End Tax Saving Ideas for Individuals

There are a number of steps you might take by year-end to cut your 2006 tax bill, such as deferring income, accelerating deductions and capital gain planning.

Caution: If you expect to be subject to the alternative minimum tax (AMT), you may want to accelerate income and delay deductions.

Deferring Income

• If you are planning on selling an investment on which you have a gain, it may be best to wait until after the end of the year to defer payment of the taxes for another year (subject to estimated tax requirements).
• If you are due a bonus at year-end, you may be able to defer receipt of these funds until January. This can defer the payment of taxes (other than the portion withheld) for another year. Deferral of tax generally won’t work where the bonus is contractually due in 2006.
• if your company grants stock options, it may be wise to wait until next year to exercise the option or sell stock acquired by exercise of an option. Exercise of the option is often but not always a taxable event; sale of the stock is almost always a taxable event.
• If you're self employed, and can afford the delay in cash inflow, defer sending invoices or bills to clients or customers until the end of December.

Caution: Keep an eye on the estimated tax requirements.

Accelerating Deductions

• Pay a state estimated tax installment in December instead of at the January due date. However, the payment should be based on a reasonable estimate of your state tax.
• Pay your entire property tax bill, including installments due in year 2007, by year-end (not applicable to mortgage escrow accounts).
• Try to bunch “threshold” expenses, such as medical expenses and miscellaneous itemized deductions. (Threshold expenses are deductible only to the extent they exceed a certain percentage of adjusted gross income.) By bunching these expenses into one year, rather than spreading them out over two years, you have a better chance of exceeding the thresholds, thereby maximizing your deduction. For example, you might pay medical bills and dues and subscriptions in whichever year they would do you the most tax good.
• Bunching of large purchases subject to state sales tax may in your case yield a deduction larger than for state income tax. Since this sales tax deduction is scheduled to end in 2006, consider buying, this year, taxed items you might otherwise put off until 2007.

Caution: Credit cards charges are considered paid in the year of the charge regardless of when you pay on the card.

Caution: It can be wise to put off into early 2007 certain energy-saving purchases. Tax credits become available then for many residence-related outlays-and alternative power vehicles.

In the case of tax benefits that are phased out if you have more than a certain level of adjusted gross income (AGI), a strategy of deferring income and accelerating deductions may also allow you to claim larger deductions, credits, and other tax breaks for 2006. The latter benefits include Roth IRA contributions, conversions of regular IRAs to Roth IRAs, child credits, higher education tax credits and deductions for student loan interest.

TIP: Deferring income into 2007 is an especially good idea for taxpayers who anticipate being in a lower tax bracket next year, generally because of much-reduced income or much-increased deductible expenses.

TIP: It may pay to accelerate income into 2006 if your marginal tax rate is much lower this year than it will be next year.

TIP: If you have a sum of income coming in that is not covered by withholding taxes, increasing your withholding before year-end can avoid or reduce any estimated tax penalty that might otherwise be due. On the other hand, the penalty could be avoided by covering the extra tax in your final estimated tax payment and computing the penalty using the annualized income method. See which your adviser prefers.

Caution: Do not overlook the effect of any year-end planning moves on the alternative minimum tax (AMT) for 2006. Items that may affect the AMT include the deductions for state property taxes and state income taxes, miscellaneous itemized deductions, and personal exemptions.

Make charitable contributions. You can donate property as well as money to a charity. A deduction is usually available for the fair market value of the property. However, for certain property, the deduction is limited to your cost basis. While you can also donate your services to charity, you may not deduct the value of these services. You may also be able to deduct charity-related travel expenses and some out-of- pocket expenses.

TIP: Contributions of appreciated property (i.e. stock) provide an additional benefit in that you avoid paying capital gains on any profit.

Minimize taxes on investments by judicious matching of gains and losses. Where appropriate, try to avoid short-term gains, which are usually taxed at a much higher tax rate (up to 35%) than long-term gains (15%). You might consider, where feasible, trying to reduce all capital gains and generate short-term capital losses up to $3,000.

TIP: If you have a large capital gain this year, consider selling an investment on which you have an accumulated loss. Capital losses are deductible up to the amount of your capital gains plus $3,000.

TIP: After selling securities investment to generate a capital loss, you can repurchase it after 30 days. (If you buy it back within 30 days, the loss will be disallowed.) Or you can immediately repurchase a similar (but not the same) investment, e.g., another mutual fund with the same objectives as the one you sold.

TIP: If you have losses, you might consider selling securities at a gain and then immediately repurchasing them, since the 30-day rule does not apply to gains. That way, your gain will be tax-free, your original investment is restored and you have a higher cost basis for your new investment (i.e., any future gain will be lower). Mutual Fund Investors

Before investing in a mutual fund, determine whether there will be a dividend at the end of the year or a dividend that will occur early in the next year but be deemed paid this year. The year-end dividend could make a substantial difference in the tax you pay.

