Year-end tax planning for 2001

Year-end tax planning is increasingly important to a number of taxpayers. Strategies once reserved for the super-wealthy have long passed. Good reasons exist for most middle and higher income taxpayers to investigate year-end tax options.

This year, in addition to a growing list of "tried-and-true" year-end tax strategies, tax changes brought about by the historic Economic Growth and Tax Relief Reconciliation Act of 2001 have added to the opportunities available.

Careful timing of your financial situation now and in January may help you realize significant overall tax savings. Most of these tax benefits, however, won't "just happen." You must take action to be entitled to -- or effectively use -- many of these changes.

Here's an abbreviated list of some of the tax opportunities, and challenges, to consider for year-end tax planning this year:

-- Tax rates have dropped 0.5 percent in 2001 and will drop again by 0.5 percent in 2002, from the former 28, 31, 36 and 39.6 percent income tax brackets;

-- Starting in 2002, the annual contribution limit for individual retirement accounts (IRAs) increases to $3,000, with those 50 and older allowed special "make-up" contributions;

-- Starting in 2002, education IRAs can accept up to $2,000 each year, up from $500 in 2001; qualified state tuition programs are also more generous;

-- The alternative minimum tax (AMT) exemption increases for 2001 and 2002 to $4,000 for joint filers and $2,000 for others;

-- The estate tax begins its slow decrease starting in 2002, requiring many taxpayers to draft new will provisions while adopting new gift-giving strategies;

-- A new reduced rate on long-term capital gain for property held for more than five years started in 2001, giving a new and sometimes complicated twist to buy-sell decisions this year-end;

-- The maximum student loan interest deduction rose from $2,000 to $2,500 starting in 2001, and in 2002, the income phase-out limits increase;

-- The IRS continues its massive reorganization, creating not only new rules for taxpayers who anticipate trouble with the IRS, but also new opportunities to "audit-proof" this year's tax returns through year-end and pre-filing strategies.

In addition to the year-end issues generated by recent legislation, many "tried-and-true" year-end tax strategies have particular relevance this year. Here is an overview of some of the more important techniques that may be used:

-- Time your income and deductions so that your taxable income is about even for 2001 and 2002. If you anticipate being in a higher tax bracket for 2002 (even with the drop in the tax rates caused by the 2001 Tax Relief Act), accelerate income into 2001 and defer deductions into 2002. Income can be delayed through setting up deferred compensation, postponing year-end bonuses, maximizing deductible retirement contributions, and delaying year-end billings.

-- Maximize the value of itemized deductions between 2001 and 2002. Some taxpayers achieve this balance by taking the standard deduction one year and paying all bills that generate itemized deductions in the other year (be careful not to run afoul of pre-payment rules). Other taxpayers must carefully watch whether their itemized deductions for medical expenses will exceed the 7.5 percent adjusted gross income floor, or their miscellaneous itemized deductions exceed the designated 2 percent floor. Still others may need to balance income if they anticipate exceeding the income level above which certain itemized deductions must be reduced ($132,900 in 2001, rising to $137,300 for 2002);

-- Check whether you are in danger of being subject to the alternative minimum tax (AMT) for 2001 or 2002 (a growing number of "average" taxpayers are). If necessary, investigate whether certain deductions should be more evenly divided between 2001 and 2002 and whether certain deductions won't qualify -- or won't be as valuable -- for AMT purposes;

-- If you're in business, consider timing final quarter equipment purchases to capitalize on "half-year" and "mid-quarter" conventions; and space the purchase of depreciable assets to take full advantage of the $24,000 immediate write-off allowable for each year, in 2001 and 2002.

-- Time the recognition of capital gains and losses to minimize net capital gains tax (and maximize deductible capital losses). This involves an often complicated process of determining short term gains (taxed as ordinary income), long-term gains, short-term losses, long-term losses, depreciable gain, and gains and losses from collectibles, and then determining how you might vary the mix before year-end to maximize existing losses and minimize existing gains. Unfortunately, the maximum capital gains tax rate was not reduced along with the regular income tax rates in the 2001 Tax Relief Act. Adding to the confusion, will be an 8 percent capital gains rate for 15 percent income tax bracket taxpayers realizing long-term capital gain from property held for more than five years, and an 18 percent rate available beginning in 2006 (but subject to a 2001 election) for other taxpayers.

-- Income shifting between low-bracket family members and higher-bracket members usually starts with transferring income-rich assets before the start of another tax year, followed by careful timing of year-end sales to maximize use of the lower tax bracket.

In addition, changes in circumstances, such as marriage, divorce, the birth of a child, death, retirement or an economic windfall (or set back) through the stock market, earnings or inheritance, may signal a special need for year-end tax planning. Once Jan. 1, 2002 ,rolls in, it will be too late to alter most of your bottom-line tax liability for 2001 due to these, or other ordinary events.

If you are interested in investigating what year-end tax planning will work best in your situation, contact us early enough to allow full consideration of the options available. If you have any questions in the meantime, please do not hesitate to call.

Melvin J. Van de Ven, CPA, CVA is a partner in the certified public accounting firm of Schott & Van de Ven in Cape Girardeau. He can be reached by email at mvandeven@schottvandeven.com.