Although your 1999 tax bill becomes due on April 15, 2000, you only have until the end of December to reduce your tax liability. The following are suggestions for lowering your taxes by taking action before midnight, December 31^st.

TAX PROPHECY FOR THE MILLENIUM

Watch out for the Y2K problem. Retain all bank and brokerage statements, year-to-date wage and employment records, and canceled checks. Back up and print out critical financ1al data needed for your 1999 tax returns. Double-check all W2 and Form 1099 statements you receive, including mortgage payment statements. If you've stored your 1999 tax return electronically, print out a hard copy. The last thing you want is a Y2K crash that zaps your financial records. Whether IRS’ computers will survive the Y2K problem without serious glitches remains to be seen.

TAX POLICY

For 2000, an election year, look for the Republican candidates to suggest large tax cuts, if not radical "flat tax" proposals. Republicans like cutting capital gains and estate taxes, while Democrats push for narrowly targeted tax cuts, benefiting the working poor and middle class.

Remember, the Republican enthusiasm for tax cuts stems from 10-year projections of mammoth budget surpluses, an assumption that can quickly change if the economy slows. Nevertheless, if you are planning to sell real estate with substantial depreciation recapture, it might be prudent to wait and see whether the promised capital gains cuts materialize in 2000.

YEAR-END TAX PLANNING OPPORTUNITIES

As discussed in last year's article on year-end tax planning, the simple rule -- defer income to next year and accelerate deductions in 1999 -- no longer automatically applies. Such a strategy could backfire, causing taxpayers to lose benefits in 2000. The problem with the current tax law is that tax breaks will be phased out (reduced ratably over a range of income) when a taxpayer's adjusted gross income ("AGI") reaches certain levels. Therefore, it is critical to determine which tax breaks you are eligible for and then take the appropriate steps to keep your AGI within the limits. The accompanying chart illustrates the impact of AGI on various tax incentives.

1999 TAX PLANNING ISSUES

The most important investment decision most taxpayers will make this year is whether to take advantage of the Roth IRA by rolling over some or all of their investments held in traditional IRAs.

If your adjusted gross income ("AGI") is less than $100,000, seriously consider converting all or a part of your IRA to a Roth IRA by year's end. The tax is due in the year of the rollover. Those who converted prior to the market's decline, may switch back to an IRA and then reconvert to a Roth (at the lower value) by the 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 $12,000 or a lower valuation.

Capital Gains: Sales of securities and real estate held for more than one year qualify for the maximum long-term capital gains deduction. These assets are taxed at a maximum 20% federal rate (California does not have a special rate for capital gains). If these assets are received by inheritance, they are treated as long-term capital gains, whether or not you hold them for a year. Note: The long-term capital gains rate for collectibles (generally trading cards, automobiles, antiques, artwork, jewelry, stamps and coins) is 28%.

To Marry or Not to Marry?

The impact of getting married on one's taxes cannot be under-estimated. Usually, marriage will have a negative impact if both parties are earning significant amounts of income, but that is not always the case. For instance, the initial exemption under the Alternative Minimum Tax is $45,000 for joint filers, but only $33,750 for single taxpayers. Conversely, the 10% surcharge on high incomes (increasing the top marginal tax bracket from 36% to 39.3%) applies to taxable income greater than $283,350 for single and joint filers alike. Therefore, two individuals with a combined taxable income of more than $283,350 should postpone marriage until the year 2000.

Couples who "tie-the-knot" on or before December 31, 1999 are considered married throughout the entire year, and this may significantly impact your taxes.

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 fiancé's combined AGI will exceed $100,000. Although it is patently unfair to limit a married couple's AGI to the same amount ($100,000) that applies to single filers for the Roth rollover, there is little movement in Congress to change this rule.

Avoid the 10% Surcharge: The 10% surcharge (36% tax bracket becomes 39.6%) applies to individuals or couples with taxable incomes exceeding $250,000. Therefore, if two individuals with taxable income of $225,000 each ($450,000 total) get married, $200,000 of their income will be taxed at 39.6% ($450,000 taxable income - $250,000). 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 five years prior to sale ("residence"), may exclude up to $250,000 in profits ($500,000 for joint filers). Assume a single woman, who has lived in her residence with her fiancée for at least two years, sells her residence during the year for a $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 their marriage.

ESTIMATED TAX PAYMENTS

Taxpayers with multiple sources of income or significant investment gains should be concerned with their quarterly estimated tax payment obligation. In general, you need to make estimated tax payments in an amount at least equal to your actual tax liability for 1998.

