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Don't wait for April
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June 20, 2001: 9:09 a.m. ET
Summer is perfect for the beach, and preparing for next April's tax deadline
By Staff Writer Hope Hamashige
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NEW YORK (CNNfn) - It's June. The sun is out and the outdoors is calling. And almost no one is putting together a tax strategy for next April.
Summer may be a good time to work on your tan, but experts say it's also a good time to get your financial house in order – while there's still time to trim what you owe to Uncle Sam.
Completing your own midyear tax audit helps to identify income tax deductions you may not be taking. It'll also give you a better idea of what to expect come April 15 – whether you're likely to owe the Internal Revenue Service or receive a hefty refund.
"June is a good time to sit down with your tax practitioner and review things to date," said Cindy Hockenberry, an enrolled agent and spokeswoman for the National Association of Tax Practitioners. "If you wait until later it is going to be harder to catch up."
Check your last return
If you're among the legions of taxpayers who receive a sizeable refund each year from the federal government, she said, now is the time to adjust your withholdings and even out your returns. Don't forget that large refunds represent an interest free loan to the IRS.
Had that money remained in your pocket throughout the year instead, it could have been earning money in an interest-bearing account, used to pay off credit card debt or allocated toward long-term investments, including tax-deferred retirement plans.
Click here for a W-4 calculator
Taxpayers can change their withholdings from their paychecks at any time during the year by filing a new W-4 tax form with your employer. It can even be changed more than once during the year.
By amending your W-4 to include a larger number of withholdings, you will have less money taken out of your
paycheck.
Of course, the reverse is true as well. If you owed a large sum of money to the IRS on April 15, now is the time to adjust those withholdings so you break even next year.
You may also want to adjust your W-4 if you expect a significant pay increase later this year. Higher income could bump you into the next tax bracket and you don't want to end up owing.
Hockenberry added that taxpayers need to be aware that W-4 tables are due to change on July 1 and less money is going to be withheld. Check your pay stub to see how much more has been taken out and you may need to consider adjusting your W-4 accordingly.
Reduce taxable income
Rather than waiting until December 31, taxpayers also should use the summer months as an opportunity to make clear-headed decisions about reducing their taxable income, said Frank Degen, a spokesman for the National Association of Enrolled Agents.
You should start by determining whether enough of your money is being allocated towards tax-deferred retirement accounts, he said.
Anyone with an employer-sponsored 401(k) plan currently can contribute up to $10,500 each year in pre-tax dollars. With a little help from the 10-year tax bill just signed into law by President Bush, however, that limit is being gradually raised to $15,000 by 2006.
Using pre-tax dollars to fund your 401(k) not only gives your nest egg a boost, it also helps to reduce your taxable income in the eyes of the IRS.
In order to claim 401(k) contributions on your current year tax returns, however, those contributions must be made during the calendar year – by Dec. 31.
Individual retirement accounts, or IRAs, offer greater flexibility – allowing contributions to be made for the prior tax year all the way up until the tax filing deadline of April 15.
Contributions made to Roths are done so on an after-tax basis, so it won't immediately affect your taxable income. But the earnings in your account are withdrawn tax-free in retirement.
By contrast, traditional IRAs allow individuals to use pre-tax dollars, which gives them a tax break in the year they make the contribution. But the earnings are taxed upon withdrawal.
Degen said taxpayers who fail to plan ahead often make bad decisions when it comes to retirement savings, because they don't leave enough time to weigh the pros and cons of traditional IRAs versus Roth IRAs. They also run the risk of not saving enough money to fully fund their retirement plans on a yearly basis.
Both traditional IRAs and Roth IRAs allow you to set aside $2,000 per year. But that ceiling also is being raised to $5,000 from by 2008.
Click here for a Roth IRA calculator
Degen added that anyone who takes significant deductions each year also should have a system in place by midyear for keeping those records in order.
"So often people can't remember what they spent or how they paid for it," he said. "People need to keep records and they need to start now by keeping a diary to track their deductible expenses."
Mildred Carter, a tax analyst at CCH Inc. which provides tax law information, said anyone who is planning an elective medical procedure should consider the timing.
That's because you're only able to claim medical expenses as an itemized deduction in a given year if they cost more than 7.5 percent of your gross adjusted income. As such, if you've already spent enough on medical costs to get you close to the 7.5 percent threshold, you may opt to have that elective procedure done before year end – thereby bumping you into eligibility for the write-off.
Changes
To be sure, big changes in your life also can mean big changes in your financial situation. If you are getting married, getting divorced, sending a kid to college or buying a home in the next few months, you'll need to factor that into your tax planning strategy, too.
When getting married, Hockenberry said many couples make the mistake of thinking their tax rates will drop and are later surprised when they get hit with a bigger bill. In some cases, marriage does nothing but bump both individuals into a higher tax bracket where they end up owing more together than they would have alone.
The tax relief passed by Congress for the so-called marriage penalty does not take effect until 2005.
Divorce, too, can bring about a change in your tax status so it is best to check now before waiting until late in the year. If you get dropped down to a lower tax bracket you may find yourself handing too much of your paycheck over to Uncle Sam, resulting in an oversized refund.
Pay estimates; ignore the President
Lastly, if you are among the individuals who are required to pay quarterly estimated taxes, summer is a good time to calculate how much you need to pay in your quarterly installments to make sure you don't have to pay any penalties. Independent contractors, the self-employed and people who earn their income from investments – people who do not have taxes regularly taken from their paychecks – are required to pay quarterly estimated taxes.
The general rule of thumb to follow is that you must pay at least 90 percent of the total amount you paid last year, spread over four quarterly payments, or you may have to pay additional sums in penalties.
As for President Bush's tax reductions, individuals need worry about that for at least another year. Not much of the 10-year tax plan will have any effect on anyone's 2001 tax payments. Most of the changes kick in for the first time in 2002 or later.
"For this year there's not a lot than anyone needs to worry about," said Hockenberry. 
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