Ask The Money Coach

Posts Tagged ‘income taxes’

I know it hurts to get a big tax bill, and it’s not fun to find out that you owe the government nearly five thousand bucks. But there are some ways you can start to lower your taxes in the future. Here are six strategies I’d recommend:

Adjust Your Withholdings At Work
Since you said that you owed money last year also, and that your wife was recently laid off for two months, it very well could be the case that your W-4 withholdings need to be tweaked at work – possibly at both of your places of employment. In essence, you need to adjust your withholdings so that more taxes are taken out over the course of the year. Even though this is still paying taxes, it’s spread out. So you’re less likely to feel the sting of it. Also, by prepaying the proper amount of taxes due over the year, you’ll avoid those nasty IRS penalties for under-payments. Publication 919 from the IRS has more details about properly adjusting your withholdings to that you don’t wind up paying too much tax. The IRS also has a Withholding Calculator available online. Click the following link for more info. www.irs.gov/individuals/article/0,,id=96196,00.html.

Max Out Your 401(k)
If you have a 401(k), a 403(b) or any other type of employer-sponsored retirement plan, try to contribute the maximum allowable. Not only might you get a matching contribution from your employer, but you will also reduce your taxable income because money put into a 401(l) plan is contributed on a pre-tax basis. In 2010, the maximum contribution for a 401(k) plan is $16,500. People who are 50 and older can put in an additional $5,500.
The 2010 maximum contribution amount is $5,000 for IRAs, and an additional $1,000 contribution to an IRA is allowable for those 50 and older. So max out that 401(k) plan. Ditto for your wife at her job.

Take Advantage of Health Savings Accounts and Flexible Savings Accounts
If your company has a Health Savings Account, and you haven’t already done so, do sign up for it. Since you have two young children, you can contribute up to $6,150 to an HSA on a pre-tax basis. If you’re going to have to pay for certain health-related costs anyway, why not get a tax break for doing so? Do the same thing with a flexible spending account, which currently has a maximum contribution of $5,000. So get prepared for your next open enrollment season at your job, when you’ll be able to make 2011 selections for your FSA.

Itemize and Boost Deductions
One other way to lower your taxes is to ramp up your deductions. If you don’t take the standard deduction, you obviously need to itemize your deductions. This calls for some good record-keeping. Even though many taxpayers could benefit financially from itemizing their deductions, the IRS reports that lots of people don’t do it – simply because of the extra work involved.

To boost your deductions, here are some ideas about what you can claim:

•    charitable contributions
•    mortgage interest
•    interest on student loan payments
•    business use of a home
•    state, local and foreign income taxes
•    real estate taxes
•    personal property taxes
•    state and local sales taxes
•    qualified motor vehicle taxes
•    any estimated taxes you paid to state or local governments during the year
•    any prior year’s state or local income tax you paid during the year
•    miscellaneous deductions (in excess of 2% of your adjusted gross income)

In your case, your 2010 miscellaneous deductions could be significant. Since your wife was recently out of work, she can claim job-search expenses (like resume preparation, headhunter services, postage for mailings, unreimbursed travel and hotel bills for interviews, etc.). Under the category of “miscellaneous deductions,” you can also take deductions for things like tax and investment advice, as well as unreimbursed employee expenses.

Fund a 529 Plan for Each of the Kids
Since you mentioned having a 5-year-old and an 8-year-old, it’s possible that you’ve already thought about saving money for their future. One great way to do it is by opening a 529 Plan. That’s a state-sponsored college savings plan. Money invested in a 529 plan grows tax free and when you later take the money out to pay for college, the appreciation or gains that have been racked up in a 529 plan are also tax free. Best of all, many states offer a tax deduction for 529 Plan contributions. In 2009, you could put up to $13,000 in a 529 plan without triggering any federal gift taxes. In Massachusetts, where you live, unfortunately there is no direct state tax deduction or credit for contributions. However, according to SavingforCollege.com, which offers great information about 529 plans, Massachusetts does exempt qualified distribution from 529 plans, in conformity with federal law. The state also allows for tax-free treatment of 529 rollovers (i.e. earnings rolled into or out of a 529 plan). Again, if you’re already saving for your kids’ college education, or had planned to do so, you can get some serious bang for your buck with these tax-advantaged 529 plans.

Professional Help Wouldn’t Hurt
In addition to the strategies I’ve just recommended, as a practical matter, it would certainly not hurt you to also do some front-end planning with an accountant or financial advisor. This means you should get going now on tax-reduction activities, ahead of the April 15th tax filing deadline, and continue to make some smart money-moves all year long. A qualified CPA or other tax/financial expert should be able to review your overall financial picture, and give you even more specific advice about how to lower your tax bill.

If you use all these options, chances are by the time next year rolls around, you won’t find yourself having to write yet another big check to Uncle Sam.

By all means, start contributing to your company’s 401(k) plan immediately. Even if you leave the company or take another job elsewhere, you will have access to your 401(k) funds and can transfer them later – if you decide to – into an IRA. There are six big benefits to taking advantage of your 401(k) plan right now.

Lower Your Tax Bill
First, you will immediately lower your taxable income and start paying fewer income taxes to Uncle Sam. This is because you contribute to a 401(k) plan right out of your paycheck, on a pre-tax basis. By contrast, you fund an IRA with after-tax dollars. Your ability to take an IRA tax deduction is based on several factors, including your income.

Matching Contributions
Additionally, you may get additional retirement dollars from your employer, if your company offers any kind of matching program. Some companies match dollar-for-dollar, up to a certain percentage of your salary. Others offer 50 cents on the dollar. No matter how much or how little your company match might be, it’s still a great benefit, because it’s free money.

