Eleventh-hour tax strategies.
As an anonymous pundit once said, "One thing about death and taxes -- death doesn't get worse every time Congress meets." And since Congress, at press time, had not yet met to take action on what may affect taxes next year, it's hard to know how much worse the tax situation might get. Gone are the days of deductions for interest on consumer debt, fully deductible IRAs -- and whatever else the Tax Reform Act of 1986 did away with. What else could happen? And how do you work your 1990 tax plan if you don't know what's going to happen in 1991?
It seems the American public is in a perpetual state of "intaxification" -- a year-round daze of trying to figure out what will happen to tax circumstances next, and then trying to figure out what to do about it.
This is the time of year that two inevitable things occur. One, people begin to scramble to make last-minute adjustments to yearly financial plans and, two, Congress scrambles to produce tangible evidence it really, really does take a $200 billion budget deficit seriously. And, although there's been talk all year about possible changes to the tax laws, the discussions typically reach their zenith in the fall, as the end of the year looms. This year, many financial professionals are convinced the tax laws will change.
"There are always bills before Congress," says John Hurlburt, a financial planner with Perimeter Financial Group in Atlanta. "And Congress always needs additional revenues. This year, in particular, it appears the deficit will be worse than has been publicly stated, plus Congress has to deal with the S&L crisis. Income rates may or may not be raised, but I believe something will definitely be done on the deduction side."
Tax tinkering may actually occur as late as November, long after Congress has prepared its fiscal 1991 budget. After all, once elections are over, tax changes (particularly the more unpopular ones such as raising income tax rates) are obviously easier for politicians to enact.
While no one -- not even the White House or Congressional committee members -- knows if new legislation will be the outcome in 1990, some much-discussed changes may be likely enough to warrant year-end "defensive" action on the part of taxpayers. The possible changes and general year-end strategies to help reduce your 1990 tax bite fall into several major categories.
Capital Gains and Losses
Many tax and financial experts believe Congress will lower the top capital gains tax rate from 28 percent to 20 percent. Others, however, believe this type of "break" is an unlikely scenario.
"This Congress is not in the mood to be giving breaks," says Dennis J. Sterk, a CPA with Sterk & Associates in Atlanta. "A capital gains tax rate is unquestionably viewed as a 'gimme' to the wealthy."
If you fall in with those who do anticipate a lowering, consider delaying the sale of significantly appreciated stock or real estate until Congress makes a decision. If the capital gains rate doesn't go down, you can avoid a big tax hit by giving an investment to charity. This kind of contribution can fulfill your desire to help your favorite charity and give you a tax break at the same time. Not only will you avoid paying taxes on the appreciated portion, but you will also get a deduction for the asset's full market value.
Bear in mind that you should not sell the stock and donate the proceeds. If so, you'll be cheating yourself out of a deduction, says Hurlburt. "Be sure your broker understands it's to be transferred to the charity, then sold."
The appreciation element in a gift of appreciated securities is a tax preference item for purposes of the alternative minimum tax period. The rules are complicated, so talk with your tax advisor about this problem.
If, on the other hand, your securities have gone down in value, you can't donate them and claim a capital loss. Sell first, then give the proceeds. If giving money after a loss in the market is not in your plans, remember that you can sell your stock at a loss, wait 30 days, buy it again, and still claim a loss.
Children and Grandchildren
If you have children or grandchildren over 14 years old, consider transferring money to them to be set aside for college. For children under 14, unearned income greater than $1,000 is taxed at the parents' rate. But once that magic age is passed, interest, dividends or capital gains are taxed at the child's rate, typically 15 percent.
The law allows you to make as many tax-free gifts to children or grandchildren as you want, as long as they're no greater than $10,000 each (to a maximum of $600,000, the top exemption for gift and estate taxes). If you shift money or property to your children in the last couple of months of the year, you will get the benefit of removing it from your income. But the biggest advantage in this tax-saving technique comes with implementing it as early in the year as possible. This is especially true if you give your heirs an interest- or dividend-bearing asset. In 1991, do this in january; otherwise, the longer you put this off, the more taxable interest you earn.
