Year-End Preparations Can Lower Taxpayers’ Bill

Taxes may be the last thing consumers want to deal with during the holiday season, but making a few smart moves before the end of the year could save taxpayers a bundle on their 2002 returns.

“Get out your papers and pretend it’s April 15th,” advised Nick Childers, senior financial consultant with Merrill Lynch & Co. “See what you can do to lower your tax bill and put a few more dollars in your pocket in the coming year.”

Traditional sources of last-minute deductions include making charitable donations, renewing work-related magazine subscriptions, locking in losses on investments and doubling up on mortgage payments and other deductible expenses.

Thanks to last year’s federal tax-cut legislation, there’s another option: contributing more money to tax-advantaged retirement plans, such as 401(k) accounts, said Don R. Weigandt, managing director at J.P. Morgan Private Bank in Los Angeles.

The 2001 tax law increased the amount Americans can contribute to retirement plans in 2002. The annual limit on 401(k) or 403(b) plan contributions, for example, rose to $11,000 from $10,500 last year. Maximum contributions to 457 plans also rose to $11,000 from $8,500. And the annual limit on IRAs rose to $3,000 from $2,000.

Increasing contributions to tax-deferred retirement savings shields additional income from both state and federal income taxes. And those age 50 and older can save even more, thanks to so-called catch-up contributions, Weigandt said.

The maximum allowable catch-up contribution this year is $1,000 for 401(k) or 403(b) plans and $500 for IRAs -- meaning a 50-year-old with a 401(k) plan could contribute as much as $12,000 this year.

“If you turn 50 in 2002 -- even if your birthday is on Dec. 31 -- you can make a catch-up contribution” this year, said Martin Nissenbaum, tax partner at Ernst & Young in New York.

It’s important to remember that retirement plan providers generally won’t make a catch-up contribution unless they are asked to do so by the plan participant.

To qualify for 2002 tax returns, 401(k), 403(b) and 457 plan contributions must be made by Dec. 31. IRA contributions can be made until April 15, 2003, and still qualify for this year’s tax returns.

Here are some other tax-saving tips:

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Harvest Market Losses

Investors who have seen the value of their stock holdings plummet during the bear market may want to use those losses to shield investment gains -- assuming they have any -- and to offset as much as $3,000 in regular income from state and federal taxes.

But there are no write-offs for paper losses. To get the tax break, investors must “realize” the loss by selling securities for less than they paid.

“There’s an opportunity to take advantage of the downturn,” Nissenbaum said. “See if you’ve got losses worth harvesting.”

Capital losses are used, first, to offset any capital gains realized during the year -- that saves 20 cents on the dollar in federal capital gains tax alone. In California, using capital losses to offset capital gains saves closer to 29 cents on the dollar because the state’s top income tax rate is 9.3% and there isn’t a lower rate for capital gains.

In addition, those with more capital losses than gains can use excess losses to offset as much as $3,000 in ordinary income each year. That saves even more, because ordinary federal income tax rates run as high as 38.6%.

What about securities that can’t be sold because the company has filed for bankruptcy protection or simply evaporated, rendering its securities worthless?

If a security is worthless, the taxpayer need do nothing but claim the loss on his or her return, Nissenbaum said.

But if the security still trades -- even if it’s only for pennies a share -- the shares must be sold to take the loss, he said. Many brokerage firms offer “penny for the lot” programs that allow customers to get rid of near-worthless shares without paying a brokerage commission.

A reminder: If a security is repurchased within 31 days of its sale, the transaction is dismissed by tax authorities as a “wash sale” and the capital loss deduction would be disallowed.

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Make a Charitable Gift

Planning a large charitable contribution before year’s end? Those who still have appreciated securities in their portfolios might consider giving stock rather than cash, Childers of Merrill Lynch said. The deduction is the same, and the giver won’t have to pay the capital gains tax when the security is eventually sold.

Consider an investor who bought 500 shares of XYZ company five years ago for $5,000. The stock now is valued at $10,000. If the shares are sold and the proceeds given to charity, that’s a $9,000 contribution -- the $10,000 from the sale minus the $1,000 tax on the capital gain. A $9,000 gift nets the giver $2,700 in tax savings, assuming an income tax rate of 30%.

