Think it’s too early to worry about planning for 2007? Think again. When it comes to tax planning, there’s no such thing as too soon. Each year brings changes in tax laws and investment options; it’s up to you to be informed and take the necessary steps to benefit from them.
Here are six practical strategies for saving on taxes that you may find useful in 2007—and beyond.
IRA Infusion
Need a cash infusion, but don’t want to pay the onerous penalty for a pre-retirement age IRA withdrawal? The little known IRS provision Code 72(t) lets you can take a penalty-free distribution for a variety of purposes, including disability, health insurance premiums, medical expenses, education expenses, and conversion to a Roth. The caveat? Your withdrawal must also comply with certain conditions that vary by purpose. For example, penalty-free withdrawals for first-time home buyers are capped at $10,000, while medical expenses must be greater than 7.5 percent of the IRA holder’s adjusted gross income to qualify.
Audit Avoidance
If the sight of a letter from the Internal Revenue Service in your mailbox is enough to make your heart race, watch out. The rate of audits rose 20 percent in 2005, and the IRS has pledged to continue to prioritize high-income individuals ($100,000-plus) and the self-employed. One way to minimize your chances of hearing from the agency’s enforcement division is to be careful with deductions likely to be used for both business and personal purposes. Home office deductions and those taken for equipment such as a cell phone or a laptop often used as a personal use item can attract unwanted attention. It’s often best to pro-rate deductions for such items at 60/40 or 70/30 percent depending on your usage rather than take a straight 100 percent deduction.
Energy Effects
It pays to go green. Taxpayers can now claim a tax credit for a portion of any amount paid for qualified energy efficiency improvement installed in 2007. Improvements must involve interior lighting, heating, cooling, ventilation, hot water systems, or any part of the building separating the interior from the outdoors, including windows, walls, ceilings and insulation. They must also be made under a professionally certified plan approved by the IRS showing how the steps taken will reduce total annual energy costs by more than 50 percent, and the deduction cannot exceed $1.80 per square foot.
Capital Idea
Hit with a hefty bill for capital gains in 2006? This year, plan ahead by tallying your gains before yearend and offsetting them with the sale of in-the-red investments. Capital losses offset capital gains dollar-for-dollar. Conversely, if 2006 was not your year, be sure to carry over any losses above the $3,000 annual maximum for 2006 on your 2007 return.
Salary Savings
Thinking about foregoing a salary and funneling your profits back into your business? Before you make that call, be sure to factor in your retirement planning needs. The amount you can contribute to a qualified retirement plan—SEPP IRA, Keogh—is based on a percentage of eligible compensation. With no earnings, you won’t be able to fund your retirement with pre-tax dollars.
Don’t Sell—Swap
If the prospect of a hefty capital gains bill is the only thing keeping you from selling an investment property, consider a 1031 or “like kind” exchange. An exchange lets an investor or business owner to trade in a holding that has peaked in value for one in a market with greater upside potential. The downside? The IRS requires a qualified intermediary to handle the transaction and also enforces strict time limits—45 days from the sale of the property to identify up to three replacement properties, and 180 days to complete the purchase. •