Federal and state governments are pretty good at extracting revenues from their “customers” (in the form of taxation). Governments are expensive to run and tax laws have been designed to minimize individual tax avoidance strategies. However, with the calendar ready to close out 2008, there are still a few things you can do to cut your 2008 tax burden. Here are a few actionable items you may want to consider for the next month:
Increase contributions to your 401(k) plan – I consider this the Holy Grail of tax avoidance techniques. Some 55 million Americans participate in a defined contribution plan (i.e. 401(k) plan) with the average person contributing about seven percent of their salary. Most individuals do not contribute the maximum deduction of $15,500. Contributions made to the plan in December will not be taxed to you in 2008. Furthermore, income earned in the account is deferred until you draw the money from the account. Consider increasing your contributions for the month of December by $50, $100 or whatever you can afford. This is the easiest and most effective strategy to decrease your 2008 tax liability. If you are not covered by a 401(k) plan, consider making a contribution to an Individual Retirement Account.
Accelerate your itemized deductions – Most individuals are considered “cash basis” tax payers. This means that a deduction can be taken on your tax return in the year you make the cash payment. For example, if you are planning on making a contribution to your church on Sunday January 4, 2009, instead cut them a check on Wednesday December 31, 2008. By accelerating the cash payment by four days, you are eligible to take the deduction in 2008 as opposed to 2009. Also, consider this technique on your home mortgage payment (make your January 1st payment on December 31 and your mortgage interest becomes deductible in 2008) or your real estate tax bill (pay your remaining real estate taxes on December 31st). There is one thing you will need to consider if you use this technique, the Alternative Minimum Tax. Accelerating deductions can trigger the Alternative Minimum Tax, which reduces the effectiveness of this tax avoidance strategy. (As I noted above, lawmakers want to limit your ability to reduce your taxes.) You should probably consult with your tax advisor to determine of this technique is appropriate to your situation.
Take a capital loss – With the recent decline in the stock market, every investor is holding some losses in their portfolio. If you no longer see great long term prospects for the company, consider selling the stock. This will create a capital loss, which can be used to offset any capital gain income and up to $3,000 in ordinary income.
Tax planning and avoidance strategies require action on your part. Consider these strategies to cut your tax bill on April 15th.
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