Year End Tax Tips

Posted by   admin on    December 1, 2003

Our Wealth Management business is special because we are not only in the Return on Investment business, but we seek to improve our clients Return on Life as well!

As mentioned in last months letter, over the coming months, we will be providing articles on various aspects of wealth management to assist your understanding of why planning for the present and for your future has importance. Of course, you may expect some self-promotion contained within; yet, we will always seek to present thought provoking topics.

Given the time of year, this months letter is dedicated to year-end tax tips that you still have time to act upon. Not only have I gathered the thoughts of my colleagues, but Ive scoured the world-wide-web to compile The Best of Year End 2003 Tax Planning Tips for you. Special thanks goes out to the professionals at Intuit, the makers of TurboTax software; Bill Bischoff at SmartMoney.com; KPMG, LLP; Grant Thornton LLP; and Gray, Gray and Gray. Their efforts significantly contributed to the article. At the end, dont forget to review and update yourself on the performance of our investment program. We continue to perform well!! Also, dont forget that we are also open to topical suggestions coming from you.

Year End 2003 Tax Planning Tips

A number of provisions in the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), many of which are retroactive to January 1, 2003, may impact significantly how you approach your year-end tax planning. In this article we highlight items from this new law as well as tax law provisions from other legislation that took effect in 2003, and suggest ways you can benefit from the changes.

We cannot address every possible situation that may apply to you, but this article may provide you some ideas you had not previously considered. Give us a call to discuss how you can benefit from our assistance with your tax planning.

Beware! These Tips May Be Right For Some And Wrong For Others!

Be careful not to let the tax cart drive the horse -- ensure that any tax-planning actions you consider make economic sense. For example, delaying a sale as a way to put off paying the related tax makes little sense if the price drops markedly while you wait.

Provisions from the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) gave us a schedule of tax rates that were scheduled to incrementally decrease over time. This provision made deferral of income a good idea in 2001 and 2002. However, passage of the JGTRRA changed all that, accelerating rate cuts into 2003 that were scheduled to occur through 2006. As a result, deferring taxable income past 2003 will not necessarily bring a lower federal tax rate unless your total taxable income has been reduced.

Yet, sometimes accelerating deductions can cost you money because you inadvertently trigger the Alternative Minimum Tax (AMT). Originally designed to make sure wealthy people paid their fair share of taxes, the AMT is now affecting the middle class, in large part because of incentive stock options.

Some Advice Never Becomes Stale! -- Defer Income and Maximize Deductions

When you defer your 2003 income and maximize the deductions you report in 2003, you shift the payment of income taxes to a future year. An additional benefit may be that you might be in a lower tax bracket in the future, subjecting this deferred income to a lower tax rate. Here are some time-tested techniques to accomplish this deferral.

Defer income

Will your employer let you postpone that year-end bonus until 2004? Waiting an extra month or two for the cash will buy you 12 extra months to pay the income tax. Note: If you cannot postpone receipt of the bonus, consider contributing it to a tax-deductible retirement account.

If you are planning a year-end retirement withdrawal, consider waiting until January so you can defer the taxes on that withdrawal until your 2004 taxes.

If you are self-employed and report on the cash method of accounting, can you delay sending year-end bills so as to postpone December receipts into January? If you report on the accrual basis, wed be happy to evaluate if cash basis reporting is better for you.

Maximize deductions

If you have a property tax bill due early in 2004, consider prepaying it in 2003.

Do you make quarterly estimated tax payments? If so, you may want to prepay your state and/or local income taxes in December. (Be careful, however. The alternative minimum tax may rob you of this benefit.)

Pay your January mortgage payment in December. However, keep in mind that this action buys you a benefit only in the first year.

Review your charitable commitments for this year and next. Can you accelerate some 2004 contributions into 2003? We doubt that the charity will complain. If you like this strategy but have no extra cash at the moment, consider one of two alternatives:

  • Give appreciated long-term capital assets. This way you get the deduction for the appreciated value without paying tax on converting the asset to cash.
  • Charge your gift on a credit card. The gift is considered made when the charge is posted -- not when the bill is paid.

