Tax Tips
Year-End Tax Planning for Individuals - December 2003
Richard Scrivanich - Partner
Even though December 31 may still seem far away, it will arrive before we know it. Now is the time to take the tax planning steps that will make a big difference on your tax bill next April.
WHERE ARE YOU NOW?
Before undertaking any year-end strategies, it’s a good idea to get an overall picture of your tax situation. Have you projected, roughly, what your tax will be for the year if you don’t make any changes to your current course? By estimating your taxes before December 31, you can accomplish several goals. First, you will know whether to take additional steps before the end of the year to minimize your taxes. Also, you will be able to determine whether your tax payments are on target or whether you need to take further action to avoid an underpayment.
PLANNING FOR CAPITAL GAINS AND LOSSES
Stock market investments can have significant tax consequences. Knowing the tax rules may affect your investment strategies and help you make informed decisions.
Timing.
Be aware of the impact of capital gains in other areas. For instance, a capital gain or loss will affect your adjusted gross income (AGI). Will inclusion of a gain or loss affect your eligibility for tax deductions and credits that are limited by AGI?
Use your losses in two ways.
If your investments saw gains in 2003, search your portfolio for offsetting losses. Conversely, if you expect high losses next year, try to postpone realizing gains until then. And if you have incurred losses in 2003, don’t forget that you’re allowed to write off losses dollar for dollar against your gains plus $3,000 of ordinary income. If you have no gains, you can still deduct the losses against up to $3,000 of ordinary income.
Generate a loss, then repurchase a stock.
If you think your depressed fund or stock will bounce back, but you’d still like to generate a taxable loss, you can sell it and then buy it back. But be sure you wait more than 30 days after the date of sale before you buy it back. If you buy or sell identical securities prior to this period (30 days before or 30 days after the date of sale), the so-called “wash-sale rule” won’t let you take a loss.
Don't buy mutual funds at the end of the year.
Fund companies usually distribute all their capital gains and dividends at year end, and you’ll be taxed on the payout without enjoying any increase in the value of your investment.
DEDUCTIONS AND THE POWER OF SMART TIMING
Don't forget to consider the timing of deductions.
If you can “bunch” deductions into a single tax year, you may be able to decrease your tax. For instance, perhaps you cannot itemize because you live in an income-tax free state, your mortgage is almost paid, and your only significant itemized deduction is your real-estate tax, which you normally pay in January and July. If, instead, you make your January 2004 payment in December 2003, you may be able to itemize for 2003. First, though, be sure such a move won’t trigger the alternative minimum tax (AMT).
Another timing move is to bunch medical deductions into one year if the increased amount will bring you over the 7.5%-of-AGI threshold. Paying the orthodontist’s bill in December instead of January, for instance, may make the difference.
USE THE RIGHT FAMILY MEMBER
Before a particular family member enters into a transaction, consider the tax consequences. For instance, are you considering helping out a child who lives on his or her own by paying the real estate tax on the child’s home? You cannot get the property tax deduction because you do not own the home. And the child cannot get the deduction because he or she did not make the payment. In this situation, you may wish to make a gift to the child, who can then make the tax payment and get the deduction.
If you have a student in college and are planning to sell appreciated securities to pay the tuition, you may want to gift the securities to the child, then have the child report the income and pay the tax, because any capital gain may be taxed at lower rates. Think twice, though, before gifting stock that has decreased in value. If you make a gift of stock, and the recipient then sells the stock at a loss, his or her basis for computing the loss will be the lesser of your basis or the value at the time of the gift – which might mean no capital loss deduction at all for the donee.
Remember to keep in mind the possible gift tax ramifications when considering these, or any other, gifting strategies.
SHOULD YOU ADJUST YOUR WITHHOLDING?
Before the end of the year, match your withholding to your projected tax liability. If you’ve moved up to a higher tax bracket, adjust your withholding or you may be hit with an underpayment penalty. Conversely, you may be giving the IRS more than you need to; if you received a tax refund last year you may want to adjust your withholding downward.
RETIREMENT PLANNING AND TAXES GO TOGETHER
Good tax planning will not only save you money this year, it can also help you save money for your retirement, and is a strategy you should always consider if eligible. The tax breaks available for saving for retirement are better than ever, and can be accomplished in several ways.
Contribute to your 401(k).
A 401(k) is still hard to beat for tax leveraged retirement savings, especially if you make careful, informed investment choices within the opportunities offered by the plan. Your contribution lowers your gross income, and your earnings will grow, tax-deferred, until retirement.
Contribute to an IRA or Roth IRA.
Plan to make maximum contributions to your individual retirement account (IRA). Even if you cannot deduct your contributions, IRAs still make tax sense, because earnings grow tax-deferred until withdrawn. (Note: Roth IRA contributions are not tax deductible.)
Open a Keogh.
Keoghs are available to individuals with any amount of self-employment income. Generally, if you qualify, you can make a contribution to a defined contribution plan, subject to limitations based on a percentage of your business income, up to a maximum of $40,000. The contribution is an above-the-line deduction.
DON'T BE CAUGHT BY SURPRISE BY THE ALTERNATIVE MINIMUM TAX
When doing your year-end planning, be sure you don’t unknowingly fall into the alternative minimum tax (AMT). For example, prepaying state or local taxes can suddenly reduce your tax bill so that your regular tax falls below the AMT. If this happens, you can permanently lose the federal tax savings from these deductions. If you are concerned about triggering the AMT, our office can help you with your year-end planning so you won’t be surprised by an unexpected AMT when you file your 2003 return.
START NOW
Don’t wait to begin your 2003 tax planning. Through careful planning, your tax liability can be reduced and your overall financial position improved.
If you have any questions about this article, or any other tax matter, please feel free to give me a call at (562) 698-9891.
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Some of the articles included here were written in a prior
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relate only to the year for which the article was written and could be different
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