Loading ...[Updated November 28, 2006]
As in prior years, you will want to push income into 2007 while using the remainder of 2006 to make charitable contributions, pay home mortgages, and pay miscellaneous deductions, such as investment fees or a retainer for legal services (i.e., the deduction that is allowed in 2006 saves total taxes between 2006 and 2007). To begin your planning, you will want (a) to coordinate tax planning with the review of your investments for tax loss harvesting or repositioning (see below) and (b) to review the alternative minimum tax (“AMT” – See below). When you pay the AMT, you lose the value of your deductions. Therefore, you need to reverse the general rule from above. To find out what steps to take, you need to create a projection for both 2006 and 2007 to minimize total taxes paid. Here are actions you should consider now to put income and deductions in the proper year for optimal impact:
- Take income out and push deductions into the year subject to the highest tax rate:
- To move income, defer salary and bonus not yet earned or delay collection of self-employed receivables. You can also buy treasuries or CDs to shift interest income into 2007.
- To move deductions, pay the balance of your state taxes or pay sales taxes on car purchases, pre-pay mortgage interest and real estate taxes, make charitable donations, pay job-related moving expenses or other non-reimbursed business expenses, and pay alimony by December 31. Note that gifts of autos to charities are limited to the amount for which the car was sold.
- Review your portfolio for tax loss harvesting. A short-term loss goes against short-term gains, with savings at your marginal rate. A long-term capital loss is worth only 15% against long-term gains. However, you can take losses in excess of gains of up to $3,000 against ordinary income.
- Bunch miscellaneous deductions (expenses for job hunting, tax preparation, investment, and safe deposit box, and unreimbursed business expenses) into a single year to increase the amount that exceeds 2% of adjusted gross income (or “AGI”), in order to be deductible. Also, do this in the year with the lower income, so the 2% threshold will be less so more is deducted. Do the same for medical expenses against their 7½% threshold.
- Contribute the maximum to (1) 401(k) plans, now $15,000 plus $5,000 for participants 50 or older, (2) employee stock purchase plans, (3) SIMPLES and Keoghs, and (4) IRAs (so long as the phase-out rules do not apply). See our August 2006 update on the pension law passed this summer for the limits on each plan.
- Review conversion to a Roth IRA if your AGI is $100,000 or less. You pay a tax now, but the later distributions from the Roth will be tax-free. (But see our June update on post-2009 conversions, when there is no cap.)
- Gift appreciated assets to a charity. You avoid tax on the gains yet still get a deduction for the full fair market value (as long as you are not giving to a private operating charity). See our August 2006 update for the tighter rules on charitable giving and for the rules on direct IRA distributions to charities.
- Review your withholdings and any estimated payments to avoid interest or penalties. The test for income over $150,000 is the lesser of 90% of the tax this year or 110% of the tax paid for 2005.
- File separate returns for children under age 18 because their income is otherwise included on your return, which affects both the 2% miscellaneous deduction threshold and phase-out of itemized deductions. Also, you may be able to have children deduct interest on student loans, contribute to a Coverdell educational IRA or use the Hope Education Credit or Learning Credit (but be sure the phase-out rules do not apply).
- Review home office expenses to see if you qualify for this deduction. The office use must be exclusively for administrative activities of the business, with no other fixed location in which these activities could be conducted.
- Review your flexible spending or cafeteria plans to be sure that you applied for and received all available funds and reimbursements. Also, review frequent flier accounts for benefits that will expire by year-end if not converted into tickets.
- Check for tax credits on hybrid vehicles or for energy-efficient home improvements.
- Use the “above-the-line” deduction available for tuition expenses.
- Caution, as noted above, if you are in the AMT, the general rule of deferring income and accelerating deductions may not apply and the reverse strategy may work. You might be in the AMT (1) if you had a large state income tax payment in January or April of this year for 2005 taxes, and will deduct this against much lower 2006 income, (2) if most of your income is from capital gains, or (3) if you exercised and held incentive stock options. Creating a tax projection will tell you.
Other Year-End Planning
First, review your investment allocation. Make sure you have a good allocation that includes small and mid cap stocks, as well as international stocks. Also, remember to combine your investing with tax sheltering when possible (i.e., the “tax loss harvesting” and 401(k), IRA and SEP contributions discussed above). With the dollar at risk for further declines, make sure you have a proper allocation to international investments.
Second, review your estate plan and gifting strategies, as the federal unified credit is $2 million. If you have not updated your estate plan for the state de-coupling from federal law, do so now.
Third, make sure you are paying the lowest rate on mortgages. Rates have gone up, but long-term rates have not moved as much as short-term rates.
Fourth, review your insurance needs. Life insurance should replace of earning capacity or meet liquidity needs. Disability insurance should be maximized. Liability insurance should include an umbrella policy equal to your net worth. You can also do a homestead declaration in many states to protect from a forced sale of your home.
Fifth, review your spending to make sure you are saving enough for retirement. As more baby boomers face retirement age, they are finding that they have spent to much on current consumption and need to work longer than their parents.