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Year End Tax Planning Legal Tax Angles: How to Save Taxes Without Going to Jail Before 1986, it was possible (although not often worth while) to buy an investment that was structured to provide maximum tax deductions and credits in the year of purchase. At the end of each year, there was a mad flurry of activity by high income taxpayers to buy some of these tax shelters. In many (perhaps most) cases, there was little or no serious due diligence about the merits of the investment. The only thing the taxpayer wanted to know was, “What’s the write-off?” I hate to admit that the government did anything sensible, but they may have accidentally helped some taxpayers to avoid putting their money into stupid investments just to save some taxes. The few “tax shelters” that are left provide little help if purchased late in the year. If you start early in the year, there are some ongoing tax benefits available from rental real estate investments, from certain oil or gas investments and from low income housing investments. In addition, it’s very difficult to generalize about year end tax planning because ideas that help one taxpayer could backfire on other taxpayers. What is useful depends on the specifics of each family, the source and type of income, whether they own a home or any rental realty, whether they have unrealized capital gains or losses, etc. etc. An exhaustive discussion of some of the things that can be done late in the year to reduce your taxes would be almost as extensive as a complete checklist of tax avoidance methods. You might therefore want to take another look at the checklist at http://www.offshorepress.com/vkjcpa/checklist.htm to see if there are any ideas in that checklist that might be applicable in your situation. It’s my opinion (after about 35 years of helping people to save taxes) that tax planning is best done all year long. But for those who procrastinate, it’s better to do something late in the year than to wait until the year is over. Among other issues, each dollar of federal tax that you can defer to next year will most likely also result in the deferral of another dollar for estimated taxes and some deferral of state income taxes. When I say “do something” I do not mean throwing good money into something that is worthless just to defer taxes. However, for long term tax savings, you must continue to make these same expenditures at the end of each year in order to avoid having the tax benefit for this year turn into higher taxes next year or the year after. Having made that caveat, the basic choices near the end of the year are to (1) defer income, (2) accelerate deductions and credits, (3) make exempt gifts. Most taxpayers are not able to control when they receive their income. And it’s always better to have a “bird in the hand” than to defer income if there is any risk that such deferral could cause a loss of the income. In addition, having the income now should make it possible to make some money by investing what is received. The self employed who are on a cash method of accounting probably have maximum flexibility in terms of delaying the receipt of income. Investors with unrealized gains can choose to take the gains this year or to gamble on what the price will be next year. Investors with unrealized losses should seriously consider selling the loss securities this year in order to generate an offset against any realized gains or to generate a deduction of up to $3,000 against other forms of income. In some cases, investors may be able to defer income from the sale of property with an installment sale. If real estate is involved, a tax deferred exchange may be worthwhile. In the right circumstances, a contribution to a charitable remainder trust in exchange for a deferred (future) retirement income could also generate a small tax deduction this year. Taxpayers who own a
taxable corporation may be able to get the best mix of tax rates by adjusting
their salary or bonus at the end of the year. With the new tax law, it may be
possible to pull some money out the corporation as a dividend at a maximum
federal rate of 15%, but it will be necessary to also pay dividends to any
other stockholders. For some small corporations, a contribution to a corporate
retirement plan will produce a deduction for the corporation and won’t result
in current taxes for the owner-employee. However, other employees of the
corporation may have to be included in plan contributions. Owners of taxable
corporatons with a medical expense reimbursement plan should be sure that all
reimbursable expenses are reimbursed in the year they are paid by the
owner-employee. Taxpayers who own S corporations may want to talk with their local tax preparer to be sure they have enough investment in the company to utilize any losses that may arise. Lately, some business owners are asking about being able to get a tax write off of up to $100,000 for the purchase of business equipment that qualifies for the immediate write off under tax code section 179. Hopefully, these business owners won’t be buying equipment they don’t need just because it provides a tax deduction. However, if you are going to start or to expand a business in the next few months, it would help you to save some taxes by buying any deductible equipment this year. (Your deduction may be limited by the date the equipment is “placed in service”.) If you will have to spend some money on something that is deductible, it certainly makes sense (most of the time) to do it this year rather than early next year. Assuming that you will itemize your deductions, you might want to make extra charitable deductions this year and you would benefit (in states with an income tax) by making your last estimated tax payment before the end of the year. You might also be able to benefit from making any state or local property tax payments at the end of the year instead of paying part of it the following year. Taxpayers who are concerned about saving for college (for their children) should look into the tax code section 529 plans in their state to see if there is a benefit from making a contribution to that plan before the year is over. Another option is to make gifts of appreciated assets to children who are college bound. Even though the federal tax rate on long term gains is now just 15%, the rate can often be reduced to zero percent when the assets are sold by low income taxpayers – like children over the age of 13. For high net worth
taxpayers, any gifts that they want to make need to be made before the end of
the year in order to utilize the annual exemption of $11,000 per recipient.
Married couples can make exempt gifts of up to $22,000 per recipient. One type of deduction
that doesn't have to be made until the date that you actually file your tax
return is the IRA contribution. But if you are self employed and want to
contribute to a SEP-IRA or a Keogh plan, you will need to establish the plan
before the end of the year. If you are receiving
social security benefits and are close to the threshhold for having 50% or 85%
of your social security benefits treated as taxable income, there may be
some value in finding ways to defer other income so that the social security
benefits will be tax free. If you are an employee
who incurs business travel expenses, try to arrange for a reimbursement of
your actual costs before the end of the year. Otherwise, a substantial part
of your business expenses may not be deductible. If you are an employee
and participate in a 401(k) plan, ask your employer if you can increase your
contribution for any of your December, 2003 pay checks or bonuses. If you are
not making hte maximum contribution allowed by your plan, you should be able to
increase it for the balance of this tax year. If you expect that you will owe some taxes when your file your 2003 return, and if you have wages that are subject to withholding, you can reduce any penalties for an underpayment of estimated taxes by increasing your withholding late in 2003. I could probably continue for quite a while, but each year end tax avoidance alternative is dependent on the business, investment and family situation of each taxpayer. Serious planning therefore requires help from someone who knows the tax law and who also has an intimate understanding of your family’s financial and tax situation. Vern Jacobs
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Books and Services by Vern Jacobs
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