Year-End Tax Tips

Although taxes are not the primary focus for most of us during the holidays, now is a great time to ensure that you maximize as many tax breaks as possible for the 2005 calendar year.

What is new for this year?

The big new thing is that all charitable cash contributions made after Aug. 28 are fully deductible as part of the government's Katrina relief efforts. The contribution does not have to be Katrina-related, although that is what Congress intended when it passed the legislation. In previous years, your cash donations were capped at 50 percent of your adjusted gross income.

Keep in mind that not only must you itemize your taxes to take a deduction for charitable contributions, but you must maintain receipts for any deductions more than $250.

Finally, it is essential to make sure the organization you donate to is considered tax-exempt by the Internal Revenue Service. In addition to asking the organization directly, you can log on to www.irs.gov and click on the charities and nonprofits link to determine whether your charity of choice is tax-exempt.

What can homeowners do before Saturday to save some extra money?

If you itemize your tax returns, consider sending your January 2006 mortgage payment now. If you submit this payment by Dec. 31, you can deduct the interest this year. For example, let's assume you have a $150,000 mortgage at a 6 percent rate and pay $750 every month in interest alone. You could save more than $187 in 2005 by paying your mortgage now (assuming a 25 percent tax bracket). Simply stated, by paying your mortgage in advance, you can put the monthly interest payment directly toward your tax bill for 2005. If possible, it is best to get your payment to the lender before the year ends, as it will show on the lender's paperwork, which is reported to the IRS (and you). Keep in mind, though, that an extra payment in 2005 means one less payment in 2006.

If you pay your property taxes directly as opposed to having your lender pay them through an escrow account, contact your county or municipal tax office to determine if you can pay part or all of your 2006 tax payment early to take advantage of the tax benefits in 2005.

However, if you think you might have to pay the alternative minimum tax, you will not be able to benefit from this early payment, as the alternative minimum tax does not allow for tax breaks on real estate and personal property taxes, nor state and local income taxes.

Is time running out on contributions to retirement and education savings accounts?

Yes and no. Although you have until April 17, 2006, to make your 2005 IRA and Coverdell Education Savings Account contributions, your 2005 contributions to your 401(k) and 529 plan need to be made by Friday, Dec. 30, 2005.

Education: There are two tax-advantaged ways to save for education -- a 529 plan (contribution deadline: Dec. 30, 2005) and an Education Savings Account (contribution deadline: April 17, 2005).

The 529 plans are designed to help families save for future college costs -- earnings and withdrawals are tax-free so long as you use them for qualified education expenses. Although 529 plans do not have specific contribution limits, you can contribute up to $11,000 in 2005 free of gift tax. If you invest in your home state's 529 plan, you may be eligible for tax breaks. However, although you may receive tax benefits by investing in your own state's plan, you can invest in any state's 529 plan, so be sure to evaluate your options carefully. Depending on your income, you may also be able to invest in a Coverdell Education Savings Account, which allows you to invest up to $2,000 per year in a savings account, mutual fund or brokerage account (through which you can invest in individual stocks and bonds). Although your contributions are not tax deductible, the money you invest grows tax-free, and all withdrawals from the account are tax-free as well, provided you use them for qualified education expenses.

Retirement: When saving for retirement, there are different deadlines for 2005 contributions. Regarding your 401(k) plan, you need to make all your contributions by Dec. 31. If possible, you should consider maxing out your 401(k) before year-end to reduce your taxable income. You can defer up to $14,000 this year (up from $13,000 in 2004), and if you are age 50 or older, you can defer an additional $4,000 for a total deferral of $18,000. You have more time for IRA contributions -- specifically, you have until Monday, April 17, to make your 2005 contribution and you can contribute up to $4,000. If you are age 50 or older, you can contribute an additional $500 for a total of $4,500.

Are there any other last-minute tax moves you should consider before Saturday?

If you live in one of seven states with no state income tax -- Alaska, Florida, Nevada, South Dakota, Texas, Washington or Wyoming -- consider buying your big purchase, such as a car, boat or flat-screen television, before Saturday. Why? The state sales-tax deduction for people who live in these states may disappear next year, thus eliminating this significant tax-savings opportunity.

Mellody Hobson, president of Ariel Capital Management (arielmutualfunds.com) in Chicago, is ABC News' personal finance expert. Matthew Yale and Aimee Z. Daley contributed to this report.

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