Year End Tax Strategies Part 2 of 2

OTHER TAX SAVING IDEAS FOR INVESTORS

These ideas are not tax deferral strategies, and will generally result in permanent tax savings.

• Donate appreciated securities or property to a charity Instead of making a cash gift to a church or charity, check your portfolio to see if you have some appreciated securities that are worth as much as the planned contribution. The greater the portion of untaxed gains, the better. Give the securities to the church or charity. If you still want to maintain a position in that security, you can buy back identical securities without any time limit. The “wash sale” rule does not apply in this case.

• Document the time securities become worthless The best way is to sell the stock, note or other asset to someone else for $1 or some other nominal amount. The tax law only permits a deduction for worthless securities in the tax year they become worthless.

• Deduct Investment related Interest Investment interest expense is fully deductible to the extent of any investment income, including short-term capital gains. Note that taking losses on your capital gains may work against you being able to deduct all of your investment interest expense in the same year.

• Check tax shelter status before the year is over Losses on tax shelters that have not been allowed as deductions are only suspended. You can deduct those expenses when you dispose of your interest in the tax shelter. One way to unload a tax shelter is to sell it back to the general partner. You may only get a few cents on the dollar, but at least you get to salvage some tax benefits.

• Claim Rental Home expenses Do you have a rental home that you sometimes use as a vacation home? If the personal use of the property is more than 14 days (or more than 10% of the rental days), then it is not treated as investment property and you can deduct all of the interest on the mortgage loan.
In some cases, it might be best to have a second home instead of a rental property. However, if the property is investment property, you get to deduct the depreciation, interest and operating expenses - up to $25,000 in excess of any net income from this and any other rental property. However, that deduction may not be fully allowed if your adjusted gross income exceeds $110,000.

TAX DEFERRAL IDEAS - PERSONAL

There are some additional tax deferral strategies that are not directly related to specific investments. Here are a few that should be useful to almost everyone.

• Pay estimated state income taxes this year Many states allow you to pay some of your estimated taxes in January of the next year but they will not return your check if you send in the payment in December of the current tax year.
It is not a “big deal” but you might as well get the deduction a year earlier.

• Shift medical expenses to the lowest income year You can only deduct un-reimbursed medical expenses in excess of 7.5% of your adjusted gross income (AGI). It stands to reason that your will get a bigger tax benefit if more of these deductions are claimed in tax years when your AGI is smaller. Some cosmetic dental work and other non-essential medical care can be paid for in the year when the deduction is worth the most.

• Prepay charitable contributions You still cannot make a profit by giving away money to a charity, but if you have made some charitable commitments, you can make some of next year’s contributions this year in order to shift some taxes to next year.

INCOME SHIFTING IDEAS

Shifting taxable income from the current year to the following year is simply putting off the eventual tax. However, if you can shift income to a dependent that is in a lower bracket, you will enjoy permanent tax savings. This tactic is best suited for providing income to dependent children in college or to dependent parents. Here are a few ways you can still divert the income, and the income tax, to a dependent.

• Gifts of appreciated capital gain property Suppose you own some stock that cost you $1,000 and it is now worth $11,000. You are looking at paying a tax of up to 15% on $10,000. By giving the stock to a dependent parent, the parent would get up to $6,700 of minimum standard deductions and personal exemptions and would owe a tax of only 10% of $3,300.
There is little advantage in using this tactic with children under the age of 18 because of the "kiddie" tax, but it still works for older dependent children.

• Reorganize as a S corporation business entity If your primary source of income is from a business, consider setting up a spin off part of your business and organize it as a family limited partnership or as an S corporation. Then give shares of a family partnership or S corporation to your dependent children over age 13 or to dependent parents.
The income from the business will be taxed to them, but you can control how much cash is distributed each year. This tactic works better when the business is in existence all year long, but a creative business owner could probably find some legal ways to shift some business profits to the new entity late in the year.

