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Last-minute tax tips: are you ready for April 15?

Some shrewd tax planning right now can do at least three things for you: help make sure you don't pay more than required for 1992, improve your cash flow, and ultimately increase your net worth. The specific objectives of year-end tax planning are usually to have as much income as possible treated as either nontaxable or partially taxable and, if it is taxed, taxed as late as possible. This assumes no change in your marginal tax rates between this year and next year.

On the other hand, generally you want to include as deductions in your tax calculation as many expenditures as possible--and as early as possible, again assuming no rate changes.

After you determine (or estimate) the lowest tax, your payment strategy should defer any cash outflows as long as possible without incurring interest or penalties for late payment. Tax filing strategies that are too aggressive also can cost you penalties. The bottom line: Avoiding taxes is not illegal; evading them is. Judge Learned Hand once wrote, "Over and over again, the courts have said that there is nothing sinister in so arranging one's affairs as to keep taxes as low as possible."

YOUR DEFENSE

Exempting or Deferring Income--Arranging for your income to be exempt or taxed later is one possibility. The most common source of income exempt from federal income tax is state and local bond interest. With some municipal bonds and bond funds currently yielding at least as much as taxable funds, you may find your after-tax yield better with these investments for the remainder of 1992 and also early into 1993.

Remember, the yield comparison of taxable to tax-exempt bonds must take into account tax liabilities (including state taxes on out-of-state tax-exempt bonds). You may defer taxable income by purchasing certain certificates of deposit or U.S. government T-bills that mature after year-end. You can defer recognizing income on these investments until the following year. Also, if you have the ability, defer a year-end bonus or, if you're self-employed, defer billing for services. You'll push the associated tax liability to the next year.

Gains and Losses--If you're lucky enough to have an appreciated asset such as stock or business property, certain strategies can help defer the tax upon sale. With stock, you can sell "short-against-the-box," which is selling now borrowed shares that will be replaced later with shares you now own. So, you'll lock in the profit today but not recognize the gain until you deliver the securities to cover the sale.

With assets other than stock, you may be able to structure an installment sale. This treats the property as being sold over the period of years the sales proceeds are collected with a portion of the gain reflected in each future year. Installment sales may be particularly advantageous if capital gains rates drop in the future.

Although selling loss investments in 1992 seems appropriate, remember that net capital losses in excess of $3,000 will be carried forward and will not provide any current benefit.

Since investment interest expense is limited to net investment income (gross investment income less investment expenses other than interest), you may want to sell some investment assets at a gain so the two will offset.

Accelerating Your Deductions--When planning income and deductions timing, aside from rate changes, you must consider the limitations based on income levels. In 1992, limitations will start on personal exemptions for married/filing jointly taxpayers at adjusted gross income levels of $157,900 ($105,250 for singles) and at $105,250 for total itemized deductions for almost all filers. Therefore, to effectively plan, you have to look at more than one year at a time to determine whether bunching income or deductions in a given year will provide the biggest benefit.

For charitable deductions, consider this area as a way to generate deductions by timing the money you're giving. Many charities have fiscal year-ends. Therefore, each of their years includes two of your calendar years. So pick the best year to meet that pledge to your alma mater or other favorite cause. And note that making payment with a credit card before year-end is treated the same as using cash or a check.

Retirement Plants--Retirement plans can be thought of as both deductions and income-deferral mechanisms. Plans such as 401 (k) plans, Keogh or H.R. 10 plans, and IRAs allow you to reduce income currently as well as have the earnings on the assets in the plan accumulate tax free. These plans are very important elements of a long-term, wealth-building strategy, and you should maximize your contributions to them.

If you're in a retirement plan and ever in a serious cash bind, keep in mind two points. One, you can receive a distribution from your IRA and then roll over the proceeds to another IRA. You have 60 days to complete the transaction, so you in effect have a 60-day, interest-free loan. Second, if you expect a refund of taxes due to overwithholding or excess estimated payments, you can file your return in time to get your refund before funding an IRA or Keogh. Funding must occur on or before April 15 for IRAs and, for Keoghs, on or before the extended due date, which is usually August 15.

There are, however, two more things to consider when you receive an IRA distribution or when you delay contributions to your IRA or Keogh: the loss of earnings in the plans and the risk that the cash won't find its way to the plans. The cost of not making the 60-day rollover deadline will be tax plus interest and possible penalties.

Also, beyond taking advantage of your employer's 401 (k) plan, remember to make the most of any arrangements your company provides that benefits you with pre-tax dollars, such as cafeteria plans or flexible spending accounts.

AMT, the Other Tax--Since the increase in the alternative minimum tax (AMT) rate to 24 percent from 21 percent in 1991, more people find themselves subject to the tax. Determine whether it applies to you. Even if the AMT is greater than regular tax, it may be refundable (as minimum tax credit) in a future year when AMT is less than your regular tax in that year.

LOOK AT THE WHOLE PICTURE

Remember, you have to consider all of the above items--and others --for at least two years and coordinate them to get the smallest possible economic cost due to taxes (including the time value of money). Many tax accountants and taxpayers use tax planning software to calculate tax estimates for the current and subsequent year. Much of this software is reasonably priced and can be used by beginners. This allows you to run various scenarios with a minimum of pencil pushing and errors.

A final point: The withholding tables and rules for estimated tax payments were both changed for 1992. Be sure you're properly paid up through withholding (usually the best way) or estimated payments to avoid underpayment penalties. This area used to be simple, but now the old advice of paying in at least the same as last year may not work for some people.

Mr. Black is senior tax manager at Price Waterhouse's national office in New York, New York.
COPYRIGHT 1992 Financial Executives International
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1992, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Title Annotation:Viewpoint
Author:Black, Jay D.
Publication:Financial Executive
Date:Nov 1, 1992
Words:1204
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