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5 smart ways to cut your tax bill


Take advantage of recent changes in the law to lower Uncle Sam's take in the years ahead.

"Sunset provisions" in laws enacted since 2001 threaten an end to some generous tax breaks for many doctors. Hamstrung by political and economic conditions, Congress and the Bush administration have had only limited success in countering this disturbing trend. But they did manage to pass a few key measures in recent months that, with proper planning, can lead to substantial tax savings in the years ahead. These guidelines will help you make hay while the sun still shines:

Give investment profits more chance to grow. Dr. Martin's stock portfolio includes several issues that would net him a total profit of around $200,000 if he sells them now. Since he's held them for more than a year, his gain would be taxed at 15 percent. But he thinks they have potential for further substantial growth over the years ahead. Trouble is, the tax bite is scheduled to increase by a third-to 20 percent-if he waits too long.

Suppose that holding on would add $25,000 to his profit. Taxed at 20 percent, the $225,000 gain would shrink to $180,000. By selling now, Martin can reap a sure $170,000 after-tax gain ($200,000 minus 15 percent, or $30,000). Is the $10,000 difference worth the risk that the market will turn against him?

Martin also owns a stock that's declined $12,000 in value. If he opts to hang onto his winners until 2010, he'd be wise to take his loss this year. That way he can deduct a maximum of $3,000 annually from his highly taxed regular income in 2006 through 2009. In his 35 percent bracket, this would save $4,200 of tax. By contrast, if he takes the loss in an intervening year, he'd be required to offset some of it against his 2010 gains taxed at 15 percent. In the worst case, Martin might end up saving only $1,800.

Go for dividend income to cut market risks. The revised law provides the same two-year extension for the 15 percent rate on dividend income. That's good news for Dr. Payne. Because he's dubious about the market's medium-term outlook, he's reducing his stake in an aggressive-growth mutual fund and putting the money into a more conservative fund that concentrates on stocks in well-established companies paying high dividends. Without the change in the law, Payne would've had to pay tax on the dividend income at his top-bracket rate of 33 percent after 2008. Now he'll enjoy the tax break an additional two years.

Payne should select the income fund with care, though. The 15 percent rate generally applies to cash dividends declared on common stocks in a fund's portfolio. But if the fund invests in bonds or other debt securities, the special rate doesn't apply to any portion of the fund's dividend representing interest income from those sources. Dividends paid by real estate investment trusts (REITs) generally don't qualify either, and gains distributed to fund shareholders are ineligible for either the 15 percent dividend or capital gains rate if they come from the sale of assets the fund owned short term (a year or less).

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