PENSION ROLL OVER VERSUS THE LUMP SUM TAX

If you are eligible for a pension distribution, does it make any difference if you take the distribution in this year or next? Generally, a future taxable distribution would be better if only because it gives you an extra twelve months before you have to pay the tax. It will also reduce the amount of minimum estimated taxes you have to pay to avoid penalties.

However, if you have a choice between a lump sum distribution and an IRA rollover, the rollover should be seriously considered unless you have an immediate need for most of the money from the pension plan.

Do not forget that you only have 60 days to make the rollover to an IRA account after you receive the money from your pension plan. There is no reason to wait until the next year to make the roll over, even if it would be within the 60 days.

If this is a year when you will have excess deductions and if you are over age 59.5, consider taking some distributions from your pension plan or IRA account this year. Anytime you can make a withdrawal that will be tax free, do it. In fact, if you can make a withdrawal at a 15% tax rate, it would be worth considering unless you expect to have no other taxable income when you retire.

GET MORE TAX SAVING IDEAS FROM YOUR TAX PREPARER

A common complaint of investors is that “My tax preparer never gives me any ideas to help me reduce my taxes.” There is a good reason. Tax preparation is not the same as tax planning. Contrary to popular misconception, your tax preparer cannot just “whip up” a few new tax tips for you every year as a free bonus.

First, you may not be aware that many public accountants regard personal tax preparation work as a “loss leader.” Because the public does not understand the difference in what they get at mass production tax services and what they get from an experienced tax professional, the public views tax preparation services as a price competitive service.

Many public accountants only do tax work for clients for whom they do other, more profitable work, such as accounting or auditing services. They often discourage this type of work from other taxpayers, but they feel obliged to charge everyone the same fees. If you want your tax preparer to give you tax saving ideas, ask them to write you a letter after they prepare your tax return, and offer to pay for it. Discuss it in advance and agree on what the fee will be.

Second, finding legal strategies to save taxes can be very time consuming. It is not the sort of thing where you can pick up a few good ideas without looking for them. In addition, conscientious professionals will take the time to be sure they understand the idea before they adopt it. If they recommend it, they will likely have to sign off on it on the tax return. Finding these ideas requires an investment of time and money by the accountant or financial advisor.

Of course, a tax preparer can learn about some tax saving ideas by subscribing to newsletters or various tax services that are designed for professionals. They can also gather ideas from tax conferences or seminars, but that does not mean they will remember these ideas at the time they are concentrating on your tax return, or that those particular ideas will fit your situation.

You can either pay your tax preparer to spend time looking for tax saving ideas (which is likely to be very expensive) or you can subscribe to newsletters, and then ask your tax preparer if some of the ideas would be suited to your situation.

A third reason why many tax preparers do not offer tax saving ideas to their clients is because it takes extra time. On simple returns, it could take as much time to prepare a tax strategy checklist as to prepare the return. Think about how long it would take a tax preparer to go through a checklist of 120 tax saving ideas for investors to determine applicability. Such a checklist is 40 pages, single-spaced. It takes at least an hour to just review it. If you want that type of service, offer to pay for it, but set a limit on how much you are willing to pay.

Fourth, there are some tax preparers who feel their job is to simply prepare your return, according to the instructions provided by the IRS. Tax preparation focuses on the past and on rules that are reasonably clear. Tax planning focuses on the future and can be affected by future changes in the law. Your preparer may not be comfortable with trying to be a financial planner. In that case, either you need to get another tax preparer or you should find a financial planner with a strong tax background to do the planning for you.

A fifth reason why tax preparers may not offer tax saving ideas is that many tax returns are done by preparers who have very little experience. The preparers who work for the mass production tax services are often paid minimum wage and have not done this work for more than a few weeks. (The turnover is enormous.) The more experienced tax professionals are often preoccupied with clients who retain the firm for a variety of other tasks, such as auditing or monthly accounting. The solution is to find out in advance just who will be doing the return, how much experience that person has and if that person is also trained to offer tax saving ideas.

