• Interest income
• Dividends
• Gains from sales of stock or other assets
• Earnings from a business
• Alimony

1. Do you expect to owe less than $1,000 in taxes for 2009 after subtracting your federal income tax withholding from the total amount of tax you expect to owe? If so, you’re safe—you don’t need to make estimated tax payments.
2. Do you expect your federal income tax withholding (plus any estimated taxes paid on time) to amount to at least 90% of the tax that you will owe for 2009? If so, then you’re in the clear, and you don’t need to make estimated tax payments.
3. Do you expect that your income tax withholding will be at least 100 percent of the tax on your 2008 return? Or, if your adjusted gross income (Form 1040, line 37) on your 2008 tax return was over $150,000 ($75,000 if you’re married and file separately), do you expect that your income tax withholding will be at least 110% of the tax you owed on for 2008? If so, then you’re not required to make estimated tax payments.

If you answered “no” to all of these questions, you must make estimated tax payments with Form 1040-ES. To avoid a penalty, your total tax payments (estimated taxes plus withholding) during 2009 must satisfy one of the requirements we just covered.

• Your 2008 return. Use your 2008 federal tax return as a check to make sure you include all the income and deductions you expect to take on your 2009 tax return. You should also look at the total tax you paid if you are going to base your estimated tax payments on 100 or 110 percent of your 2008 taxes.
   
• Your record of any estimated tax payments you’ve already made for 2009. You need to take those payments into account when you determine how much tax you still owe, so have your check register handy to look up the amounts and dates you paid.

Start or add to your emergency fund. It’s always a good idea to have three to six months of living expenses tucked away in a secure stash like a bank account, short-term CDs or a high-quality money-market fund to serve as a cushion against financial setbacks. And given the rate at which economy has been shedding jobs in this recession, such a reserve is especially crucial.

Of course, if you’ve managed to avoid the chopping block up to this point, you may figure you’ll be able to hang on until the recovery begins. Don’t be so sure. After the 2001 recession officially ended, the economy still lost another 1.4 million jobs.

So if you haven’t already set up an emergency fund, consider using your tax refund to create one, or expand the one you have if it’s not large enough to sustain you for a reasonable period.

Repay debt. Did you run up credit-card, home-equity or other debt during the boom years? If so, your tax refund may provide a relatively painless way to eliminate or reduce what you owe. One big benefit to whittling down debt is the interest savings: credit cards are charging 14% annual interest on average these days.

And in addition to hefty interest charges, credit card companies and banks looking for ways to boost income in the face of this recession have also begun raising late fees and other charges.

Congress is working on legislation to curb fees and interest rates and the White House economic advisor Lawrence Summers says the Obama administration also plans to address credit card abuses. Whether or not these efforts will actually help consumers is an open question. In the meantime, your best shot at paring interest charges, avoiding fees and adding more wiggle room to your budget may be to apply at least some of your refund to outstanding loan balances.

Contribute to a retirement account. If your 401(k)’s balance has shrunk, your tax refund may allow you to restore at least some of its value – and grab some tax benefits as well. Probably the easiest way to do that is to use your refund to open up a traditional or Roth IRA account, assuming you qualify.

Alternatively, you could boost the percentage of pay you contribute to your 401(k) to reflect the extra bucks you’ll have with the refund. If you don’t have a 401(k) and have already maxed out your IRA, you can always just invest the refund in a taxable account and mitigate the tax bite on any gains by sticking to tax-efficient investment options like tax-managed funds and index funds.

Oh, and assuming you meet the eligibility criteria, you might also qualify for a Savers Tax Credit of up to $1,000 ($2,000 for a joint return) on top of the regular tax breaks you get from contributing to an IRA or 401(k), effectively allowing you to parlay your tax refund into another tax goodie.

Invest in yourself. Higher education certainly doesn’t immunize you against the possibility of a job loss. But, as these unemployment figures comparing workers with and without college experience show, the more education you have, generally the better your chances of remaining employed (not to mention earn more over your lifetime).

