We'll suggest key steps readers should take before yearend to boost personal and professional deductions and reduce income. This is Larry Farber's Financial Guide evergreen, for the 2000 Fin Guide.
Promised tax breaks may never appear, so make the mostof those already on the books.
There they go again. Republicans and Democrats still can't seem to agreeon who should get tax relief and how much. So, it looks as if you'll havelittle to cheer about as you prepare your 1999 return. Don't despair, though.The year-end moves suggested here can save you hundreds, if not thousands,of dollarsbut you need to get started on them right away.
You already know that you can claim a personal exemption$2,750for 1999for each dependent child, as well as one each for you andyour spouse. But don't stop there.
You can get an additional $2,750 exemption if you provide more than halfthe support of a parent or someone else who qualifies as a relative andwhose gross income for tax purposes is less than $2,750. If it's not certainwhether you've more than matched the amount your relative spent from hisown money, making an additional contribution before year-end may safeguardyour claim. Or you can have your relative save some of his income, and youcan make up the difference, if necessary.
Suppose you provide $9,000 to a relative whose only other income is $10,000from untaxed Social Security. If he puts $1,100 in the bank, your paymentswill exceed half his total support. If you and other family members furnishmore than half of a relative's support and you contribute more than 10 percent,you still can claim the full exemption. But each of the other contributorswill have to sign a Multiple Support Agreement form waiving their rightto the exemption, and attach it to their returns.
Special dependency rules exist for children: The support test applies,but the income test doesn't if the dependent is younger than 19 or a studentunder 24 who attended school full time for at least five months during theyear. You lose the dependency deduction for a son or daughter 24 or olderwith gross income above $2,750.
Family members can also qualify you for tax credits, whichbecausethey reduce Uncle Sam's bill dollar for dollaryield more savings thanthe same amount of deductions. Generally, a married couple with adjustedgross income no higher than $110,000 can claim a $500 credit for each childunder 17. Every $1,000 of AGI above that will lower their total child creditby $50. For example, with two eligible kids and AGI of $115,000, the creditwould come to $750.
The size of your AGI won't freeze you out of another type of credit,if you pay for the care of a dependent while you work. A working couplewhose joint AGI tops $28,000 can claim a maximum credit of $480 for thecost of caring for one child younger than 13, or $960 for two or more. (Adisabled dependent other than a child may also qualify, if she lives withyou.) To figure your credit, take 20 percent of your expenses up to $2,400for one child or $4,800 for two or more. However, the spouse who earns lessmust have AGI at least equal to the appropriate expense limit. Otherwise,you can claim only 20 percent of the lower salary. So if your spouse makes$4,000 a year and you have two kids, your maximum credit is $800.
A Hope Scholarship credit may be available if one of your children isa college freshman or sophomore. Although the credit can come to $1,500for each student, the amount drops 5 percent for every $1,000 of AGI above$80,000 on a joint return, phasing out completely at $100,000. (For singletaxpayers, the threshold is $40,000, phasing out at $50,000; that's a 10percent loss per $1,000 of AGI above $40,000.)
The same income limits apply to the Lifetime Learning credit, which canhelp with family education expenses if you don't benefit from other taxbreaks. That credit applies if you've paid for college or graduate-levelcourses taken by your dependents, your spouse, or yourself at an eligibleinstitution. You must have taken the courses to obtain a certificate ordegree or to acquire or improve job skills. To figure the credit, add upall such expenses paid during the year for the entire family. You can claim20 percent of the first $5,000. If you haven't spent that much in 1999,you can still get the maximum $1,000 credit by prepaying for courses thatbegin in the first three months of next year.
The tax laws frown on deductions for personal expenses, but don't overlookimportant exceptions such as home mortgage interest. You're not apt to forgetto claim your monthly interest payments, but also keep in mind that youcan deduct points the lender charged up front for a mortgage to help youbuy your main home. Points you pay to refinance generally have to be amortizedover the term of the mortgage, but if you complete a second refinancingby year-end, you can claim any unamortized points paid for the first oneon your 1999 return, regardless of when you first refinanced.
