The leaves have changed color and disappeared and, despite the recent run of unseasonably warm weather, store displays are in full holiday regalia. It all adds up to one thing: Time to start thinking about taxes.
Yes, it’s enough to snuff out most holiday cheer, but so is a tax hangover come next April.
Besides, year-end tax planning is a series of small steps, done in anticipation of reducing headaches next spring. It’s not the full-blown migraine Uncle Sam inflicts on us when the snow melts, but rather a few minutes of forethought to take some of the sting out of what happens early in the new year.
Moreover, not looking at your taxes now could make some potential problems virtually unavoidable next year.
Here are some steps most consumers should consider between now and year’s end to make things a little less taxing in 1999.
– Harvest your losses. For the first time in years, investors have losses to play with. The stock market has rebounded sharply from its midsummer blues, but many investments have been slow on the uptake.
When you sell an investment at a loss, the decline can be used to offset other gains, plus up to $3,000 in ordinary income.
Even if you are a long-term investor in your stocks or funds, you may have some losses to cash in. For example, you might keep shares purchased in years past and sell only the ones that did poorly this year.
“For the last few years, no one really had losses to speak of,” says Mark Watson, partner in KPMG Peat Marwick’s personal financial planning practice. “This year, losses will be a big way for people to save some money. Most people should look to see whether they have some losses that can be turned into something good.”
– Check your withholdings. If 1998 has been a better year than you anticipated, or if you simply have not withheld enough money, consider setting aside some extra now. To avoid penalties, you must pay either 90 percent of what you owe for this year or all of what you owed in taxes for 1997.
And if your income declined this year and you expect a big refund, cut back on the amount you pay Uncle Sam between now and year’s end. While it will reduce the amount of your tax refund, you will have more disposable income for the holidays.
– Convert a traditional account to a Roth or reconvert the account you moved early in the year. If you have a traditional IRA and want to change it into the new Roth account, where it grows tax-free for life, do it this year. The income you realize making the switch in 1998 gets realized over the next four years (so $20,000 of IRA income becomes $5,000 a year until paid off). Wait until 1999 and you take the entire income hit in one lump sum.
If you converted a traditional IRA to a Roth earlier in the year, look at the value of your account now. If it is less than when you made the switch, you can “recharacterize” the account back to its traditional self and then reconvert back to a Roth account, moving less money and lowering the tax burden.
You are allowed one of these changes between now and the end of this year. If you are near the $100,000 adjusted gross income threshold for being allowed to make a Roth conversion, put off this strategy until you are certain you are eligible for the Roth. Otherwise, you could wind up in a Roth when you are not allowed one, which is sure to be a nightmare.
You also are allowed to recharacterize and reconvert your 1998 Roth once next year. Bob Rywick, executive editor at The RIA Group, a publisher of tax reference materials, suggests that anyone who made a conversion this year might want to file an extension on his taxes next year.
“That way, if the market goes down again between now and August,” Rywick says, “you can lower your taxes on the conversion even further.” One drawback, Rywick notes, is that reconverting this year’s Roth conversion in 1999 wipes out your ability to spread the income over four years.
– Accelerate, or minimize, deductions. If you won’t be able to itemize deductions for 1998, push back as many expenses as you can into 1999. This would include charitable contributions, medical expenses and the like. It should increase your chances for itemizing in the future.
Conversely, if you are able to itemize, do as much as possible to increase deductions now. Pay your tax preparer and state income or real estate taxes in advance, pay ahead on expenses if you are self-employed. The more you pump up the deductions now, the less tax you will owe in the spring.
– Max out retirement plan contributions. Contributing to your retirement plan drops your taxable income. If you haven’t contributed as much as possible to your retirement savings and can afford to cut your salary for the last few weeks of the year, set aside more of your earnings now. Not only do you get the benefit of increasing your nestegg, but you lower your tax bill for next spring.
– Beware the “alternative minimum tax.” Alternative minimum tax (AMT) is the worst-named and least-understood tax program out there. It should be called “always the maximum tax,” because it is designed to make sure individuals and companies pay the most possible in taxes.
The AMT is so complicated that it can’t be fully explained here, but it is a flat tax that applies broadly to high-income individuals. Essentially, if the method of calculating the AMT produces more revenue for Uncle Sam than the conventional method, you get stuck with the bigger bill.
Chances are–and the way the AMT works it doesn’t get much more accurate than “chances”–you won’t need to worry about this tax unless you have adjusted gross income of $175,000 or more. But Roth IRA conversions, stock options and other one-time income-generating moves could push some into AMT range.
One big problem with the AMT is that there are no deductions. So if you bunch deductions this year to cut your tax bill but wind up in the AMT zone, your deductions are worthless.
One more problem with this tax is that it is hard to pin down who falls into it. Suffice it to say the AMT is not something that should be taken on without a tax preparer, and that adjusted gross income of $150,000 should send you rushing in that direction to see if you can avoid this plight.
– Donate to charity. From appreciated stocks, in which you get the full value of the investment without ever paying capital gains on your earnings, to old refrigerators, books and clothes, year-end contributions are a savvy tax strategy.
Don’t just pull out the checkbook, do a little winter cleanup and get rid of things you don’t need. If the value of the goods exceeds $250, you will need to have a letter from the charity acknowledging your gift, but most charities will respond promptly to any offering you have to make.
These gifts in kind become a nice tax deduction without hurting your pocketbook. And, more so than everything else having to do with taxes, donations are in keeping with the season.
