The Tax Prophet Newsletter - Last Minute Tax Planning 2004

The Tax Prophet Newsletter

Issue # 18 December, 2004

In This Issue:

Net Capital Gains and Losses

Wash Sales Rules

Last Minute Deductions

Last Minute Tax Planning Ideas for 2004

Net Capital Gains and Losses

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 15% 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 12 months. Note: The long-term capital gains rate for collectibles (generally, trading cards, automobiles, antiques, artwork, jewelry, stamps and coins) is 28%.

Capital gains and losses during each year are netted: If you have a net capital gain, you pay tax on the gain; if you have a net capital loss, you may carry forward the loss to future years. The loss is applied first against capital gains, and then up to $3,000 can offset ordinary income, per year.

Because of these rules, those with a large capital gain in one year and a loss the next year could face disaster – the loss does not offset the previous gain.

Note: Many "day-traders," those who use the internet to execute stock trades on a daily basis for their own personal gain, are in for a rude tax surprise. Not only are their STCG taxed at ordinary income rates (as high as 43% for federal and California combined), but short-term capital losses (STCL) incurred in the subsequent year do not offset gains for the prior year.

Wash Sales Rules

Suppose you own a stock that has lost value, but you want to keep it. Can you sell it, recognize the loss, then repurchase it? Yes, if you wait at least 31 days before repurchasing it. This is called a "wash transaction" and the rules state that you cannot acquire "substantially identical securities" within a 61 day period which begins 30 days before the sale and ends 30 days after it.

The lesson for all investors: If you have a net recognized capital gain during 2004, get your tax money off the table; do not let it ride in the stock market.

Last Minute Deductions

For those looking for last-minute tax deductions for this year, there is still time to act:

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.

If you have a used car, consider donating it to charity for a full blue book deduction. This favorable valuation ends December 31, 2004, so donate your clunker now!

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. If you still want to own the stock, purchase it again and receive a higher basis. However, if your stock has a loss, sell it first to recognize the capital loss, then donate the proceeds to charity.

Example: If you donate stock having a $1,000 basis worth $11,000, you receive a charitable deduction for $11,000. 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 $10,000 gain. Assuming a combined federal and state tax rate of 20%, your cash donation would be $10,000, less $2,000 (20% of $10,000 = $8,000).

Mortgage Interest

It may be advantageous to pay your January mortgage several weeks in advance so that your mortgage company will properly record the payment as made in 2004 when it issues you a Form 1096, a tally of your principal and interest payments.

Pre-Pay Taxes

Pay your fourth-quarter state income tax estimate this year. Pay your second property tax installment due in 2005, by the end of 2004. The same holds true for deductible alimony payments and deductible student loan interest. State taxes are not a deduction under the AMT. Note: It is estimated that 3 million taxpayers will fall under AMT in 2004.

For those taxpayers living in states with little or no income taxes, consider itemizing your state and local sales tax under a new provision available for the 2004 tax year. If you are considering the purchase of a big-ticket item which is subject to sales tax, crunch the numbers to determine whether the purchase should be made in 2004 or 2005.

Medical Expenses

Schedule medical and dental work prior to the end of this year and pay all medical expenses before December 31; 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 educational expenses for maintaining skills, union and professional dues and expenditures for equipment (up to $100,000) placed in service in 2004, supplies and publications. Note: Special rules might apply to computers, automobiles and other mixed-use equipment. Itemized miscellaneous deductions are not deductible under the AMT.

Credit Card Use

Business expenses and tax-deductible personal expenditures paid with a credit card by the end of the year are deductible in the year the expenses were incurred, not when the credit card charges are actually paid. Promotional and entertainment expenses incurred in December but paid in January, 2005 are therefore deductible in 2004. The same is true with personal medical and dental expenses, charitable contributions, real estate tax payments and itemized miscellaneous deductions.

NEW! - Action Guides

Check out the Tax Prophet's New ACTION GUIDES, dealing with such subjects as: (1) Wealth Preservation; (2) Foreign Investment; (3) Independent Contractor vs. Employees; (4) Employee Stock Options and (5) Off-Shore Asset Protection Trusts.

All contents copyright © 1995-2003 Robert L. Sommers, attorney-at-law. All rights reserved. This internet site provides information of a general nature for educational purposes only and is not intended to be legal or tax advice. This information has not been updated to reflect subsequent changes in the law, if any. Your particular facts and circumstances, and changes in the law, must be considered when applying U.S. tax law. You should always consult with a competent tax professional licensed in your state with respect to your particular situation. The Tax Prophet® is a registered trademark of Robert L. Sommers.

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