Year-end tax planning becomes an even trickier proposition

The Baltimore Sun

A new administration takes office in January promising to raise taxes on the wealthy. Then again, the weak economy and declining stock market could delay any tax changes until 2010.

This makes year-end tax planning trickier than usual.

"This is probably the most difficult year in my entire career" of nearly 30 years, says Bill Fleming, a director at PricewaterhouseCoopers in Connecticut.

But with less than six weeks left, you need to figure out what steps to take before year's end to lessen your tax bill in the spring. Here are some options:

Planning for higher taxes

Some traditional year-end strategies will be turned upside down if capital gains and ordinary income tax rates are raised for the wealthiest households next year.

For instance, you usually try to defer income into the next year to keep taxes lower in the current year. But you'll want do the opposite if your income tax rates are headed up in 2009.

President-elect Barack Obama wants to restore the top two income tax brackets from the 1990s - 39.6 percent and 36 percent - for couples earning more than $250,000 and individuals making more than $200,000.

The capital gains tax rate could also be raised from 15 percent to 20 percent for those in the top two tax brackets.

If you're in that club, this could be another reason to sell some of the losers in your portfolio now.

You can use losses to offset any gains this year - if you have any - plus up to $3,000 in regular income. If losses are even greater, you can use them to offset future gains when the capital gains tax could be higher.

If you think your losing stocks will eventually make a comeback, you can sell them now to get the tax break and buy them again later, said Bob D. Scharin, senior tax analyst with Thomson Reuters' Tax & Accounting in New York. Just make sure you wait at least 31 days to repurchase the shares, otherwise the IRS won't let you write off the losses, he says.

Review deductions

If you are self-employed or work on commission, your income this year could be significantly lower than in good economic times. In that case, you might be eligible for deductions or credits that you never used to qualify for, Scharin says.

For example, you might be able to deduct your contributions to a traditional IRA, he says. To deduct some or all of your contributions, your income must be less than $63,000 for singles or $105,000 for joint filers.

The most you can contribute to an IRA this year goes up $1,000 to $5,000; or $6,000 if you're 50 and older.

Larger standard deduction

Under this new tax break, you will be able to claim a bigger standard deduction if you pay real property taxes but don't file an itemized return. In addition to the standard deduction, you will be able to claim up to $500 of real property taxes paid if single or up to $1,000 if filing jointly.

Charitable contributions

If you're 701/2 or older, you may make donations of up to $100,000 a year directly from your traditional IRA to a charity without having to pay income taxes on the distribution. This popular tax break expired last year but was recently revived and extended through next year.

If you don't have cash to donate this year, make your charitable donation next month with a credit card, says Barbara Weltman, author of J.K. Lasser's 1001 Deductions & Tax Breaks 2009. You'll get the charitable deduction on your 2008 return but won't have to pay the bill until next year, she says.

Depressed securities, silver lining

Yes, your investment portfolio is in the tank, but you might be able to turn that to your advantage.

This would be a good time, for example, to convert a traditional IRA into a Roth IRA, said Jim Ellis, a certified public accountant with Ellis & Associates CPAs in Baltimore. The traditional IRA money will be subject to ordinary income tax at conversion, but the tax hit won't be as high now because your account is worth less.

Once you switch to a Roth, your money can grow tax-deferred and you won't have to pay taxes on withdrawals in retirement. To be eligible for a conversion, your income this year can't exceed $100,000.

Falling stock prices also mean you can give more shares to children or others without gift tax consequences. You can give away up to $1 million in assets gift-tax free over the course of your life. On top of that, you can give up to $12,000 a year to an individual without tax consequences. If your stock has fallen by a third or more, that means you can transfer more shares to a child or other individual.

First-time home buyer credit

Congress created a tax credit this year worth up to $7,500 for those buying their first homes after April 8 of this year through June 30 next year. The credit is refundable, meaning you will get the money even if you don't owe any taxes.

But it comes with caveats.

"You have to repay it, for one," says Mark Luscombe, analyst with CCH, an Illinois provider of tax information. The credit is basically an interest-free loan that must be repaid over 15 years, he says.

Also, the credit doesn't help with the down payment or with cash at closing because you don't get the money until after you buy a house.

Some businesses have sprung up to lend the money in advance and charge interest, sort of like a refund anticipation loan, Luscombe says. This defeats the purpose of the interest-free loan, he says.

If you're still interested, a full or partial credit is available to singles with income of less than $95,000 and joint filers with income under $170,000. Even if you buy a house early next year, you could still claim the credit on your 2008 return, instead of waiting until filing your 2009 return.

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