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Five Tax Mistakes to Avoid at Year End

One of my sisters checks her investments and cleans her financial house in December. The other one prefers to sip hot toddies and leave organization and thank-you notes for the new year. Funny thing is that both approaches could prove costly during tax season. Make sure to avoid these common tax mistakes whether you’re relaxing or making Excel spreadsheets over the next few days:

Busy-Bee Errors:

1) Buying mutual funds that pay dividends at year end Many funds distribute dividends to investors in December. Think you should buy in right before the payout? Not so fast.

Usually the share price of the fund drops by the same amount of the payout, so investors are not truly collecting anything here. They are paying taxes though; the IRS treats these dividends as taxable gains. If you want to buy a new fund before December 31st then call the fund company and make sure the fund isn’t about to pay a big dividend.

2) Selling winning investments before an income drop Individuals in the two lowest tax brackets won’t have to pay capital-gains taxes in 2008. So if you’re going to graduate school or are self-employed and can control your (limited, in this tax bracket) income then wait until next year to cash in your winners.

3) Donating cash instead of investments It’s smarter to give to your favorite non-profit by unloading some of the taxable gains in your portfolio. Why? You don’t have to pay capital-gains taxes on assets that you donate to charity. Plus you can still deduct the full value of the securities you donate. It’s a neat trick that rich people know but many others don’t.

Forget-Me-Nots:

4) Overlooking portfolio losers Selling an investment for less than you bought it for can work in your favor when it comes to taxes. That’s because you can use your losses to offset your gains, thus reducing your tax bill.

5) Leaving money in a flexible spending account If you contribute a piece of your paycheck to an FSA, remember that the you lose the money in it at year-end unless you spend it all. You might want to schedule a trip to the pharmacy or eyeglasses store this week. Some FSAs do not expire until mid-March, however, so check with your HR department to find out if you have a few extra months to spend the loot.  We’re big fans of FSAs. You can read more about them here.

By the way, if all of your investments are in a retirement account like a 401k or an IRA, then don’t worry about points one through four. These assets are protected from taxes for the time being and you shouldn’t take them out of retirement accounts, even to give them to charity.

– Kristen Sullivan

Illustration: taxes.allaboutbusinessnews.info