Take Steps Now to Lower 2005-2006 Taxes, CCH Says
(RIVERWOODS, ILL., August 4, 2005) – Taking a look at your finances now can pay dividends next April 17, the Monday when tax returns are due, according to CCH INCORPORATED (CCH), a leading provider of tax and business information and software. CCH’s Tax Planning Strategies 2005-2006, which provides average taxpayers with help in making the right tax planning decisions, points out that getting a rough idea of your tax situation can be key to adopting strategies that will lower your 2005 taxes and putting in place long-range plans to reduce taxes for 2006 and beyond. ($28.50, 164 pages. For more information or to order, call 800-248-3248, or visit the CCH Online Store at onlinestore.cch.com.)
“There are many things the average person can do to lower this year’s taxes,” said Mark Luscombe, CCH principal federal tax analyst. “It’s also not too early to think about strategic tax moves for next year,”
Know Your Bracket
Tax planning begins with simple things, such as knowing your tax bracket – the percentage at which your top dollar of income will be taxed. Brackets currently range from 10 to 35 percent. The income levels at which the brackets begin and end are adjusted annually for inflation.
As a general rule, it’s better for anyone to pay a tax later than sooner, but in addition, people in higher brackets benefit from the annual indexing of the brackets and other items for inflation, so more of their income will be taxed at lower rates in 2006 than in 2005.
If you’re an employee and are usually paid a year-end bonus, you may be able to make arrangements with your employer to have the bonus paid in and credited to 2006 rather than 2005. If you run your own small business and bill your clients, you might be able to defer income simply by not billing until next year.
Retirees may have an opportunity to lessen their taxes by carefully planning how they take large distributions from IRAs – for example, a distribution to buy a retirement home or pay off credit-card debt.
“By splitting up a large distribution and taking part in December and part in January, you may avoid moving to a higher tax bracket in either year, and keep more of your Social Security benefits from being taxed as well,” Luscombe observed.
Making the Most of Deductions
You can exercise control over the timing of deductions, as well as income. If you have a property tax bill for 2005 that’s due in January, you can pay it in December to clinch a deduction on your 2005 return. Similar opportunities may exist with scheduling elective medical procedures or making a charitable contribution.
The question is whether accelerating deductions into the current year is always the best strategy. Sometimes it is and sometimes it isn’t.
“If your itemized deductions are close to the size of your standard deduction, you’re often better off ‘bunching’ deductions in alternate years. That can give you a significant amount of itemized deductions in, say, odd years while you take advantage of the standard deduction in even years,” Luscombe observed.
Another case in which it’s best to be careful with deductions is for people who may be subject to the alternative minimum tax, or AMT. In the topsy-turvy world of the AMT, some items that are deducted in figuring your regular tax are added back in to figure a tentative “alternative” minimum tax. If the alternative minimum tax is larger than your regular tax, you pay it instead.
“If your regular tax and alternative minimum tax are fairly close together, you’re probably better off not bunching deductions, but trying to smooth out the ones that can trigger AMT liability from year to year,” Luscombe suggested.
Some high-income taxpayers have a special reason to defer both income and deductions into 2006. These are taxpayers who are currently subject to “phaseouts” of their itemized deductions and personal exemptions that begin when their income hits certain levels.
For joint filers in 2005, the phaseout on itemized deductions begins at $145,000; the phaseout for personal exemptions is $218,950. The phaseout levels for 2006 will be adjusted for inflation and will not be officially announced by the IRS until December, but CCH will calculate the phaseouts in September, when the inflation numbers for August are known.
In 2006, the effect of the phaseouts will begin to diminish. Taxpayers will experience only one-third the loss of itemized deductions and personal exemptions that they otherwise would.
“This means less of their income will be taxed and their deductions will count for more,” Luscombe noted.
Making Tax-wise Choices
Even if your income and deductions are pretty well set for 2005, contributions to certain retirement plans can still reduce the size of the check you write next April, or increase the size of the check you receive. And, if you are an employee, your company may be offering you opportunities between now and the end of the year to reduce your 2006 taxes.
A tax-deductible IRA can have several impacts on your 2005 tax bill by reducing your adjustable gross income.
“When you lower adjusted gross income, there’s a direct flow-through to a lower taxable income, and the size of your allowable itemized deductions may increase as well,” Luscombe observed. “What’s more, a lower adjusted gross income on your federal return can make you more eligible for a variety of federal tax benefits that are subject to phaseouts, and is often the starting point for figuring state income taxes, as well.”
