Tax Planning in a Recession

Americans are saving more money. The budget deficit will eventually give way to spending cuts or higher taxes; ergo, we need to prepare for a higher tax environment. Below are twelve ways to save money on taxes during a recession:

1. Tax Loss Harvesting – Unfortunately, because of the market decline, we had a lot of losses last year. Fortunately, we captured those losses so that you could use them to offset ordinary income up to $3,000.
2. Pay off Debt – You do not have to pay tax on your savings if you use it to pay down debt. If you save it in CDs or mutual funds you pay tax on gains and interest.
3. Low Turnover - Invest in funds with low turnover and dividends. Exchange traded index funds have extremely low turnover, meaning that they don’t buy and sell within the fund creating capital gains and dividends. Dividend investing may loose its moxy if we see tax rates increase.
4. Take Advantage of Tax Deferral – Use the tax deferral feature of retirement accounts to defer interest on your fixed income or bond investments. By allocating the bond portion of your overall investment plan to your IRAs and 401ks, you defer that interest until retirement.
5. Save in Retirement Accounts – By adding money to your retirement accounts, be it IRA or 401k accounts, you defer income tax on that money until retirement.
6. Use Municipal Money Markets – Sometimes you can’t avoid having some money market positions in a taxable account. If you have large amounts of money in a money market position, like for an emergency fund, put that in a municipal money market to avoid paying state and/or federal income tax on the interest.
7. Take Advantage of Tax Credits – If you are planning on putting savings to good use, add them to your home. Tax credits are available at 30% of the cost up to $1,500 in 2009 and 2010 for existing homes.
8. Review Legal Structure of Your Business – With business evaluations down, this could be a good time to convert to a C-Corp to an S-Corp with low built in gain tax impact. You could also maximize the impact of loss generating businesses. Sole proprietors may wish to change structure for asset protection.
9. Itemize Deductions Every Other Year – For those of you close to the increasing standard deduction, or who don’t have enough to itemize your deductions every year for one reason or another, you can try to double up some payments in some years. For example, pay your winter property taxes a little late (Jan), and make double charity donations in the same year (Jan and Dec) to increase your itemized deductions every other year.
10. Convert IRAs to Roth IRAs – This could lower your overall income tax burden during distribution and reduce your estate tax.
11. Gift at Lower Values – Right now we can transfer funds to our heirs at lower values than we could have in 2007. If these values increase, they increase at your heir’s tax rates, not yours.
12. Have Kids! – This $1,000 credit may not be feasible for all of you, but I thought I’d bring it up because, with a little luck, my wife and I will qualify for this credit before year end. Our next child is due December 26th.