Tax Law Changes Make Annual Planning Crucial
April 15 is 6 1/2 months away, but it’s still a good time to start thinking about next year’s tax-filing season.
In fact, because of a long list of tax changes approved by Congress last spring, year-end tax planning is more pivotal than ever -- and could be more painful as well.
Though the 2003 tax law provided some generous breaks, such as cuts to the capital gains and dividend tax rates, big credits for kids and a reduction in the so-called marriage penalty, there’s a greater chance than ever of getting snared by the onerous alternative minimum tax.
“It’s still a stealth issue, but people really need to be looking at the AMT this year to make sure that they have a handle on their liability,” said Don Weigandt, managing director of JPMorgan Private Bank in Los Angeles. “They may need to pay more in estimated taxes than they expect.”
The AMT, a parallel system that operates alongside the traditional tax code, turns year-end tax planning on its head.
At this time of year, taxpayers normally look for ways to accelerate deductions and delay receiving taxable income. But taxpayers who may be subject to the alternative minimum tax would be wiser to do the opposite because they might pay fewer tax dollars in the end.
The AMT, which recalculates your tax using a system that imposes slightly lower rates but eliminates deductions for children, state taxes and many business expenses, originally was envisioned as a way to ensure that wealthy Americans paid at least some income tax every year. But the income thresholds that determine who falls under the AMT have never been adjusted for inflation, so these days the tax is more likely to hit middle-income filers in high-tax states than it is to hit the super-rich.
Californians with significant capital gains -- a group that may have expanded thanks to the stock market’s strong performance this year -- are at particular risk.
Some taxpayers -- those who paid sufficient tax through employee withholding last year, who have remained with the same employer and who haven’t had a change in family status or sold any capital assets this year -- don’t need to worry about year-end planning, unless they’re habitually in trouble with the Internal Revenue Service or they think there may be ways to reduce their tax bill.
But everyone else -- those who married, divorced, had a child, sold a substantial asset or changed jobs during the year -- would be well advised to figure out their potential tax liability for 2003 and find out if there are any ways to lower it.
Prepare an Estimate
The first step requires estimating your tax liability -- that is, how much taxable income will you have this year and how much tax will you have to pay on it? There are three ways to do this: by hand, by computer or by using a professional.
The easiest answer is to dump the whole process in the lap of an accountant or a professional tax preparer. But because of the cost involved, that’s advisable only for high-income taxpayers and small-business owners, who are likely to have greater liabilities and more opportunities for reducing their taxes, said Philip J. Holthouse, partner in the Santa Monica tax law and accounting firm of Holthouse Carlin & Van Trigt. Getting a good estimate and tax advice generally costs one-third to one-half the cost of having an annual return professionally prepared.
Those with Internet access can go to www.turbotax.com, where software maker Intuit Inc. offers a free “2003 Tax Relief Estimator” that calculates your taxes under current and past law. That can tell taxpayers whether they’ve put aside enough money through withholding, but it doesn’t provide advice on reducing your taxes.
The by-hand approach is the toughest because of all the changes in the tax code this year. There are new standard deductions for married filers; new tax rates and schedules; a new form for capital gains and losses; and new tax deductions for students, teachers and even for people who buy particular cars.
An advantage of this option is that the tax forms you fill out for this exercise give you a head start when tackling your real 1040 next year. To get the right forms, go to the IRS Web site (www.irs.gov) and search for the new 1040 and any additional schedules you may need. (Forms also can be ordered over the phone at 1-800-TAX-FORM.) Many of the forms are still preliminary; they can be found in the “for tax professionals” section of the Web site. The 1040 is slated to be available in final form Oct. 8.
Assess the AMT Threat
Both professional preparers and tax software will signal whether you’re likely to fall under the shadow of the alternative minimum tax. If the AMT is an issue, you should postpone making certain deductible payments, such as property taxes, state income taxes and unreimbursed employee business expenses.
All of these are so-called “preference items,” which get no credit under the AMT system, Holthouse said. If these expenses are postponed to a year when the AMT is not an issue, the taxpayer gets to deduct them. But in a year in which you are likely to fall under the AMT, these otherwise tax-saving deductions become worthless.
Give Generously
If the AMT is not an issue, now is the time to consider charitable gifts. Dollars and goods given to charity generally reduce taxable income dollar for dollar.
Tax-smart donation strategies are to give appreciated stock -- that saves the taxpayer from having to pay capital gains tax on the profit -- and used but usable items, such as clothing and furniture.
The deductible value of donated stock is the market value of the shares on the date they are donated if you have owned the shares at least a year. It doesn’t make sense to give shares held less than a year because, in that case, the deductible value is what you paid for the stock, not what it’s worth now.
The deductible value of used items is roughly what the goods would sell for at a garage sale or thrift store. A software program called It’s Deductible can help estimate the value of those items and is available at retail outlets and through many tax preparers. Be sure to keep good records if you give a lot of used items away, because high deductions here are an audit trigger.
Save More
Those who haven’t already contributed the maximum amounts to retirement plans should think about doing so now. Though contributions to some employer-based plans can’t be changed midyear, self-employed individuals and those who have access to deductible individual retirement accounts still have time to reduce their tax bills by contributing to their own savings.
Stay-at-home spouses can make deductible IRA contributions of up to $3,000 (or $3,500 if the individual is age 50 or over), even if their spouse is covered by a qualified retirement plan, as long as household income is less than $150,000.
Manage Gains, Losses
Though it’s never wise to make an investment decision based solely on tax consequences, this normally is the time of year when investors decide if they want to trigger losses to offset capital gains.
Two factors may make that either unwise or unnecessary this year.
First, the three-year bear market left many investors with “rollover” losses from previous years that can be used to offset capital gains and up to $3,000 annually in ordinary income.
Second, the 2003 tax law cut the top rate on long-term capital gains to 15%, which provides comparatively less incentive to trigger losses to offset that tax.
It’s worth noting, however, that California taxes all income at the same rate. For high-bracket taxpayers, that boosts their total tax -- state and federal -- to about 25% on a capital gain, Holthouse said. That can make triggering losses a bit more worthwhile.
Then, too, substantial capital gains are one of a few items that can throw an otherwise middle-income taxpayer into the grip of the AMT. The reason is complicated, but if a sale of a residence or a large block of stock leaves a taxpayer with gains that make up a substantial portion of total income, it may make sense to consult a tax advisor.
Kathy M. Kristof, author of “Investing 101” and “Taming the Tuition Tiger,” 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; e-mail: kathy.kristof @latimes.com. Past columns: www.latimes.com/perfin.
