December 98

TAX PLANNING 

The purpose of tax planning is to minimize income taxes and maximize your savings. Tax planning is an ongoing process and not a single event. Keep in mind that everyone’s situation is different based on your specific facts and circumstance. The following is a brief look at some of the methods used to reduce your tax bill, which increase your savings.

I. MAXIMIZE YOUR 401K OR TAX DEFERRED PLAN CONTRIBUTIONS

Individuals whose employers have such plans should take advantage of the plan for 1998. The maximum allowed by law for contributions to a 401K plan is $10,000. Many employers will match a portion of the employee’s contributions.

Example: An individual earns $60,000 per year and is allowed to contribute 6% of his salary to his 401K plan the employer may match up to 1% of the individual’s salary. In this case the individual will contribute $3,600 into the plan and the employer will contribute on behalf of the employee $600. The $3,600 the employee contributes is not subjected to income tax and the individual is not subjected to any type of tax for the $600 employer contribution. Assume the individual is in the 28% tax bracket the tax savings will be $1,008. (the net "cash outflow" is $3,600-$1,008 = $2,592)

If your company has a cafeteria plan or flexible spending account maximize it’s use for pretax medical, child care any other expenses as designated by your employer. These are pretax items.

$5,000 * 28% = $1,400 $2,400 * 20% = $ 480

III. FUND AN IRA- THE EARNINGS IN THE IRA ARE TAX DEFERRED.   IF IT IS A ROTH IRA,
THE EARNINGS CAN BE TAX-FREE

If one spouse earns less than $2,000 (or has no earnings for the year), a couple may contribute a total of $4,000 to their IRAs if a joint return is filed, and together they have at least $4,000 in earnings.

IV. REVIEW YOUR WITHHOLDING TAXES

Make sure your withholding taxes are neither too low or too high which will maximize the use of your funds. If your withholding is too high during the course of a calendar year, granted you will receive a large refund but you will not receive any interest on that refund. You could have invested the excess withholding and received interest or dividend income. Alternatively, if your withholding is too low you may be subjected to an underpayment of estimated tax penalty.

V. REVIEW YOUR EXEMPTIONS

If you are supporting relatives and they qualify as your dependant, they should be deductible on yourtax return. Possible dependants include parents, nieces, nephews, grandchildren or other relatives you may be supporting.

$2,700 * 28% = $ 756

VI. SHIFT INCOME

If you are in a high tax bracket you may have an opportunity to shift income to family members who are in lower tax brackets. One strategy is gifting up to $10,000 per year to $20,000 if your spouse consents to a split gift to your children or others, which is free of federal gift tax. The income generated from the gift (i.e. the earnings on the gifted amount) is not taxed to you but will be taxed to the recipient of the gift. If your children are under the age of 14 the kiddie tax applies. If unearned income is in excess of $1,300, the children will be taxed at your marginal rate. Children who are 14 years or older are not subjected to those rules, but their first $25,350 of income earned and unearned are subjected to a tax at the 15% rate.
If you own your own business consider employing your children. You can pay them a salary that is taxed at their marginal rate, which will generally be less than yours. The kiddie tax does not apply since wages are classified as earned income and not unearned such as interest and dividend income. Self-employment tax does not apply on the first $400 of payments treated as "contract" work.

VII. ACCELERATE OR DEFER INCOME

The timing of income and deductions can provide opportunities for tax savings if you take advantage of accelerating or deferring items from one year to the next. If in 1998 you will be in a 28% tax bracket but forecast being in a much higher tax bracket in 1999; it may make sense to accelerate income into 1998. You do this by controlling the receipt of certain items of income in order to accomplish this objective.

Example: If you are self- employed you may be able to accelerate collections of work that has been performed. If you are an employee you may have some latitude regarding receiving a bonus from your employer with the cooperation of your employer. If you expect to be in a lower tax bracket in 1999 you may want to defer receiving collections or bonus money until 1999.

VIII. ACCUMULATE EXPENSES / BUNCH ITEMIZED DEDUCTIONS

Itemized deductions are subjected to limitations or phase out which reduce or eliminate their benefit. Medical expenses are not deductible unless they exceed 7.5% of adjusted gross income. Unreimbursed employee business expenses are not deductible unless they exceed 2% of adjusted gross income. If you can control the timing of these expenses you may be able to accumulate several deductions into one tax year to exceed the floor and benefit from expenses incurred by receiving a tax deduction for those expenses.

Example: If your adjusted gross income is $100,000 and you have $5,000 in medical expenses during 1998 and you anticipate having additional $5,000 in medical expenses in 1999 and you are not jeopardizing your health, consider pushing the procedures from 1999 to 1998 as the $5,000 you would have spent in 1998 does not exceed 7.5% of your adjusted gross income and you therefore lose the deduction. Likewise, if you made the payment in 1998 you would therefore have $10,000 of medical expenses of which $2,500 will be deductible ($7,500 will not be since that is the floor for 7.5% of adjusted gross income.)

