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                                                                       by Anil Deora

Taxes/Business/Personal

Year -End Tax Strategies Anil Deora As the new millenium approaches many people have high hopes and others have some trepidation because of the 'byte-pinching' (analogous to 'penny-pinching') by the early programmers. Everybody seems to be thinking and talking about their plans to usher in the 21st century. The other day someone mentioned that after the clock strikes midnight on December 31, 1999, it would take another 1,000 years before our descendents usher in the next millenium. We do indeed live in historic times. Y2K or not, a year-end review of your personal tax situation is one of the most effective ways to reduce your overall tax liability. It is never too early or too late to start thinking about what you can do to reduce your taxes for the year. Defer Revenue, Accelerate Expenses: A large majority of taxpayers swear by the year-end strategy of "defer revenue, accelerate expenses". Is this the best strategy to follow? The answer depends on the individual taxpayer's situation. Deferring revenue and accelerating expenses can reduce the taxes for some taxpayers, but in some cases could also end up in increasing the taxes. The objective should not be limited to reducing the current year's taxes alone, but to reduce the overall taxes for the taxpayer for the current and future years. Keeping this in mind, instead of deferring revenue and accelerating expenses, it is more important to time your income and expenses. This may sometimes require accelerating revenue and deferring expenses. Timing Your Income: For individual taxpayers and businesses operating on cash basis. Income is generally taxable in the year in which it is received. In general, a taxpayer may defer payment of tax by deferring receipt of the income. If you operate a business or collect rental income and report that income on the cash receipts and disbursements method, you have the opportunity to delay or accelerate the billing to your customers or tenants and determine the timing of the related income. If the business is operated on an accrual basis, there is less freedom to time the income or expense. Timing Your Deductions. Cash basis taxpayers have some opportunities for reducing taxable income by controlling the payment of deductible expenses. You may deduct certain expenses that are due for payment next year on your 1997 return if you pay them by December 31. This strategy helps you the most when you expect your marginal tax rate to be higher in the current year than in the next, because the rate differential makes the deduction worth more in the current year. Taxpayers reporting on accrual basis have less freedom to time their expenses. For example, if you pay a deductible expense in December 1999, instead of April 2000 when it is due, you will reduce your 1999 tax instead of your 2000 tax, but you will also lose the use of your money for three or four months. You need to decide whether the cash used to pay the expense early is needed for anything more urgent or more valuable than the accelerated tax benefit. Individual taxpayers wanting to accelerate their expenses can pay the state taxes, prepaid interest, medical expenses, and miscellaneous itemized deductions, earlier than they would in the normal course. Some factors to consider when deciding to defer or accelerate revenue and expenses include:

1. Changes in your filing status.

2. Marginal tax rate.

3. The effect of phase-out of deductions and exemptions.

4. Meeting minimum thresholds, such as 7.5% for medical expenses.

5. The effect on AMT. Minimizing Your Taxes:

There are two ways to minimize your tax bite, permanent savings of taxes or by deferring taxes to some future year. Avoiding Estimated Tax Penalties: Federal tax laws require the payment of income taxes throughout the year as you earn your income. This obligation may be met through withholding or quarterly estimated tax payments or both. For 1999, if total tax minus withholding and payments is greater than $1000, you will be assessed a penalty for underpayment of estimated tax unless 1998 estimated payments and withholdings equal (a) 90 percent of the current year's tax liability; (b) 100 percent of the prior year's tax liability, unless you are subject to special rules; or (c) 90 percent of the tax liability based on quarterly annualization of current year-to-date income. However, if you overpay your estimated taxes, you are in effect making an interest free loan to the government, which you would probably prefer to avoid. Year-End Tips:

1. Shelter interest and dividends in your tax advantaged accounts. While the capital gain taxes are generally lower than the ordinary taxes, interest from bonds and dividends from stock are taxed at the same rate as ordinary income: up to 39.6%. It now makes more sense than ever to use tax-advantaged retirement accounts, such as 401(k)s and IRAs, to hold your taxable bonds and high yield stocks.

