It's never too soon to start compiling tax deductions

The Baltimore Sun

This is the time of year when taxpayers pull out the rule book that guides them in making last-minute moves before year-end to reduce their income tax bill.

The summary: Do whatever you can to delay receiving income for the year, and hunt for whatever deductions you can find, so that when you prepare your tax return in a few months, the outcome is as painless as possible.

In essence, you move income - like bonuses or pay you might receive from a business activity - into the new year if you can. And perhaps you pay coming expenses - like January's mortgage payment or property taxes - in 2007 so you can use the deduction this year, rather than next. The strategies are particularly useful to people who think their income is going to be substantially higher in 2007 compared with 2008.

But what do you do when you aren't sure what next year's rule book might say?

That's where taxpayers stand this year. Members of Congress, such as Rep. Charles B. Rangel, a New York Democrat, are proposing a major tax overhaul. So as you plan for the end of 2007 and early 2008, the rule book could end up very different.

In essence, with your year-end tax planning this year, you are aiming at a moving target for next year. Still, Northern Trust tax strategist Grace Allison said: "Don't let uncertainty lead you down the path of inertia."

Although the future remains murky, tax planners are urging the following moves:

Do a quick checkup. Rather than waiting for unpleasant tax surprises when you sit down with your return, pull out a recent pay stub, calculate about what you will earn for the year, and look at how you stand compared with last year, said Rande Spiegelman, vice president of financial planning for Charles Schwab.

There are valuable tax credits you don't want to miss, but they have income limits. For example, the child tax credit - which can lower your tax bill by $1,000 per child - starts to phase out if you are single and your modified adjusted gross income exceeds $75,000, or married with income over $110,000.

A credit for up to $11,390 in adoption expenses diminishes after a couple's income crosses $170,820. Or collecting the maximum Hope and Lifetime Learning Credits for college tuition starts to phase out when income goes over $45,000 for singles or $90,000 for married couples.

Don't waste money. If you set up a flexible spending account at work to pay medical expenses or child-care expenses, make sure you use it up. Depending on your company, you might have to use it by the end of this year, although some plans give you until March 15 to use the money.

Use medical deductions. The threshold for taking advantage of the medical deduction is a difficult one for many taxpayers to meet, especially if your health insurance covers most of your medical costs, says Joseph Karczewski, managing partner at WTAS, a tax and consulting firm.

Your out-of-pocket expenses - or those not covered by insurance or Medicare - are deductible only if they exceed 7.5 percent of your adjusted gross income.

Review your investments. If you have sold investments such as stocks or mutual funds this year and made money, you will owe capital gains taxes on the profit unless the investments are in a tax-deferred account such as an individual retirement account or 401(k).

So look over your investments now and see if you are holding on to any losers you might want to unload. By doing this, you can reduce the capital gains taxes you will owe, or perhaps get rid of them completely.

Timing capital gains with children. If you will be in the 15 percent tax bracket in 2008, and you want to sell an investment with large capital gains, you could have an exceptional opportunity if you delay until January. Then, the 5 percent capital gains rate that applies to relatively low-income taxpayers drops to zero.

But Congress is reviewing capital gains taxes, so this might not last.

Be careful when transferring shares of stock or other investments to children, said Bob Scharin, tax analyst for RIA, a provider of tax information. The kiddie tax laws have changed. So if children under 18 have shares of stock, and sell them, they will pay the same tax as parents.

In 2008, that increases to under 19, or under 24 for full-time college students. That means that if you intend to use stock, mutual funds or other investments to pay for college, you might do well to transfer them to your 18-year-old now, and have him or her sell the shares, Scharin said. The child will probably have to pay only 5 percent on the gain. After this year, the opportunity will disappear.

Before transferring stock to a child, however, make sure the student is not eligible for financial aid. Giving stock, mutual funds or any other investment to a college student, or a student about to go to college, could damage financial aid.

Give to charity. The easiest deduction might be in your closet. If you have clothes or household items you don't want, list them, mark an appropriate value, bring them to a charitable organization and ask them to sign your list and give you a receipt for the contribution.

You can even give an old car, and you will be able to deduct the value that the charitable organization receives when it sells it.

Rather than making cash donations, consider giving shares of stock or mutual funds that have increased in value. You can deduct the full value of the investment, and neither you nor the charitable organization will have to pay capital gains tax.

Be good to the environment. If you are in the market for a car, a refrigerator or have been thinking of making your home more energy-efficient, you might be able to obtain a tax credit.

Credits might be available up to $3,400 spent on hybrid cars. But don't just run to the dealer. This time of year, the benefit might have run out on the most popular models. They aren't available after the manufacturer has sold 60,000. So ask before you buy.

You might also receive a credit for energy-efficient appliances, or home improvements such as insulation or energy-efficient windows. But the credit is up to 10 percent of the cost, with a maximum of $500. If you used the full $500 on improvements last year, you can't claim it again this year, Scharin said.

Beware of the AMT. If you have never been subject to the alternative minimum tax - or AMT - in the past but have an income around $100,000 and live in a high-tax state, you could find yourself subject to it this year.

The AMT was designed to make sure the very rich paid taxes, but with inflation, it is snaring the middle class. About 25 million taxpayers are estimated to be hit this year unless Congress changes the law.

Don't wait until tax time to find out, because you might inadvertently dump yourself into the high-tax system if you don't pay attention now.

Typically, it's a wise move to try to pay local taxes - like property taxes - before the end of the year. "But prepaying state taxes or real estate taxes could put you into the AMT this year," said Brittney Saks, tax partner for PricewaterhouseCoopers.

You can run this year's numbers through your old software to see if you might be hit by the AMT. If it's possible, be careful about taking capital gains, exercising stock options and paying local taxes early.

The AMT, however, is a moving target. Congress might provide relief for 2007, or future years, but nothing is certain yet.

gmarksjarvis@tribune.com

Gail MarksJarvis writes for Tribune Media Services.

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