There are exceptions to this general rule: If you expect: (1) to owe less than $1,000 in 1999 after subtracting income tax withholdings and credits from your total tax (do not subtract estimated tax payments); (2) your income tax withholdings and credits to equal at least 90% of the tax shown on your 1999 return; and (3) your income tax withholdings and credits to be at least 100% of the amount shown on your 1998 return (105% of the 1998 return if your AGI for 1998 was greater than $150,000). Note: the percentages for items (2) and (3) for farmers and fisherman are reduced to 66.67%, regardless of AGI.

Remember, in addition to income tax, you must pay estimated taxes on self-employment taxes as well, which includes income from a sole proprietorship and often includes income from a partnership, limited liability company or S corporation.

LAST MINUTE DEDUCTIONS

Those who itemize their deductions and who are searching for last minute write-offs should consider the following techniques:

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 Goodwill or your favorite charity to claim a charitable deduction. Items over $250, require a receipt. Also, if you have a used car, consider donating it to charity for a full blue book deduction. Note: IRS is investigating abuses involving charitable donations of automobiles so be prepared to substantiate the value of your automobile at the time of donation.

Contribute appreciated property to public charities and receive a deduction for the full fair market value on the date of the donation. Congress restored the provision allowing a full charitable deduction for gifts of publicly traded stock (held more than 12 months) to a private foundation for the full fair market value of the stock. Remember, donations of appreciated property, such as stock, include the appreciation as part of the charitable donation, but you do not have to pay capital gains tax on the transaction.

Example: If you donate stock having a $1,000 basis worth $10,000, you receive a charitable deduction for $10,000. When the charity sells the stock, it pays no tax on appreciation. In contrast, if you sold the stock and gave the proceeds to the charity, you’d pay tax on the $9,000 gain. Assuming a combined federal and state tax rate of 27.5%, your cash donation would be $10,000, less $2,475 (27.5% of $9,000) = $7,525.

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 2000, by the end of 1999. The same holds true for deductible alimony payments and deductible student loan interest.

The mortgage and property tax prepayment techniques work when you make direct payments to the property tax authorities, rather than include them ratably with your mortgage payment. Also, it is prudent to pay your January mortgage several weeks in advance so that your mortgage company will properly record the payment as made in 1999 when it issues you a Form 1096, a tally of your principal and interest payments.

Note: Although an inaccurate Form 1096 does not prevent you from deducting the January payment, it could require you to prove to IRS that you actually made the January payment in December, if you are audited. Remember, if you prepaid your January, 1999 mortgage payment in December, 1998, then you must prepay your January, 2000 payment in December, 1999 to obtain a full 12 month’s of deductions.

Medical Expenses: Schedule medical and dental work prior to the end of this year and pay all medical expenses prior to the end of 1999. These expenses are deductible to the extent they exceed 7.5% of your AGI.

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. These include uniforms, travel expenses, automobile expenses, job-related moving 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 $19,000) placed in service in 1999, supplies and publications. Note: Special rules apply to computers, automobiles and other mixed-use equipment.

PAYING DEDUCTIBLE EXPENSES

Payments by check and credit card made in 1999 count as 1998 deductions, even though the credit card charges are paid actually in 2000. Note: If you are considering several large expenditures, obtain a less-expensive (less than interest charged on credit cards) home-equity line of credit (or use one you already have) to pay the expenses in 1999. Generally, interest on the first $100,000 borrowed against a home-equity line is deductible.

Note: It is possible to earn bonus mileage or rebates by paying your property taxes with a credit card. Also, consider paying your federal income tax liability with a credit card. Determine which credit cards are available for these payments and the service charges. Earn bonus points on your credit card without incurring the high interest rates by paying for taxes with your credit card, then using your home-equity loan to pay off the credit card balance.

Capital Gains: Reduce your tax bite by netting your long-term capital gains and losses. Remember, you may sell stock at a loss for tax purposes and reacquire the same stock, provided you wait at least 31 days after the sale. Note: You can sell your stock in one company and purchase stock in a similar company (or mutual fund) without running afoul of the wash sales rules.

Watch out when purchasing mutual funds just before a year-end distribution of gains and dividends. You’ll pay a higher price for the shares because of the anticipated dividend, but receipt of the dividend will be ordinary income to you.

