Take the "Ouch" Out of Next Year's Tax Bite

Question of the week:I'm dreading April 15th already. I know I'm going to owe--is there anything I should be doing now to lower my taxes? --Philly76

Dear Philly76,

We feel your pain. The economy is down and its future is uncertain, but we still have to pay the tax man. When we recently asked members of the Armchair Millionaire community about what they're doing to cut their taxes, we heard a few grumbles and some good suggestions:

"I'm going to sell one index fund that I've had forever that is down 30 percent overall, and then use the money to buy shares in another index fund. I'll get a nice capital loss to write off, plus get somewhat better diversification than I had before." --MBL

"I'm paying all my property taxes before the end of year, increasing my 401(k), and taking capital losses, but my taxes will be still be high this year ..." --SM

My suggestion is that you step back and take a good look at your overall financial picture. Ask yourself: Can I save more in tax-deferred accounts? How much can I afford to give away? How can I adjust my investments to reduce my tax liability? My checklist will guide you on some of the specific moves you can make.

The Armchair Millionaire Checklist of Tax-Busting Moves

• Give to a good cause. It's no coincidence that you receive most of your charitable solicitations at this time of the year. Haul out your checkbook and donate to those less fortunate than yourself and get a tax deduction at the same time. And don't overlook non-cash donations. That old clunker sitting in your driveway, for example, might be worth more as a write-off when you donate it to a local charity than it would be if you sold it to your 16-year-old nephew.

• Harvest your capital losses. There is one advantage to selling when the market is down: You can use up to $3,000 of capital losses to offset any capital gains or "ordinary" income, like your salary. (If you have any capital gains this year, by the way, I congratulate you.) If you have more than $3,000 in losses, you can carry them over to future years. To not truly "lock-in" your losses, I suggest selling one investment and immediately reinvesting your proceeds in another investment that is similar enough to fit in with your overall investment goals.

• Max out your 401(k). Every buck you stash away for retirement is a buck that won't be taxed. The maximum most people can contribute this year is $11,000, a figure that will go up by $1,000 every year until it hits $15,000 in 2006. If you're over 50, take advantage of the new "catch-up" provision, which lets you contribute even more: $12,000 this year, going up to a sweet $20,000 by 2006. See your HR folks for details.

• Take advantage of flexible spending accounts. Many employers these days offer these accounts (also called "cafeteria plans") that allow you to have a set amount of money withheld from your paycheck that you can use later for medical expenses or childcare. Your contributions come out pre-tax, so you get to save a few bucks on these basic expenses. Fall is often the time when employers let their employees begin or change their contributions, so check with your HR department.

THE BOTTOM LINE: There are plenty of ways to lower your taxable income, and you'll find that many of them will not just cut you tax bill, but improve your overall financial picture, to boot.