Appeals - Edgar Palacios

Ten Tax Tips for the Year 2002
If you think the government takes too big of a bite out of your income, it's time to do something about it. Even if it's still earlier in the year and you haven't filed last year's tax return yet, a little advance planning now will put you on the right foot for this year and help you avoid scrambling down the road.
Cutting your taxes isn't quite as easy as it used to be, but you still have options. Just understanding your own tax situation and keeping track of deductible expenses can put money in your pocket. The timing of when you sell stocks, give money away, or pay your tax obligations can be critical. And participating in any tax-deferred retirement plans available to you means a deduction this year and the potential for further gains every year after.
The tips below will help you save money this year and for many years to come.

1. Get organized.
Do it at the beginning of the year for a change -- it will save you a lot of grief later. Instead of throwing receipts into a shoebox, put your expenses on a computer program like Quicken and file the receipts. Organization is critical, and it's best to use a computer program so that your information is reliable. Here are some hints:

Create documentation for your expenses whenever possible.
Record mileage for business or charity in a book that you keep in your car.
Get receipts for charitable contributions.
Don't think you'll remember to do all this later. You probably won't.
Also, keep careful records of stock options. You need to know when they were granted and exercised -- and at what price. This information can have important implications for this year's taxes and for next year's tax planning.

Savings: Possibly hundreds, even thousands, of dollars in forgotten expenses and in hours of your time.

2. Contribute the maximum to your 401(k).
Check at the beginning of each year with your company that you are signed up for the maximum contribution. The ceiling for contributions, which is $10,500 in 2001, will increase by $1,000 every year starting in 2002 until it reaches $15,000 in 2006. As a tax-deferred vehicle, a 401(k) rarely can be beat. It allows your investment to compound quickly, and you can contribute substantially more to it than to an IRA. When employers match your contributions, the extra money makes a 401(k) even more appealing. Only if your investment choices are limited should you commit less than the maximum to the plan. Put in enough money to get the full company match if you can invest only in company stock, for example, and then diversify with an IRA.

Savings: $275 in federal taxes on every $1,000 in contributions for someone in the 27.5% tax bracket in 2001. Plus, funds grow unhindered by taxes until you withdraw them.

3. Adjust your withholding.
If you received a big refund, it's definitely time to fiddle with your W-4. While many people look forward to getting a nice check from the government in April, it's a terrible way to manage your money. You are essentially giving the government a free loan when you could be putting your money to work for yourself.

On the other hand, you might leave yourself wide open for interest and penalties if your company doesn't withhold enough. Watch out if you got married recently. Working couples may pay more in taxes than when they were single. You also may need to increase your withholding if you're earning more than last year. As your income goes up, the withholding tables don't usually provide adequate withholding unless you have a large amount of itemized deductions.

Any time you have a major change in your life, your taxes are going to change. So after you get married, buy a home, or have a baby, be sure to ask to fill out a new W-4 form.

Savings: Interest that you could have earned on overpayments to the government. On the flip side you will save on interest and penalties that you may owe to the government on underpayments.

4. Figure estimated payments.
If you can't withhold enough from your paycheck or if you are self-employed, you can make yourself penalty-proof with quarterly estimated payments. Figure what they should be early in the year. You can always change the amount later. Check your income, withholding and estimated payments periodically throughout the year to make sure you are staying on track.

According to IRS rules, you must pay 100% of last year's tax liability or 90% of this year's. You have to pay more than that if you made more than $150,000 last year -- 110% of last year's tax liability.

Savings: Interest and penalties on tax underpayments.

5. Sell stocks and funds early in the year.
If you delayed selling a stock last year in order to postpone a gain, take it as early as you can in the following year to maximize earnings from investing the proceeds. First, make sure that you have made yourself penalty-proof by paying the required amount of quarterly tax estimates. Put aside any extra money you eventually will have to pay in taxes. Then you can invest it until Tax Day, which could be more than a year away. Be sure to pick a CD or other short-term investment so that the funds will be available when you need them.

Savings: Interest on the investment that is earmarked to pay taxes.

6. Contribute to your IRA early.
Instead of waiting until the end of the year, put money into your IRA in January. Believe it or not, those extra few months can make a big difference over time -- you'll do a lot better with interest compounding over the longer period. An added bonus: in 2002 the maximum you can contribute to IRA accounts increases to $3,000 ($3,500 if you'll be 50 or older) and eventually climbs to $5,000 in 2008.

