New Year’s Day is rapidly approaching and by that time most of your tax fate will be sealed. The wisest tax plan is one that has long range as well as current impact on your tax liability, but there are many tax ideas that can still be implemented between now and New Year’s Day. These strategies can amount to quite a large savings and are well worth considering. Five such tax saving ideas are discussed below in general terms.
1. Retirement Contributions
You can set up a retirement plan and defer income taxes until you take the money out of the plan. Presumably, you won’t draw out the money until you reach retirement age. At that point, you may be in a lower tax bracket, but even if you are not, you will have delayed paying taxes on the principal savings and the earnings on the principal savings for many years. This allows the principal retirement contributions, the earnings, and the tax savings to multiply all those years. This is because the retirement money is “sheltered” or not taxed until it is withdrawn.
What if you are thirty years or so away from retirement?
First of all, you are the ones who can benefit most from a retirement program because of the profound effect of the growth of the money over long periods of time and the additional benefit of having the money grow tax-deferred. Secondly, if you leave the money in your retirement account for nine years, you can draw it out, pay the taxes and the penalties and still have more money left than you would have had in a regular savings account.
This is considered to be “year end” tax planning because a 401k or a SEP (Self Employed Pension) must be set up before the end of the tax year. Additionally, your 401k must be funded by the end of the year.
The maximum 401k contribution is $9,500. You may actually put the money into your SEP retirement plan before April 15. The maximum allowable contribution to a SEP is 15% of your income. You can open an IRA (Individual Retirement Account) and fund it any time until April 15. The biggest advantage of any tax-sheltered retirement plan is the tax-free accumulation of the earnings, which hopefully will dwarf the principal at retirement age. Non-deductible IRA’s should not be funded this year because of the Taxpayer’s Relief Act of 1997. Beginning in 1998 there will be a new “Roth IRA,” which is better than the old nondeductible IRA. Also, the new tax bill will liberalize the qualifications for all IRAs, so even if you weren’t eligible before, you may be eligible now. One spouse can be in a pension plan, and it does not automatically disqualify the other spouse. Also, limitations are relaxed beginning this year.
Which plan is best for you and why?
This is another subject within itself. The rules are somewhat complicated, and it is best to consult a tax or investment professional for guidance.
2. Capital Gains And Losses
Do you own any stocks and bonds? If so,now is the time to review your portfolio. You will need to figure the profit or loss on each security in the event of a sale before year-end. Don’t forget to list projected capital gains from mutual funds. All such information is necessary to figure potential gains and losses for tax planning purposes. You also need to know your projected taxable income for the year, any capital loss carryovers, and other special credits or deductions. The idea is to estimate how much tax you think you will owe before the end of the year actually gets here.
If you have built up a big gain or a big loss on sales already completed this year, it might be wise to sell some stocks at a gain or a loss to offset gains or losses incurred earlier this year. This will offset other tax factors such as credits, windfall gains, net operating loss carryovers, or other such items. The net resulting taxable income is small instead of having a giant capital loss and only being able to deduct $3,000 of it. If your income is pushing you into those high tax rates of 36% or even 39.3% you can take your capital gains and pay at the capital gains tax rate of “only 28%.”
The new long-term holding period is eighteen months for sales made after July 26, 1997, so it may pay you to delay a sale until the investment is eighteen months old. This will let you pay out a capital gains tax of “only 20%,” instead of the higher bracket imposed on any other income. If you are in a 15% bracket, the capital gains rate is 10%.
One final word of caution on this subject; never trade stocks merely for “tax purposes” without considering the investment wisdom of buying when you should buy, and selling when you should sell. There are many other factors to consider besides taxes when managing a stock portfolio. If you have a trusted investment advisor or broker, you should discuss these plans with him. Of course, you should consult with your tax advisor as well.
