November 12, 2010

By: Rande Spiegelman
CPA, CFP®, Vice President of Financial Planning, Schwab Center for Financial Research

Key points

• Consider these tried-and-true strategies to make tax time a little easier this year.
• Here, we provide tax tips for key areas of your financial life: portfolio planning, retirement, education planning, charitable giving and more.
• Useful strategies for all tax payers.

If you find yourself stressed come tax time, read on. First, take heart that there are actions you can take before the end of the year to minimize the pain of April 15. Then, consider the tax tips below affecting key areas of your financial life—from your portfolio to your retirement and education planning to gifting and more.

Whether you do your own taxes or rely on a tax professional, these tried-and-true strategies may help you keep more of your hard-earned income and boost your after-tax returns. After all, it's what you keep that counts!

Get started: six simple steps
Dust off last year's return. Using it as a starting point, begin this year's process by updating some of the key inputs: your salary and other income, deductions, and the dependents you'll claim. If you use tax preparation software, it's easy to run a quick estimate of where you stand. Alternatively, you can ask your accountant for an early read. If the initial estimate seems high, don't panic. Get going by taking these six simple steps.

• Double-check your withholding. You want to pay the IRS its due but not a penny more. So make sure you're not having too much (or too little) taken out of each paycheck. The same holds if you make quarterly estimated tax payments.
• Consolidate debt. Consider replacing credit card debt with a lower-rate, tax-deductible home equity loan or line of credit (HELOC).
• Account for refinancings. If you lowered your mortgage interest rate in the past year, you may now have a lower-interest deduction. Also, if you used any of the proceeds for something other than physical improvements to your home, that amount may be subject to the alternative minimum tax (AMT). On the brighter side, remember that points paid in prior refinancings that you didn't already deduct can be deducted in the year you refinanced again.
• Prepay quarterly estimated state tax payments. If you're not vulnerable to the AMT, consider paying your fourth-quarter 2010 estimated state income taxes (plus any estimated balance due) by December 31 so you can take the deduction on your 2010 taxes.
• Prepay property taxes. Many counties bill taxpayers twice, in November and February. If you pay your February installment by December 31, you can take it as a deduction on your 2010 return. Again, watch out for the AMT, which disallows these deductions.
• Avoid the AMT if you can. More taxpayers are facing the AMT, particularly two-earner homeowners who have children and live in high-tax states. If you're one of these taxpayers, you might want to flip the typical strategy of deferring income and accelerating certain deductions. Instead, try to defer payment of state and local taxes and accelerate income to the point where you're no longer subject to the AMT. Multiyear planning is a must—talk to a tax professional

Portfolio planning: three tax-smart rebalancing strategies
Year-end is a great time to give your portfolio a checkup. Consider these tax-smart strategies to help boost your after-tax returns.

• Harvest losses. No one likes a losing investment. But at tax time, they can be blessings in disguise, as you can use capital losses to offset taxable capital gains, plus up to $3,000 in ordinary income ($1,500 for married couples filing separately). Look in your taxable accounts for investments with relatively large losses where you don't expect a comeback. Remember, any losses you can't use to offset gains this year can be carried over into future tax years. One word of caution: Watch out for the so-called wash sale rule, which prohibits taxpayers from recognizing losses on sales of securities that are repurchased within 30 days.
• Make the most of tax-advantaged accounts. You might be able to further bring your asset allocation back in line without incurring taxes by rebalancing in tax-deferred retirement accounts like IRAs or 401(k)s.
• Consider cash flow. If you're living off your portfolio in retirement, remember to set aside any cash you might need for the next 12 months as you rebalance. For example, if your portfolio is overweight to stocks, you could take out what you need to live on from that overweight portion and then reinvest the rest in bonds until you're back on target.

Retirement: four tax-savvy planning ideas

• Take full advantage of your employee retirement plan, at least to the point of any employer match. And if you're 50 or older, make a catch-up contribution (see table). If you expect to be in a higher tax bracket down the road (for example, younger workers who have yet to reach peak earning years) and your employer offers the new Roth 401(k), consider it. You won't get any up-front tax reduction. But after you retire, qualified distributions will be tax-free.

2010 federal limits for retirement accounts
Account	Contribution limit	Catch-up contribution
401(k), 403(b) and 457	$16,500	$5,500
SIMPLE IRA	$11,500	$2,500
Qualified Retirement Plans/Keogh and SEP-IRA	20% of net self-employment income (or 25% of compensation), up to $49,000	None
Individual 401(k)	20% of net self-employment income (or 25% of compensation) plus $16,500, up to $49,000	$5,500
Traditional IRA and Roth IRA	$5,000	$1,000

• If you're self-employed, consider a small business retirement account such as a SEP-IRA, SIMPLE IRA, Individual 401(k) or other qualified retirement plan (see table above and Read more at right). Contributions are tax-deductible and grow tax-deferred. If you open a qualified retirement account by December 31, you have until the day you file next year, including extensions, to make this year's contribution.
• Be sure to make your annual IRA contribution (see table). Even though you have until next April 15 to make your 2010 contribution, the sooner the better—your money will have more time to benefit from potential long-term compound growth. Then, make your 2010 contribution early next year. Consider a Roth IRA if you're eligible, especially if you're not eligible for a deductible traditional IRA contribution.
• If you're age 70½ or older and required to take minimum distributions from your retirement accounts, you need to do so before year-end (if you just turned 70½ this year, you have until April 1, 2011, to take your first required minimum distribution).

