Ways to save on taxes

Entry Notes

Posted: 03312007
Author: Correy Phillips
Category: Taxes



When you see a mistake, are you likely to correct it, or do you just glance over it? If we’re talking about your taxes, hopefully you would correct it. Chances are that the mistake you are catching would have cost you money. There are a number of simple mistakes that people make on their taxes that, if corrected, could help them save money on taxes. Some of these mistakes are just silly errors that are easily eliminated.

Withholding Too Much

Most people I know get refunds at the end of the tax year. However, many of these people are receiving too much. I’m not saying that the government is paying them more than they are entitled to, I’m saying that these people have been withholding too much money from their paychecks. Tax refunds are good, but the smaller they are the better. Why is that? Because the more money you pay into the government during the year from your paycheck, the less money you have to help achieve your goals.

By lowering your withholding from your checks, you will increase the amount of money that goes into your pocket. This is money that can be used to help increase your investments or used as cash to buy something that you might otherwise put on a charge card and pay interest on later. Plus, when was the last time you received your refund from the government plus interest on that amount? Probably never. When you withhold too much from your paycheck you are essentially giving the government an interest-free loan for the year. Think about what you can be doing with that money, and then think about what the government is probably doing with your money. I’m sure you have better plans for it.

Compromising Wealth for Taxes

When trying to build wealth, most people focus on saving money in taxes as their number-one priority, but is that really the way to go? It’s important to do proper research before deciding that an investment that will save you in taxes is more important than a taxable investment that may perform better. Saving money in taxes is important, but it’s not your ultimate goal. Make sure that you are making decisions that are in the best interests of your long-term goals, not just so you can save on taxes. Realistically, strategies that are employed solely to save on taxes shouldn’t work for investment purposes because that wasn’t why they were undertaken in the first place. When deciding which road is the best to take for your investments, consider why you are choosing to do anything. Is it because you want to save on taxes? Or is it the best decision based upon your risk tolerance and financial objectives?

Real Estate Trade-Ups

Did you know that you don’t have to pay taxes on the gain of your home if you purchase another, more expensive house? Section 1031 of the Internal Revenue Code says that you can delay paying tax on the gain of the sale of your home as long as you roll that money into the purchase of a new, more expensive house. The only stipulation to this is that you have to live in the house, or keep it as your primary residence, for at least two years. The allowable appreciation for a taxpayer filing as single is $250,000. For those who are married, the allowable appreciation is $500,000. Therefore, as long as you continue to trade up in value, you won’t have to pay any taxes on the appreciation. However, once you liquidate (sell off your property and don’t purchase another home), you will have to pay the tax on the gain.

Statements? What Statements?

Poor record keeping is a killer for many people. Make sure that you keep track of all your investment statements, check registers, charitable contributions, and all other pertinent financial data. Not having these papers may result in paying your CPA and the IRS more money than necessary because you may wind up missing deductions that will help lower your taxes. But there is also such a thing as too much record keeping. I have a client whose father recently passed away. His father was a meticulous record-keeper. However, he also kept things that were of no importance. Therefore, upon his father’s death, my client had to wade through the quagmire of paper that his father had kept for years and years. It’s very important to keep good records of your investments and transactions, but that prospectus that’s eight years old? It’s all right to throw that away.

Special note: I have quite a few clients who came to me from other firms. When they first come to see me, they have many different statements from multiple companies. I have found that many people truly don’t know what their assets are because they simply have too many accounts at too many firms. It’s very easy to get swept up in the latest advertisement from a bank or mutual fund company; then, before you know it, you have a torrent of paper coming to your mailbox every month from way too many investment companies. In order to combat this, try to find a company that will allow you to hold your existing mutual funds and other assets in one consolidated account, like a brokerage account. There are many firms that will allow this, and it will make keeping track of your investments much easier. You don’t want to compromise your investment strategy or results by limiting yourself to one or two investment companies; however, you also don’t want to lose track of your portfolio because you have too many accounts at different firms.

Mathematical Errors

These are probably the easiest to fix, but the most difficult to find. Many times the only mistake in a client’s taxes is that two numbers are added incorrectly or aren’t entered correctly. The most common mistake that I see happens when people use spreadsheets they have formulated themselves to help them. If there is an error in the spreadsheet, it will continue into perpetuity as long as you don’t know the error is there. This is why it’s important to have someone else double-check your work. If they find an error that you missed, they may have just saved you some money. However, that’s not to say that all errors result in your paying more taxes. There are times when the errors that are made result in the government’s paying more back to you. But, when the IRS goes over your return and finds an error, if it’s in their favor they’ll let you know. If it’s not, they’ll let it go.

Doing Your Own Taxes

If you are a trained tax specialist or a CPA, then doing your own taxes makes sense. Even if your taxes are simple you don’t itemize, and you use the 1040EZ form, then doing your taxes is alright. However, if that’s not the case, then perhaps you should consider hiring a professional. The advantages of hiring a professional outweigh the potential cost of paying someone to prepare your taxes.

First, whomever you hire will be more objective about your tax situation than you will be. Second, tax professionals are trained in up-to-date tax codes. They know what they’re doing and what the best way to do it is. They also know the best way to save you money on your taxes and whether you should itemize or not. Third, hiring someone will help stem the tendency to procrastinate. Are you one of those people who stand in line at the post office at 11:30 p.m. on April 15 to send in your taxes? Or perhaps, you’ve been so busy that you had to file for an extension? If so, then hiring a CPA is probably a good idea.

Plus, you know that little box on the bottom of the second page of the tax forms, the one that says preparer’s signature? By hiring someone to prepare your taxes for you, if there is a problem, it becomes their problem, too. If you make a mistake, the IRS hunts you down, right? But if your CPA makes a mistake, it’s his or her problem, too, because it’s the CPA’s job to make sure that things are done correctly. Therefore, the onus of doing the job right falls directly onto the CPA, not you. This may result in fewer sleepless nights for you!

Not Using Qualified Plans

We talked about this earlier. Qualified plans are one of the best ways to help lower your taxable income and shelter your money from current taxes. Not utilizing these types of accounts is one of the surest ways to cost you money, both currently and over time.

Investing in Bonds Needlessly

The tax advantages of muni bonds are for those with higher incomes. While I’m not advocating that those in the lower tax brackets stay away from municipal bonds, I am saying that there may be other investments better suited to those investors. Evaluate your tax situation and make your decision based on that. If you want to add some stability to your portfolio by using bonds, there are different types of bonds that exist that may give you higher returns. And, those after-tax returns may be higher than those returns offered by nontaxable muni bonds.

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