Year-end tax planning (part 2).
The basic strategy is to time your income so it will be taxed at a lower rate, and to time your deductible expenses so they may be claimed in years when you are in a higher tax bracket. In terms of investment planning, investing in capital assets may increase your ability to time the recognition of some of your income and may help you take advantage of tax rates that are lower than the ordinary income tax rates. You have the flexibility to control when you recognize the income or loss on many types of investment assets. In most cases, you determine when to sell your capital assets. In some cases, however, shifting potential capital gain income to other taxpayers through gifting may be an appropriate strategy.
Plan Capital Gain and Loss Status
Capital gains and losses are accorded special tax treatment. Currently, the top long-term capital gains tax rate is 15% (for most types of assets), while the top ordinary income tax rate is 35%, a difference of 20%. As a consequence, by converting some of your ordinary income to long-term capital gains income, it may be possible for you to reduce your federal income tax liability.
Caution: Under the Jobs and Growth Tax Relief Reconciliation Act of 2003 (2003 Tax Act) and the Tax Increase Prevention and Reconciliation Act of 2005, long-term capital gains tax rates are 15% for taxpayers in brackets higher than 15%, and 0% (in 2008-2010) for taxpayers in the 15 or 10% tax brackets. Prior to May 6,2003, long-term capital gains tax rates were 20 and 10%, respectively. Beginning in 2011, long-term capital gains tax rates will revert to these pre-2003 Tax Act levels.
Careful timing of when you sell capital assets may help reduce your federal income-tax liability.
For example, if it's late in the year and you want to sell a capital asset, you can wait until January so you realize your capital gain or loss next year (assuming you have a calendar tax year). This strategy is particularly useful if you are in a higher marginal tax bracket in the current year and expect to be in a lower one in the following year. Timing can also be important because capital-gain income increases your adjusted gross income (AGI). Itemized deductions and personal exemptions may be phased out or decreased if your AGI in a given year exceeds a specified threshold.
Planning the time when you recognize capital losses may also be important. If you expect to recognize a capital gain this year, you should review your portfolio for possible capital losses that can be used to offset the gains. If you have any capital loss carry-forwards, review your portfolio for capital-gain opportunities to make use of such carry-forwards. In general, net capital losses are deductible dollar-for-dollar against net capital gains. Excess losses are allowed to offset up to $3,000 ($1,500 for individuals filing married-filing-separate tax returns) of ordinary income per year. Losses above the limit may be carried forward indefinitely.
The following strategies may be appropriate:
* Sell capital-gain property before the end of the year if your capital losses for the year exceed the sum of any capital gains you have realized plus $3,000 ($1,500 for individuals filing married filing separate tax returns).
* If your gains for the year exceed your losses, sell property with built-in losses to offset the excess gains.
* If your other allowable deductions for the year exceed your income, you should, to the extent possible, avoid realizing any further capital losses for the year.
* If you've held a capital asset for close to 12 months and want to sell it, wait a while (if possible). You can take advantage of the lower long-term capital gains rates if you hold the asset for more than 12 months before selling it.
Selecting Investments That Control Income
You can select investments likely to produce ordinary income such as interest, or income that is taxed at reduced rates (certain qualifying dividends or long-term capital gains). You can also choose those likely to produce ordinary or capital losses. You can control when your investment earnings are taxed, bearing in mind that income distributions are generally not taxed until you receive them (assuming you use the cash method of accounting). By knowing the tax rules, you can lower your taxes.
What About Shifting Income?
It maybe possible to shift potential capital gains to other taxpayers through gifts. If you are in a 25% or higher individual marginal tax bracket, the 0% long-term capital gains tax rate for those in the 10 or 15% bracket (in 2008 through 2010) may provide an incentive for you to transfer appreciated assets to relatives in those lower tax brackets.
Accelerating Deductions/Postponing Income
If you'd be in a lower tax bracket next year, you may wish to accelerate your deductions into this year and postpone your income into the following year.
You can accelerate your deductions into this year by:
* Making next year's charitable contributions this year instead
* Prepaying deductible interest
* Paying estimated tax installments in December instead of January
* Accelerating capital losses
* Taking advantage of flexible spending accounts, Archer MSAs, and cafeteria plans
* Making January's alimony payment in December
* Prepaying next spring's college costs in December (if it qualifies you for education tax credits)
Higher Tax Bracket to Lower One
You can postpone your income into the following year by:
* Delaying the collection of any debts you are owed
* Deferring compensation
* Deferring year-end bonuses
* Delaying the exercise of incentive stock options (ISOs)
* Transferring funds to bank certificates and Treasury bills in order to delay tax on the interest
* Setting up a tax-deferred annuity or retirement account
* Deferring the sale of capital gain property or taking installment payments rather than a lump-sum payment
* Postponing receipt of distributions that are over the required minimum from retirement accounts
* Increasing your contributions to your company's 401 (k) plan or other tax-deferred plans
If you'll be in a higher tax bracket next year, you may wish to accelerate your income into this year and postpone your deductions into the following year.
Accelerating Income/Postponing Deductions
Accelerate your income into this year by:
* Collecting any debts you are owed
* Taking distributions from your IRA or retirement plan if you will not incur an early-withdrawal penalty
* Collecting accounts receivable if you're self-employed and use the cash method of accounting
* Arranging to receive dividends
* Settling lawsuits, insurance claims, etc.
* Selling any assets that would result in a capital gain
* Redeeming any Series EE savings bonds (also called Patriot bonds) on which you have elected to defer taxes until they are redeemed
* Converting a traditional IRA to a Roth IRA
* Lower Tax Bracket to Higher One
Postpone your deductions by:
* Postponing charitable gifts
* Paying December's deductible expenses on January 1
* Delaying the payment of deductible interest
* Scheduling non-emergency dental and doctor's visits for the following year
* Delaying the realization of deductible capital losses
This information was developed by Forefield, Inc., an independent third party. It is general in nature, is not a complete statement of all information necessary for making an investment decision, and is not a recommendation or a solicitation to buy or sell any security. Investments and strategies mentioned may not be suitable for all investors. Past performance may not be indicative of future results. Raymond James & Associates, Inc. does not provide advice on tax, legal, or mortgage issues. These matters should be discussed with an appropriate professional.
Contact: Dan Jones at Dan.Jones@RaymondJames.com/www.RaymondJames.com/DanJones/800-657-8969/610-771-0316.
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|Title Annotation:||MONEY talks|
|Author:||Jones, Daniel C.|
|Publication:||PN - Paraplegia News|
|Date:||Dec 1, 2010|
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