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JS+A 2006 Year End Tax Tips
Happy holidays everyone!
This is the time of the year for mulled cider, mulled wine and mulling
over year end tax maneuvers. While you are enjoying your spicy brews,
consider these as well. As always, this is general advice. If you are a
client of John Schachter + Associates, please call or email us with any
questions you may have about how these tips could apply to you.
All the best
John
PUSHING AND PULLING
Almost all individual taxpayers are cash basis. That means they report
income when they receive it, and take deductions when they pay them.
Therefore, the most common and effective way to manage tax bills is to
manage the timing of income and deductions. You can push income into
next year by slowing down collections or billing of business fees. You
can also choose to sell gain-making investments in the new year. Hiding
your Christmas bonus in a drawer till New Year's won't work, however:
the IRS counts income as received when you have control of it. But if
your company pays its bonus in January, that should accomplish this
goal.
You can pull expenses and deductions into this year by paying them by
year end. An expense is generally considered "paid" when you mail the
check that pays it - even if the check hasn't cleared by year end. If
you charge deductible items on a credit card, the deduction counts as of
the day the charge posts to your statement NOT when you pay the credit
card bill. That means you could buy a computer for your business on Dec
29 and take its cost off this year's taxes, even though the bill hasn't
come by year end. It also means you could make charitable contributions
on a credit card and take them this year.
If you pay estimated taxes to your state, and if you itemize deductions
on your Form 1040, then consider doing the final installment by December
31 - don't wait till next January 15th. That's because state taxes can
be deductions on your federal tax return. WARNING: This won't help if
you are subject to the dreaded Alternative Minimum Tax (AMT). Under the
AMT, state taxes paid do not count as deductions, so you might as well
wait till January. A couple quick ways to see if you are subject to AMT:
Check last year's tax return. If Line 45 of Form 1040 shows a balance,
you owed AMT last year and are likely to owe it again this year if your
income and deductions are similar. For more sophisticated queries, IRS
has a calculator at irs.gov. Search on their home page for "AMT
Assistant".
This pushing and pulling can be really effective. It makes sense for
most people but NOT if you think next year's taxes will be worse than
this year's. If you expect much more money next year than this, you
would do better to take the income now, in your "poor" year, and pay
expenses next year, when you are "richer".
MORE ABOUT AMT
If you are subject to Alternative Minimum Tax, certain deductions are
not allowed. Others are. Some "good" deductions generally allowed for
both regular and AMT purposes include:
Mortgage interest on up to two homes
Charitable contributions
Most business expenses of a self employed person or partner
Most rental expenses of a landlord
Investment interest expense
But these important deductions are not allowed, so paying them won't
help your federal tax bill:
State and local taxes
Unreimbursed business expenses of an employee
Home equity loan interest - unless the loan was used to fix up your
residence
A quick tip for everyone that's especially salient for AMT payers: since
employee business expenses are not allowed under AMT, and are limited
for regular taxes by various rules, and self-employed business expenses
ARE allowed, with looser limits, it might be time to start a sideline
trade. You could generate useful contacts, experience and income while
getting the benefit of legitimate deductions that might otherwise be
lost.
CONVERT AND SAVE
If you have money in a traditional IRA, consider converting some or all
of it to a Roth IRA. You will probably have to pay taxes on the money as
it comes out of the traditional account. But your money can grow tax
free forever in the Roth - and there are other, taxpayer-friendly
attributes of Roths that add even more to their appeal.
Of course, you need to reserve enough cash to pay the taxes that would
be due on the conversion. And not everyone can convert in 2006: your
Adjusted Gross Income, not counting the Roth conversion and a few other
relatively rare items, cannot exceed $100,000 and you cannot be married
and filing a separate return.
Still, the benefits can be quite large over time. And you can manage the
current tax bill by converting some this year, and some in later years.
The point is, to make such a conversion for 2006, you have to move the
money by December 31. Special tax rules allow you to undo the conversion
later without penalty if you realize after the fact that you shouldn't
or couldn't have done so.
WHO LET THE DOGS OUT?
Review your investments. Do you have dogs lurking in your taxable
accounts? If so, consider selling by year end to offset any capital
gains you may have had. If your capital losses exceed your gains, up to
$3,000 of loss can be applied to your ordinary income - this can save
lots of money. Net capital losses of more than $3,000 get carried into
the next year, where they can be used to offset capital gains or, if the
losses are large enough, ordinary income as well.
Beware the "wash sale" rule: basically, if you sell at a loss, and buy
that same stock, bond or mutual fund within 30 days before or after the
loss-making sale, the IRS will not allow you take the loss in the year
of the sale. So if a stock is down and you really like it, consider
selling to take a tax loss. Then, either wait 30 days to buy it back, or
replace it with a different investment in the same asset class or
sector.
AFTER THE CHAMPAGNE IS GONE
You can still do things to help your tax hangover long after any New
Year's Eve headache has faded. You can contribute to traditional or Roth
IRA accounts up to April 15, 2007 and still take any allowable deduction
on your 2006 tax return. If you own a business, its retirement plan can
often take deductions for contributions made right up till September or
October of next year, if the business files an extension request. If you
need to pay estimated taxes, you can send in money up till January 15
and limit or avoid estimated tax penalties. And, probably, most
importantly, you can do a thorough job pulling together records for the
year that just ended, so you don't overlook valuable deductions - or
fail to report income that the IRS could later charge you penalties for
missing. This year, charity receipts are going to be especially valuable
as new rules require more documentation. But make sure you have 1099
forms, mortgage interest statements, W2 forms, and gain/loss statements
from brokers, and that your files include all bank and credit card
statements where deductions could be lurking.
AT YOUR SERVICE
Please remember that all of us at JS+A like talking about and working
with taxes and accounting problems. If you have questions or need help,
shoot us an email or give a call.
And here's to a happy, healthy and prosperous 2007!
PS We will be MOVING IN JANUARY to fabulous Newbury Street! Watch
for more information on this in the coming weeks.
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