around $7,900. And that’s if you don’t make any more purchases with that card. If you use your credit card, try to pay the full balance each month. This will help keep you out of financial trouble and boost your credit rating scores, which allows you get better terms and interest rates for financing your good debt.  About.com has some objective advice on how to deal with credit card companies.

What do you do if you get into trouble? Get help as soon as you need it. I have friend who came to me for help when he was $38,000 in credit card debt. He and his wife were addicted to the cable TV shopping channels. Bankruptcy was the only answer in his situation. Don’t wait so long that this becomes your fate too. There are many reputable debt-reduction firms out there, but there are plenty of scammers too, so you have to be careful and conduct the due diligence to protect yourself.

Credit counseling organizations often arrange for debts to be paid through a debt management plan. You deposit money each month with the credit counseling organization. The organization uses this money to pay your credit card bills, student loans, medical bills, or other unsecured debts according to a payment schedule they’ve worked out with you and your creditors. Creditors may agree to lower interest rates or waive certain fees if you are repaying through a DMP.

The Federal Trade Commission website  describes these plans in detail. But remember, anything that seems too good to be true usually is. Beware of hidden fees and the people that tell you “you’ll be debt free in no time!” Ask for a recommendation from a friend, family member, or financial professional. But get your debt under control as quickly as possible. It’s almost impossible to live debt-free.

Minimizing your bad debt can save you a lot of money and anxiety over your lifetime while maintaining a manageable degree of good debt can increase your wealth and help you plan for a comfortable financial future. It’s all up to you.  www.bfsnow.com