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Making April a tad less taxing
Myrtle Beach Sun News
10/22/2005
If you work for a company that offers flexible spending accounts for dependent care and health care, watch the mail for a pack of forms. These tax-cutting deals are too good to miss. At most companies, fall is sign-up time for the coming year.
Flexible spending accounts allow employees to set aside up to $5,000 a year for care of dependent children and adults. For flexible spending accounts with health care, there's no federal limit on contributions, but employers can set ceilings.
Your contribution is automatically deducted from your pay each week and put in a special account used to reimburse you for qualified expenses.
Most important: The contribution is subtracted from your taxable income, reducing your federal income tax. A $5,000 contribution could reduce that tax by $1,250, assuming a 25 percent tax bracket.
The accounts do have a drawback: the use-it-or-lose-it rule. Any money not used for an approved expense within the permitted period is forfeited to the plan.
The forfeiture rule became somewhat more flexible this year, with a provision allowing employers, at their option, to grant a grace period for eligible expenses. Thus, if you do not spend everything in the account by Dec. 31, you can get reimbursed for expenses incurred as late as March 15 of the following year.
As with all things related to taxes, the rules on flexible spending accounts are complicated, especially when it comes to identifying eligible expenses. Your benefits or human resources folks can give you the details.
Furthermore, year-end tax planning can be confusing, and it's not the sexiest subject. But people who do it well are awfully pleased with themselves the following April, when they find how much they've trimmed their tax bills.
One of the trickiest areas is using investment losses to reduce the taxes on investment gains, especially when it comes to a blend of short- and long-term investments sold during the year.
Short-term capital gains are those on investments sold after being owned for 12 months or less. They are taxed as income, at rates as high as 35 percent.
Long-term capital gains are for investments sold after being owned longer than 12 months. They are taxed at rates from 5 percent to 15 percent, depending on your income.
Year-end tax maneuvers involve selling losers so that taxes on winners can be reduced.
But what if you have a combination of short- and long-term winners and losers? Here's how it works, according to tax-information firm RIA:
Tally short-term gains and losses to get a net short-term gain or loss. Do the same with long-term gains and losses.
If you have a net short-term gain and a net long-term gain, the first is taxed at income tax rates and the second at long-term capital gains rates.
If there's a net short-term loss and a net long-term gain that's larger, the loss is subtracted from the gain and the remainder is taxed as a long-term gain.
If there's a net short-term gain that's larger than the net long-term loss, the loss is subtracted from the gain and the remainder is taxed at income tax rates.
This last combination is the most interesting. In effect, it converts a long-term loss that otherwise would have a fairly small tax benefit into a short-term loss with a much larger one.
The rule of thumb on taxes: Take deductions as soon as possible and postpone tax bills as long as possible.
So it's usually best to beat Jan. 1 with deductions such as contributions to charity or big elective medical expenses.
You don't, incidentally, actually have to pay for these by the end of the year. You could use a credit card to contribute to charity but not pay the bill until 2006, for example.
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