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How To Do Year-End Tax Planning
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Business New Haven
11/10/2003
By: Mitchell Young
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The good news is that taxes have been lowered across the board, and most readers will find that their federal tax bites are shrinking.
There are new deductions and credits for families, married couples, stock-market investors, small-business people, low- and high-income taxpayers. The federal deficit may be going up, but personal balance sheets and spending will also be on the rise or not.
While the government is giving taxpayers some pretty good breaks, many readers will find that employing the proper strategy has become more important than ever.
Capital gains taxes have been reduced from 20 to 15 percent. Dividend income is now taxed at only 15 percent, instead of as ordinary income. Married filers have seen the standard deduction increase to $9,500 from $7,850, while the child tax credit increased from $600 to $1,000, and the education tax credit has doubled to $2,000.
There is one major caveat, however: A great many taxpayers - perhaps three million more than in the past - will find that the new rules will cost them big-time if they're not prepared.
The biggest snare is the ATM. Not the one that takes a $1.50 bite out of each transaction, but the Alternative Minimum Tax. The ATM is a tax trap that until now has affected only a handful of taxpayers.
With this ATM, the IRS is assured that everyone pays the "vig." Taxpayers with incomes above $58,000 for a couple or $40,250 for a single are affected. The goal of the Alternative Minimum Tax is to assure that otherwise allowable deductions don't reduce your tax bite too low. When taxpayers compute their taxes under ATM, they may not take deductions for state and local taxes or miscellaneous deductions.
According to USA Today, "Year-end tax strategies usually come down to one time-tested principle: Accelerate deductions, defer income." This year they agree that as favored a tax strategy as it is, this year it may not work for you. If you are to be taxed under ATM, you don't want to accelerate your state income-tax payment to 2003, because under ATM it is not a deduction. Neither will you get a tax-deduction benefit by claiming uncompensated business expense, tax preparation expense and even some health expense deductions may be lost.
Not all deductions are eliminated under ATM. Mortgage interest and charitable deductions remain fully deductible, and capital gains and dividend income maintain their favored tax treatment.
How do you know whether you will fall under ATM? It's tough to predict. If you have big state tax payments, numerous dependents and a lot of miscellaneous deductions, be forewarned. The best tactic may be to have your tax preparer do an estimate of your taxes before accelerating any deductions to 2003.
Connecticut Taxes
As you may recall, Connecticut's tax bite went up from 4.5 to five percent. Confirm that your salary withholdings or estimated tax payments have kept pace with the state's appetite for your money. If you don't feed the beast enough prior to year's end, you will find yourself ponying up a penalty.
Stock-Market Gains
The mutual fund industry's troubles may mean big tax problems for you. Large-scale redemptions at many funds will likely cause portfolio re-balancing. Your portfolio's value may not be up as much as you like, but if the fund takes profits in your account you may find that you have long-term (stocks held longer than one year) or potentially short-term gains.
Check your fund notices carefully, they should come in November and early December. Selling a losing stock - even one on the rebound - may produce a better yield when factoring the tax benefits than a rising market. If you simply must own the stock, you can buy it back in 31 days.
Charitable Contributions
November and December is the time for giving, and your charitable deductions remain fully protected under the ATM.
Qualified Investment Plans
While you can set up and fund an IRA at any date until April 15, a qualified plan such as an SEP must be established before December 31, and it can still be funded until April 15, for the tax benefits for this year.
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