You can put up to $4,000 into an IRA if you have that much earned income and are not covered by an employer’s qualified plan. Even if you are covered by a qualified plan, you can now make the maximum IRA contribution if your adjusted gross income is less than $70,000 and you file jointly. The contribution phases out completely for joint filers at $80,000, while for single filers the phaseout range is from $50,000 to $60,000. If you’re age 50 or older, you can contribute up to an additional $500 as a “catch-up” contribution in 2005.
The IRA does not have to be established in this year. As long as it is in place and the money is contributed as of April 17, 2006 – the filing deadline for 2005 taxes – you can take the deduction. You can enjoy several months of tax-free earnings if you fund the IRA now, however.
If you’re self-employed, you can probably defer much more in a Keogh account than in an IRA, with a correspondingly larger effect on your tax bill. Like an IRA, a Keogh can be funded as late as next April, but unlike an IRA, a Keogh must be established with your bank or other financial institution by December 31 to have an effect on your 2005 tax bill.
Employee Plans Can Lower Next Year’s Taxes
The closing months of the year are often “open enrollment” periods for employee benefit plans that can reduce your taxes for next year, if not this one.
“Paying for health or dependent care expenses on a pre-tax basis and contributing to a 401(k) will directly lower your taxable income for 2006,” Luscombe observed.
For 2006, opportunities for saving through an employer-sponsored plan such as a 401(k) will be bigger than ever. If you’re under 50, you can contribute up to $15,000 to a 401(k), 403(b), salary reduction SEP or 457 plan and up to $10,000 (adjusted for inflation during 2005) to a SIMPLE plan. If you’re 50 or older, you can also make additional “catch-up” contributions of $5,000 to employer plans other than SIMPLEs and $2,500 to a SIMPLE plan.
For 2006, some employees will have yet another retirement savings option: the opportunity to contribute to a “Roth” 401(k). Like a Roth IRA, contributions to a Roth 401(k) are made with after-tax money, and therefore don’t lower your current tax obligation. But withdrawals from a Roth IRA, including qualified withdrawals of earnings, are not subject to tax or “required distribution” rules that force the distribution and taxation of money from non-Roth retirement plans after age 70 ½.
Roth 401(k)s will be especially appealing to high-earning individuals who currently are barred from contributing to Roth IRAs because their income exceeds the limitation of $110,000 for single filers or $160,000 for joint filers. In addition, contributions to a Roth 401(k) can be as high as the $15,000 allowed for regular 401(k) accounts, whereas contributions to Roth IRAs are limited to $4,000.
“It’s not clear how many companies will add a Roth feature to their 401(k) plans,” Luscombe noted. “Even if a Roth option is offered, people will have to think long and hard about whether it’s the right choice for them. But it’s all the more reason to do some research and start thinking about your opportunities early.”
Enjoy Your Tax Savings Now, Not Later
As you take steps to lower your tax bill, you should take one more step – to make sure that those savings go straight into your pocket, rather than sitting in the IRS’s coffers until you apply for a refund, Luscombe says.
“If you know your tax bill will be lower for any reason, you should take steps to enjoy your lower taxes by increasing your take-home pay. You can invest the money, or buy things you need without racking up credit card debt,” Luscombe advises.
“By adjusting your withholding on Form W-4, you can start receiving your 2005 refund in August, and your 2006 refund in January,” Luscombe said.
About CCH INCORPORATED
CCH INCORPORATED (www.tax.cchgroup.com), based in Riverwoods, Ill., is the nation’s premier provider of tax, audit, and accounting information, software and services. It has served tax, accounting and business professionals and their clients since 1913. Among its market leading products are The ProSystem fx® Office, CCH® Tax Research NetWork™, Accounting Research Manager™ and the U.S. Master Tax Guide®. CCH is a Wolters Kluwer company.
Wolters Kluwer is a leading multinational publisher and information services company. Wolters Kluwer has annual revenues (2004) of €3.3 billion, employs approximately 18,400 people worldwide and maintains operations across Europe, North America and Asia Pacific. Wolters Kluwer is headquartered in Amsterdam, the Netherlands (www.wolterskluwer.com). Its depositary receipts of shares are quoted on the Euronext Amsterdam (WKL) and are included in the AEX and Euronext 100 indices.
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EDITOR’S NOTE: For members of the press, a complimentary copy of CCH's Tax Planning Strategies 2005-2006 is available by contacting Neil Allen at 847-267-2179 or firstname.lastname@example.org or Leslie Bonacum at 847-267-7153 or email@example.com.