Here they come. Articles, columns, emails, and websites by the dozens (hundreds? thousands?) each offering tax advice in the guise of tips and tricks while actually offering up nothing more than the same old retread of a supposed gold mine of tax savings.
This is the true, cold, hard fact: There is virtually nothing you can do to lower the amount of taxes you pay on earnings that come in the form of a steady paycheck. Sorry, but it is true.
Tax Advice and Tips and Tricks
So, what exactly is in these so called advice articles? Mostly things that will not apply to most people, or nickel and dime savings that won’t make much of a dent. But, tax advice articles are popular, especially at year end. Let’s take a look at the most common advice.
- Pay Your Next Mortgage Payment By December 31 – This doesn’t lower your taxes so much as borrow a deduction from next year’s taxes. The idea is that by paying your January 1st mortgage payment in December, you get to deduct 13 moths worth of interest, instead of 12.(Mortgage payments used to be due on the 1st of the month, that isn’t always true anymore, but old tricks die hard.) While this works, it works one time. Worse, you have to do the same thing every year from now on. Why? Because you already deducted your January mortgage interest last year, you will only get to deduct 11 months worth of the interest the following year unless you pay the year after January payment early too. This idea is really only valuable to people whose income varies from year to year. If this was a good year for you, then you could use this trick to help lower your taxes in this high income year. Then, if the next year or two you have a bad year, you can “reset” this trick by not paying the January mortgage in time. Sure, you’ll only get to deduct 11 months worth of interest, but if your income is significantly lower then it works out.
- Charitable Donations – This one is actually very true. Make your charitable donations by December 31, and you can save on taxes this year. Unfortunately, for most people, this is small potatoes. Look at it this way. If you made $100,000 this year and you end up paying 20% that is $20,000 in taxes. By donating $1,000 in December, you reduce your income to $99,000 and pay 20% which is $19,800 in taxes. Sure, it is a savings, but the difference between $20,000 and $19,800 isn’t what most people mean when they ask how to lower their taxes. Unless you are donating big (and if so, you should set it up before December so there is no rush) this won’t make much change. Still, if you have a donation sitting in your garage, get it in by December 31. Everything helps, just don’t expect miracles.
- Selling Investments to Generate Taxable Losses – If you learn one thing about investing ever, please let it be this: Always do what is right for your investment strategy/plan FIRST, then worry about taxes. Sure, lots of your investments may be negative right now, but that doesn’t mean that selling is the smart move. If you have mutual funds that you did not pay a load for and will not pay a load to sell them, AND you have a replacement fund in mind that you can also purchase without a load, then selling to generate losses makes sense. Otherwise, if you have good investments, keep them. Remember, you can only deduct your capital losses against your gains, so if you don’t have profits you can’t deduct the losses, except for $3,000. The rest carries forward until you have gains. Generating $15,000 of losses doesn’t do you any good for your taxes this year.
- Scheduling Medical Appointments or Other Medical Expenses – Repeat after me: Getting medical expenses in before the end of the year is smart in order to spend all of the money in a flexible savings account, not because of deductions. In order to deduct medical expenses, they have to exceed 7.5% of your income. If your income is $100,000 you can only deduct expenses that are OVER $7,500 for the year. In other words, $8,000 worth of medical expenses gives a $500 deduction. Unless you don’t have insurance, or you had a lot of medical problems this year, there probably isn’t anything for you here.
- Other Expenses – Everything from moving expenses, job training, to tax preparation fees falls under the miscellaneous deduction. In order to get any deduction, these expenses have to exceed 2% of your income. Again, if you have $100,000 income, you’ll need $2,000 in expenses before you save one penny on your taxes. If you are close, then spend away. If not, then you are better off waiting because you might be over it in 2009.
There are good legitimate ways to save on your federal income taxes. However, most of them can’t be done with ten or twenty days notice. So, make your donations and spend down your flexible spending accounts, but don’t sweat the other stuff.
By the way, you have until April 15 of next year to make your IRA contribution. We’ll cover that in another post.