2. Go for growth in your taxable accounts. The tax ;laws make long term investment in growth stocks the most attractive option for your taxable accounts. That's because the returns on such shares come almost exclusively in the form f capital gains, which are taxed (only after you sell) at the lower capital gains rate.

3. Mutual fund investors can take advantage by choosing growth-stock funds that keep their taxable short-term capital gains to a minimum.

4. Match your losses and gains for maximum benefit. When the capital gains rates were closer to the rate on ordinary income, investors were advised each year to comb through their portfolios in search of unpromising stocks that they could sell at a loss to offset any gains, short or long, that they planned to realized. Now, though, your best tax strategy is to sell your losers only in years when you have short-term capital gains and other income to offset.

5. Beware the alternative minimum tax (AMT). The current law virtually guarantees that more Americans will pay the AMT. And the law's incentives to go for capital gains will push even more taxpayers into the AMT. Consider: If you realize a big capital gain, you're likely to also incur a large state income tax bill. That in turn would create an outsize deduction on you federal return-and big write-offs can trigger the AMT So can the exercise of ISOs. Avoiding or mitigating the AMT may take multiyear planning.

6. Calculate you potential gain carefully before you sell your home. If your married and filing joint and your gain is under $500,000, feel free to sell. Do not throw out records showing what you spent on your home improvements. Over time, you could exceed the $500,000 profit cut-off - or tax laws could change again.

7. Maximize contributions to retirement plans, for example a 401K at work. IRA contributions can be made till April 17, 2000, since April 15, 2000 falls on a Saturday. This year like last year the amount that joint filers can deduct for individual retirement account contributions in one year is $2,000 for each spouse. The combined compensation of both spouses must be at least equal to their combined contributions.

8. Even if you have a 401 (k) at work, consider contributions to a ROTH IRA, if you are eligible.

9. Look at whether you are eligible and if you would benefit by converting your traditional and/or Non-deductible IRAs to a ROTH IRA. If you decide to covert this year, you need to do it on or before December 31, 1999. Remember Y2K, and do not wait till December 31, 1999. Also remember that conversions to ROTH IRA would trigger taxes that would need to be paid in full along with your current years taxes.

10. Convert ordinary income to capital gains with a Section 83(b) election. If you receive eligible property, you can elect under Section 83(b) to recognize immediately as income the value of the property received (that is, the fair market value less any amount paid to acquire the property) and convert all future appreciation to capital gains income.

11. Contributions of Appreciated Stock to Private Foundations remain attractive. The rule that allows tax payers to deduct an amount equal to the fair market value of "qualified appreciated stock" contributed to a private foundation is still applicable.

12. Self-employed taxpayers should consider take advantage of Section 179 expensing.

13. If you're self-employed, consider employing your children less than 18 years of age in your business.

14. Self-employed taxpayers do not forget deductions for health insurance premiums.

15. Make your charitable contributions before December 31, 1999.

16. Miscellaneous deductions are deductible only to the extent they exceed two percent of AGI. Grouping or bunching miscellaneous deductible expenses in a single year may help the taxpayer meet the two- percent floor.

17. If you have high medical expenses, similar planning can help you make at least part of the medical expenses which exceed the threshold of 7.5% of AGI to be deductible. Disclaimer: Most of the time the general rule is stated, but there may be exceptions or certain conditions to be met before the general rule can be applied. The information in this article SHOULD NOT be acted upon without first checking with a professional to determine its applicability to your situation.

(c) Copyright Anil Deora 1999.

Anil Deora, B.Sc., B.L., MBA is a Management Consultant and Registered Tax Preparer based in the Bay area. He can be reached at Tel: (408)-865-0700. email: deora@rightskills.com. Please see this and other articles at www.indzine.com/adeora/taxes

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