Send Uncle Sam A Smaller Slice

By Sharon Epperson

This splendid slack week between Christmas and the New Year is one during which many Americans start pulling together their financial records for the year. And it's a good time to engage in some last-minute tax planning--especially this year, with the tax code changing considerably on Jan. 1. Since the passage of the new tax law earlier this year, most taxpayers have already enjoyed a reduction in their income tax rate. Further reductions will kick in starting in 2002, so deferring income and accelerating deductions can translate into even bigger savings than usual. Here are a few ways to save.

--Defer compensation. Ask for a written agreement from your employer to defer some of your December earnings into January. Caution: if your company pulls an Enron and goes bankrupt, you may not receive the payments.

--Put off your bonus or severance payment. Casualties of the nearly 2 million job cuts so far this year should ask their employers to send severance payments in 2002, when they may be in a lower tax bracket.

If you're expecting a bonus, try to arrange for it to come in January rather than December. (It's when your employer writes the check, not when you deposit it, that determines the year in which it must be declared as income.) You also may be able to divert all or part of the bonus into your 401(k) plan, so check with your plan administrator.

--If you're self-employed, wait to send out your pending bills until early January, so you'll receive your checks next year. Also, set up a Keogh plan by Dec. 31. Like an IRA, a Keogh allows investment earnings to grow tax-deferred until the money is taken out. But while you can save $2,000 in a Roth or traditional IRA in 2001, you can contribute as much as 25% of eligible compensation, up to a maximum contribution of $35,000, in a Keogh, and you don't have to fund it until your tax return is due.

--Pay your real estate and state income taxes by Dec. 31, so you can deduct them on your 2001 return.

--Make charitable contributions. Remember, you can use your credit card to make such contributions in December and deduct them from your 2001 taxes, while waiting until January to pay the bill. Donate appreciated stock or mutual-fund shares by Dec. 31. If you have owned them more than a year and the value has gone up, you can deduct the full market value on the date of the gift and avoid paying tax on the capital gains.

--Use capital losses. Consider selling the dogs in your portfolio by Dec. 31. You can use capital losses to offset capital gains, plus as much as $3,000 of ordinary income each year. Suggests Barbara Raasch, a partner at Ernst & Young: "If you have $10,000 of capital gains from mutual funds, look in your portfolio for losses of up to $13,000 and get a tax refund, in essence, by recognizing those losses and selling the security by the end of the year."

--Give your doctor--and your insurer--a call. Medical expenses that exceed 7.5% of adjusted gross income are tax deductible, so if you're near the threshold, get that orthodontic work done, or stock up on prescription drugs, by Dec. 31. For the self-employed this year, 60% of health-insurance premiums are tax deductible, so consider making those payments now.

--Get as much credit as you can. The new tax law includes a $600-per-child tax credit. The Hope Scholarship provides as much as a $1,500 tax credit for college tuition for a student's first two years. After that, with the Lifetime Learning credit, you can claim as much as $1,000 more. If your income exceeds the eligibility limit for these credits, Raasch suggests taking the credit on the tax return of the student, who is likely to be in a lower income tax bracket and may still be eligible.

Finally, if you're considering taking money out of a state-sponsored 529 plan to pay your child's college bill before Dec. 31, don't do it! Starting in 2002, the withdrawals are tax free.

Sharon Epperson is a correspondent for CNBC Business News. You can e-mail her at [email protected]