September 2001 On-line Tax Planning

Year End Tax Planning

As we approach the last few weeks of 2001, now is the time to consider some last-minute options for saving taxes next April.  For the most part, these decisions need to be made and completed by December 31, 2001 to help you on your 2001 tax return.  Here are some useful and easy suggestions for you to minimize your tax liability:

Contributions to an IRA
Individual Retirement Accounts (IRAs) are a very useful tool in reducing one’s tax liability.  Contributions to a regular IRA can be made up until the due date of the taxpayer’s income tax return (not including extensions), which is April 15, 2002.  The maximum contribution a person may make each year to an IRA cannot exceed $2000.  For those people who are not active participants in an employer’s retirement plan, the entire $2000 may be taken as an above-the-line deduction.  For those people who are covered under an employer’s plan, they still may be able to deduct a portion of the contribution, providing their income does not exceed specified threshold amounts of $43,000 for a single taxpayer or $63,000 for a joint return.

Accelerating Expenses
This is a tool used by people to minimize tax liability by paying expenses in December which may not actually be due until next year.  For example, taxpayers who itemize their deductions are able to deduct all state taxes paid during the calendar year.  For those people who pay quarterly estimates, moving the date of payment for the last installment from January 2002 to December 2001 will result in additional state tax deductions for the 2001 income tax return.  Another possible deduction would be paying your January 1, 2002 home mortgage payment on December 31, 2001 so that you have additional interest deductible on the 2001 return.  However, your bank statement reporting mortgage interest paid during the year may not reflect this payment since it is made late; you will need to verify the balance with your bank or run your own amortization schedule. 

Expenses Subject to Floors
Some deductions are based upon the taxpayer paying a minimum “floor” amount out of pocket before a deduction is allowed.  For example, medical expenses are deductible to the extent they exceed 7.5% of Adjusted Gross Income, or AGI.  If you had AGI of $100,000, you would only be able to take a deduction for medical expenses above $7,500.  With expenses subject to floors, the strategy is to defer or accelerate them into years when you can meet the floor amount.  If your AGI will be significantly more next year, and you know you will be paying for something which is eligible for the deduction, you may want to prepay those expenses in 2001.  This would allow you a lower level of AGI with which to figure your floor for deductions.  The reverse is also true in the case of an expected decrease in AGI next year: deferring payment of those amounts until 2002 will allow you to deduct them next year, when your AGI is lower and you will not have as high of a floor to meet for deductibility.

A common strategy used by tax professionals is a method called “bunching.”  This method involves looking at expenses which can be used as itemized deductions and determining if it would be more beneficial to “bunch” the expenses into one year to minimize the tax liability.  For example, let’s say a taxpayer is doing some last minute tax planning at the end of the year.  If the taxpayer pays some additional expenses before the end of the year, it would give the taxpayer just enough expenses in 2001 that he or she is eligible to itemize deductions instead of taking the standard deduction.  However, depending on the expected tax situation in the following year, it may be more beneficial for the taxpayer to take the standard deduction in 2001 and put off paying those last minute expenses until 2002.  By doing this, the taxpayer would have more itemized deductions in 2002 and would therefore minimize the tax liability in 2002.  This is an especially useful tool when the taxpayer expects to have higher income the following year which would be offset by the additional itemized deductions available due to the “bunching” of the expenses.

Consider Your Tax Position in 2001 and 2002
When figuring out year-end tax planning techniques, a taxpayer needs to be sure to consider not only the current year tax situation but also the expected situation for the next year.  As briefly mentioned in the medical expense example above, if you expect a significant change in your income from this year to the next, you need to consider which year will give you the best savings for your tax move.  With the changes to the tax law enacted by President Bush earlier this year, you may want to discuss with a tax advisor what the best course of action is to maximize the benefit to you.

Capital Gains and Losses
As most people are aware, the stock market has not had a very good year.  Many of your stocks may have fallen in value.  If you have stocks that you want to get rid of this year, you are allowed to take a maximum net capital loss of $3000 on your tax return.  If you had significant capital gains earlier in the year, selling off the stock from which you will have a loss before the end of the year may help offset those initial gains. 

Charitable Donations of Stock
During the past few years, when the stock market was doing well, people would often gift stock directly to charities in order to reduce the capital gains tax that would have been incurred had the taxpayer sold the stock.  While this was an effective tool in the past, the stock market and economy have changed this year, and many stocks have significantly decreased in value.  As a result, if a taxpayer wanted to give stock to charity in 2001, there is a more effective way to maximize the benefits received.  Instead of transferring the stock directly to the charity, the taxpayer should sell the stock and contribute the cash proceeds received from the sale to the charity.  In doing so, the taxpayer gets a double benefit:  he or she is able to claim a capital loss on the sale of stock and can also claim a deduction for the cash donation to the charity.  This is the most effective way to maximize your tax benefits should you find yourself in this situation. 

This was a quick summary of some of the common areas people use for tax planning.  As always, these tips do not apply to all taxpayers.  For tips that will help you, please feel free to call any one of our CPAs on staff to help you figure out how to minimize your 2001 tax liability.

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