Tax Planning – The Top 10 Mistakes

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Yesterday I saw a Christmas tree in a local department store. It’s way too early to think about Christmas but not to early to do some 2007 tax planning. Ask yourself, are you making one or more of these tax planning mistakes? If so, you’ve got some time to correct the situation, but act now, or we’ll be having this conversation again next year.

1. Not planning your tax strategy

The biggest and most costly tax planning mistake is the failure to understand and plan to maximize your tax situation. Proper tax planning can save you valuable dollars this year and for many years to come. Well thought out tax strategies, with a little planning help, can save you from overpaying your taxes. Once it’s January 1st your tax planning opportunities for this year are over. So the number one tax planning mistake is the failure to do any tax planning. Don’t let it happen to you.

2. Not maximizing your 401(k) or 403 (b) retirement plans

Are you leaving money on the table with your 401(k) or 403(b) retirement plans? Do you know how much the employer contributes to your plan based on your contributions?

For example, if your employer puts in 50% for everything you contribute up to 5% of your pay and you are only contributing 3%, at $40,000 a year you are leaving $400 on the table ($40,000 x 5% contribution=$2000 x 50%=$1000 company match at 5% vs $600 at 3% or a $400 difference.)

A quick tip: Where do you get the $800 or about $15 a week, in the above example, to raise your contribution from 3% to 5%? Have you thought about the tax savings with the new before tax contribution? You can now adjust your W-4 form to properly reflect your lower taxable income. If done properly your take home pay will stay almost the same and you will have annually invested and additional $1200 ($800 from you and $400 from your employer).

If your spouse is working or self-employed don’t forget to apply the same approach to their income.

3. Excessive worry about IRS audits

Many taxpayers do not take absolutely legitimate deductions because they were afraid of showing up in an IRS audit. As long as you play by the rules, you shouldn’t fear an IRA audit. When in doubt get help from a professional, keep good records and receipts, and if you are scheduled for an audit you should get good results. Planning so you can get your affairs in order so you pay the least amount of tax required by law is completely legal.

4. Self employed paying too much SE tax

If you are self employed there are many ways to organize your business. Do you really know if you are paying too much self-employment tax? If your business is organized as a sole proprietorship or a partnership you may find the answer is yes. It could pay to investigate you options on how you should set up or reorganize your business.

5. Not Using all the Retirement Plans Available

With the continued concern about the long term viability of the Social Security system it is more important now to set up your retirement planning to assure a secure retirement. If your entire knowledge of retirement plans is your 401(k) or 403(b) and simple IRA’s you may have some additional investigating to do.

What is available goes well beyond these well-known favorites. Changes in tax laws in recent years have created additional opportunities. To find the best plans in your situation get help before the end of the year.

6. Not considering a Roth IRA in your tax planning

In continuation of #5, let’s take a quick look at the Roth IRA. A Roth IRA is an after-tax retirement device that produces huge tax savings because all tax distributions are tax-free. The initial disadvantage of a Roth IRA is the fact that contributions are not tax deductible as with traditional IRAs or 401(k)s. The advantage of a Roth IRA, however, is that all distributions are tax-free once you reach the age of 59½. If appropriate, a Roth IRA should be included in your overall planning.

7. Not Employing Family in Your Business

Employing a family member in your business is an opportunity to move income from your higher tax bracket to perhaps a zero, or much lower tax bracket. If it makes sense to employ one of your children in your business there can be big tax savings.

8. Medical Expenses: Missed Opportunities

Medical expenses, if possible, should not be paid with after tax dollars. A Section 105 medical reimbursement plan should be considered if you are self-employed. If your employer has a medical expense reimbursement plan that allows you to pay for medical expenses with pre-tax dollars take advantage of the plan. Normally individual taxpayers will never reach the high threshold for deducting medical expenses on their tax returns. If your medical expenses are paid with pre-tax dollars, your money will go a lot farther. If possible you should plan to take advantage of this benefit before year end.

9. Not using a Tax Professional

Taxes and tax planning for maximum benefit can be complicated. You have questions. Ask your friends and co-workers who is the best tax professional in your area. If the same name comes up several times consider using them to help you get started moving in the right direction.

In order to get the most out of their advice pull your personal information together and search the internet and the IRS publications and highlight your questions. This will assure you make the best use of the professionals time. And they are usually not busy at this time of the year. The few hundred dollars you invest in their advice could save you much more in tax savings and keep you from making a costly mistake. Don’t overlook the value of securing professional assistance in your tax planning.

10. Not actively managing your Investing in 401(k), 403(b) and IRA’s

Not strictly a tax planning mistake, but as you more actively manage your tax planning, this area warrants a closer look. Depending upon your time frame, a recent study concluded that a large number of retirement plan participants are too conservative in their investment choices. Periodically study your investment choices and keep them up to date. Remember to carefully consider your time frame before you will need the funds. Keep active and study your investment choices year round not just once or twice a year. As you knowledge grows your choices should be more closely aligned to your long term objectives.

If any of the 10 mistakes apply to you, make an early resolution to do something about them. Don’t wait, start your tax planning now. Write out your tax plan. Get advice as appropriate. You may be amazed at the amounts of taxes you’ll save or the new money you’ll have to invest for your future. Remember, the improvement in your tax and retirement situation will carry over into next year and the years beyond. Now is the time to Plan for a brighter future.

This article is intended for general interest and should not be construed as specific legal or tax advice. You should always consult a tax professional to get more information before you take any action.

Andy Andersohn is a small business owner and long time tax preparer. Learn more valuable tax planning resources for business owners and individuals. Get your FREE 11 page Tax Saving Guide. Find up to date tax articles. At our tax tips blog discover more tax help and good ideas.

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