Young Singles Can Beat the Tax Man, Too
[Ed. note: required ID: , POV magazine, "the guy's survival guide"]Think you pay too much in taxes? Who doesn't? Fear not. Here are ten strategies that are the next best thing to an accountant. By Rebecca LewinUncle Sam may sound like a friendly name, but if you're a young, single person, you're not his favorite relative. When it comes to taxes, the tax laws are stacked against you, in favor of older, more established folks. You probably don't own your own home, so you don't get a mortgage credit. And single people generally have fewer deductions.So basically to play it smart, you've got two choices. Hire an accountant, who should know all the tricks to minimize the government's take. Or buy a green eyeshade and utilize our handy-dandy guide through this singularly unpleasant chore.1. Establish A Retirement PlanThis one is an easy -- and obvious -- one. The more money you can defer from taxes, the more money you'll have compounding. If you're offered a 401(k) plan at work, take maximum advantage of it-always. This allows you to sock away money before it's taxed, which puts you somewhere around 30 percent ahead from the get-go. Many companies also make matching contributions. If you don't have a 401(k), establish an IRA and make the maximum allowable contributions -- usually $2,000. This gives you many of the same benefits. If you're self-employed, start an SEP-IRA or a KEOGH, which again defer taxes until the money is withdrawn.2. Contribute Early In The YearThe sooner you start accumulating tax-deferred earnings, the better. So if you maintain an IRA or other retirement plan, contribute as early in the year as you possibly can. "If you contribute $2,000 on January 1 each year instead of waiting until April 15 of next year, over 30 years, earning an average rate of 10 percent annually, you'll accumulate an additional $3,500 per year on that one contribution alone," says Ted Tesser, a New York-based accountant with Waterside Financial Services and author of The Trader's Tax Survival Guide.And yes, you did read that quote right. You can still make an IRA contribution for 1996 even though it's 1997, as long as you do it before April 15. So if you aren't deferring taxes yet, you can get started today by knocking off 1996 and 1997 in one fell swoop.3. Defer Income With T-Bills And T-BondsAnother way to defer income is to buy Treasury bills that don't mature until next year. You won't be taxed on the interest this year, as you would if the cash was in a savings account. Interest on T-bills isn't taxed on the federal return until maturity, and they're tax-free on most state tax returns. Avoid Treasury notes, which pay taxable interest twice a year. With Treasury bonds, the purchaser is not required to declare interest until the bond matures. If the proceeds are ultimately used for college tuition, interest may not be taxable at all.4. Defer Income With Put OptionsThink a stock you own is ready to top out? Say you bought 100 shares of the Acme Widget Co. at $50 five years ago and it's shot up to $150. You fear the price will fall soon, but don't want to pay capital gains tax on the $10,000 profit you'd have if you sold now. (Especially smart since Congress and the Clinton administration are currently haggling over a capital gains tax cut.) The solution? Defer capital gains income and tax until next year by buying an Acme Widget "put" option and lock in your profit at today's level. A put grants the investor the right to sell a specific number of shares at a specified price by a certain date. If, in August, you buy an Acme February $150 put, you have the right to sell 100 shares at $150 at any time until the put contract expires in February. You've accomplished the same thing as selling the stock and you've bumped the tax into the next year.5. Generate Losses With Tax SwapsAnother way to minimize capital gains taxes is to offset them with losses. Of course, doing that means dumping a loser in your portfolio that you may well feel is ripe for a comeback. Fair enough. Try a "tax swap." In other words, sell the security and immediately buy a similar, but not identical, holding. This will generate a loss for tax purposes, but keep the composition of your portfolio intact. Caution: If you want to buy back the identical investment, wait 31 days, or the IRS will disallow the loss under its "wash sale" rule. Or better yet, buy it back for your retirement account -- wash sale rules don't apply to IRAs and their kin. There's no limit on the amount of gains that can be offset with losses, but taxpayers may only declare $3,000 in losses in excess of gains. And no, Las Vegas gambling losses don't count.6. Before Selling, Consider the "Cost Basis"The "cost basis" -- an asset's original price -- is used to determine capital gains. Depending on your tax bracket, and what it will be next year, you may get more of a tax advantage by selling the highest -- or lowest-cost-basis shares first. So before selling shares of a stock or mutual fund, consider the cost basis of the shares you want to sell.Say you bought 100 shares of a fund at $10, another 100 shares at $15 and 100 more at $20. Now that the stock is $30, you want to sell 100 shares -- but which shares should you sell? Believe it or not, it matters which batch of shares you order sold. To produce the smallest gain (or sometimes, the greatest loss), review your records to identify the shares that have the highest cost basis, and sell them. If you're in the 15 percent tax bracket this year, but just got a big raise which will soon shoot you into the 28 percent tax bracket, sell your lowest cost basis first. Selling those shares will generate the highest gain (or lowest loss), thus maximizing your taxes when it's most advantageous to pay them.7. Prepay State TaxesPrepay your estimated state taxes before year's end. The fourth-quarter estimated tax payment is not due until January 15 of the following year, but if you mail it prior to December 31, you can deduct it on that year's tax return. Be careful to pay close attention to the amount due, and not to overpay state taxes just to get the deduction. The IRS can penalize you for overpaying and deducting an unreasonable amount.8. Consider AnnuitiesFixed annuities are investment contracts sold by insurance companies. Like a certificate of deposit (CD), they guarantee payments with a fixed rate of return for life or for a specified period, but the money is invested more aggressively, usually resulting in a greater return. There are also things called variable annuities -- a life insurance annuity contract whose value fluctuates with that of an underlying securities portfolio. The portfolio manager may invest in a variety of securities, just as a mutual fund manager does.Annuities grant the same tax benefit that CDs do: You're only taxed on the interest when the annuities' term is done. Unlike mutual funds and some CDs, with an annuity you pay no capital gains tax on your investment or dividends, so your money compounds tax-deferred as long as it's in the annuity. Put money in an annuity at age 30 for retirement at 65, and you won't be taxed until you take it out.9. Dodge the Bite with Growth FundsYet another reason to invest in growth funds. The earnings and dividends from mutual funds are taxable, even if you reinvest them. Growth funds bet on companies with lots of upside potential, but little current earning power -- thus little or no dividends. Thus little or no taxes. If you do choose a fund with hefty dividends, don't buy it at the wrong time. Many funds pay dividends on December 14 or 15. If you invest on December 13, though you've only been in for a day, you're taxed as if you were in all year.10. Let the IRS Help Pay A Fund's LoadInvestors should avoid all mutual funds with "loads" -- that is, mutual funds that charge a sales commission and thus shrink your investment from the start. Some people, however, just have to have that fancy new Peruvian Emerging Growth Fund that comes with a fee and has no no-load peers. If you must, here's a nifty little trick to help minimize the damage: First, make sure the fund family doesn't charge a load for switching between funds. Then buy a money-market fund within the same fund family. Now switch the investment into the fund you really want. You'll realize a loss, which is the load charged for the original purchase, when you sell the money-market. Report this transaction on your tax return as a loss equal to the amount of the load and deduct the sales fee from your taxes. Now that's tax management.