If you're thinking about contributing to a Roth IRA, you might want to wait until you're sure you qualify. You might have to undo your contribution if you go over the income ceiling of $150,000 for married couples and $95,000 for singles.

Savings: More than $30,000 over 30 years if you contribute $2,000 at the beginning of every year and get a 10% return on your investment.

7. Make gifts to children and grandchildren.

People with substantial assets can lower taxes on their estates by giving cash to children and grandchildren every year. In 2001, the IRS allows you to give $10,000 to each person free of gift taxes. This maximum amount is indexed for inflation, so that amount increases to $11,000 for 2002. That gift does not affect the amount that is excluded from estate taxes when you die, which is $675,000 for 2001 and $1 million after that.

How does the repeal of estate taxes affect this strategy? Estate taxes are reduced from 60% to 45% over the next several years until they disappear altogether in 2010 -- only to return in full force in 2011! And, the repeal doesn't apply to gift taxes.

The earlier in the year you make the gift, the better it is for keeping money in the family. Chances are that your children or grandchildren are in a lower tax bracket. If so, they will pay less in taxes on the gains from that money than you would have.

Savings: Up to 60% on the amount you give away in 2001, depending on the size of your estate.

8. Consider tax-efficient investments.

People in high tax brackets who have maxed out on their tax-deferred retirement accounts should think about putting money into investments without a big tax bite.

As early in the year as possible, project what your taxable situation is going to be. If you're in the 35.5% tax bracket, it doesn't make sense to buy taxable investments.

Tax-free municipal bonds have been good tax shelters for high-wage earners for a long time. But there are other ways to get a higher return without forking over a lot to the government.

Because you can postpone taxes almost indefinitely, growth stocks are a savvy tax-efficient investment. When you sell, you pay taxes on the appreciation of the stock at capital gains rates. These stocks often don't pay dividends, which are taxed at higher ordinary income rates.

You can get almost as much tax efficiency from some mutual funds, plus diversification and professional management. Consider ones that have low taxable distributions and hold a large proportion of stocks that don't pay dividends. They also keep the stocks they buy for the long haul so capital gains from turnovers are low. When they need to sell some stock, gains usually are offset by losses on the sale of other shares. Index funds historically have had a small tax liability because they have a low turnover in stocks.

Savings: A good chunk of the return on your investment, depending on your income tax bracket. High turnover of stocks can cut into mutual fund after-tax returns by 40% or more.

9. Consult your tax adviser about stock options.

In recent years, many middle-class employees benefited from company stock options. If you were one of the lucky ones, you also have some important tax issues. It may be time to ask for some professional advice even if you never needed any before.

When you exercise nonqualified stock options -- the most common kind, the company often withholds money for taxes at a flat rate. But you can easily owe more if your tax bracket moves up as a result of your new wealth. Your adviser can help you figure out whether you need to make quarterly estimated tax payments so you won't owe penalties and interest when tax-filing season rolls around.

You also will want to know whether your incentive stock options will make you vulnerable to the alternative minimum tax. To avoid it, you may need to turn traditional tax planning on its head by deferring deductions into next year. You also may be able to spread out the sale of your options, which also spreads out your tax liability. Of course, this may be a good tax decision, but that doesn't mean it's a good financial decision. So -- run the numbers to make sure you take the path that leaves you the most money.

Savings: Easily thousands of dollars, depending on the number of options, the stock price, and your income tax bracket.

10. Put domestic employees on the payroll.

In the early 1990s Zoe Baird backed out on a presidential nomination to be attorney general because she had neglected to pay taxes for a nanny. After that, many -- but not all -- taxpayers came clean and put their nannies and housekeepers on the payroll. If you haven't yet, don't delay. Otherwise, you could be liable for penalties and back taxes.

If you pay a household employee than $1,300 a year, then you're obligated to pay employment taxes. How do you know that your housekeeper or gardener is an employee? The IRS tests can get confusing. But basically if you control the work, then they are employees. Someone who provides his own tools and offers his services to the general public might not be an employee.

Of course, reporting your employee's income means that he or she must have a social security number. So employing illegal aliens is out.

The paperwork is less burdensome than it used to be. Now you need to report your employee's income to the federal government only once a year. Some states still require quarterly reports, however. You also need to apply for an Employee Identification Number from the IRS.

In the short run, paying taxes for your employees will cost you some money. But you could save yourself a big headache in the future.

Savings: Back taxes and penalties. Plus you might get that government appointment you always wanted.