Did you or will you refinance your existing home mortgage this year witha new loan for a larger amount? If you used or will use some of the extrafunds for home improvements, for 1999 you can deduct a proportionate shareof any points paid. The rest you must amortize. Say you borrowed $100,000on July 1 to retire an outstanding $80,000 loan and build a $20,000 additionto your house. If you paid $3,000 for three points, write off 20 percent,or $600, on this year's return plus half a year's amortization of the remaining$2,400. Be mindful, though, that this tax break applies only to improvementson your principal residence, not a vacation home.
Deductions for state and local property taxes are more straightforward,but you may be able to increase your write-off if they're levied on a fiscal-yearbasisfrom July 1, 1999, through June 2000, say. Even though part ofthe tax isn't due until next year, you can claim it on your 1999 returnif you pay it by Dec. 31. And don't neglect to claim your share of the taxif you bought or plan to buy any property this year. As long as your settlementbill includes the tax, you can deduct the part covering the date of salethrough the end of the property-tax year.
Push hard to save your right to a deduction for miscellaneous expenses.Remember, to do you any good, they must top 2 percent of your AGI. If you'llhave trouble exceeding this threshold in 1999, consider paying in advanceexpenses such as professional dues and fees for personal tax assistance,and extending subscriptions to investment publications and medical journals.
Do you use a home computer to help with your investments or taxes? Thenyou can depreciate part of its cost. Say you use the computer 60 percentof the time for these purposes, after factoring in the time other peoplein your family use it. If the computer cost $2,000, you can depreciate $1,200over six years.
You can also deduct personal legal expenses, but only if they involveyour income, your taxes, or your investments. When the work a lawyer doesfor you also includes other mattersfor example, estate planningaskhim for a bill specifying how much he charged for each element.
Accelerating your business expenses before year-end is a good way totrim taxes, but beware speed bumps in the road. Let's say you spent $30,000on medical equipment in July and plan to buy $25,000 more this month toraise your depreciation deduction for the year. The rules normally allowa partial first-year write-offup to $19,000 in 1999with thebalance depreciable in the usual way. So on this year's return, you expectto claim $19,000 plus 20 percent of the remaining $36,000 ($7,200), or $26,200altogether. But if your fourth-quarter expense is more than 40 percent ofthe total outlay for 1999, you'll have to use a rate lower than 20 percent.By spending only $20,000 this quarter, you pass the 40 percent test andcan write off $25,200$19,000 plus 20 percent of $31,000.
Another quirky depreciation rule to bear in mind: You can write off thefull cost of repairs to your business property in the year you make them,if they merely keep it in good operating condition, but you must depreciateimprovements that increase its life or value. If a contractor is doing bothkinds of work for you and doesn't have time to finish before year-end, havethe repairs done first and pay the bill by Dec. 31. That will give you themaximum deduction for 1999.
Are you about to buy a new professional car? Consider selling the oldone instead of trading it in. Because of caps on annual write-offs, thedepreciated value on your books may well be higher than the car's currentmarket value. Remember, you can claim a business loss when you sell, butnot on a trade-in. You'll also need receipts for or records of professionalcar expenses, unless you're willing to accept the IRS' standard mileageallowance. If so, remember that the 1999 rate was reduced from 32.5 centsto 31, starting April 1.
Even if your corporation reimburses you for such expenses, your recordsmust comply with the IRS' rules. If you turn them over to the corporation,it can exclude the reimbursements from your income and claim deductionsfor them. Otherwise, it adds them to your income and you deduct the costsas miscellaneous expenses on your personal return.
Deductions for travel and entertainment are another favorite IRS target.Your records must show not only the amount, date, and place of each expense,but also who was pres-ent and the business purpose. To get your 50 percentbusiness meal write-off, be sure there's a notation on the bill or in adiary indicating that a substantial business discussion took place duringthe meal or immediately before or after it. If you're claiming expensesfor attending a medical convention, especially in a resort area, make sureyou have a program or other evidence that helps prove the trip was connectedwith your field of practice. Additional, stricter rules apply to foreignconventions and cruises.
Financial advisers rightly warn against letting taxes rule your investmentdecisions, but it's a mistake to ignore them entirely, especially at year-end.This is the time to check your portfolio for stocks you can sell to offsetgains or losses you've already taken. You may do even better using lossesto offset ordinary income instead of capital gains.
