Year-end financial strategies may dictate some nimble moves

Dollars & Sense

December 28, 2003|By THE DALLAS MORNING NEWS

In winter, thoughts turn to spring, and the Jobs and Growth Tax Relief Reconciliation Act of 2003.

As you do your year-end financial planning, the tax cuts passed in May permeate nearly every decision.

For most people, the standard advice still holds: accelerate deductions and defer income. But for others, that advice is reversed, because of complications such as the alternative minimum tax.

"While most taxpayers will come out ahead by following the traditional approach, others with special circumstances will do better by accelerating income and deferring deductions," according to RIA in New York, a provider of information and software to tax professionals.

Many hard truths may need a rethink.

"A lot of year-end strategies assume that the taxpayer is going to be itemizing," said Bob D. Scharin, senior tax analyst at RIA. "The reason why fewer people can be expected to itemize is that the standard deduction was increased greatly for married individuals."

The standard deduction for married couples jumps this year from $7,950 to $9,500, part of the marriage penalty relief.

Another factor that might argue against itemizing: If you refinanced your mortgage this year, you're paying less in interest. The mortgage interest deduction is one of the biggest benefits from itemizing.

Since more people are on the bubble between itemizing and not, it may be helpful to alternate accelerating deductions one year to allow you to itemize, then deferring deductions the following year while you take the standard deduction, then accelerating, and so on.

Take those considerations into your year-end planning, as you try to reduce your taxes and maximize your investments.

Many investors are ending 2003 with portfolios far healthier than they've seen in some time.

Tally up your investment winners and losers for this year. Then, determine whether it would make sense to take tax losses by selling your dogs so that you can use your losses to offset any investment profits, also called capital gains.

"This could be a good time to lock in gains to offset losses you have carried forward for the last few years," said Shashin Shah, a certified financial planner at Financial Design Group in Addison, Texas. "With the reduction of the capital gains tax, consideration of selling may increase."

To parlay capital losses into tax savings, you have to actually sell your investment and take the loss.

If your capital losses exceed your capital gains, you can deduct only up to $3,000 of those losses a year against ordinary income. Any excess can be carried over until it can be offset against future capital gains or be deducted as a loss against ordinary income, with a limit of $3,000 a year.

Here's where this year's tax changes come in: Taxes were lowered on both dividends and long-term capital gains, which are profits from investments held for more than a year. (The law also lowered most regular income tax rates.)

For this year through 2008, both dividends and long-term capital gains will be taxed at 15 percent for taxpayers in the 25 percent and higher brackets. For those in the 10 percent and 15 percent tax brackets, dividends and long-term capital gains will be taxed at 5 percent this year through 2007, then at zero percent in 2008.

Gains on investments held less than a year are short-term and taxed at your regular tax rate.

For capital gains, the rates apply to transactions on or after May 6.

"The rate changed in the middle of the year, so people have to segregate their transactions," Scharin said. "That's going to be a tax-return issue."

The IRS has added a column to Schedule D for you to list post-May 5 gains and losses.

On the dividends side, the lower dividends tax is a good jumping-off point for tweaking your personal financial planning.

"With dividend income now being taxed at a top rate of 15 percent, it may be advantageous to revisit your portfolio allocations to favor dividends over interest," said Michael Busch, a certified financial planner and president of Vogel Financial Advisors LLC in Dallas.

In other words, consider putting dividend-paying stocks into a taxable account and using your tax-deferred account to stash investments, such as bonds, that otherwise would be taxed at your ordinary rate.

The alternative minimum tax has become a giant thorn in the side of average taxpayers.

Congress created the AMT about three decades ago when it discovered that many affluent taxpayers paid little or no tax by cleverly using deductions and credits.

The AMT triggers when a taxpayer claims big deductions, such as unreimbursed employee expenses; has lots of dependent exemptions; and has high local and state taxes.

Because the tax isn't inflation-adjusted, it's ensnaring more average-income taxpayers.

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