Tax Tips
Last Minute Tax Trimmers - December 2007
Richard Scrivanich - Partner
Right up until the end of the year, the following are steps you can take to reduce the tax you'll owe on your return for 2007.
Itemized deductions
Several strategies can pay off for taxpayers who itemize deductions on Schedule A of Form 1040:
Miscellaneous itemized deductions. These include items such as tax preparation, employee business expenses, and investment expenses. If all of your miscellaneous items top 2% of your adjusted gross income (AGI), the excess is deductible.
Medical expenses. Similarly, itemized medical deductions are permitted only to the extent they exceed 7.5% of your AGI. Pay now for eyeglasses, elective dental procedures, etc., if you're over the 7.5% mark for the year, or defer until 2008 if you're not.
Adapt to the AMT
If you're subject to the alternative minimum tax (AMT), miscellaneous itemized expenses are not deductible and medical expenses are deductible only to the extent they exceed 10% of your AGI. Therefore, you should proceed cautiously before making year-end payments in these categories if you expect you'll owe the AMT in 2007.
If you cannot avoid the AMT this year, you may decide to postpone other deductions, such as charitable contributions, even though such contributions are deductible against your AMT. That's because AMT deductions are worth only 26% or 28%. You might prefer to defer such deductions to 2008, if you think you'll be paying regular tax and taking those deductions at tax rates up to 35 cents on the dollar.
Conversely, if you'll definitely be subject to the AMT this year, you might as well accelerate ordinary income and short-term capital gains into 2007, to pay tax at the "bargain" AMT rates of 26% or 28%. Our office can advise you on your AMT exposure.
Roth IRA conversions
For 2007, you can convert your traditional IRA to a Roth IRA, but only if your adjusted gross income (with certain minor modifications) is $100,000 or less. The taxable income you'll incur when converting your traditional IRA to a Roth IRA won't count towards the $100,000 limit. Neither will this year's required minimum distribution from a traditional IRA, if you're older than 70½.
Assuming you meet the income test, move money out of your traditional IRA before the year-end. You don't have to convert the entire account: you can withdraw some money from your IRA and pay a modest amount of tax, if you prefer.
This starts the Roth IRA clock. Five years after you've established a Roth IRA, all withdrawals will be tax-free, as long as you're at least age 59½. If you convert a traditional IRA to a Roth IRA any time in 2007, even at the end of December, the clock will start on January 1, 2007. That means you can get almost a full year's head start towards the five-year requirement.
What if you're not sure whether your income will meet the $100,000 test this year? You should convert anyway. If you wind up over the limit, you can rescind your Roth IRA conversion any time until you file your 2007 tax return, which can be up to October 15, 2008, if you request a filing extension.
As indicated, converting a traditional IRA to a Roth IRA will trigger the deferred income tax. To avoid penalty and to improve your investment's opportunity to grow, it's best if you pay the tax from other funds so that you can leave as much as possible in your Roth IRA, for tax-free growth.
If you're reluctant to convert all of your traditional IRA at once, which might generate a huge tax bill, you can do a partial conversion. Not only will this make paying the tax more affordable, you may be able to avoid moving into a higher tax bracket for the income from the conversion.
If you have any questions regarding last minute tax trimmers or any other tax matter, please feel free to give me a call at (562) 698-9891.
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