Tax tips for year-end planning
By Mei-Feng Moe
If you don't pay in your required amount of taxes and you end up owing $1,000 or more for federal ($200 for Wisconsin,) you'll have to pay an underpayment penalty in addition to the tax amount that you owe. What's the required amount? You are required to pay in at least 90% of current year's tax, or 100% of last year's tax, whichever is smaller.
For those self-employed people, since it's hard to predict current year's income and tax liability, it would be easier to use last year's tax amount as your required payment amount for this year. Example: Your 2004 tax was $4,000, as long as you pay your $1,000 quarterly estimated tax on time (by April 15, June 15, September 15 and January 15) for a total of $4,000, you won't have underpayment penalty for 2005 even if your income goes up and your tax for 2005 is $6,000. You will owe more than $1,000, but you have paid your required amount and no penalty will be assessed.
For most employees, income taxes are withheld from your paychecks each pay period. The taxes withheld are considered paid evenly throughout the year. If you receive unexpected income for which no tax was withheld, you may simply increase your withholding by giving your employer a signed new W-4 form. Have you sold your stock or investment property at a gain? Do you have interest, dividends, or royalties income? Did you win a prize or have gambling winnings? Did you receive social security benefits that might be partly taxable based on your income level? Or did you receive pensions, alimony, or unemployment compensation? Most of these types of income do not have taxes withheld, but will increase your tax liability when you file your tax return.
If you expect to be in the higher tax bracket this year, it would be wise to shift your income to next January and pay your deductible expenses by the end of December. One thing a lot of homeowners are advised to do when itemizing their deductions is to pay two years' property tax in one year to get a higher deduction and switch back to standard deduction the next year. When you use this strategy to save taxes, be sure to take into account the effect on your state return as well. For Wisconsin state, because you get to claim a credit (up to $300) based on the amount of property tax actually paid during the year, once you pay $2,500 of property tax, the credit is maxed out. So unless your property tax is $1,250 or less a year, you will lose some of your tax credit on Wisconsin return when you double up your property tax deduction on your federal return. Be sure to compare your federal tax savings to the credit lost on your Wisconsin return to see if it really works for you.
On the other side of the scale, if you expect your income to be low enough that you don't have to pay any taxes, it might be time to look at your IRA situations and get some tax benefits from switching your IRAs. For an example: You are a single person who did not work the entire year (perhaps you decided to go back to school full-time, you took a long vacation for the year, or you wanted to work part-time instead) and you expect to have only $4,000 of income for the year. That's great because you don't have to pay any taxes or even have to file a tax return. But wait! If you had in the past years contributed money into a traditional IRA, this is the year to convert some of that traditional IRA to a Roth. Because up to $8,050 of income can be deducted from your income in 2005 if you are under 65, you can convert $4,050 to a Roth IRA and this amount will not be taxable when you take it out later. If you are 65 or older, you can convert up to $5,250 for the same tax benefits.
About the author
Mei-Feng Moe is a Master Tax Advisor certified by H&R Block. In addition to giving tax advice and preparing tax returns, she has also been teaching income tax courses for a number of years. She is an enrolled agent who may represent taxpayers before the IRS. She also holds series 6 and series 63 security licenses.
This column welcomes your questions on tax issues. Please e-mail your questions to dlc@triwest.net. Your questions will be answered in a future issue.
