Action Now = Tax Savings in April
Military.com and TurboTax
8. Avoid the Kiddie Tax
The “kiddie tax” rules are a lot tougher this year. These rules were created by Congress to prevent families from shifting the tax bill on investment income from Mom and Dad’s high tax bracket to junior’s low bracket. The kiddie tax taxes a youngster’s investment income above $1,800 at the parents’ rate. For 2008, the tax applies until the year a child turns 19. If the child is a full-time student who earns less than half of his or her support, the tax applies until the year the child turns 24. So be careful if you plan to give a child stock to sell to pay college expenses. If the gain is too large and the child’s unearned income exceeds $1,800, you’ll end up paying tax at 15 percent on the gain, rather than the zero percent rate that is applicable for most children.
9. Check IRA Distributions
If you have reached age 70 1/2, remember that the law demands that payouts be made from traditional IRAs after the owner reaches that age. (If your parents turned 70 ½ this year, make sure they know this rule.) Failing to take out enough triggers one of the most draconian of all IRS penalties: The government will relieve you of 50 percent of the amount that should have come out of the account but did not. How much you need to withdraw is based on your age, your life expectancy and the amount in the account at the beginning of the year.
In the year you reach 70 1/2 — that is, the year of your 70th birthday if you were born before July 1, or the year you turn 71 if your birthday is after June 30 — you have until the following April 1 to take your first mandatory IRA distribution. After that, annual withdrawals must be made by December 31 to avoid the penalty. If you make a withdrawal at year end, consider asking your IRA sponsor to withhold tax from the payment. Withholding is voluntary, and you set the amount, but opting for withholding could let you avoid the hassle of making quarterly estimated tax payments. Note this: One of the advantages of Roth IRAs is that the original owner is never required to withdraw money from the accounts. The required minimum distributions apply to traditional IRAs.
10. Watch Your Flexible Spending Accounts
Flexible spending accounts, also called flex plans, are fringe benefits offered by many companies that let employees steer part of their pay into a special account which they can then tap to pay child-care or medical bills. The advantage is that money that goes into the account avoids both income and Social Security taxes. By avoiding a 25% federal income tax bracket plus the 7.65% Social Security tax, $1,000 funneled through a flex plan can pay bills it would take $1,554 of salary to pay. The catch is the notorious “use it or lose it” rule. You have to decide at the beginning of the year how much to contribute to the plan and, if you don’t use it all by the end of the year, you forfeit the excess.
That rule used to create a stampede to drug stores, dentists and optometrists each December as employees with money to spend rushed to use it before they forfeited it. Now, however, the IRS allows companies to build in a two and one half month grace period. That allows employees to spend 2008 set-aside money, for example, as late as March 16, 2009 (March 15 falls on a Sunday in 2009). But you get this break only if your company has adopted the grace period. Make sure you understand your firm’s rules and, if you’ve got leftover money that has to be spent by December 31, get crackin’.
Another important year-end point about flex plans. If this is open season at your company — when you must decide how much to set aside for 2009 — be aggressive. This is a very powerful tax-saver… so powerful, in fact, that you can actually forfeit 25% or more of the money and still come out ahead. You don’t want to forfeit a dime, of course, so don’t go overboard. But don’t cheat yourself by being unduly afraid of the use-it-or-lose-it rule. After all, you can always make that trip to the drug store, dentist or optometrist.
Updated for tax year 2008. Content provided by Kiplinger, courtesy of TurboTax, a registered trademark of Intuit Inc