Bunch your deductions. If you estimate that your 2003 deductions will be close to the standard deduction of $9,500 ($4,750 single), try to shift deductions so that you can itemize every other year. (Note that the standard deduction for married couples jumped from $7,950 to $9,500 under the new law. More may need to employ bunching to be able to itemize.)

Are you contributing the maximum to your retirement account? For 2003, the maximums are:

  • IRA : $3,000 ($3,500 if age 50 or older on Dec. 31, 2003)
  • 401(k): $12,000 ($14,000 if age 50 or older)
  • SIMPLE: $8,000 ($9,000 if age 50 or older)

Review your investment portfolio

Review your portfolio of taxable investments (those not in a retirement account).

Not all 2003 capital gains qualify for the new long-term federal rate of 15 percent. For example, gains incurred before May 6, 2003, are taxed under the old 20 percent rate.

If you anticipate reporting net capital gains in 2003, you may be able to avoid the tax entirely by generating offsetting losses. Remember, you can deduct up to $3,000 of losses in excess of gains on your 2003 return. Losses in excess of the $3,000 are carried forward.

When planning to offset losses, look to see whether you have capital loss carryovers from 2002. They should be factored into this calculation as well. Because of recent declines in the securities markets, many of our clients have substantial capital loss carryovers into 2003. Those from prior years will allow you to restructure your portfolio and report gains without a current tax cost.

If you want to record a loss in a security but believe in that particular investment for the long term, consider selling the security and staying out of the investment for more than 30 days. The "wash sale" rules prevent reporting this loss on your tax return if you buy the security within 30 days before or after the sale for which you are reporting a loss.

Bond swaps often avoid the wash sale rules. Bond prices tend to fall when interest rates are rising. Its very easy to sell a bond  corporate, government, or municipal  and then turn around to buy a similar one. There can be similar bonds from different issuers and the wash sale rule wont apply.

You also can sell bonds that are down to generate a tax loss.

What a nasty surprise to find that your mutual fund is down for the year and you still have to pay taxes on large dividends and capital gains. If you sell before the funds distribution date, you can avoid paying those taxes. You need to wait 31 days to buy the same fund back again although you can buy a similar fund with another fund family immediately.

On the other hand, if you invested with us, this wouldnt be a problem as we would be closely monitoring your investments and these opportunities for you.

Here Are Some New Things to Consider

Buy Equipment and Software Before Year-End! As you've probably heard, new and pre-owned "heavy" SUVs, pickups, and vans used over 50% in your business qualify for the $100,000 "Section 179" instant depreciation write-off. (The 2003 Act increased the maximum Section 179 deduction from a mere $25,000 to the current $100,000 amount.) This break is so juicy, it seems almost too good to be true.

Say you spend $60,000 on a new Porsche Cayenne that's used 100% in your business. Provided you make the purchase before year-end, you can probably deduct the entire $60,000 cost on this year's return.

Just make sure you buy a heavy-enough SUV, pickup or van. That means a machine with a manufacturer's gross vehicle weight rating (GVWR) above 6,000 pounds. Only these heavy vehicles qualify for the ultra generous $100,000 Section 179 instant deduction privilege. (First-year depreciation deductions for lighter vehicles are much skimpier.) Fortunately, it's pretty easy to find attractive machines with GVWR above 6,000 pounds. Most that look big enough to qualify, do qualify. You can verify the GVWR specification by checking the label on the inside edge of the driver's side door.

Thanks to the 2003 tax cut, you can also use your $100,000 Section 179 instant-deduction privilege to immediately write off the cost of new business software purchased between now and year-end. Under the previous rule, you had to depreciate most software costs over 36 months.

