Tax planning considerations Featured

8:07am EDT October 25, 2006
April 15 is often marked on the calendar in pen; whether it’s with red or black ink may be determined by how much effort went into your year-end tax planning.

When fall takes hold and the days get shorter, it’s time to work with your CPA or tax adviser to develop a year-end tax-saving strategy. Given time, tax professionals can suggest adjustments that should produce more favorable year-end results. After Dec. 31, there are few moves available that impact the prior year.

Taxpayers often are unaware of the advantages available to them in the tax code.

“I’ve seen investors sell a piece of real estate for a substantial gain. Frequently, they will take the revenue and buy another piece of property, creating a large capital gain tax,” says Beth Engelhardt, CPA, Whitley Penn LLP. “Had the individual worked with a tax professional to develop a plan, the property could have been exchanged in a Section 1031 transaction for another like-kind property, thus deferring the long-term capital gain for the current year.”

Smart Business spoke with Engelhardt about the benefits of year-end tax planning and what key categories are included in a successful plan.

What is the major goal of year-end tax planning?
The desired result of tax planning is optimizing tax savings. A comprehensive year-end strategy can identify categories that need attention, allowing the taxpayer ample time to adjust the plan. A strong understanding of your current tax situation helps form the basis of a beneficial year-end plan.

What key areas of tax planning often are overlooked?
The Alternative Minimum Tax (AMT) frequently traps taxpayers. The AMT is a separate set of rules that disallows certain deductions and personal exemptions. For instance, when gifting to charitable organizations or itemizing expenses, people believe they are eligible for a full deduction, but these add-backs could force them into the AMT. Year-end planning will help project if you are subject to the AMT, leaving sufficient time for a new approach during the last few months of the year.

Some investors make the mistake of selling appreciated stock to raise cash for a charitable donation. The resulting capital gain increases adjusted gross income (AGI) and decreases the benefit of the itemized deductions that have limits based on AGI. Instead, by using a direct transfer of stock to the charitable organization, no additional capital gains or increased income is realized, and the taxpayer can claim a deduction for the fair market value of the donated stock.

Were there any substantial changes to the 2006 federal tax code?
Yes, the Pension Protection Act was added, and a change to IRA distributions is now in place. The IRA change permits a donation of $100,000 directly from an IRA to a charity as part of the required minimum distribution. Additionally, a change to the Heritage 401(k) plan allows for a rollover into a separate IRA not only for a spouse, but also for other beneficiaries, with withdrawals stretched out over the beneficiary’s life.

Parents of working children should note a change in the kiddie tax. The age limit for this tax was raised from 14 to 18, meaning that children’s income will be taxed at the parents’ higher rate for four additional years.

As we approach the end of the year, what tax planning items should receive top priority?
People should review the status of capital gains and losses. Each year, an individual is allowed a $3,000 overall loss, so gains early in the year could be offset by investment losses later in the year. Conversely, early-year losses might be offset by late-year gains.

Additional aspects to consider are itemized deductions, real estate tax payments and charitable donations. It may make sense to double-up on these items in one year, and not take them all in the following year, depending on your income, the phase-out of itemized deductions, and matters relating to the AMT.

Ideally, when should individuals start their year-end planning?
Of course, CPAs and tax advisers promote a year-round planning strategy. An excellent time to review your current position is when you pay estimated quarterly taxes. Some taxpayers may not need to act until the fourth quarter or even December, but they should give themselves time to implement their tax plan. After Dec. 31, contributions to certain retirement plans may be the only way to impact the prior year’s tax liabilities.

Frequent communication with your CPA or tax consultant will lead to pro-active year-end tax planning. Contacting a professional for advice before making a major decision is much easier than trying to dig your way out of trouble after the fact.

BETH ENGELHARDT is senior manager of the Tax Department at Whitley Penn LLP. Reach her at (817) 258-9118 or