Start Tax Planning Early
It may not be as much fun as tobogganing, but sledding through early tax planning strategies is a seasonal ritual that can pay handsome dividends for individuals.It's important to begin your 1997 planning process now. Most of us will be reviewing our 1996 financial data in preparation for individual income tax filing by April 15, 1997 and there is still plenty of time to implement meaningful changes.The goal of tax planning is to allow you to pay the lowest overall tax. One strategy is to postpone when taxable income must be reported and accelerate the time when expenses can be claimed as deductions. Another strategy is to trade taxable investment income for nontaxable revenue such as municipal bond interest. (However, this second strategy only makes sense if the tax-free yield on the new investment is greater than the after-tax rate on the old one.) Still another smart move for many people is to convert ordinary income (taxed at rates up to 39.6%) into long-term capital gains that are subject to a lower tax rate of 28%. Regardless of the approach taken, you should look at your tax situation for at least a two-year period, with the objective of reducing your tax liability for the two years combined rather than just for 1997.Some of the tips and hints below have exceptions and additional "rules" which you need to pay attention to. It is always best to discuss your particlur situation with your tax consultant for all the details.Ways to Postpone Taxable IncomeTaxpayers who will benefit from pushing otherwise taxable 1997 income into 1998 and beyond include those who expect to have a more favorable filing status next year (for example, head of household rather than single) and those who anticipate to be taxed at the same rate in the next two years.* Delay billing customers until after year-end if you use the cash method of accounting for your business and you're comfortable that this will not significantly increase the risk of not getting paid.* Defer gain by selling property in return for a note. Gain is recognized only as you collect any down payment plus principal payments on the note. This strategy generally works best for sales of real estate and doesn't apply at all in the case of publicly traded stock and securities.* Postpone receipt of taxable distributions from qualified plans or take them as an annuity distribution instead. Based on a recent law change, you can even postpone payments from qualified plans (but not from IRAs) past your normal required beginning date of age 70 1/2 if you continue to be employed and don't own more than 5% of the company you work for.* Realize capital losses on investments that have decreased in value. You can declare losses up to $3,000 above your capital gains. When calculating current year gains, don't forget to include expected capital gain distributions from any mutual funds that you own.* Shift your short-term investment income to 1998 by purchasing U.S. Treasury bills maturing next year. This also works with bank CDs that have a term of one year or less if the bank doesn't post the interest to your account until the CD matures. Also consider Series EE U.S. savings bonds, whose interest is generally tax-deferred until the bond is redeemed or tax-free to the extent the bond proceeds are used for qualified higher education expenses.* Avoid collecting income such as alimony, rents, director fees, and bonuses until after the first of next year. However, watch out for the constructive receipt rule. Under this rule, income credited to you before year end (or otherwise set apart in a way that effectively makes it available) is taxable in 1997.Options for Increasing Your DeductionsAnother way to reduce your 1997 tax liability is to look for additional deductions. Here's a list of suggestions to get you started:* Donate appreciated stock. If you plan to make a substantial contribution to a public charity this year and you also own appreciated stock, keep the cash and donate the stock (or a portion of it) instead. By doing this, you avoid paying tax on the donated stock's appreciation but still receive a deduction for the stock's full value (as long as you've owned it for more than a year prior to the donation). This tax strategy also works with mutual fund shares.* Maximize the benefit of the standard deduction. For 1997, the standard deduction is $6,900 for married taxpayers filing joint returns. For single taxpayers, the amount is $4,150. In 1998, these amounts will be slightly higher after adjustment for inflation. If your total itemized deductions are normally close to these amounts, you may be able to leverage the benefit of your deductions by bunching deductions in every other year. This allows you to time your itemized deductions so that they are high in one year and low in the next. You claim actual expenses in the year they are bunched and take the standard deduction in the intervening years. (Deductions you may be able to shift between years include state and local income taxes, property taxes, and charitable contributions.)* Bunch deductions subject to an adjusted gross income limit. Miscellaneous itemized deductions (such as unreimbursed employee business expenses) are deductible to the extent they exceed 2% of your adjusted gross income (AGI). (Your AGI is the number at the bottom of the first page of your return.) Medical expenses are deductible only to the extent they exceed 7.5% of adjusted gross income. To lessen the affect of these AGI limitations, try to bunch your miscellaneous and medical expense deductions into every other year.* You may be able to claim a deduction for medical expenses you pay on behalf of a family member (such as a parent) even if you can't count that person as a dependent on your return, this change in the deductibility of long-term care expenses could net you larger tax deductions in the future.start planning nowThrough strategic planning, it's possible your 1997 tax liability can be significantly reduced. But start now. The longer you wait, the less likely it is that you'll be able to achieve a meaningful reduction and the tax filing season slips into summer activities. And, besides us accountants, who really wants to tax plan during those lazy days of summer?