2006 YEAR-END TAX PLANNING
The period from now until the end of 2006 holds unique opportunities for you to save taxes. It is the ideal time of year for tax planning for at least three reasons:
- You finally have a good fix on what your taxable income and expenses are shaping up to be for 2006 and for several months into 2007, allowing you to effectively use acceleration or deferral techniques to maximize your overall tax savings between 2006 and 2007.
- Time still remains to take advantage of new-for-2006 tax laws before the door to do so for the 2006 tax year shuts tight behind you.
- Last, but not least, you can use this time to fully prepare for new tax breaks that will begin immediately on January 1, 2007.
Shifting income and expenses
Having only a few months left to the year, you usually can forecast fairly well what income and deductions you will be reporting on your 2006 tax return next April if things continue the way they have been. You can also forecast fairly well your income and expense situation for the first few months of 2007. Therein lies a golden opportunity to shift some income or expenses into one year or the other depending on what will save you the most overall taxes.
Income and expense shifting is the "bread and butter" of year-end tax planning. It requires information gathering and a proactive approach in determining your final tax bill. It allows you to do something about your taxes rather than "just writing the check out" to the IRS at tax time.
The year-end techniques that may be used to accelerate or defer income and/or expenses are as varied as there are situations to be addressed. Some of the more frequently used strategies include:
- Smoothing out taxable income between 2006 and 2007 by accelerating and postponing transactions that either produce income or yield deductible expenses;
- Matching long and short term capital gains with losses to lower overall capitals gains tax and possibly maximize the $3,000 amount of capital losses that can offset other income;
- Bunching deductible expenses into one or the other year depending upon whether the standard deduction may be taken in one of the years, or whether the adjusted gross income limits for medical (7.5 percent) or miscellaneous itemized deductions (2 percent) may be more easily met;
- Maximizing the tax law limits on annual contributions to your retirement plan accounts, since one year's limits cannot be added to the next year's when not taken in time;
- For businesses, taking advantage of the full $108,000 expensing deduction for 2006 and the $112,000 deduction available for 2007; and
- If you're an S corp shareholder, making certain that your stock basis is high enough to entitle you to any available loss deductions.
2006 opportunities and pitfalls
The tax law changes constantly. New tax breaks -- and pitfalls -- come and go all the time. 2006 is no exception. Literally scores of changes have been made to the tax law that impact 2006 tax year returns. Among those most notable for impacting the largest groups of taxpayers are:
- Start of the extended "kiddie tax" under which a child's income is taxed at a parent's tax rate, under age 18 (up from age 14 and applied retroactively from January 1, 2006);
- Start of the hybrid vehicle credit available to purchasers, along with its reduction once a manufacturer sells more than 60,000 units (which is already the case for Toyota hybrids starting October 1, 2006);
- Start of the residential energy credits of $500 for residential energy improvements, $2,000 for solar equipment and $500 for fuel cells per half kilowatt capacity, restricted to 2006 and 2007 only;
- Start of strict limitations on the quality of clothing and household items that are entitled to a charitable deduction, beginning August 17, 2006;
- Start of the new (and generally unfavorable) limitations on the housing allowance for those working abroad, retroactive to January 1, 2006; and
- Start of allowing direct, tax-free charitable contributions from IRAs for those 70 1/2 and older, for 2006 and 2007 only.
2007 opportunities and pitfalls
Despite the number of new provisions that began this year, 2006 does not have a lock on recent changes. 2007 is set to inaugurate several changes of its own, even before tax legislation in 2007 will likely produce still more changes. Here's a list of some of the major ones:
- Starting in 2007, cash donations of any size must to be backed up by paperwork that includes either a cancelled check or a written note from the charity indicating amount, date and the name of the charity;
- Starting in 2007, businesses will face a more generous, but stricter, domestic production activities deduction that includes a rise in the deduction cap from three percent to six percent and a restriction of the W-2 wage limitation to manufacturing activities only;
- Starting in 2007, heretofore fixed contribution limitations on individual retirement accounts will be inflation adjusted, including Roth IRAs income limits of $156,000 (formerly 150,000) for married individuals filing jointly and $99,000 (formerly $95,000) for most others;
- Starting in 2007, inflation adjustment of the Saver's Credit for lower income taxpayers means higher income levels will qualify (for example, joint filers will get a 50 percent credit with income up to $31,000, 20 percent up to $34,000 and 10 percent up to $52,000).
Also noteworthy, starting in 2010 there will be no maximum income level to restrict conversion of regular IRAs into Roth IRAs. Maximizing that opportunity, however, can begin immediately for those taxpayers presently over that limit. This strategy calls for making annual contributions to a nondeductible IRA that can then be converted into a Roth IRA in 2010 when the income cap is lifted.
Congress has had an extremely active year already, already passing two major tax bills: the Tax Increase Protection and Reconciliation Act and the Pension Protection Act . Its tax revision activities, however, may not be over. That creates a particularly urgent need for this office to continue to monitor the situation in Washington and prepare you for quick action should Congress act in a way that affects you directly.
In that regard, there are several key provisions now under consideration in Congress:
- Estate and gift tax repeal or raising the exemption to $5 million;
- Retroactive extension back to January 1, 2006 of the state and local sales tax itemized deduction option;
- Retroactive extension back to January 1, 2006 of the above-the-line higher education tuition deduction and the teacher's classroom expense deduction;
- Extension and/or modification of a host of tax breaks for business, including the Work Opportunity and Welfare-to-Work tax credits, Archer Medical Savings Accounts; the research tax credit; and
- Further closing of the SUV purchase loophole that has continued to allow up to a $25,000 expensing deduction in the first year of business use.
AMT relief is temporary
The alternative minimum tax (AMT) was designed to ensure that wealthy taxpayers were not able to escape taxation by exploiting deductions. However, the AMT has not been appropriately indexed for inflation, which means that it affects a growing number of taxpayers every year. Congress has passed a few legislative "patches" to keep it from hitting too many people, the latest in 2006 to cover 2006.
While the patch maintains the status quo, that situation does not prevent a growing number of taxpayers of falling victim to the AMT each year. 2006 and 2007 will prove to be "record years" for the IRS's collection of AMT.
To make sure you don't wind up paying AMT if you can avoid it, start by projecting your income for the rest of this year and next, at the least. That will help figure out how likely it is that you need to address the situation. Some of the items to consider regarding AMT are:
- State and local taxes;
- Home equity loans and other mortgage interest not incurred in buying, building or improving your principal residence;
- Incentive stock options -- these may generate AMT income even when sold at a loss;
- Private activity bonds; and
- Other itemized deductions.
Give our office a callAll of the tax opportunities and considerations at this time of year can be a lot to remember, and the details of all these provisions can make it even more complicated. Fortunately, you won't have to remember all of them by yourself -- that's why you hire a tax professional. The two most important pieces of tax advice to keep for any year are to keep good records and ask questions. We look forward to hearing from you.
If you have any questions as to how these rules apply to
your particular situation, please do not hesitate to call
the Certified Public Accountants at Wood, Johnson, Heath,
P.C. at 512-343-8075.