Forget those year-end alerts about tax planning-the time to start is when you are filing your tax return for last year.
Your individual income tax return (Form 1040) is a great place to map out some tax savings ideas. One of the most critical pieces of information is your marginal tax bracket. No, that number is not on your tax return-you'll need to look it up in the tax tables based on your taxable income, or ask your CPA. That marginal rate is what you'll pay on your next dollar of taxable income or save on that next dollar of deductions.
That marginal tax rate will help you decide whether or not tax-free municipal bonds are right for you. Remember, it's the amount of interest after taxes that matters. It will also tell you how much you'll save from that IRA or 401(k) contribution.
If you're working, you need to fund that 401(k) or other company retirement plan during the year. If you're self-employed and want to start a 401(k) you'll need to establish it early in the year as only earnings earned after the plan adoption can be used to fund the plan. If you have a SEP or other plan, consider funding it during the year to smooth out your personal cash flow.
Do you have a high deductible health insurance plan with a Health Savings Account attached? If so, be sure to fund the HSA early in case some medical expenses occur early in the year. Also, make sure you use the HSA as unreimbursed medical expenses are generally only deductible if you itemize and they exceed 10% of your income. Look at Schedule A of Form 1040 to see if you claimed medical expenses.
Are you going to convert an IRA to a Roth IRA? If so, do it early and give yourself time to re-characterize later in the year if necessary. Your marginal tax rate is critical when making that decision.
Do you have unused passive losses from real estate and the like? Finding passive income isn't easy, but be aware of using the losses against sales of other passive investments (not including stocks and bonds).
Don't itemize your deductions? If so, think about doubling up on real estate tax payments in one calendar year, or funding that charitable pledge you made. Then you may get the tax breaks from those deductions you might otherwise forego.
Getting an early start on tax planning can pay off. If you have to file an extension, get a draft of your tax return so you can use that estimate to plan with.