Copyright 1996, Marc S. Weissman
Weiss & Weissman, San Francisco, California
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This Article is designed to be of general interest. The specific techniques and information discussed may not apply to you. Before acting on any matter contained herein, you should consult with your personal legal adviser.

YEAR END TAX PLANNING

We are quickly approaching the end of 1996. As always, it is important to review your year end tax projections to see what can be done to reduce your income tax obligations. The key to all tax planning is planning! In April, it is too late to position yourself to reduce taxes for the closed year; you must do it NOW while there is still time.

The routine strategy for people in stable brackets is to postpone payment of taxes by deferring income and accelerating deductions. For example, delaying a year end bonus until January, 1997 means the taxes are not due until April 15, 1998.

However, with the expanded Alternative Minimum Tax ("AMT") and reduced deductibility of many items, planning is more important than ever, and a thorough review with your tax adviser before the year is over is essential. Otherwise, your tax adviser is merely a scorekeeper who can only calculate tax liability after the fact.

Knowledge is Money

Computer planning software enables you to see how you will be affected by timing choices.

First, examine tax events over which you have no control. Then look at those events within your control and make decisions to give you the best tax results.

Obviously we want to:

move income into low bracket tax years (when the tax hurts the least);
use deductions when we are in high brackets (when they help the most); and
postpone paying any tax whenever possible.

Most people should try to delay income and accelerate deductions. This works if your tax rates and income are stable; of course if you expect to be in a higher tax bracket next year, reverse the strategy. Make your best guess now, while you can still do something about 1996 taxes.

Of course, if you are self-employed, you have more opportunities, but even if you have little flexibility about the timing of your employment income, there are some factors within your control.

DEDUCTION TIMING

Many people make charitable gifts during the holiday season. It may make a big difference to your tax liability if the gift is made in December or in January. Making charitable gifts feels good; giving to achieve bigger tax savings feels even better.
If you will owe state income tax for 1996, should you pay now or wait until April when it is due?
Should you prepay your property taxes in December?
Should you make yourJanuary mortgage payment in December?

Moving these payments into 1996 means that the tax savings are received a full year earlier.

These are easy questions, but the answers require careful analysis of your personal situation. As a rule of thumb (which will be wrong 49½% of the time), the answer to each of these is probably yes, if your marital status and income levels are stable.

Some deductions have floors which must be reached before anything becomes deductible.

Medical Expenses less than 7.5% of Adjusted Gross Income arenot deductible. One common technique is bunching deductions (paying all 1996, 1997, and 1998 medical expenses in 1997). For example, if the first $1,000 of medical expenses doesn't save you taxes, and you average $800 annually, "bunch" them into one year. Time new glasses, filling prescriptions, and routine checkups for when it will help save the most in tax.

INCOME TIMING

You might be able to control the timing of income by controlling events which create income. For example, a self- employed person could delay December billings until January; your employer may be willing to delay your holiday bonus until January.

Capital Gains / Losses

If you bought XYZ at 70 and it is now at 45 and you want to keep it, can you deduct the loss? The Tax Code prohibits "wash loss sales." If you sell XYZ now to claim the loss, you may not buy it again within 30 days if you want the deduction.

It is also important to let economics control, rather than letting taxes control economic decisions. If economics dictate selling a stock (you expect a drop in price), but it is more advantageous to wait until January for tax purposes, call your broker. A short sale lets you do both.

If you already sold stock and took a loss which you cannot use, should you sell another stock with built-in gain? Find out now, rather than next April 15 when it is too late to see what you should have done.

Social Security

A portion of Social Security is taxable, up to 85%; as your income increases, the portion of taxable Social Security Income goes up. Delaying other income can have 2 benefits: delaying tax on that income, as well as lowering the percentage of Social Security income taxable now.

STATUS CHANGE TIMING

If you plan on getting married or divorced (your status on 12/31 controls your status for the whole tax year), your brackets could change dramatically. Should you marry now or wait until January? It might make a big tax difference.

Alternative Minimum Tax Concerns

The AMT is designed to prevent elimination of tax liability through certain deductions which have been given less favorable status. The AMT recomputes tax liability without deduction for "preference items." Preference items include state income and property taxes, employee business expenses, personal exemptions, and the portion of accelerated depreciation in excess of straight line depreciation.

While these preference items are legitimate deductions allowed for regular tax computation, they are disallowed for AMT purposes and may result in an ugly surprise.

With the Alternative Minimum Tax ("AMT") and limited deductibility of many items, planning is more important than ever, and a thorough review with your tax adviser before the year is over is essential.

The AMT is payable only if it is greater than the regular tax. The AMT for 1996 is at two rates: 26% and 28%, depending on your income level.

Proper planning is essential to minimize the AMT as well as the regular tax.

REAL ESTATE CONCERNS

Another important area to study is vacation home strategy. Actual usage for rental and personal purposes may alter the deductibility of expenses in connection with the property. It is important to meet certain thresholds regarding how many days it was actually rented (at fair market value), compared to used personally for pleasure (and personal use for maintenance) to maximize tax savings. You might not meet these thresholds unless you plan ahead. For details, see Vacation Home Tax Rules.

Passive losses also need scrutiny. The degree of participation in an activity governs deductibility. Make changes now while you still can, to qualify for larger deductions. For details, see Passive Losses Rules.

Issues Affecting Children

Verify that children's Social Security numbers are on their bank or stock account. If they should pay tax (at lower rates), the 1099 should have their ID numbers.

The Kiddie Tax affects children under age 14 with income (other than from their labors) in excess of $1,200. Under that level the child pays tax at his own rate. This would save $385 per child if the family in the top bracket shifts $1,200 of income to each child.

The most important lesson is that a year-end review is vital; otherwise taxes just happen. The important thing is to PLAN. Review your personal tax situation with your tax adviser. Using new computer programs it is possible to plan very precisely if you take a little effort before you are locked in on New Year's Day and it is too late.

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