News Column

Four Ways to Lower Your Taxes

March 2007, HISPANIC BUSINESS Magazine

Rick Munarriz

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No, it's not too late.

Even if you find yourself digging through stacks of junk mail and takeout menus to unearth scrunched up receipts and charitable donation slips that you just swore you didn't throw away, there is still time to save on your 2006 tax returns.

More importantly, there is always enough time to commit to a tax-friendly investing lifestyle that will help you recover from tax bites come 2007 and beyond.

You won't be able to avoid taxes entirely. That's OK. If you're blessed with the skills to make money, your inner optimist should be grateful to kick back some greenery to keep the machine going. Even if you don't fundamentally agree with that last point, accept that our country's tax code offers opportunities to shave or defer your tax burden. We're not talking about iffy tax shelters or incorporating overseas. As an investor, you have several simply ways to slim down your tax tabs.

Let's take a closer look at four sensible solutions.

BE OK WITH YOUR 401(K)

If your employer offers a 401(k), there are two good reasons to participate. The first is that these are tax-deferred dollars that you will be contributing to your own retirement fund. In 2007, you can set aside as much as $15,500 to go into your company's 401(k) plan, and that is money that won't go toward your adjustable gross income on your 1040 form come April. If you're at least 50 years old, you can set aside as much as $20,500 this year.

The second reason to give 401(k) plans their due is that some companies will match employee contributions. If it's a corporate perk, that is money that you are leaving on the table. Don't deny yourself the opportunity to retire wealthier with your boss footing the bill. There is a streak of irony in that. Relish it.

Don't have a 401(k) plan at work? That's OK. Similar plans exist for other occupations like 403(b) for teachers or 457 plans for local government workers. If you're your own boss, look into available options like Keogh or SEP (simplified employee pension) IRA plans that are available to you, even if your only employee is the one staring back at you in the morning mirror.

Unfortunately, it is too late to make a contribution to your 401(k) to trim away at the fat of your 2006 return. That deadline came and went back in December. Don't worry, though. You may still have personal IRAs at your disposal.

LET'S PLAY WITH YOUR IRA

Individual retirement accounts, or IRAs, come mostly in two flavors: Traditional and Roth. They both work essentially the same, with your contributions (as much as $4,000 a year, or $5,000 a year if you've blown out 50 birthday candles) working for you without annual taxable implications.

The difference between the two IRAs comes down to when you want your tax break. Traditional IRAs allow investors to deduct their contributions right away. This year you have until April 17 (April 15 falls on a Sunday) to make a contribution that may potentially lower your 2006 tax bill. Potentially? Yes, only those making less than $50,000 a year (or with a household income of less than $75,000 if you are married and filing jointly) will be able to write off the entire amount of their contributions. Also keep in mind that traditional IRAs won't keep Uncle Sam away forever. These are tax-deferred investments. In other words, you will eventually be taxed as you begin your withdrawals.

Roth IRAs offer a different twist to the more conventional IRA. You don't get a tax break at the beginning, yet withdrawals are tax free at the end. For example, if you have $10,000 in a Roth IRA that appreciates at an annualized clip of 10 percent, you will be able to cash out at $74,000 in 20 years without incurring taxes on the capital gains.

Before you start nodding off, let me point out that IRAs are not boring. While you are welcome to start an IRA through any mutual fund or fund family of choice, you can also take a more hands-on approach and establish self-directed IRAs at a broker. That way you can trade in and out of stocks as you would in a taxable portfolio, generally without any tax time implications.

I've been doing it that way for years, through my discount brokerage account. It certainly makes April a little less taxing to know that my Schedule D isn't a laundry list of every stock or mutual fund that I sold during the previous year.

EAT RIGHT WITH TAX-FREE BONDS

It's easy for income investors to be skeptical of "tax-free" investing. Aren't you suspicious when you take that first bite into a "fat-free" or "sugar-free" snack? Will it pack the same kind of flavorful punch as its more decadent replacement?

There is no free lunch. Tax-free municipal bonds or mutual funds that invest in them provide lower yields than their taxable counterparts. The key to making it work is to realize what your effective yield would be. That depends solely on your tax bracket. The higher your bracket, the greater the potential tax-free savings.

If you can be earning 4.25 percent on a tax-free investment, that is the taxable equivalent of 5.67 percent if you are in the 25 percent tax bracket or 6.54 percent in the 35 percent bracket. So if your alternative is a 6 percent taxable yield with the same level of risk, you would be better off with the tax-free option only if you are taxed at the higher brackets.

WINNING BY LOSING

Your cousin really blew it when he recommended that "can't miss" penny stock. A mint julep drive-thru chain? What were you thinking? Thankfully, there can still be victory in the failure of Just Julep Jalopy Incorporated. Selling investments at a loss can offset capital gains elsewhere in your taxable portfolio. You are not allowed to deduct more than $3,000 in net losses in any given year, but you can carry over any excess losses toward future years.

It's too late to sell your losers to benefit your 2006 returns. At this point you are down to reminding yourself to do a little portfolio maintenance come December. Prune effectively and your 2007 tax return may come in a little heavier than you thought.

So no, it's not too late to start investing smarter. Do your Uncle Sam proud.

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Rick Munarriz is a freelance financial writer living in Miami, Florida. He has written more than 5,000 articles for sites like The Motley Fool, Citysearch, and Nickelodeon, and now is a regular on HispanicBusiness.com. He has also appeared on CNN en Espaņol and NPR. E-mail him at Aristotle@gmail.com.



Source: HISPANIC BUSINESS Magazine and Hispanicbusiness.com, Copyright (c) 2007 All Rights Reserved.


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