If the shares are given directly, the charity gets the whole $10,000 -- and the investor gets a write-off for the entire amount. Because the charity is tax exempt, no one has to pay the capital gains tax when the shares are sold. The investor ends up saving $3,000 in tax instead of $2,700.

However, it doesn’t make sense to donate depreciated securities. In this case, it’s wiser to sell first and give later. Why? Because the charity can’t use the capital loss and the donor can.

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Pay Taxes Early

Property tax payments, billed in November, usually are due in two installments -- one before year-end and one shortly after. Those looking for an additional deduction can pay both before Dec. 31, said George McCrimlisk, a Los Angeles tax partner at KPMG.

But beware the alternative minimum tax -- a parallel tax system that can hit people with large families and unusually high state and local tax deductions. If the taxpayer falls under the AMT, the value of the property-tax deduction is lost, which defeats the purpose of prepaying the tax, McCrimlisk said.

Before making the early property tax payment, run a tax projection to make sure you’re safe from the AMT.

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Bunch Expenses

Now is the time to pay -- or delay -- dues for professional memberships, work-related magazine and newspaper subscriptions, and bills from lawyers and accountants for professional services.

The decision about whether to pay these costs now or, if possible, delay paying them until 2003 hinges on how many other miscellaneous itemized deductions the taxpayer claimed in the last year. That’s because miscellaneous itemized deductions are deductible only once they exceed 2% of adjusted gross income. That makes it smart to push two years’ worth of expenses into one year whenever possible.

For those who were unemployed during 2002, remember that job-hunting expenses -- from resume preparation to travel costs -- are miscellaneous itemized deductions.

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Make Payment Early

The mortgage bill that homeowners receive in January actually is for interest expenses accrued in December. That makes it possible to pay the bill in December and deduct the interest from 2002 income.

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Give Personal Property

When donating personal property to charity, taxpayers get a deduction for the current market value of the item, or the amount they paid for it, whichever is less. It’s up to the taxpayer to establish the market value at the time of the donation.

The IRS recently simplified what taxpayers need to do when giving a car to charity -- an area of huge growth and possible abuse.

The agency stated that values in a standard car-pricing guide -- if matched to the donated vehicle’s condition, age and mileage -- would be sufficient to establish market value, Weigandt said. Taxpayers no longer need to get a professional appraisal.

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Check Withholding

Taxpayers should do a tax projection at least a month before year’s end to ensure that enough money has been withheld from their pay during the year to avoid a big tax bill -- and penalties -- in April, Nissenbaum said.

To do this projection, pull out pay stubs, mortgage and investment records and project estimated year-end numbers. Plug those numbers into a 1040 as if completing a real tax return. Compare the estimated tax owed with what already has been paid. If past payments and withholding through the last few weeks of the year are sufficient, keep the projection and records in a file to make next year’s tax season simpler.

Those who have paid far too little can make an estimated tax payment or have their employer withhold more from remaining paychecks. The withholding option is better, Nissenbaum said, because it eliminates underpayment penalties that still may be assessed if you make an estimated payment with cash.

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Your Tax Papers, Please

Here are the documents and other information needed to do an accurate tax projection -- a key step in year-end tax planning:

* Recent pay stub, with year-to-date earnings and tax payments

* Bank statements, showing interest earned and/or mortgage interest paid

* Brokerage statements, showing interest and/or capital gains and losses to date

* Estimate of freelance or self-employment income

* Loan information from any mortgage refinancing completed during the year (if deductible points were paid) and/or from a previous mortgage refinancing if all the points haven’t been deducted

* Business expenses

* Charitable contributions

* Baby-sitting bills for children younger than 13 if both parents work or attend school

* A 1040 form and tax tables, which can be printed from the IRS Web site at www.irs.gov. (For instructions and tax tables, click on “information for individuals” and look for Publication 17, the IRS’ official individual income tax guide.)

-- Kathy M. Kristof

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Times staff writer Kathy M. Kristof, author of “Investing 101” (Bloomberg Press, 2000), welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof@latimes .com. For past Personal Finance columns, visit The Times’ Web site at www.latimes.com.