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Plan NOW for your 2007 tax return!

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Head’s up folks – your 2007 Federal Income Tax return is due April 15, 2007, a little more than 9 months from now! Get ready now!

So how many of you think I’m nuts to tell you to start preparing now for your 2007 return? It may seem nuts to think about taxes now considering a child conceived today would be here before your return is due, but the advantage in thinking about taxes now is that you have time to do something about it.

Your biggest decision is going to be around whether to itemize deductions. If you incur deductible expenses but end up just taking the standard deduction, you get no tax benefit from those deductible expenses. What is the standard deduction going to be? For tax year 2007, the standard deduction will $5,350 for singles or married filing separately and $10,700 for married filing jointly or widow(er) with dependent child. Limits vary for seniors and the blind, as well as those filing as head of household.

Think about what deductions you’re likely to have at year-end. Charitable donations, mortgage interest, and state and local income and property taxes should be the biggest items on this list. Also included are uninsured casualty and theft losses, medical expenses, and unreimbursed job expenses, although these can be severely limited based on income, so be careful when adding these to your calculations.

If these amounts for you are minimal, great! Just take the standard deduction and be done with it. It is about as easy as you can get with taxes.

If these amounts well exceed the standard deduction for your filing status, just add everything up for your itemized deduction. A little more difficult, but a pretty easy decision.

Where it gets tricky is when you are relatively close to that standard deduction amount. You don’t get much advantage if any from itemizing deductions. However, if you can time your deductions to occur in one year or the other, you get the best of both worlds by itemizing in one year and taking the standard deduction in the next. It is a technique known as “bunching” of deductions, and it can save you a bundle on taxes.

Here’s an example to illustrate the point (using 2006 deduction amounts). Say you are married filing jointly and have a 25% marginal tax rate. You plan to give $2500 per year to charitable organizations, have to pay property taxes of $3500 each year (bill mailed in November due in January), and pay about $4000 per year in mortgage interest on your home.

Without trying to time the deductions, you have $10,000 of deductions each year. Your standard deduction is $10,300, so you don’t itemize on your taxes. At a 25% marginal rate, the benefit to you each year is $2,575, or $5,150 over two years.

Now let’s try timing the deductions. You know you’re going to give $2,500 for each year, so you go ahead and give $5,000 this year and don’t plan for any additional giving next year. You also go ahead and pay your property tax that is due next January before December 31, so you have the $3,500 you paid in January and the $3,500 you paid later in the year for a total of $7,000 in property tax paid. You can’t really time mortgage interest, so you still have the $4,000 in interest paid this year and another $4,000 paid next year.

In year one you have a total of $16,000 in deductible expenses ($5000 charitable, $7000 property tax, $4000 mortgage interest). As this is more than your standard deduction you itemize, yielding a tax benefit of $4,000. In year two you only have the $4000 in mortgage interest, so you take the standard deduction of $10,300, yielding a tax benefit of $2,575. Total tax benefit over the two years is $6,575, or $1,425 more than if you didn’t bunch the deductions.

As always you should do your homework and consult an adviser if necessary to make sure it will work for you, but unless you get ensnared by the Alternative Minimum Tax or some other landmine in the tax code, this is an effective way to minimize the amount that Uncle Sam steals from you each year.

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July 31, 2007 - Posted by | Taxes, Tips

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