Example: Your mortgage interest for a year is $3,000. Your property taxes are $3,000 and you generally donate $2,000 to charities each year.

$18,100 – $16,000 = $2,100
$2,100 * 28% = $ 588

IX. MAXIMIZE INTEREST DEDUCTIONS – PAY OFF NONDEDUCTIBLE INTEREST

Use a home equity loan to pay off credit cards, personal loans such as automobile loans, which converts what would have been nondeductible interest to deductible interest.

X. GIVE TO CHARITY – IF YOU ITEMIZE, YOU CAN INCREASE YOUR DEDUCTIONS BY DOING SO.

You must have written substantiation for any charitable donation for over $250. Retain these records for at least three years from the date of filing your tax return including extensions. Obtain receipts for non cash gifts and keep a detailed listing of the items donated.

XI. CONSIDER DONATING APPRECIATED ASSETS TO CHARITY

By donating appreciated assets to charities you may obtain a deduction equal to the fair market value of the appreciated property which will produce a tax deduction and also you will avoid tax on the capital gain.

Example:

XII. MUTUAL FUNDS

If you had dividends reinvested over the years in mutual funds, the dividends reinvested increase your cost basis for calculating your gain or loss upon redemption. Be sure to keep accurate records.
The dividends increase your basis and will reduce your capital gains.

XIII. OFFSET CAPITAL LOSSES WITH CAPITAL GAINS

Capital losses can only be deducted against capital gains with any excess loss allowed to offset $3,000 per year of other income. An ideal situation would be to offset short-term capital gains with long term capital losses because short-term capital gains are taxed at ordinary income rates. Between now and December 31 review your investment portfolio and take advantage of long term losses if it applies.

XIV. USE A LIKE KIND EXCHANGE TO DEFER GAIN ON INVESTMENT OR BUSINESS PROPERTY

If you own investment property or business property you have the option to exchange it rather than sell.

Examples: exchange rental property in one location for rental property in another location. All you would have to do is reduce your basis in the newly acquired property, therefore, any gain exchange is deferred and not currently taxable.

XV. CONSIDER TAX FREE INVESTMENTS IN YOUR PORTFOLIO

This requires careful analysis, as you would want to compare after tax yield with taxable investments. Sometimes you might be better off paying tax on an investment since the after tax yield would be greater than the tax free investment.

XVI. EXPENSING ELECTION

If you are self employed or own a business you may elect to deduct the first $18,500 of fixed assets and equipment purchased during 1998 rather than having those assets depreciated over a five or seven year period. This amount will gradually increase to $25,000. The amount for 1999 is $19,000.

XVII. HEALTH INSURANCE FOR THE SELF EMPLOYED

If you are self-employed and your spouse is employed in the business, you may be able to deduct the entire cost of your family’s health insurance as a business expense by providing your spouse with health coverage through your business. If you have other employees, the health plan can’t discriminate against them.

XVIII. HOME OFFICE DEDUCTIONS

An increasing number of people are now working from their home. If you maintain a separate space or office in your home to conduct business you may be able to deduct some expenses.
Beginning in 1999, more individuals should qualify for home office deductions because the definition of "principal place of business" has been expanded. Now you can qualify for a deduction if you use a space in your home exclusively and regularly for administrative and management activities of your trade or business and you have no other fixed location where you conduct substantial administrative or management activities of the trade or business.

XIX. RECEIVING LUMP SUM FROM A PENSION PLAN

If you are receiving a lump sum from a pension plan in 1998 consider rolling it in to an IRA account. If the transfer is made directly to the IRA, the plan will not have to withhold 20% for taxes.
Of course, you will have to pay income taxes as you withdraw money from the Rollover IRA. But you can take the IRA distributions gradually as you need the income. Any money that remains in the IRA will continue to be tax deferred.

This special type of IRA offers you the chance to earn investment income that is tax-free rather than tax deferred. If you are eligible, you can contribute up to $2,000 of compensation to a Roth IRA each year on a nondeductible basis. You may access these annual contributions anytime without tax consequences. After you have had a Roth IRA for five tax years, account earnings also may be withdrawn tax free if:

You are age 59 ½ or older;
You are disabled; or
You are paying qualified first-time home buying expenses (lifetime maximum of $10,000).

Tax-free distributions are also available to beneficiaries after the death of the account owner, provided the five-year requirement has been satisfied.

Adjusted Gross income limitations:

These are just some of a few tax planning techniques that can be utilized to minimize your income taxes. Remember that everyone’s facts and circumstances are different and what method works for you may not be adequate for someone else. Please consult with your tax professional.