Education: two tax-preferred savings plans

• Coverdell Education Savings Accounts. If you're eligible, you can contribute up to $2,000 to a Coverdell account on behalf of a child (the contribution limit will reduce to $500 in 2011 unless Congress extends the law). Contributions grow tax-free and qualified K-12 and higher-education-related withdrawals are tax-free. You have until next April 15 to contribute for income-tax purposes, but if you make the contribution by December 31, it will count as a gift for this year instead of next year for gift-tax purposes.
• State-sponsored 529 plans. Anyone, regardless of income, can contribute up to $65,000 ($130,000 for a married couple) this year, without incurring gift taxes, if you make an election to have the gift treated as though it were made over five years. You don't have to invest in your own state's plan. But if your state offers an income tax deduction on in-state 529 plan contributions, then that's another reason to make your contribution by December 31. Still, it's a good idea to compare state plans—especially if you live in a state with no deduction, such as California.

Giving: five tax-smart tips

• Act before year-end. For 2010, you can give up to $13,000 each to as many individuals as you wish this year and pay no gift tax. Spouses can "split" gifts for a total of $26,000 per beneficiary, per year. Gifts beyond that are taxable, but only to the extent they exceed $1 million over a donor's life. The lucky recipient of the gift owes no gift or income tax, and doesn't even have to report the gift unless it comes from outside the United States.
• Pay someone's education or medical bills. You can also make unlimited payments directly to medical providers or educational institutions on behalf of others without incurring a taxable gift or dipping into your $1 million lifetime gift tax exemption.
• Shift income to tax-advantaged children. Consider gifting appreciated securities and stocks whose dividends are taxed at low long-term capital gains rates to children, at least to the extent that the "kiddie tax" will not apply. Up to a limit, even younger kids will pay tax at their own rate—likely 0% (through 2010, expiring in 2011 unless Congress extends lower capital gain tax rates). Kids over the age of 18 (or 24 if a full-time student relying on you for more than half of their support) aren’t subject to the kiddie tax at all.¹
• Give appreciated securities to charities by year-end. Consider donating appreciated securities that you've held for more than a year for a full fair-market-value deduction and no capital gains tax. If you give to a donor-advised fund (such as Schwab Charitable Fund™) by December 31, you get the tax break this year and can take your time deciding how best to distribute your gift.
  
  
  Consider donating appreciated securities
  
  Let's say you'd like to donate $10,000 this year. If you have appreciated stock (or bonds or mutual funds) that you've held for many years, consider donating that instead of cash.
  
  Why? If you sell your appreciated stock first and then give the cash, you'll pay the 15% capital gains tax on the gain (state taxes may also apply). But if you donate the stock to a charity, there's no capital gains tax. The charity gets the full $10,000, and you get to claim a $10,000 tax deduction. In this example, if the long-term gain would have been $5,000, you would save $750 versus selling first and then donating cash.
  
  On the other hand, if you're holding securities at a loss, sell them first and then donate the cash. That way, you can claim the capital loss on your tax return.

All of the above?
Whether some or all of these suggestions fit your situation, we're only scratching the surface here. Get advice from a qualified planner if you need it.

After you decide what to do this year, resolve to make financial planning a year-round exercise going forward (you've probably got better things to do around the holidays). That way, it'll be easier to check your progress, update your plan and, if necessary, take action long before the ball falls in Times Square on New Year's Eve.

1. The so-called kiddie tax applies to children under 19. In addition, full-time college students under the age of 24 will also be taxed at their parents' rate on unearned income in excess of $1,900 unless the students' earned income is greater than one-half of their support.

Important Disclosures
As with any investment, it's possible to lose money by investing in a 529 plan. Additionally, by investing in a 529 plan outside of your state, you may lose tax benefits offered by your own state's plan.

This report is for informational purposes only and is not an offer, solicitation or recommendation that any particular investor should purchase or sell any particular security. Schwab does not assess the suitability or the potential value of any particular investment. All expressions of opinion are subject to change without notice.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

All charts and research have been compiled from publicly available, proprietary and/or licensed data believed to be reliable, but its accuracy or completeness is not guaranteed.

Past results are not indicative of future performance.

Diversification and asset allocation do not eliminate the risk of investment losses.

This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner or investment manager.

The Schwab Fund for Charitable Giving has entered into service agreements with certain affiliates of The Charles Schwab Corporation (Charles Schwab & Co., Inc. and Charles Schwab Investment Management, Inc.). It is an independent nonprofit organization.