Do you have too much of your total wealth tied up in your solely owned C corporation? Have your corporation buy back some of your shares as a partial redemption. The payment you receive from the company in exchange for the redeemed shares will generally be a qualified dividend that gets taxed at no more than 15% (plus the state income-tax hit, if any). Depending on some complicated rules, part of the redemption payment may simply reduce the basis of your shares, which means totally tax-free treatment for that part. Bottom line: You pay no more than 15% to the U.S. Treasury (maybe less), and you retain ownership of all the outstanding stock in your corporation (assuming you owned 100% in the first place). The big change is that you now have lots of cash to invest in a diversified portfolio that we can manage for you!

If you withdrew retirement funds and failed to reinvest the money within 60 days, the rule has always been that the amount must be taken into income -- and an additional 10 percent penalty tax might apply. If this is your situation and you intended to meet the 60-day deadline but were unable to because of facts beyond your control, discuss the matter with us. The IRS can now be lenient with the 60-day reinvestment rule.

If you own a business, have you hired your children? It can be a win-win for everyone -- a tax deduction for the business and no tax for the child. In addition, if the pay is at least $3,000, the child can make a maximum Roth IRA contribution. Plus, the pay may be exempt from payroll taxes! (Think this is small change? If you deferred $3,000 for a 10-year-old child in 2003 and in each of the next four years, a 6 percent return gives an account balance at age 70 of almost $500,000!)

Some Last-Minute Thoughts

Analysts expect that a growing segment of U.S. taxpayers will be subject to the alternative minimum tax (AMT). If this includes you, all bets for conventional tax planning are off. You may want to consider deferring some deductions to preserve any chance of benefiting at all.

Don't forget your option to give $11,000 per donee ($22,000 if filing jointly) in gifts without incurring a gift tax liability. This simple technique remains a good way to transfer wealth to the next generation under your long-term estate plan.

A year-end review of your tax situation must include a comparison of your 2003 payments to your newly reduced 2003 federal tax liability. If you paid the 2003 quarterly estimates that were provided before April 15 and you expect 2003 taxable income very similar to last year, you may have overpaid your federal income taxes because of the retroactive rate cuts in JGTRRA. A careful look at your 2003 tax liability may allow you to reduce or even eliminate your fourth quarter federal estimate.

ELF Capital Management investment performance update.

For the month ended November 30, 2003, our one-month performance is up 1.59% and our three-month return is up 5.40%.

For disclosure purposes, past performance is not necessarily indicative of future results and ELF Capital Management LLC (ELF), formerly Hoffman White & Kaelber Financial Services LLC, cannot guarantee the success of its services. There is a chance that investments managed by ELF may lose a substantial amount of their initial value.

ELF is an independent discretionary investment management firm established in February 2003. ELF manages a strategic allocation of primarily exchange-traded index funds (ETFs), and may invest in other carefully selected securities. ELF may also employ hedging techniques, through the use of short positions and options. ELF manages individual portfolio accounts for both individual and business clients.

The ELF ETF Strategy returns presented herein represents a composite of actual results from all client portfolios managed by ELF. Currently, it is the only composite presented by ELF and separate client account portfolio positions are substantially similar, except as may be modified for retirement plan accounts and accounts with net equity of $60,000 or less. There is no minimum account size for inclusion into ELFs ETF Strategy composite and accounts with net equity of $60,000 or less have a tendency to downwardly skew the combined results.

The performance data presented herein includes the reinvestment of dividends and capital gains; as well, ELFs ETF Strategy composite returns are presented after deducting actual management fees, transaction costs or other expenses, if any. ELF charges an annual investment management fee as follows: 1.25% on the first $250,000; 1.00% on the next $750,000; 0.95% on the next $4,000,000; and, 0.75% thereafter.

Money is good. It is important. Without money, daily survival  not to mention further development  is impossible At the same time, it is wrong to consider money a god or a substance endowed with some power of its own. To think that money is everything, and that just by having lots of it all our problems will be solved is a serious mistake. Dalai Lama

Copyright 2003 ELF Capital Management, LLC. All rights reserved.