It is time to start thinking about what you can do to minimize your tax position for 2007.
This year will be more challenging than usual because it is uncertain whether Congress will extend Alternative Minimum Tax (AMT) relief to avoid millions more becoming entrapped by it, and whether Congress will extend a number of important tax breaks expiring at the end of 2007.
In most situations, year-end tax planning utilizes the approach of deferring income and accelerating deductions. However, each taxpayer experiences his own unique tax situation and planning goals and therefore the traditional approach may not necessarily be the correct one due to the individual’s special circumstances.
Many of the numerous tax breaks (tax credits, deductions and other benefits) are reduced or eliminated if a taxpayer’s adjusted gross income (AGI) exceeds specified thresholds. Examples of items subject to reduction or elimination are the deduction of up to $4,000 for qualified higher education expenses; converting a traditional IRA to a Roth IRAs; the tax credit for the Hope Scholarship Credit (up to $1,650 per student for 2007) and the Lifetime Learning Credit (up to $2,000 per taxpayer); interest paid up to $2,500 on qualified education loans; contributions up to $2,000 annually to a tax-exempt Coverdell Education Savings Account; adoption assistance/adoption credit and allowing a limited amount of nonpassive income to be offset by passive losses from an active participation in rental real estate activity.
Other key areas where deductions may be limited are miscellaneous itemized deductions like; medical expense deduction and nonbusiness casualty loss deductions.
The following tips represent strategies to help keep AGI below some of the thresholds resulting in reduction or elimination of tax benefits:
Convert taxable interest to tax-exempt interest. Need to first determine how much gain would result from this transaction. If little or no gain, taxpayer probably should consider converting.
Taxpayers who might be subject to alternative minimum tax (AMT) should not invest in tax-exempt private activity bonds since the interest on these is included in determining AMT taxable income.
If an individual has both income-generating investments and debts on which he is paying interest, he should consider selling part of his investments and using the proceeds to pay off debt. If a taxpayer is reluctant to repay current debt because he may need the capital, then, if eligible, he should consider taking out a home equity credit line.
Increase contributions to 401(k) plans, SIMPLE pension plans and other retirement plans if you are not making the maximum contributions. You are allowed to make additional contributions in excess of the normal amounts if 50 years of age or older.
Increase contributions to your Health Savings Account if you are enrolled in this type of plan to the maximum coverage amounts under which you are participating.
Since capital gains are included in AGI, a taxpayer should consider reducing 2007 AGI by deferring the realization of some capital gains to 2008. However, if the taxpayer believes there may be substantial risk that the value of the property would decline before it can be sold, then the property sale should not be deferred.
Taxpayers with unrecognized capital losses should consider taking them in 2007 to reduce AGI by offsetting capital gains and $3,000 of ordinary income if capital losses exceed capital gains by at least that amount.
An employee who believes he/she will be receiving a bonus before year-end may request that his/her employer delay payment until early in the following year. The employee considering that strategy must request the bonus postponement before it is due and payable or he/she will have to include the bonus amount currently in income.
If a business activity in which losses and credits related to your ownership would be considered to be passive because you did not materially participate, you should step up your participation before year-end in order to satisfy the participation test by (1) participating in an activity more than 500 hours during the tax year; (2) participating more than 100 hours if no one else does more, or (3) participating more than 500 hours in all your “significant participation activities.”
Sell the activity that generates passive activity losses in order to deduct any loss from the activity for the tax year of disposition (including losses carried over from earlier years). It usually is not a good idea to use the installment method on the disposition of a passive activity.
Use credit card charges to accelerate deductible expenses. Charitable contributions and medical expenses are deductible when charged to a taxpayer’s credit card account.
Make energy saving improvements to your home to qualify for tax credits or purchase a credit-eligible hybrid car or alternative fuel motor vehicle.
Pay estimated state income tax payments before year-end.
Re-think your strategies involving children under the age of 18 receiving unearned income from investments as the rules have significantly changed in the last two years. If your child holds appreciated stock and isn’t in the kiddie tax territory this year but will be in 2008 (most full time students’ age 19 through 23 will be subject to new rules), consider having him/her sell the stock this year.
If you are age 70 1/2 or older, own IRAs and are thinking of making a charitable gift before year-end, arrange for the gift to be made directly by the IRA trustee as an exclusion from gross income (not to exceed $100,000) is available for otherwise taxable IRA distributions that are qualified charitable distributions.
If you are thinking of donating a used auto to charity, you may want to inquire whether the charity plans to sell the car or use it in its charitable activities; the latter may allow you to receive a bigger deduction. ?
Tax tips provided by Mickey Shackelford, Tulsa tax partner with Eide Bailly LLP