5 Tax Moves You Must Make Now

A record federal deficit and expiring tax laws have put the spotlight on income taxes this year,with many predicting rising rates for at least some well-heeled filers. That’s got experts urginghigh-income individuals to quickly review their employee benefit plans to see if they can uselittle-understood programs that can save thousands of dollars in taxes.You may have to take action within the next few weeks: Your ability to use these tax breaks in 2011hinges on signing up during this year’s open enrollment period, which has already begun at manycompanies.“People are focused on the higher taxes that may be in the offing — [and] this is something you cando to counteract that,” said Philip J. Holthouse, a partner at the Santa Monica tax law and accountingfirm of Holthouse Carlin & Van Trigt. “Everyone should spend a few minutes reading through theirpaperwork to figure out what they have available and sign up for as many of these plans as they canuse.”There are five potential tax shelters buried in your employee benefit plan. Only one — the 401(k) plan— is widely understood and commonly used. But the other four options provide even sweeter taxbenefits, Holthouse said. That’s because they come out of your check before both income taxes andemployment taxes — that’s the 7.65% of your wages that you pay into Social Security and Medicare— are figured. Moreover, reducing your income with contributions to these plans can help you qualifyfor other tax breaks. That means that each $100 you contribute can be worth as much as $35 to $40in tax savings for upper-middle-income taxpayers.