One last point to keep in mind about transferring money: Once children turn 18 years old, they have legal control over assets placed in their names and have the right to use the money as they choose.
Another tax-wise way to save for a child's education is with good old savings bonds, particularly Ee bonds. These simple investments are free from state and local taxes, and interest on EE bonds purchased this year is now free of federal tax if used for higher education expenses. The interest exemption does phase out for married couples filing joint returns with an adjusted gross income of $60,000-$90,000 and for single individuals with an adjusted gross income of $40,000-$55,000.
Income and Expense Timing
Your strategy in this area depends partly on what Congress does in the waning months of 1990. But even if the changes affecting 1990 returns aren't enacted until the last minute, you can still take some last-minute steps to respond.
If personal income tax rates are slated to rise in 1991, accelerate as much income as possible into this year. If you're self-employed or a small-business owner, for example, do some aggressive year-end invoicing and collections. At the same time, defer whatever expenses and deductions you can into 1991, to help offset higher rates.
If the opposite scenario is true for 1991 (lower rates), defer income until January and step up expenses in December. For example, prepay your January mortgage, office rent or other fixed expenses; pay January state income taxes in December. (A word of caution: When you receive your mortgage statement in January, check it carefully to make sure you were credited with your 13th payment.) Finally, go ahead and make your planned 1991 charitable contributions before December 31.
One additional factor may affect your deductions: 1990 is the last year you can deduct any consumer debt, and in this phase-out year it's only 10 percent. So if you still have interest charges from credit card companies, consider a home-equity loan to consolidate bills and get a tax deduction. Unlike "regular" consumer interest, interest on a home-equity loan of up to $100,000 is still fully deductible. But remember, this is not "easy money" -- you are putting up your home, so don't use the loan for a spending spree.
If you work for a company that matches your contributions to a 401(k) plan, by all means make the maximum contribution (just under $8,000 for 1990) into your plan. Although you have selected a percentage or dollar amount to be withheld year-round, many companies will let you increase your amount for the last couple of months.
Similarly, individuals with self-employment income should fund their Keogh or Simplified Employer Pension (SEP) plan to the maximum. "This is one of the biggest tax breaks around for self-employed people," says Sterk. "Even if you do nothing but establish the plan by December 31 and wait until filing deadlines, including all extensions, to actually fund it, you'll get that deduction for this year."
Don't forget your IRA either. As it is now, married couples with no employer pension plans who file a joint tax return and who have an adjusted gross income of less than $40,000 can still fully deduct IRAs; those filing single returns, with an adjusted gross income of less than $25,000 may also take a full deduction. A phase out ($.50 on the dollar) is allowed for those with adjusted gross incomes between $40,000-$50,000 (married) and $25,000-$35,000 (single) -- again, only if such taxpayers are not covered by employer pensions.
Many tax experts and consumers alike believe Congress will expand the deductibility of the popular IRA sooner or later. The fully deductible IRA, taken away with the Tax Reform Act of 1986, may never resurface. It is important to note that anyone can purchase an IRA of up to $2,000; while the purchase price is not tax deductible, the interest earned on it is not taxed, rather it is tax deferred. You have until April 15 to fund your IRA, but the sooner the better -- the difference in tax-deferred earnings funded earlier vs. later becomes very substantial after 10 to 15 years.
Finally, advisors suggest that as you consider your last-minute moves, try to keep things in perspective.
"Don't let taxes overwhelm you," says Hurlburt. "And remember that 'saving' tax dollars usually means spending money or losing money, so don't go after the elusive 'tax savings animal' without carefully considering the underlying economics. In other words, ask yourself why you are really doing what you're doing. It has to make sense for you."
And one final thought advisors stress: There is no such thing as year-end tax planning; it's year-round tax planning. "Ideally, you should be meeting with your CPA in December to work on next year," says Sterk. "So if you're making adjustments to your financial plan for 1990 in December, just keep in that mind frame and continue into 1991. And pay attention to what Congress does!"
Shelley A. Lee is a freelance business and financial writer based in Atlanta. She is a contributing editor to Business Atlanta magazine and has written for American Medical Association News and Financial Strategies magazines.
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|Author:||Lee, Shelley A.|
|Date:||Nov 1, 1990|
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