So you might want to consider using your refund to pay for courses at a local college or to otherwise boost your marketability and job skills. You might also qualify for a tax break under the recently revamped and renamed Hope education credit (now the American Opportunity Tax Credit) or the Lifetime Learning Credit.

At the very least you may be able to deduct the cost of a class that maintains or improves skills needed in your present work as an unreimbursed work-related expense in the miscellaneous itemized deduction category.

Buy something you can really use – that might also get you a tax break. The last thing I want to do is encourage spending for its own sake. But there may be instances in which your needs nicely dovetail with some recent tax incentives.

For example, if you’ve been thinking of replacing a home water heater, installing new windows or investing in alternative energy systems like solar or geothermal heat pumps, doing so now might snag you one of the enhanced energy-conservation credits that are part of the giant stimulus package president Obama signed in February.

If you need to replace a beat-up car, you may be able to cash in on a new sales tax deduction for new cars (and motorcycles). Or, if your refund is really big and you’ve been considering new digs, you could consider putting your refund toward the purchase of a first home and possibly qualify for a tax credit of up to $8,000.

But whatever you do with your refund – whether you spend it, save it, invest it, use it to repay debt or give it to charity – do it because you believe that’s the right move for you and your family.

Looking for advice on your personal situation?  Contact Omega for a Free Financial Review!

The Great Tax Dodge is under way already.

The how and which of tax increases are still unclear. But there is no question about the if: Higher taxes are coming.

Fearing that tax-code changes could slam fortunes large and small, investors aren’t sitting still. In the first three weeks of February, they poured twice as much money into tax-free municipal-bond funds as into all foreign-equity funds combined. At Fidelity Investments and Charles Schwab Corp., account holders are converting taxable Individual Retirement Accounts into tax-free Roth IRAs at quadruple the pace of last year. And more executives are passing on deferred compensation in favor of cash today, tax experts say.

“I’m having no trouble convincing my clients their taxes are going up,” says Dean Barber, a financial planner near Kansas City, Mo. “They’re scared already.”

The list of potential rises is long and growing. The likeliest include increases in income and capital-gain rates. Most ominous: lawmakers may breach the wall between wages and investment income by applying Social Security or Medicare taxes to dividends, interest, capital gains, and annuities.

We have been down this road before. Two decades ago, when U.S. debt and deficit levels were on an unsustainable path, market pressures forced the governments under George H.W. Bush and Bill Clinton to cut spending, impose budget constraints, and raise taxes. Now, as then, legislation is notoriously unpredictable. The only near-certainty is that lawmakers won’t raise taxes for 2010—unlike cash-strapped states that already have boosted rates. So investors have some time to prepare for federal changes.

Experts warn not to let panic spawn stupid moves. When marginal tax rates reached 70% in the 1970s, investors were lured onto tax-shelter shoals later littered with empty railcars, idle barges and see-through buildings. “A lot of them were bad deals that wound up costing more than paying the taxes would have,” recalls independent tax expert Robert Willens.

Given the certainty—if not the timing—of tax increases, here are some cool-headed moves to consider now.

Roth IRA Conversions

This is the first year all taxpayers have been allowed to convert regular IRAs to Roth IRAs regardless of income. Until 2010, those who made more than $100,000 were out of luck. In regular IRAs, contributions come from pretax dollars and grow tax-free. But payouts are both fully taxable and mandatory after a certain age.

Roth accounts are different: Contributions come from after-tax dollars, and all growth and payouts are tax-free. Also, the owner doesn’t have to take mandatory payouts. That means a Roth IRA can offer an escape hatch to those worried their tax rates will be higher in the future.

The drawback is that full income taxes are owed on the conversion. Anyone converting in 2010 can defer those taxes into 2011 and 2012. But many are planning to take the hit this year to lock in the 2010 rate.

Costs associated with Roth IRAs are minimal compared with hiring experts to develop conventional tax shelters. They can easily be customized: Accounts, for example, may be converted piecemeal over several years to avoid tax-bracket leap.

Better yet, conversions allow for do-overs: owners may divide an IRA into smaller pieces before converting and then reverse switches as long as 22 months later, if the asset value has dipped. But other traps bedevil profitable Roth conversions (see box).