Yet less than one-quarter of all employees who are offered these accounts use them, said BarrySchilmeister, a partner at the national employee benefits consulting firm Mercer Inc. Why? Experts- 2 -can only speculate, but a recent survey by Wage Works found that 86% of respondents had at leastone misconception about how they work.So what are these accounts and how could they help you?1. Flexible Spending AccountsAlso known as medical and health care spending accounts, these are offered by about 85% oflarge employers, Schilmeister said. The accounts allow workers to set aside their own money tocover co-payments, deductibles and other uninsured medical expenses ranging from dentistry toprescriptions.You decide how much to contribute; the company deducts a pro-rata share of that contribution fromeach paycheck. If you get paychecks every two weeks and wanted to contribute $1,300 a year, forinstance, they’d take $50 out of each check.To use your savings, you’re usually given a debit card loaded with the entire year’s worth of savings,said Joe Jackson, CEO of WageWorks, which provides the administration services for manyemployer plans. When you have an eligible expense, you swipe and go. No paperwork necessary.The plans are particularly helpful for people with big planned expenses — the $3,000 upcomingexpense for your child’s orthodontia or speech therapy, said Jackson. They’re also good for chronicailments that require regular prescriptions; or to handle costly elective (but not cosmetic) proceduressuch as Lasik eye surgery.But even if you just want to cover co-payments, it’s worth using these accounts, Jackson said: “IfI gave you a card that allowed you to save 40% on groceries every time you used it, there’s noquestion that you’d use it,” Jackson said. “This is no different.”• What to do: Go through this past year’s out-of-pocket expenses and project where you mightspend more or less in 2011. Pay particular attention to dental costs, which often leave you withbigger co-payments, and orthodontia, which is often not covered at all. Then use your employer’sbenefits system to fund a flexible spending account with that amount.• Drawbacks? The one catch is that any amount you don’t use by year end is forfeit. But becausethe money can be used for everything from eyeglasses to bandages, it’s pretty easy to use everydollar. Anyone who is using one of these plans should be aware of a change for next year: Asof January 1, over-the-counter medicines will not be eligible, unless you have a prescription.(Here’s a list of what products are, and are not, eligible for flexible spending accounts.)- 3 -2. Health Savings AccountsThese are relatively new savings plans that are paired with high-deductible health insurance plans.Next year, consumers will be able to save up to $3,050 per person or $6,150 per family, in an HSA,Schilmeister said. This money can be used to cover deductibles and co-payments — just like thesavings from the health care accounts — but it doesn’t have to be used up in one year. In fact, HSAsavings can be rolled forward indefinitely and eventually even used as additional retirement savings.The accounts can only be opened by those who couple them with a high-deductible health insuranceplan, however.• What to do: If you have only minor medical bills, consider enrolling in your employer’shigh-deductible plan. Pairing it with a HSA will allow you to save money today for bills you mighthave when you’re older.• Drawbacks? If you have lots of current medical needs, you’ll probably pay more with ahigh-deductible than a traditional plan.3. Dependent Care AccountsThese accounts allow workers with children under the age of 13 to set aside as much as $5,000annually to cover day care expenses for families in which both parents work. This includes summerday-camp programs, but does not include tuition for private schools or overnight camps.• What to do: If you have kids in daycare, find out if your employer or your spouse’s employeroffers a plan and sign up for the maximum contribution.• Drawbacks? There’s some paperwork and, like health savings accounts, amounts not spent arelost. But daycare expenses are predictable, so losses are rare.4. Transportation or “Commuter” AccountsWorkers are also commonly offered so-called commuter benefits that allow them to set aside asmuch as $230 per month to pay for public transit or parking, said Jackson.You should never contribute more to these accounts than you’re likely to use. But, if you pay forparking or daily commuting expenses in a high-cost city such as Los Angeles, San Francisco, New- 4 -York or Boston, it’s not difficult to spend that full $230 on commuting — a total of $2,760 a year.Paying these bills through an employee account just lets you save taxes on that expense.• What to do: Call your benefits representative and find out how to sign up.• Drawbacks? If you pay for parking or mass transit, there’s no catch. This just allows you to paywith pre-tax dollars. It’s a no-brainer.5. 401(k) PlansYes, we know you know about this: Roughly 65 million 401(k) plan participants have already sockedaway $3.4 trillion in retirement savings through 401(k)s, according to the Profit Sharing/401(k)Council of America. That’s partly thanks to a tax break that allows contributions to come out of paybefore income taxes are computed, so each $100 in savings only costs you about $75, after youtake into account the $25 in federal income tax savings. (This assumes a 25% federal bracket,which applies to singles with up to about $83,000 in taxable income and married couples with up to$138,000 in income. Higher income filers get a bigger break.)Still: As long as you’re meddling with your benefits elections, you might want to give your 401(k)a quick look. Are you contributing as much as you can? Also, check to see if your company offersautomatic increases whenever your pay goes up: You won’t miss money that was never in yourpocket to begin with.• What to do: Reconsider how much you’re contributing, particularly if you’re among the manypeople who cut back on contributions when the economy tanked and the market soured. Youshould contribute at least enough to get the full company match – and more if you can afford it.• Drawbacks? The savings are mostly locked up until retirement, but some companies let youborrow from your accounts to finance college and home purchases. Any amount permanentlywithdrawn is subject to tax and tax penalties,Adding Up the ImpactWhy do these five deductions make such a difference? An increasing number of income tax breaksare “income-tested” these days, which means that you lose the benefits if you earn more than setamounts. These are not. Most large employers offer them and anyone with a plan available can usethem, regardless of how much they earn.Better yet, because they reduce your taxable income, they also allow you to qualify for thoseincome-tested breaks that you might otherwise earn too much to get.Consider, for example, a married couple living in suburbs of New York and earning $200,000annually, with two children in college. There’s a lucrative tax break called the American OpportunityTax Credit for people paying their kids’ college bills, but married couples earning more than- 5 -$180,000 are locked out of it. In fact, you lose a portion of the break for every $1,000 you earn over$160,000. (This credit is slated to expire in 2011, but Obama plans to reinstate it.)If both spouses contributed $16,500 to their respective 401(k) plans and $200 each month to theirrespective transportation accounts; and one spouse puts $2,200 into a health savings account topay medical co-payments, deductibles and dental bills, they would reduce their taxable income by$40,000 — bringing them to the magic $160,000 level.What does that save them in tax? It saves $11,200 in federal income tax; $535.50 in employmenttaxes; and it allows them to claim American Opportunity Tax credits for both of their children. Totalsavings: $16,735. And that’s before state and local taxes are considered.“These accounts give employees a tremendous opportunity to save on their taxes,” saidSchilmeister. “Everyone should be participating in these plans.”

Team Bold Spicy (235 Posts)

Blogging Co-Op Team of Awesomeness for all things Cocktails, Music, and Fitness.