Most of us would rather do just about anything (clean the oven, organize the garage, vacuum under our kids' beds) than tackle that growing pile of income tax paperwork. But if you, like most Americans, are looking to cut costs, it's time well spent: Just a few hours of savvy strategizing can shave big bucks off your final tax bill.
Before you file your return this year, check out these tips for keeping your hard-earned dollars in the family:
Open an IRA
Every year, you have until the April tax deadline to open a traditional individual retirement account (IRA) or contribute to an existing account and use it as a deduction on your tax return for the previous year. Even stay-at-home parents can open an IRA and contribute the max -- a big change from several years ago.
A traditional IRA allows you to deposit money for retirement and not pay taxes on it until you withdraw it -- theoretically, that'll be when you're 59 1/2 or older and in a lower tax bracket because you're retired or working less.
Not all contributions are fully deductible, however. The amount you can write off depends on your marital status, how you file your taxes if you're married (jointly or separately), whether you participate in retirement plan at work, and how much money you make.
If you don't already have an IRA, and you're eligible, it's easy to open one. Just ask at your bank or request an application from a mutual fund family like Vanguard, Fidelity, or T. Rowe Price.
For more information on IRAs, see Publication 590, Individual Retirement Arrangements (IRAs) [RL1] on the IRS website. Be sure to click on "What's New for 2008" for updated tax rules.
Open a SEP IRA if you're self-employed
A simplified employee pension plan (SEP) lets you shelter as much as 25 percent (but no more than $46,000) of your net self-employment income in a tax-deferred account. Every year, you have until the April tax deadline to set up and contribute to a SEP for the previous year.
For more information on SEP IRAs, see Retirement Plans FAQs Regarding SEPs on the IRS website.
Contribute to your 401(k)
If you work for a company with a 401(k) plan, enroll in it or start contributing more -- this is one of the easiest ways to cut your taxes and ramp up your retirement savings at the same time. Not only will your money grow tax-deferred until you withdraw it at retirement, but you'll significantly reduce your taxable income.
If you're in the 25 percent tax bracket, every $1,000 you put in your 401(k) saves you $250 in federal taxes. Bonus: Many companies will even match your 401(k) contribution up to a certain percentage, so not funding your account at least up to that percentage is like refusing free money.
Take the child tax credit
As long as your annual income is more than $8,500 and no more than $110,000 ($75,000 for singles, and $55,000 if you're married but file separately), you can whack $1,000 off your tax bill for each child who was under 17 on December 31, 2008. (The lower-than-usual $8,500 minimum is part of the government's $700 billion economic rescue bill; in 2009, it may jump back up -- and then some -- to $12,550.) In addition to checking off the appropriate box on your tax form, be sure to note the exact amount of credit you're entitled to.
For more information on the child tax credit, see Tax Topic 606 - Child Tax Credits on the IRS website.
Deduct your mortgage points
If you bought a home last year, you may be able to deduct any mortgage points you paid. As long as the points were based on a percentage of the loan amount and you paid for them in cash at or before closing, the deduction should pass muster with the IRS. A quick reminder: Don't forget to reduce the tax basis of your new home by the amount of seller-paid points you deduct.
For more information on deducting mortgage points, see Publication 936 (2008), Home Mortgage Interest Deduction on the IRS website.
Take the adoption credit if you adopted a child last year
In the year the adoption is finalized, you can subtract from your tax bill certain adoption-related expenses – such as court costs, attorney fees, and travel expenses – up to $11,650 for 2008 ($12,150 in 2009). This is true even if you incurred those expenses in previous years.
Note: Credit for previous years' expenses is limited to the maximum allowed for that year. The credit begins to phase out if your combined income exceeds a certain amount ($174,730 in 2008; $182,180 in 2009) and stops altogether if it gets high enough. Married adopters must file a joint return to claim the credit.
For more information about the adoption credit, see Topic 607 - Adoption Credit on the IRS website.
File as "head of household" if you qualify
Not only will you be taxed at a lower rate than if you filed as single or "married filing separately," but you'll get a higher standard deduction. To qualify for 2008, you must have been single, separated, or divorced on December 31, 2008; paid more than half the cost of keeping up a home; and had a child living with you for over half the year.
You may also be able to file as head of household if you claim a parent as a dependent and pay more than half of his home costs, including costs for a home that's separate from yours.
For more information about filing as head of household, see Publication 501 (2008), Exemptions, Standard Deduction, and Filing Information on the IRS website.
If you're divorcing, ask for child support
Alimony is taxable, child support is not -- so if given a choice, take the child support. Of course, you may need both. If that's the case, make sure the alimony and child support aren't rolled into one monthly payment called "family support." Otherwise, you may end up paying unnecessary taxes on the entire amount.
Get your child a social security number
If you expanded your family last year, don't put off getting your new child a social security number. Without it, you won't be able to claim him as a dependent exemption, a move that could cost you hundreds of dollars come tax time – $350 if you're in the 10 percent bracket, $875 in the 25 percent bracket. (Like many tax breaks, the dependent exemption is phased out for higher-earning families.)
If you haven't already filled out an application (at the hospital after your baby was delivered, for instance), call the Social Security Administration (SSA) at (800) 772-1213 and ask for Form SS-5, or download the form from the SSA website.
Prepare and file electronically
Preparing your return on a computer and filing it electronically reduces mistakes and speeds up the return process. One study found that 20 percent of returns done by hand had mistakes, compared with just 1 percent of those prepared electronically. What's more, if you're getting a refund, it'll be credited to your bank account in just eight to 15 days if you e-file, compared with five to seven weeks if you use U.S. mail.
To find out whether you qualify to have your tax return prepared and filed electronically at no charge through the IRS's Free File program, see Free File Home: Your Link to Free Federal Online Filing on the IRS website.
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