3. Gifts of Appreciated Stocks to Charity
You can give appreciated stock instead of cash and avoid the tax you would have owed if you had sold the stock and then given the cash to the charity. You can deduct the full value of the stock instead of what you paid for it. The deduction is an itemized deduction and is subject to all the rules concerning charitable contributions on your itemized deductions. To qualify you must have owned the stock for over one year, and the deduction is limited to 30% of your income. You may carry over any unused balance.
4. Estate and Gift Taxes
Your estate may be taxable after your death. If you think it will exceed $600,000, you should begin giving some of the assets to your beneficiaries such as your children and/or a favorite charity. You are allowed to give $10,000 per year to each beneficiary and your spouse may give another $10,000. In the case of your own child you can give $10,000 to the child, and so can your spouse. You can both give another $10,000 to the child’s spouse, their children, etc. Any gifts over $10,000 are subject to gift taxes, which will be owed by the donor and not the beneficiary. Gifts of appreciated property rather than cash can often be the wisest gifts of all.
Once the year-end is past, this year’s gift opportunity is gone forever. The importance of this is that there is a maximum estate tax of 55%, so the tax savings can possibly amount to as much as $5,500 per gift per year. As for the income tax savings, if the beneficiary is in a lower tax bracket than you the income will be taxed at the lower rate.
5. Timing and Bunching
Bunching of expenses is a good year-end plan for taxpayers who don’t always have enough expenses to itemize. You can either accelerate the payment of certain expenses or delay the payment, depending on how much your itemized deductions will be with or without those expenses.
For instance, if you know you have a large dental bill this year, and have also incurred some other medical expenses, be sure to pay all of the medical bills before the end of the year. The rationale behind this is that you must subtract 7.5% of your income from medical expenses before you can even include them in your itemized deductions.
You might have a chance to pay two years of property taxes within the same calendar year. You could double up on your contributions if you are about to make an unusually large one-time contribution, or if other circumstances make one year better for the deduction than the other.
There are also certain business expenses that can be planned to fall into either this year or next year. You might be contemplating buying a home computer, or a cellular phone, or maybe paying a tax lawyer or other tax professional to do some tax planning. All of these expenses are subject to a deduction of 2% of your income before you can include them in your itemized deductions.
It is sometimes possible to cause certain income items to fall into this year’s or next year’s income. You may be planning to sell a rental house, or land, or timber that you own, or maybe you are about to sign an oil and gas lease on your property, or sell a right-of-way. Maybe you are going to earn a bonus at work this year. You might be able to delay the payment until after the first of the year. All these things have the possibility of being timed in either this year or next year if they are going to happen near the end of the year.
If you are self-employed or have a side business you can time many income and expense items to make them fall into the best year for you. You may also grant additional terms on accounts receivable so that they will be collected sooner or later than normal. You can pay-up all of your accounts payable, or sometimes you can put them off until the new year by making arrangements with your creditors.
In addition, you can plan the purchase of major equipment or fixtures to fall into either year. You can get a bonus deduction of up to $17,500 on fixtures and equipment. This deduction would be taken this year instead of being spread out over five to ten years as a depreciation expense.
Do you need more deductions this year, or would you save tax dollars if you take them next year? Do you need to put off reporting income until next year, or would you be better off paying tax on it this year at a lower rate? There are many opportunities to save on your taxes by taking advantage of the ideas mentioned in this article, but you should also seek the advice of a tax professional before attempting many of these ideas.
James W. Crawford, CPA, holds a Bachelor of Science in business administration from Northeast Louisiana University and has done graduate studies toward his MBA at Tulane University. Mr. Crawford, who has operated his own CPA firm since 1972, has 25 years’ experience in helping business leaders in several states develop business plans, marketing strategies and many related areas of business administration, as well as presiding over a large tax practice. He is particularly adept at raising working capital, and negotiating all areas of business dealings. He is the Vice President/Secretary of Doctor’s Financial Services, Inc. in Monroe, Louisiana and can be reached at 1-800-282-1947.