Suppose your one stock sale so far this year resulted in a $6,000 loss,and you have a $6,000 paper profit on a stock you've held more than a year.Sell it in 1999, and the prior loss will save you $1,200 in taxes (20 percentof your gain). But what if you wait until after year-end to sell? Then youcan claim $3,000 of your $6,000 loss on your 1999 return, wiping out anequal amount of ordinary income taxable at your top rate. You'll carry forwardthe remaining $3,000 of your loss to your return for 2000, where it willerase half of your $6,000 gain. So if you delay the sale, your $6,000 effectivelycancels out more tax.
However, there's still the remaining $3,000 of profit to consider. Ifyou won't be able to offset that with another loss in 2000, then overall,it might make more sense not to delay the sale. So before sellingsecurities at year-end, crunch all the numbers carefully, or have your adviserdo it for you.
Maybe all your sales this year have been profitable, and you have nolosing stocks you'd care to sell. In that case, a bond swap could be theanswer. Some of your bonds may have declined in value since you bought them,because their prices fell as interest rates rose. Selling them will giveyou a tax loss, and you can maintain your position by reinvesting the proceedsin similar issues. Current bond yields are generally higher than your originalbonds' yields, but you're investing less principal this time around. Soyour new bonds should deliver about as much income as you got before. Ifyou reinvest within 30 days, it's best to buy replacement bonds from a differentissuer. Otherwise, the "wash sale" rule might void the loss.
Veteran mutual fund investors know they should be wary of year-end dividends.Funds and real estate investment trusts often declare sizable dividendsin December. Even when they're not paid until January, they count as incomefor the current year. If you want to buy shares, wait until after the datewhen shareholders become entitled to the dividends (the "record"date). Why? Because the fund company reduces the share price to compensatefor the dividend payout. That means you'll pay tax on what would be, ineffect, a refund of your own money.
Some funds will give estimates of their next payouts and the anticipateddistribution dates. If a fund you're interested in won't do that, its pastdividend history may provide a clue. Another indicator is its percentageof undistributed income and unrealized appreciation. (More than 15 percentis a yellow light.) Call your adviser or the fund company for a copy ofits latest report. You may also be able to download it from the fund company'sWeb site.
If you've already held a fund's shares long term and you sell them beforethe dividend record date, the 20 percent capital gains rate will apply tothe full payout, since the share price reflects the dividend's value. Thiswill save tax if the dividend includes ordinary income or short-term capitalgains realized by the fund. (Even though you've owned the shares long term,you'll pay tax at your top bracket rate on this part of the dividend.) Assumingyou're reporting a profit, you can buy back the redeemed shares immediatelyafter the record date if you like. You needn't wait 30 days, because thewash sale rule doesn't apply to a gain.
As you go through the steps we've outlined, you'll probably think ofthings you should have done differently this year or ways to make use oftax breaks scheduled to take effect in 2000 or later. Take time to put thoseideas on paper while they're fresh in your mind, and make a New Year's resolutionto discuss them with your accountant.
In recent years, Congress has adopted a policy of phasing in tax benefitsgradually, instead of making them effective all at once. This cushions theblow to the federal budget, but it also complicates tax planning. To helpyou strategize, the accompanying chart summarizes the most important taxchanges scheduled in legislation enacted prior to 1999. We'll update theinformation in future issues.
Naturally, anyone who puts time and sweat into a sideline business wantsit to succeed. But if you're losing money in one this year, pay close attentionto the passive-activity regulations. You can deduct your loss from yourordinary income only if you "materially participate" in the business.Generally, this means you have to show that you devoted more than 500 hoursto it during the year, so you may need to put in some extra time betweennow and year-end to ensure you go over the mark. If your spouse helps managethe business, his or her time counts, too.
On the other hand, you may want to restrict your participation duringthe rest of this year if the business will net a profit and you have passivelosses from other endeavors. By spending no more than 100 hours on the businessthis year, you can treat your income from it as passive and deduct passivelosses against it. What if you put in somewhere between 100 and 500 hours?Then income from the business isn't passive, but a loss would be.
To satisfy the IRS, you'll need to keep a daily log, or have an appointmentbook or calendar showing how many hours you spent on the business and whatyou did. (For more on this subject, see "Makingsideline-business deductions stick," March 8, 1999).
Lawrence Farber. Last-minute tactics to trim your '99 bill. Medical Economics 1999;21:226.