A sixth reason why your tax preparer may not be giving you useful tax saving ideas is because he or she may seldom see you until the year is over. You buy and sell a variety of investments, buy a business, send your children to college, provide funds to help a dependent parent and never ask for any tax advice. Tax saving comes from advance planning. If you are not sure of the tax consequences of a transaction, you should ask. Do not wait until it’s time to prepare your return. It will be too late. The solution is to use a tax preparer who is available all year long and who encourages you to call for advice before you make significant financial decisions.

Reason number seven. This is scary. There are some tax preparers who seem to feel that their job is to serve as a protector of the public treasury. The preparer may have a pro-government bias and may believe that any effort to pay less tax than the maximum is a form of “cheating”. This type of preparer may discourage a taxpayer from attempting any form of legal tax planning other than some of the most clear cut areas that are encouraged by the Congress.

It is your right to protect your assets from confiscation by the government as long as you do so within the law. If you want helpful tax saving ideas, be sure to find out whom your tax preparer thinks he or she is working for. At the same time, avoid the ones that are willing to claim a few deductions you did not tell them about or the ones that guarantee they will find a way to get you a refund.

An eighth reason why your preparer may not be helping you to save taxes is because you do not know how to ask the right questions. There are a few areas of the tax law that are clearly black or white. Some things are clearly encouraged by the tax law, like owning a home. Others are strongly discouraged, like not reporting income. You need to ask questions that define the extent of the gray areas. There are always choices.

If you are faced with paying a large capital gains tax, ask your tax advisor for some ideas before you sell. Explore the advantages and disadvantages of each. If you want to deduct a trip and your tax preparer says you cannot, ask what you would have to do differently to qualify for a deduction. If you want to deduct a home computer and your preparer says you cannot do that, ask what you would have to do in order to make the deduction legal. (You can deduct a computer used to manage your investments. Can you deduct trips to investment seminars? No, not if you are an investor. Yes, you can if you are a professional trader, or a public speaker, an author, or a publisher, etc., etc., etc. Ask whether the law is very clear or is ambiguous. Ask for an explanation of the gray areas. Then ask if the preparer can prepare your return based on your taking a more aggressive position, if you feel inclined to do so.

A ninth reason is that taxpayers tend to over simplify what they read and hear. One client said that a former tax preparer told him he could not deduct tax preparation fees any more. What was said is probably different from what was remembered. The truth is more complicated, thanks to the accumulation of tax simplification laws passed by the Congress. In the past few years, many people have become convinced that barter is illegal. It is not any more or less legal than using cash or credit cards. Nor is it discouraged by the tax laws. What is discouraged is the past practice of treating barter transactions as if they were not taxable, which was never true. If you want to save taxes, avoid the temptation to seek simplistic answers to complicated problems.

A tenth reason why you may not get enough helpful tax saving ideas from your tax preparer is because you don’t push the preparer to offer other options and you don’t ask for a second opinion. Remember the expression, “There’s more than one way to skin a cat.” What will it cost to do nothing? Get a checklist of other options. What will they cost? How much tax will they save you? What are the audit risks and will the strategy increase the odds of being audited? By how much? If your preparer is urging you to accept an option that will cost you a lot of taxes, find a source for a second opinion.

Some taxpayers discourage their tax preparer from offering creative tax saving ideas because the taxpayer wants an unrealistic assurance of certainty. Most good tax preparers will run to the nearest exit when they encounter a taxpayer that does not understand the concept of probability. When the weather forecaster says there is a 90% chance of rain that is not a guarantee. The IRS can make retroactive changes in their interpretation of the law. The courts can reverse their opinions. The Congress can change the law and does almost every year. The tax law has become a game of chance. If you want more creative tax saving ideas, do not insist on guarantees.

Sources: Financial Planning Consultants, Inc.
Tax Facts 2007, National Underwriter Company

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