Certified Public Accountants & Consultants
Tax Planning Ideas (Updated 7/18/01)
On June 7, 2001 President Bush signed into law H.R. 1836, The Eonomic Growth and Tax Relief Reconciliation Act of 2001. Click here to read an in-depth analysis on this new law and the possible implications for your tax situation.
Tax planning is something to be considered throughout the entire year, not just when it comes time to file your return. Following are several good ideas:
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Consider your tax situation over a two year time period for both 2001 and 2002. This may allow you to trim your overall tax in both years by shifting income and deductions between years. Generally, your objective is to defer income and accelerate deductions. If you have minimal itemized deductions you may be able to "bunch" them in one year allowing itemized deductions in one year and a standard deduction in another year.
Some examples of what to do:
State and local taxes. Flexibility involves the prepayment of the January 2002 estimate of state and/or local taxes by December 31, 2001 so you can deduct it on your 2001 federal return. The same idea applies to real estate taxes actually billed to you in 2001 but not due till 2002.
Charitable contributions are deductible in the year you make the payment, not when you make the pledge. Also, you can deduct 14 cents per mile if you use your car for volunteer work to a charitable organization.
Interest expense. You may want to make your January 2002 mortgage payment in December 2001. But, be sure to allow enough time for the lender to include the interest payment on Form 1098.
Maximize your interest deductions by paying off credit cards, personal auto and other loans with money from a home equity loan. The interest on the home equity loan will generally be deductible whereas interest paid on credit cards and personal loans is not.
Medical deductions are limited to the amount that exceeds 7 1/2% of AGI. However, to the extent that some non-emergency expenses can be "timed" such as eye exams, glasses, and dental for example, you may be able to "bunch" these expenses into one year thereby enabling you to exceed the above limitation.
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Review your investments. Although tax strategies should not be the sole reason for selling investments it may be justified in certain cases. By realizing capital losses you can offset capital gains incurred during the year. Ideally, you would want to sell enough securities with losses to offset all capital gains plus an additional $3,000. The remaining $3,000 of capital losses can then be offset against other sources of income. Remember the holding period for securities begins with the trade date as opposed to the settlement date. The trade date also determines the year for reporting securities sold.
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If you are holding mutual funds that expect to pay large year end dividends consider selling the funds prior to the dividend record date. In effect, you will have converted the dividend which is taxed as ordinary income into capital gain income which can be taxed at a lower rate. If you sell a fund at a loss, be aware of the wash-sale rule if you then want to go back into the same fund which could prevent you from utilizing the loss.
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Be wary of buying mutual funds late in the year in any non-retirement account. If a fund is about to pay a dividend or capital gain, as most do near year end, you will end up reporting the income on your 2001 tax return even though your overall fund value remains the same. Check with the fund company before you buy to find out what the record dates and amounts of the distributions will be.
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If you are facing an underpayment tax penalty for failing to make sufficient estimated payments toward investment or other sources of income during the year, increase the amount of your employee W-2 withholding tax. In order to avoid underpayment penalties you need to prepay 90% of 2001 estimated tax or 100% of 2000 tax (or 110% if Adjusted Gross Income for 2000 was more than $150,000) in order to avoid a penalty. Estimated tax payments cannot be "made up" at year end (unless that is when the additional income was actually earned). However, employee withheld taxes are treated as being paid evenly throughout the year. Therefore, extra withholding late in the year can overcome prior underpayments.
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Use appreciated securities to make donations to charity. You can then deduct the full value of the securities (if held longer than a year) and avoid any income tax on the appreciation in value from the time you bought the securities. If you were to sell the securities first, you would be taxed on the capital gain and end up with less to give.
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Contribute to an IRA. If you participate in an employer retirement plan, the income ranges before phaseout of the deduction are higher this year. For singles: a full deduction is allowed if AGI is less than $33,000 and phases out as AGI nears $43,000. For marrieds: the phaseout range is $53,000 to 63,000. If only one spouse is covered by an employer plan, the income range is higher at $150,000 to $160,000 of AGI. There are no income limits if you are not covered by an employer plan, provided that is, you meet the other requirements such as sufficient earned income, under age 70 1/2 etc.
Contribute to a Roth IRA. While the contribution is not deductible, payouts will be tax and penalty free if taken more than five years after the account is opened and after age 59 1/2. The maximum contribution to a Roth is $2,000 per year and, like a regular IRA, there are phaseout ranges. For singles: the phaseout is AGI in the range of $95,000 to $110,000. For marrieds: the AGI phaseout range is $150,000 to $160,000.
Regular IRA’s can be converted to Roth IRA’s but any income from the conversion will be taxed this year.
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The deduction for education interest which is available even to non-itemized taxpayers increases to $2,500 for 2001 and thereafter.
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Transfer assets to family members with lower tax brackets to minimize income, gift and estate taxes. Investment income of children up to $1,400 is taxed at a lower rate while amounts in excess of this are taxed at the parents’ highest marginal rate. The child’s standard deduction will offset the first $700 of income while the next $700 is taxed at the only 15%.
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More self-employed individuals working out of their home will find it easier to qualify for a home office deduction in 1999 and thereafter. Those who regularly use their home for management or administrative tasks and have no other location where these functions are performed may now qualify for the home office deduction.
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If you operate your own business certain new business equipment purchases up to $24,000 can be written off as an expense for 2001 under IRS code sec. 179. Therefore, if you had planned to make capital asset purchases anyway, you may want to accelerate the purchase into 2001. However, the maximum expense deduction is reduced dollar for dollar by the cost amount of qualified property placed in service during the year in excess of $200,000. Other requirements and restrictions apply as well depending on the business entity type. We advise you to seek our guidance in this area first, however, as certain rules apply to these transactions.
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If your AGI is close to one of the phaseout ranges discussed in any of the above topics, consider selling investments that show a capital loss and are unlikely to recover soon so that you can lower the AGI amount. If you have children under age 14 with interest and dividends, file a separate return for the children rather than elect to report the children’s income on your return. This will also serve to reduce your AGI.
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Remember, the time for implementing tax planning strategies is before the end of the year. The above tax topics are intended only as a generalized overview of some of the tax planning stategies you can implement and should not be relied upon as an all encompassing analysis on the subject. Our staff is available to assist you with any questions or tax planning strategies. Call us if you wish to schedule an appointment.