Flexibility
Thirdly, since you are a contract worker, you may be better off initially using a 401(k) plan, instead of an IRA, because the 401(k) generally offers you more flexibility and options to access monies without penalty. For example, you can take a loan from your 401(k) if necessary. But you generally can’t take loans from IRAs. You can take distributions from IRAs, but if they aren’t paid back within 60 days, the IRS imposes a 10% penalty, and you pay ordinary income taxes on the money too.

Higher Contribution Limits
401(k) plans have higher contribution limits than do Individual Retirement Accounts. Under federal law, the maximum amount you can put into a 401(k) in 2010 is $16,500; individuals age 50 and older can stash away an extra $5,500 in a 401(k). The limit is subject to cost-of living increase after 2010. The maximum you can put into an IRA in 2010 (either a regular IRA or a Roth IRA) is $5,000; those 50 and older can contribute an additional $1,000 into an IRA. The ability to sock away substantially more money is a 401(k) is a huge benefit that should be taken advantage of whenever possible.

Disciplined Investing
Making investments through your 401(k) plan is a great way to make you consistent and dedicated to the process of investing. Because the money is taken automatically out of your paycheck, you might not think about it as much and you won’t be as tempted to just stop investing when the markets get volatile. All too often, when people put their money into Individual Retirement Accounts, at the first sign of trouble on Wall Street, they simply stop investing. That’s not a good way to invest.

Ease of Implementation
As a final note, there’s also the speed of execution factor, which shouldn’t be ignored. You can literally go enroll in that 401(k) plan today. Just pop over into your Human Resources office and fill out some brief paperwork. You’d have to do quite a bit more homework and paperwork to open an IRA. Sometimes, when things take too long and seem like to much work, we tend to procrastinate and not get them done. That won’t be the case with your 401(k).

You stated that you’ve already been working at your company for more than a year. So now is a great time to get into the habit of saving early and often for retirement. The 401(k) plan offered by your employer will help you do just that.

Accepting a settlement offer from a credit card company will negatively impact your credit rating and lower your credit scores. The reason for this is that when a settlement occurs, a creditor has agreed to accept less than the full amount of money owed to it – even though the creditor, internally, will consider the balance as paid. Externally, however, two potentially harmful things occur for the consumer. First, the creditors immediately reports to the credit bureaus that your account was “Settled” “Settled for Less Than Owed,” or “Paid by Settlement” – all of which tarnishes your credit records with Equifax, Experian and TransUnion. Additionally, any amounts “forgiven” during a settlement are usually reported to the IRS. When this occurs, the IRS considers monies “saved” during a settlement to be income. Therefore, you also therefore have to pay income taxes on the amount of money you “saved” during a settlement.

Check the “Status” Notations In Your Credit Files

If you have “settled” any accounts over the past seven years, through direct negotiation with creditors – or perhaps as a result of using a debt settlement company – you should check your credit files to see how those settlements were reported.  One of the most important sections of your credit report is the “Status” references to whether you’ve paid your debts on time, or whether you’ve been late – and if so, how late. Upon examining the “Account Summary” area of your credit report, that is where you will find “Status” notations.

Your payment history is shown on your credit reports as your “Account Status,” “Current Status,” “Pay Status” or just simply “Status.” Open accounts with no delinquencies will have these types of “Status” comments: “Pays as Agreed,” “Never Late,” or “Current.” Closed accounts with a positive credit history will be noted as “Paid As Agreed,” or “Pays As Agrees.”  Negative information will most commonly be stated as 30, 60, 90 or 120-day late payments. Other negative comments include: “Collections,” “Settled,” or references such as “Paid, Was 60 Days Late”. If an account has been “charged off” or written off by a creditor as uncollectable, that fact will be noted too, typically along with the dollar amount charged off.

In short, any notation in your credit file that indicates that you did not pay your debts exactly as originally agreed will be viewed negatively by credit-scoring firms, and potential lenders.

Without knowing the details about your situation, it’s very hard to say the impact that working overseas will have on your income taxes. It depends on several factors, not the least of which are: the exact country in which your husband will be working, how he is compensated, and whether or not he is deemed to be an employee or an independent contractor. Regardless of these considerations, U.S. citizens are legally required to pay taxes on all income, no matter where it is derived or generated (i.e. either domestically or overseas).

Lowering Your Tax Bill

To potentially lower your tax bill, find out three things:

•    Is There a Reciprocal Tax Agreement With the U.S.?
Some nations have reciprocal tax treaties and agreements with the United States; other countries do not. If a U.S. worker is employed overseas in a country that does have a reciprocal tax agreement with American, then that worker may be eligible to get a tax credit for taxes paid to that foreign country.

•    Is His Pay “Grossed Up?”
Many employers will “gross up” an employee’s pay when that person is working overseas, relocating, or doing something else to benefit the employer – which in turn, may negatively impact the employee, from a tax standpoint. So it’s important to know whether your husband’s pay will include added compensation to essentially cover his income tax bill.

•    Is He Considered an “Employee” or an “Independent Contractor?”
Your husband’s taxes will also be determined by his employment status as either an “employee” or an “independent contractor.” Each has its pros and cons form a tax standpoint. And each may be afford certain tax benefits and deductions not provided to the other. For instance, an employee may get a deduction for relocation or moving expenses; whereas an independent contractor may be able to write off some of the same business expenses as entrepreneurs and self-employed individuals.

Once you find out the answers to these three important questions, then you can begin to do some appropriate tax planning. Also, since this situation involves a far more complicated set of financial and tax considerations than normal, I would strongly advise you to also consult a qualified tax professional.