Some Handy Advice on What to Do Now to Soften Next Year’s Tax Bite

Jeffrey L. Stolper doesn’t procrastinate when it comes to year-end tax planning. But now, with individual tax rates falling next year under tax reform, the Los Angeles insurance agent is even more of an early bird.

“Whatever business expense I can write off, I’m trying to do it now,” he said, noting that he is considering buying a new car for his business this year instead of next so he can take a deduction sooner. He also is considering boosting charitable contributions, prepaying property taxes and monthly mortgage payments, and opening a Keogh plan.

Stolper, like many other taxpayers, has learned the importance of year-end tax planning. Because the top individual tax rate falls to 33% next year from 38.5%, the normal strategy of accelerating deductions and postponing income takes on even more importance this year. With higher tax rates, deductions are worth more if taken this year. With lower tax rates in 1988, income will be worth more if earned then.

Taxpayers should start planning now for other reasons as well, experts say. You may discover that--perhaps because of an expected sharp boost in your income next year--your tax rate may be higher then. If so, you will want to follow just the opposite strategies and accelerate income and postpone deductions.

These reverse strategies also may be needed if you will be subject to the alternative minimum tax, which ensures that taxpayers with high deductions pay at least some tax.

“No one can say what the best strategy is for you until you do a projection. You have to review each situation separately,” said Sidney Kess, partner in the New York office of the accounting firm of Peat Marwick Main. “You can’t wait until your returns are put into the mail. The sooner you move, the more you will save.”

If you--like most people--expect your tax rate to fall next year and if you will not be subject to the alternative minimum tax, the following basic tips are for you:

Ways to Accelerate Deductions

- Push charitable contributions into this year. Remember, however, that charitable contributions in 1987 are deductible only if you itemize. Last year, they were deductible for non-itemizers as well.

- Prepay state income taxes and property taxes. Estimate your state income tax liability for this year and pay the remainder you owe before year-end instead of as late as April 15 next year. Ditto for property taxes: Pay the installment normally due on April 10 next year before year-end.

- Pay your January mortgage in December. The IRS will allow this if your mortgage payments are in arrears--meaning that your payment in January actually covers interest owed for December. Fortunately, most mortgages are paid in arrears.

- Pay credit card interest or other non-mortgage consumer interest. This year, 65% of consumer interest is deductible, but that will drop to 40% next year and 20% in 1989. Another alternative: Convert your consumer loan into a second mortgage, home-equity loan or other type of mortgage loan. Their interest is fully deductible under most conditions.

- Bunch miscellaneous expenses into this year. Union dues, tax-preparation expenses, subscriptions, unreimbursed employee business expenses and other miscellaneous expenses can be deducted only if you itemize and only to the extent that the expenses exceed 2% of your adjusted gross income.

So if you can exceed the 2% threshold, bunch as much of these expenses into this year as possible. But if you can’t exceed the threshold, delay these expenses and bunch them up next year.

The same strategy applies to medical expenses. They are deductible only to the extent that they exceed 7.5% of your adjusted gross income. So, if you will surpass that level, bunch them up and consider adding other discretionary medical expenses, such as eyeglasses or plastic surgery.

- Accelerate business expenses such as office equipment or vehicles if you are self-employed. Also, classify miscellaneous expenses as business expenses if possible. Miscellaneous expenses are subject to the 2% threshold, while business expenses are fully deductible.

Ways to Defer Income

- Buy bank certificates of deposit or Treasury bills that mature in 1988. Many banks will postpone interest payments on CDs until they mature, so you won’t be liable for taxes on the interest until then. Charles H. Rosenblatt, tax partner for the Los Angeles accounting firm of Roth, Bookstein & Zaslow, suggests buying a three-month CD now because the interest won’t be paid and taxable until January.

Treasury bills pay their interest somewhat differently, but the net tax effect is the same. You buy T-bills at a discount from their face value and receive face value when they mature. The gain is taxable at time of maturity.

- Defer discretionary bonus payments or salary into 1988. If you think you might receive a year-end bonus, ask if your employer will delay paying it until next year. But the IRS allows this technique only if you have not yet earned the bonus. Once you are told you have earned a bonus, it is too late to defer it, Rosenblatt said.

Similarly, ask your employer to defer salary payments until next year, as long as you haven’t yet earned them. But do so at some risk: The IRS has announced that it may challenge such short-term salary deferral arrangements, said Harvey S. Gettleson, tax partner in the Warner Center office of the accounting firm of Ernst & Whinney.

- Ask others who owe you money to postpone payments until next year. If you are a doctor, lawyer or other professional, postpone billing clients until 1988. If you are a landlord, ask your tenants to postpone rental payments. If you are a lender, have your borrowers postpone interest payments.

The IRS will allow this as long as the payments have not already been given to you or made available to you, Rosenblatt said. But be careful: Allowing debtors to delay payments too long lessens chances that they will pay you at all.

Accelerate Long-Term Capital Gains but Postpone Short-Term Gains

Next year, all capital gains--whether short term or long term--will be taxed the same as ordinary income. But this year, capital gains for assets held longer than six months will be taxed at a maximum rate of 28%, compared to a top rate of 33% next year. So consider selling stocks, bonds or other assets eligible for long-term capital gains tax treatment.

On the other hand, consider postponing taking short-term capital gains until next year. Assets held less than six months will be taxed at up to 38.5% this year but no more than 33% next year.

One caveat, however: Don’t let tax considerations be the major guide in determining whether to sell a stock or other capital asset. Potential profits from holding on to the asset could easily outweigh any tax savings.

If you are subject to the alternative minimum tax, the above advice should be reversed. You should instead accelerate income and postpone deductions. One reason for accelerating income: the AMT taxes your income at 21%, lower than the 33% top rate next year for ordinary income. And you should postpone deductions because many items, such as state income taxes and certain interest expenses, are not deductible under the AMT.

Ernst & Whinney’s Gettleson said you run the risk of being subject to the alternative minimum tax if: 1) you have large tax shelter losses from shelters acquired before October, 1986; 2) you have large deductions from property taxes and state income taxes, or 3) you have large non-mortgage interest expenses. However, as a general rule, if your income is below $80,000 for couples filing jointly or $60,000 for singles, you have relatively small risk of falling under the AMT.

The typical taxpayer, Rosenblatt said, does not have excessive deductions and thus need not be concerned with the AMT. But those that do should consult an expert, he said.

“The AMT has gotten so complicated it is really difficult to plan for it,” Rosenblatt said.