Net Gains: Increase Your Tax Refund Now

Dec. 5, 2007 — -- Put away the list, and forget about holiday shopping for just a day or two. It's time to focus on an issue that can actually make a positive impact on your finances as we enter the waning days of 2007.

Yes, it's time to talk taxes.

End-of-year tax planning hardly triggers warm holiday thoughts, but it can make up for some of what you will spend over the next few weeks.

With that goal in mind, here are some steps you may want to take before this year comes to a close:

Buy the software now. If you use software like TurboTax or H&R Block's Tax Cut to prepare your tax returns, consider buying it now. The 2007 versions are available and can be updated online to accommodate any last-minute tax law changes Congress makes.

Buying the software before the end of the year allows you to see where you stand while there is still time to make a difference. Use it to project your income for the year, review your withholding payments and total potential deductions.

At this point, it is difficult to complete a detailed return, but a rough outline can be quite helpful to identify steps you might want to take.

"If you're going to be doing some year-end planning, it's best to buy the software now," said Justin Ransome, a partner in the national tax office of Grant Thornton LLP.

And if you buy the software before year's end, the cost may qualify as a miscellaneous itemized deduction on your 2007 return.

Accelerate deductions and defer income. This is standard tax-planning advice that has gotten more complicated as more taxpayers than ever are subject to the Alternative Minimum Tax.

The general advice is to lower your 2007 tax bill by prepaying deductible expenses before Dec. 31 and trying to defer income until after the first of the year. This works well particularly for business owners who can control when expenses are incurred and possibly hold off on billing.

Along with business expenses, other deductions that can be accelerated include charitable donations, state and local tax payments and mortgage interest payments.

Beware of the AMT As mentioned above, the AMT is reaching into the pockets of more taxpayers than ever before. This parallel tax system was meant to curb abuses by the super wealthy, but the fact it was never indexed for inflation means today's upper middle class are falling victim to it. Those who live in high-tax states such as New York and California and have a large number of children are particularly prone to it.

The AMT takes away certain tax deductions and other tax breaks you would otherwise qualify for and as a result increases your overall tax. These lost breaks include deductions for state and local income taxes and real estate taxes. For that reason, prepayment of these normally deductible expenses may be unwise for those susceptible to the AMT.

The early purchase of tax preparation software will help you gauge your AMT exposure.

Ransome, a family wealth specialist with Grant Thornton, said married couples need to worry about the AMT when their family income reaches about $100,000.

"I used to say $150,000, but I think now it's about $100,000," he said.

There are estimates that up to 25 million taxpayers could fall victim to the AMT for this tax year unless the exemption amount is increased, as is currently being debated in Congress.

"It you're in an AMT position this year, it may not be prudent to accelerate your tax deductions," Ransome said.

Boost 401(k) or 403(b) contributions. The contribution limit for these employer-sponsored retirement plans this year is $15,500, or $20,500 if you are 50 or over. If you're not contributing these maximum amounts, there remains time to boost your contribution rate and cut what your income tax bill.

If your company administers its plan online, it may be easy to bump up your contribution rate substantially for just a few weeks and then lower it after Jan. 1.

Prepare for 0 percent capital gains. As I've written about before, the capital gains tax rate for taxpayers in the 10 and 15 percent tax brackets is scheduled to drop to 0 percent for three years beginning next year. This presents an opportunity for middle income investors holding gains in taxable accounts.

These taxpayers in the two bottom tax brackets currently only pay a 5 percent capital gains rate. But if you think you will qualify for the 0 percent rate next year and can hold off on the sale of a mutual fund or stock, it may be worthwhile to wait until Jan. 1. Just remember, the income from an investment sale could push you above the 15 percent rate. In such a case, the resulting gain could be taxed partly at the 0 percent rate and partly at the 15 percent rate.

Watch out for the "kiddie tax" expansion. Next year, the kiddie tax rules that require a portion of a child's unearned income to be taxed at the parents' higher marginal rate will be expanded. It will go from covering children under 18 to those who are full-time students under age 24 and supported financially by their parents. As a result, a student 18 or older who owns investments in his or her name may want to sell those assets by the end of this year to take advantage of the 5 percent capital gains rate.

These are but a few moves a taxpayer can make over the next few weeks, but they show that will a little thought and effort there are ways to trim your tax bill and offset the impact of that holiday shopping bill.

This work is the opinion of the columnist and in no way reflects the opinion of ABC News.

David McPherson is founder and principal of Four Ponds Financial Planning (www.fourpondsfinancial.com) in Falmouth, Mass. He previously worked as a financial writer and editor for The Providence Journal in Rhode Island. He is a member of the Garrett Planning Network, whose members provide financial advice to clients on an hourly, as-needed basis. Contact McPherson at david@fourpondsfinancial.com