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Happy New Year! Now start your 2009 year-end tax planning.

January 09, 2009

December is the traditional time for year-end tax planning. That's sensible, of course, but it asks a lot of one month to undo the other 11. When tax planning requires actual cash, it is best to spread the planning over the entire year. Here are some ways to get started on whittling down the income tax bill due April 15, 2010.

MAXIMIZE YOUR 401(k) CONTRIBUTION

The easiest way for most taxpayers to cut their tax bill without reducing their net worth is to increase their 401(k) payroll deduction. When you have your employer withhold extra from your 401(k) plan, you may reduce your current cash on hand, but the money is still yours - it's just in a different pocket. The earnings on the 401(k) aren't taxed until they are withdrawn for retirement.

Many employers match some or all employee deferrals. In that case, failing to use the 401(k) means you are turning down the boss's money. That's not just poor planning; that's crazy. The 401(k) limit for 2009 is $16,500; if you will be 50 by the end of 2009, you can add $5,500 to that.

FUND THE IRA NOW!

Most people ask about the last day they can contribute to an Individual Retirement Account. From a tax-planning standpoint, it's better to ask what the first day is for IRA contributions for 2009. The answer is Jan. 1, 2009.

If you make your $5,000 2009 IRA contribution now, rather than the last possible day (April 15, 2010), that $5,000 has an extra 15 1/2 months to earn tax-sheltered income. The limit for the 50-plus generation is $6,000. These limits apply to both Roth and traditional IRAs.

Maybe you don't have $5,000 sitting around waiting to be put in an IRA. If that's true now, it's not any less likely to be true 14 months from now. That means you should start putting a little aside each paycheck for your IRA; that's a better bet than waiting until the last minute.

CONSIDER YOUR WITHHOLDING AND ESTIMATES

Probably the worst part of a prosperous year is the tax bill at the end of it. This is especially true for taxpayers who have a lot of income not subject to withholding - S corporation or partnership income, for example, or self-employment income.

If you don't meet the tax law rules for withholding or estimates, you may find yourself with a non-deductible underpayment penalty. Many taxpayers with a big year-end bill don't have an underpayment penalty, but they still don't like writing that big check.

The tax law requires individuals to pay in through withholding or estimates the lesser of

-90% of current year tax, or
-100% of prior year tax (110% if your AGI exceeds $150,000 in 2008).
-Lower installments may be available if your income is seasonal or fluctuating during the year.

While it might be better theoretically to pay a big check to the IRS in April (as long as you don't have underpayment penalties), taxpayers rarely are happy to hear they owe the IRS. Unless you are confident you will be sitting on enough ready cash to cover your taxes in April 2010, you should have your payroll department make sure your withholding will be enough to keep you solvent at tax time.

May you have a prosperous and happy 2009!

Cross-posted from IowaBiz.com

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