ANNUAL TAX BREAKS:

Annual Gift Tax Exclusion

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. Since this annual benefit expires on December 31 of each year, for those facing large estate taxes, it is prudent to maximize your gift giving privilege each year. Note: Gift giving reduces your estate for estate tax purposes, but does not reduce your income tax burden. There is no income tax deduction for gifts.

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. Thus, a 14.25% interest initially worth $28,500 but then discounted by 30%, receives a value of $19,950, which is under the $20,000 annual gift tax limit.

By forming a family limited partnership then gifting limited partnership interests at a discount, taxpayers hope to substantially reduce their estates. But beware of using family limited partnerships to create minority discounts when the partnership merely holds appreciated securities or other passive investments. This no longer works (if it ever did) and IRS is aggressively challenging these arrangements as lacking economic substance.

Watch for Proposition 13 Reassessment

If you are using family limited partnership techniques for real estate, make sure you structure the transaction so as not to create a "reappraisal" under California's Proposition 13. You need to transfer the undivided interest in real estate directly to the children, and than have the children and you transfer your interests to the FLP in exchange for exactly the same ownership. You can then give your interests in the FLP to your children in subsequent years without causing an immediate Proposition 13 reassessment. A reassessment will occur when the "original owners" collectively transfer (in one or more transfers) more than 50% of his or her interest or when another FLP member obtains more than a 50% interest. Note: The parent/child exemption does not apply to avoid a change on ownership under these circumstances, however, the interspousal exclusion should apply.

For example: Suppose a parent gifts a 10% undivided interest in real property to each of two children and retains the remaining 80%. The two children and the parent form a limited liability company or family limited partnership and transfer their real estate interests into the newly-formed entity, in exchange for exactly the same ownership interests held in the real estate (i.e. child one has a 10% interest, child two has a 10% interest and parent has an 80% interest in the new entity). There will be no change in ownership under California’s proposition 13 until one of the children receives more than 50% ownership, or until the parent’s interest drops below 30% through a series of future transfers (the parent, as an original co-owner transferred more than 50% of the ownership interests).

Incentive Stock Options: 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.

Note: Watch out for the exercise of stock options that produce income to you when exercised, when the stock is "locked-out" (cannot be sold for 6 months). If you exercise stock options in December, you’ll be taxed on the income in 1999, but you are prevented from selling the stock to pay the taxes owed until after the April 15, 2000 filing deadline.

Alternative Minimum Tax: If you expect to owe AMT, because of the exercise of incentive stock options or otherwise, consider accelerating income into 1999 -- by receiving bonuses or collecting on accounts receivable, collecting on installment notes, increasing retirement plan or IRA distributions, exercising your ISO and disposing of the stock -- by year’s end. Wait until January, 2000 to pay state income taxes, interest payments on home-equity loans or other expenses which are not deductible in calculating the AMT for 1999.

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

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. You need to file for dissolution with the Secretary of State prior to the end of the year. Check out the new corporate dissolution form which allows a corporate dissolution if the officers merely state that they have paid (or provided for) all the known debts and liabilities, as far as its assets permit.

Likewise, wait until 2000 to form a new entity and save the annual minimum tax otherwise payable in 1999. Note: the minimum corporate franchise tax for certain newly-formed corporations will be waived for the first two years. Corporations formed in 1999, however, cannot take advantage of this change, although the minimum tax for a corporation formed in 1999 will be $500, instead of $800. Also, in 2000, LLCs may have just one member.

CONCLUSION

Whether to reduce your income in 1999 or 2000 depends on the income restrictions for those tax breaks you desire and your AGI estimate in 2000. You lower your income in 2000 by deferring AGI adjustments to 2000 or by accelerating income into 1999. You lower your income in 1999 by doing the opposite. Remember: Itemized deductions reduce your taxable income but not your AGI.

The Roth rollover is the most important investment decision facing taxpayers in many years. The Roth holds the promise of a tremendous tax break in the future, although you'll likely pay an up-front tax, payable at the time of conversion. Juggling the incentive stock options within the AMT exclusions is another important tax decision that should be made annually. Also, maximizing your gift-giving on an annual basis will reduce your estate for estate tax purposes.

Remember, deductible expenses and charitable contributions paid by credit card in 1999 are considered 1999 expenses, even though you pay the credit card in 2000. To qualify for a deduction by check, the check must be delivered to the recipient by midnight, December 31, 1999, even if it is deposited later. You are not permitted to delay the receipt of income by deliberately not cashing a paycheck or designating a payment made to you a "deposit" and then converting it to a payment in 2000.