Compensation

Executives are scrutinizing pay and benefits to bring income into 2010. Withdrawing pay already deferred is trickier due to post-Enron rules designed to prevent executives from cashing in ahead of disaster.

Many are revisiting stock options, both incentive stock options (which receive highly favorable tax treatment) and nonqualified options, which have fewer tax benefits but are far more common.

To reap the full tax benefits of either type, owners must hold them a year after exercise. Those who haven’t started the process won’t be able to finish by the end of 2010. But it may make sense to start the clock running, especially for those with nonqualified options. Income and FICA taxes are due on the entire gain between the grant price and the exercise price of these options, and these levies may rise next year. Those short of cash can often do a “cashless” exercise by selling some shares immediately to pay the tax cost of holding onto others.

Restricted stock has become popular. None of the stock’s value is taxable until it vests several years after the grant date. But within 30 days of that date, employees may make an “83(b) election” to pay ordinary income and FICA tax on the grant price, which converts future growth to capital gains. That helps if taxes rise. But if the stock is forfeited or loses value, income and FICA taxes that have been paid can’t be recovered.

Capital Gains

If the administration’s proposals pass, the 2011 tax rate on gains will rise by a third, more than any other. If Medicare taxes are added as well, it will increase by half. Tax strategist Robert Gordon of Twenty-First Securities Corp. in New York City says most of his clients worried by this increase have already sold.

The good news is that current proposals don’t raise taxes on “qualified dividends”—most of those on stocks held longer than two months. Until 2003, dividends were taxed like interest, at higher ordinary income rates.

Mr. Willens recommends that owners of closely-held C corporations and Subchapter S corporations that converted from C status consider accelerating dividends into this year. The alternative is to leave them in the business until it is sold.

Those who are receiving income from installment sales may want to offer the buyer a discount to pull payments into this year. Or it might make sense to sell the note to a third party.

Municipal Bonds

During 2008′s flight to quality, some muni yields were twice as high as Treasury yields, and many long-term muni funds returned a sizable 10% or better for 2009. Last year, investors put more money into muni funds, $69 billion, than in the previous 10 years combined. Some investors were merely fleeing dismal yields on money-market funds.

Now some yields are closer to historic norms of about 80% to 90% of Treasury yields. Demand for munis is likely to grow even more with higher taxes, and investors should remember that rising interest rates can hit munis hard because they often have long maturities. Supply is under pressure as well, as issuers turn to cheaper (for them) Build America Bonds, which are both taxable and federally subsidized.

Credit quality isn’t the concern that the sorry state of some local economies might suggest. “There are fifty states and thousands of bond-issuing authorities; they aren’t all going to go bankrupt,” says T. Rowe Price Group Inc. municipal-bonds overseer Hugh McGuirk. Historically, the rate of recovery in munis has been higher than with other types of bonds. T. Rowe, like Fidelity, Vanguard Group and several others, does its own credit analysis.

Diversification is the best hedge against risk. Kenneth Woods, the founder of Asset Preservation Advisors of Atlanta, believes the minimum for a portfolio of individual bonds should be $1 million and likes 3% or less of the total in any one issue. Investors buying bonds outright also need a trustworthy broker to minimize spreads. But individual investors rarely can buy munis commission-free as they can U.S. government bonds at TreasuryDirect.

Muni funds are typically well-diversified, but investors should favor those with low expenses (under the average of 0.6% for no-load muni funds) and compare before- and after-tax returns listed in a fund’s prospectus. Some muni funds raise returns by trading, and that can that give rise to taxable capital gains 30% or more of the total.

Charitable Donations

Rising tax rates can make charitable deductions more valuable. The administration has proposed to limit the value of all write-offs for upper-bracket taxpayers to 28% from the current top rate of 35%. But this measure faces stiff head winds from powerful lobbies. Assuming this draconian measure stalls, many taxpayers may want to delay large gifts either of cash or appreciated property until the time, which is certainly coming, when tax rates rise.

Wall Street Journal