Example: You invest $20,000 in a mutual fund at the end of 2006. You opt for automatic reinvestment of dividends. In late December of 2006, the fund pays a $1,000 dividend on the shares you bought. The $1,000 is automatically reinvested.

Result: You must pay tax on the $1,000 dividend. You will have to take funds from another source to pay that tax because of the automatic reinvestment feature. The mutual fund’s long-term capital gains pass through to you as capital gains dividends taxed at long-term rates, however long or short your holding period.

The mutual fund’s distributions to you of dividends it receives generally qualify for the same tax relief as long-term capital gains. If the mutual fund passes through its short-term capital gains, these will be reported to you as “ordinary dividends” that don’t qualify for

TIP: Wait until after the dividend to buy the shares. (The share net asset value will drop after the dividend is paid.) Alternatively, buy the shares in 2006, but opt to take the dividend in cash instead of having it reinvested. relief.

In spite of these tax consequences, it may be a good idea to buy shares right before the fund goes ex-dividend. For instance, the distribution could be relatively small, with only minor tax consequences. Or the market could be moving up, with share prices expected to be higher after the ex-dividend date.

TIP: To find out a fund's ex-dividend date, call the fund directly.

For many, sound estate planning begins with lifetime gifts to family members, gifts which reduce the donor’s assets subject to future estate tax. Such gifts are often made at year-end, in the holiday season, in ways that qualify for exemption from federal gift tax.

Your gifts to any donee are excludable (exempt) from gift tax up to $12,000 a year per donee.

Caution: An unused annual exemption doesn’t carry over to later years. To make use of the exemption for 2006, you must make your gift by December 31.

Husband-wife joint gifts to any third person are exempt from gift tax up to $24,000 ($12,000 each). Though what’s given may come from either you or your spouse or from both of you, both of you must consent to such “split gifts”.

Gifts of “future interests”—assets which the donee can only enjoy at some future time (certain gifts in trust, for example)—generally don’t qualify for exemption. But gifts for the benefit of a minor child can be made to qualify.

TIP: Consider adopting a plan of lifetime giving to reduce future estate tax.

Cash or publicly traded securities raise the fewest problems. You may choose to give property you expect to increase substantially in value later. Shifting future appreciation to your heirs keeps that value out of your estate. But this can trigger IRS questions about the gift’s true value when given.

You may choose to give property that has already appreciated. The idea here is that the donee, not you, will realize and pay income tax on future earnings, and built-in gain on sale.

Gift tax returns for 2006 are due the same date, April 15, 2007, as your income tax return. Returns are required for gifts over $12,000 (including husband-wife split gifts totaling more than $12,000) and gifts of future interests. Though you are not required to file if your gifts do not exceed $12,000, you might consider filing anyway as a tactical move to block a future IRS challenge about gifts not “adequately disclosed.”

TIP: Consult your tax advisor if you’re considering making a gift of property whose value isn’t unquestionably less than $12,000. Income earned on investments you give to children or other family members is generally taxed to them, not to you. In the case of dividends paid on stock given to your children, they may qualify for the reduced 5% dividend rate.

Caution: Investment income of a child under age 18 is taxed at the parent’s top rate, where in excess of $1,700. Other Year-End Moves

Retirement Plan Contributions. Maximize retirement plan contributions. If you own an incorporated or unincorporated business, consider setting up a retirement plan if you don’t already have one. (It need not be actually funded until you pay your taxes, but allowable contributions will be deductible on this year's return.) If you are an employee and your employer has a 401(k), contribute the maximum amount ($15,000 for 2006, plus an additional $5,000 if age 50 or over, assuming the plan allows this much and income restrictions don't apply). If you are employed or self-employed with no retirement plan, you can make a deductible contribution of up to $4,000 a year to a traditional IRA (deduction is sometimes allowed even if you have a plan).

Health Savings Accounts. Consider setting up a health savings account (HSA). You can deduct contributions to the account, investment earnings are tax-deferred until withdrawn, and amounts you withdraw are tax-free when used to pay medical bills. In effect, medical expenses paid from the account are deductible from the first dollar (unlike the usual rule limiting such deductions to the excess over 7½% of AGI). For amounts withdrawn at age 65 or later, and not used for medical bills, the HSA functions much like an IRA.

To be eligible, you must have high-deductible health insurance (and only such insurance, subject to numerous exceptions), and must not be enrolled in Medicare.

Summary: These are just a few of the steps you might take. Contact your professional advisor for help in implementing these or other year-end planning strategies that might be suitable to your particular situation.

Judee Slack
CURRICULUM VITAE

Judee Slack is a professional advisor in all areas of small business services, personal & financial strategies and resolution of any type of tax related problem. She has been providing these services in the Orange County, CA area since 1979.

Judee has been assisting small business owners with QuickBooks support since the mid-1990’s and has been a QuickBooks Certified Professional Advisor since 1999. In 2000, she developed this training class designed to help the small business owner understand, maintain and control the financial health of his/her business through QuickBooks.

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