Tax Planning – Do It Now!

Worcester Jewish Chronicle, November 18, 2004

Tax Planning – Do It Now!

William E. Philbrick, CPA, MST, CVA

The key to substantial tax savings is timely tax planning. This applies equally to all taxpayers. Each dollar saved can be used to meet your personal and business financial goals. Timely planning allows you to take advantage of favorable tax provisions and at the same time avoid costly pitfalls.

Too many individual taxpayers’ idea of planning is to hunt for evidence of deductions before they file their annual tax return. This is too late, as their tax year has closed and they are limited to what happened in the closed year with certain limited exceptions such as IRA and Keogh plan contributions made after year-end.

It is critical to do the planning and take appropriate action before the close of the tax year. While we will discuss some of the basic tax-planning rules from the viewpoint of the individual, they are applicable to businesses as well.

Timing is everything with the reporting of income and the claiming of deductions and credits. The basic rule is to be able to report your income when you are in a lower tax bracket and claim your deductions and credits when you are in a higher tax bracket.

If you expect to be in a lower bracket in 2004 than in 2005, you would want to accelerate income for 2004 and defer deductions and credits until 2005. On the other hand, if your tax bracket is stable, timing is still critical.

Assume that you expect to be in the 15 percent bracket for 2004 and 2005 but want to remodel your kitchen. You plan to make a qualified withdrawal of $50,000 from your IRA to pay for the new kitchen. If you take the money in one lump sum, you will push yourself into the 25 percent bracket.

By splitting the withdrawal between the two years, you will be able to take maximum advantage of the lower rates, saving real money, and avoid or postpone the higher rate for at least a year.

Recognizing income in a lower bracket, claiming deductions and credits in a higher bracket and postponing the tax whenever possible are the keys to successful planning. However, your tax bracket can be influenced and affected by other factors.

Your individual tax bracket is affected by your filing status. Married taxpayers file either using married filing jointly (MFJ) or married filing separately (MFS). While the MFJ schedule will usually produce a lower tax result, there are unusual circumstances where MFS will be a benefit.

Single taxpayers generally file using single status unless they qualify for head-of-household (HOH) status. To claim HOH status, a single person must generally live with and provide support for a dependent.

The HOH rates are lower than the rates for single status but are not as favorable as MFJ rates. As your filing status is determined as of the last day of your tax year, marriage, divorce and qualified dependents play a critical role.

Another key factor that affects your tax bracket is your income level. Swings in income from one year to another can result from a variety of circumstances and events.

Divorce, marriage, death, job changes, retirement, illness, cash windfalls, sales of assets such as stock or a residence or business, and business startups can produce dramatic impacts on your income and present unique tax-planning situations that you may be able to take advantage of with timely planning.

Once you have made a careful analysis and taken all of your circumstances into consideration and planned to maximize your planning opportunities by deferring income to a lower bracket year, claiming your deductions and credits in a higher bracket year or spread income and deductions over more than one year fully utilizing your filing status, you are not done.

A key critical factor you will need to address is the alternative minimum tax (AMT). Failure to properly plan for the impact of the AMT may see all of your efforts to effectively plan crash and burn.

The AMT was originally enacted to provide that taxpayers pay a minimum amount of tax. It was targeted at high-income taxpayers who took advantage of planning opportunities to eliminate all their tax.

However, as the AMT is not adjusted for inflation, more and more middle-income taxpayers are finding they are liable for this tax, which may very well put them in a higher tax bracket than they had planned on. It has been estimated by the Joint Committee on Taxation that without any legislative intervention, the number of taxpayers subject to AMT will grow from 1 million taxpayers in 2000 to over 17 million on 2010.

The AMT is a complex calculation. It treats certain tax breaks and deductions as “tax preferences” and either modifies or eliminates the “preferences” in the calculation. The very nature of the AMT is counterintuitive. Thus you may not receive any tax benefit for the deductions you planned to claim in the higher tax bracket year.

There are still tax-planning opportunities to minimize the impact of the AMT on your effective tax bracket, particularly when you are subject to the AMT in one year and not another, further adding to the complexity of the planning process.

As you can see, timely planning should not be a last-minute effort, and you will probably need the advice of a knowledgeable tax adviser to take advantage of all your tax saving opportunities and avoid the pitfalls. Your number one rule should be “Do it now!”


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William E. Philbrick, CPA, MST, CVA, CFF is a Senior Vice President and Director of Taxes and Forensic Services with Greenberg Rosenblatt Kull &Bitsoli, P.C. of Worcester, Mass. He can be reached at wphilbrick@GRK&