Year-End Tax Planning;

This column, in slightly different format, originally appeared in The San Francisco Examiner Newspaper, November 29, 1998

Copyright 1998 Robert L. Sommers, all rights reserved.

Year-End Tax Planning

With 1998 winding down, it's time to consider several year-end tax opportunities.

Roth Rollover

If your adjusted gross income ("AGI") is less than $100,000, seriously consider converting all or a part of your IRA to a Roth by year's end. Any taxes owing are spread equally over four years. For those who converted prior to the market's decline, you may switch back to an IRA and then reconvert (at possibly the lower value) to a Roth by year's end.

For example: If you transferred your original IRA to a Roth when the IRA was worth $20,000 but now is worth only $12,000, you may switch back to the old IRA, then attempt to time the market to fund your Roth at a $12,000 or lower valuation.

To Marry or Not to Marry?

Couples who tie-the-knot before January 1, 1999 are considered married throughout the entire year, and this may significantly impact your taxes as follows:

Roth Limitation: An individual with AGI of $100,000 or less may engage in a Roth rollover, but the same AGI limitation applies to the combined incomes of a married couple. Postpone marriage until next year if you and your finance's combined AGI will exceed $100,000.

Avoid the 10% Surcharge: The 10% surcharge (36% tax bracket becomes 39.6%) applies to individuals or couples with taxable incomes exceeding $278,450. Therefore, if two individuals with taxable income of $225,000 each ($450,000 total) get married, $171,550 of their joint income will be taxed at 39.6% ($450,000 taxable income minus $171,450). In contrast, if they do not marry (each files as a single person), neither will pay tax at 39.6%.

Sale of a Principal Residence: Individuals who have owned and lived in their home for two of the past 5 years prior to sale ("residence") may exclude up to $250,000 in profit ($500,000 for joint filers). Assume a single woman, who has lived in her residence with her finance for at least two years, sells her residence during the year for $500,000 profit. If the couple marries before year's end and files a joint return, the full $500,000 will be excludable, even though the residence was sold prior to marriage.

Last-Minute Deductions:

Charitable Deductions: Empty your house of old clothes, furniture, computer and sports equipment and other "garage sale" items, estimate their fair market value (make an inventory and take pictures as part of your records), then donate them to your favorite charity to claim a charitable deduction. Items over $250 require a receipt.

Contribute appreciated property to public charities and, in general, receive a deduction for the full fair market value on the date of the donation.

Taxes and Mortgage Interest: Pay your fourth-quarter state income tax estimate and prepay your January mortgage payment this year. Pay your second property tax installment due in 1999, by the end of 1998. Remember: Prepayment could reduce your deductions for 1999.

Itemized Miscellaneous Deductions: Itemized miscellaneous deductions must exceed 2% of AGI. Employee expenses, not part of an employer’s accountable plan, are considered itemized miscellaneous deductions: Uniforms, travel expenses, automobile expenses, meals and entertainment expenses (these have strict requirements), certain education expenses for maintaining skills, union and professional dues and expenditures for equipment (up to $18,500) placed in service in 1998, supplies and publications. Note: Special rules might apply to computers, automobiles and other mixed-use equipment.

Capital Gains: Reduce your tax bite by netting your long-term capital gains and losses. Remember, you may sell a stock at a loss for tax purposes and reacquire the same stock, provided you wait at least 31 days after the sale.

Annual Tax Breaks: Maximize your annual gift-tax exclusion by gifting up to $10,000 (couples may gift $20,000), per beneficiary, in money or property, by year's end. This helps reduce your gross estate value for the future, but does not lower your annual income taxes.

Use the "minority discount" technique to gift a much larger percentage of property than the equivalent amount of cash. For example, a couple owns real estate worth $200,000 and gifts a 10% interest to their daughter. If the gift is subject to a 30% minority discount, the interest is not valued at $20,000 ($200,000 x 10%), but is worth only $14,000 ($20,000 minus 30% = $14,000). Thus, a 14.25% interest (worth $28,500) but then discounted by 30% ($8,550), receives a value of $19,950 ($28,500 minus $8,550), which is under the $20,000 annual gift tax limit.

If you have Incentive Stock Options, exercising them is not a taxable event, however, the spread between the option price and the stock price is an item of tax preference under the Alternative Minimum Tax (AMT). For example, if you exercise 1,000 options at $5.00 each (total option price $5,000) and the stock is worth $50 a share (total value $50,000), the spread will be $45,000 for AMT purposes. Calculate the maximum amount you can exercise without triggering tax consequences under the AMT. Use a tax software program or contact your tax preparer regarding this calculation.

California Businesses and Self-Employed Workers

Annual Minimum Franchise Tax: California charges corporations, limited partnerships and limited liability companies an annual minimum franchise tax of $800 a year. If you have an inactive company, liquidate it prior to the end of the year. Likewise, wait until 1999 to form a new entity.

Self-employed individuals should open a Keogh Retirement Plan prior to December 31st, although once opened, contributions may be made until the due date of your return (including extensions).


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**NOTE: The information contained at this site is for educational purposes only and is not intended for any particular person or circumstance. A competent tax professional should always be consulted before utilizing any of the information contained at this site.**