With year-end rapidly approaching, it's time to consider making some moves that will cut your tax bill.
Before acting on our recommendations, be sure to gauge your 2012 income expectations. Moves you make this year may affect next year's taxes, detailed in the table below.
With that in mind, here is the first installment of our two-part series on year-end tax planning ideas for individuals.
Game the Standard Deduction
If your total annual itemized deductions are usually close to the standard deduction amount, consider the strategy of bunching together expenditures for itemized deduction items every other year, starting with this year.
Itemize in alternating years to deduct more than the standard deduction. Then claim the standard deduction in the other years. Over time, this drill can save hundreds or even thousands in taxes by increasing your cumulative write-offs. That's because you'll bag higher itemized deductions in alternating years and relatively generous standard deductions in the other years. So regardless of what happens with tax rates, you'll come out ahead.
For 2011, the standard deduction is $11,600 for married joint-filing couples, $5,800 for singles, and $8,500 for heads of households. For next year, the standard deduction amounts will be $11,900, $5,950, and $8,700 respectively.
Prepay Deductible Expenditures If You Itemize
If you itemize deductions, accelerating some deductible expenditures into this year to produce higher 2011 write-offs makes sense if you expect to be in the same or lower tax bracket next year. (See the table at the end of this article for the 2012 tax brackets.)
Perhaps the easiest deductible expense to prepay is the interest included in house payments due on January 1. Accelerating that payment into this year will give you 13 month's worth of deductible interest in 2011. You can do the same with a vacation home. If you prepay this year, you'll have to continue the policy for next year and beyond. Otherwise, you'll have only 11 month's worth of interest in the first year you stop.
Next up on the prepayment menu are state and local income and property taxes that are not actually due until early next year.
Next, consider prepaying expenses that are subject to limits based on your adjusted gross income (AGI). The two prime candidates are uninsured medical expenses and miscellaneous itemized deductions. Medical costs are deductible only to the extent they exceed 7.5% of AGI. Miscellaneous deductions--for investment expenses, job-hunting expenses, fees for tax preparation and advice, job hunting, and unreimbursed employee business expenses--count only to the extent they exceed 2% of AGI. If you can bunch these kinds of expenditures into a single calendar year (like this year), you'll have a fighting chance of clearing the AGI hurdles and getting some tax-saving write-offs.
Warning: The prepayment drill may be a bad idea if you know you'll owe the dreaded alternative minimum tax (AMT) for this year. That's because write-offs for state and local income and property taxes are completely disallowed under the AMT rules, medical expenses must exceed 10% of AGI to be deductible for AMT purposes, and miscellaneous itemized deductions are completely disallowed under the AMT rules. Therefore, prepaying these expenses may do little or no tax-saving good for AMT victims.
Deduct Sales Taxes on Major Year-end Purchases If You Itemize
If you live in a state with low or no personal income taxes, be aware that Congress extended the federal tax deduction for general state and local sales taxes through 2011. Therefore, you have the option of deducting either state and local sales taxes or state and local income taxes on your 2011 return--but not both.
Most of you will have to use IRS-provided tables to calculate your sales tax deduction. However, if you've hoarded receipts from your 2011 purchases, you can add up your actual sales tax amounts and deduct the total if that gives you a better answer. Even if you're forced to use the IRS table, you can still deduct actual sales taxes from 2011 purchases of vehicles and boats on top of the predetermined amount from the table. So buying a car or boat between now and year-end could give you a bigger sales tax deduction and cut this year's federal income tax bill.
Warning: The sales tax write-off only helps if you itemize. And if you're hit with the AMT, you'll lose some or all of tax-saving benefit.
Prepay College Tuition
If your 2011 adjusted gross income (AGI) allows you to qualify for the American Opportunity college credit (maximum of $2,500) or the Lifetime Learning higher education credit (maximum of $2,000), consider prepaying college tuition bills that are not due until early 2012 if that would result in a bigger credit on this year's Form 1040. Specifically, you can claim a 2011 credit based on prepaying tuition for academic periods that begin in January through March of next year.
If your 2011 AGI is too high to be eligible for the Lifetime credit, you might still qualify to deduct up to $2,000 or $4,000 of college tuition costs. If so, consider prepaying tuition bills that are not due until early 2012 if that would result in a bigger deduction on this year's Form 1040. As with the credits, your 2011 deduction can be based on prepaying tuition for academic periods that begin in the first three months of 2012.
Read on for details on college tax breaks.
2012 Federal Tax Parameters
|Bracket||Single||Joint||Head of Household|
|Beginning of 15%||$8,701||$17,410||$12,401|
|Beginning of 25%||$35,351||$70,701||$47,351|
|Beginning of 28%||$85,651||$142,701||$112,301|
|Beginning of 33%||$178,651||$217,451||$198,051|
|Beginning of 35%||$388,351||$388,351||$388,351|
Standard Deductions and Personal Exemptions
Retirement Account Contribution Limits
Maximum IRA contribution (traditional or Roth): $5,000
Maximum IRA contribution if age 50 or older: $6,000
Maximum 401(k) salary-deferral contribution: $17,000
Maximum 401(k) contribution if age 50 or older: $22,500
Maximum 403(b) salary deferral contribution: $17,000
Maximum 403(b) contribution if age 50 or older: $22,500
Maximum SEP account contribution: $50,000
Maximum profit-sharing account contribution: $50,000
Maximum SIMPLE IRA salary-deferral contribution: $11,500
Maximum SIMPLE contribution if age 50 or older: $14,000
Other Key Tax Figures
Cap on Social Security tax (based on wages or self-employment income): $110,100
Federal gift tax exclusion: $13,000
Federal estate tax exemption probably: $5,120,000