End of Year Tax Planning

While the average taxpayer will avoid thinking about income taxes until the proximity of the April deadline forces them to, once the ball drops at One Times Square at midnight on December 31 and the New Year rings , there is very little that can be done. done to reduce your tax bill.

However, during the last two months of the year you can do a lot to reduce your tax liability.

Sit down with a pen and paper and list your anticipated income for 2005 and all your allowable deductions to date. What you want to do is, using your 2004 return as a guide, prepare a projected 2005 return. Once this is done, you can decide what steps to take to ensure that you pay as little federal and state income tax as possible for 2005 and 2006. ) is available on the WHAT’S NEW FOR 2005 page at http://www. robertdflach.net.

Here are some end-of-year tips:

1) Traditional year-end planning calls for postponing receipt of taxable income until 2006 and accelerating allowable deductions for claiming in 2005, with the goal of minimizing your 2005 taxable income. This strategy will generally apply if you expect to be in the same tax bracket for both 2005 and 2006, or whether you will be in a lower bracket in 2006.

However, if you anticipate a substantial increase in taxable income in 2006, bringing it to a higher level, you should do the opposite and expedite receipt of taxable income through 2005 and postpone deductible expenses until 2006. Income received in 2005 will be taxed at a lower rate, and deductions claimed in 2006 will generate greater tax savings.

I’m not sure what your 2006 income will be. Follow the “when in doubt, defer” rule: go the traditional route and postpone income and speed up spending.

2) Not worth itemizing unless the total of your allowed deductions exceeds the standard deduction that applies to your filing status, plus any additions for age or blindness. If you decide to speed up the allowable deductions to claim them in 2005, you can speed up as much as you want, but it will be wasted unless your total “itemable” deductions exceed your applicable standard deduction.

Let’s say you generally don’t have enough deductions to itemize. However, after preparing his projected return for 2005, he discovers that, due to some special circumstance, he will be able to itemize this year. During the last two months of the year you must incur and pay as many deductible expenses as possible.

If, on the other hand, your projected return indicates that you do not have enough deductions to itemize, postpone making any deductible payments until 2006. Making these payments in 2005 would not produce any tax savings, while deferring them until next year may can be broken down in 2006.

3) Timing of deductions is especially important when it comes to medical expenses and sundry work-related and investment expenses. You can deduct medical expenses only to the extent that they exceed 7 1/2% of your adjusted gross income (AGI), and most miscellaneous deductions are only deductible to the extent that the total exceeds 2% of AGI.

If you anticipate an AGI of $70,000.00 for 2005, you must exclude the first $5,250.00 of medical expenses; the first $5,250.00 is not deductible. If your medical expenses to date are close to or more than %5,250.00, you will be able to itemize, pay outstanding medical bills and schedule and pay for check-ups, doctor visits and necessary dental work in November and December. If medical payments to date are substantially less than $5,250.00, postpone payment of more medical bills until 2006. The same concept applies to miscellaneous deductions.

If you expect to be able to itemize and are making quarterly estimated state tax payments, make the fourth quarter payment in December, instead of waiting until the January 16, 2006 due date, so you can deduct the payment from your 2005 Schedule A .

4) If you don’t have the cash available to pay for the deductible items you’ve scheduled as part of your year-end plan, you can use a credit card to pay for the item and still get a 2005 deduction. Allowable expenses charged to a credit card (VISA, Master Card, American Express, Discover) are deductible in the year they are charged and not in the year you actually pay the charge.

5) The option to deduct state and local sales tax paid in lieu of state and local income tax expires December 31, 2005. This option will not be available for 2006. If you plan to purchase a new car (not is a qualifying energy-efficient hybrid – see tip #6), SUV, motorcycle, or other “great value” item in the near future, you may want to do it before the end of the year so you can deduct the tax about sales.

6) The Energy Tax Incentives Act of 2005 creates new tax credits for certain energy-efficient automobiles, consumer products, and home improvements beginning in 2006. You may want to postpone any purchase of qualifying energy-saving items until next year to be able to claim the credit.

7) While postponing income and speeding up deductions may lower your “regular” income tax for 2005, these actions can backfire and end up costing you if you fall victim to the dreaded Alternative Minimum Tax (AMT). Because? Because taxes and miscellaneous expenses are not deductible when calculating AMT, and medical expenses are only deductible to the extent they exceed 10% of AGI. When preparing your 2005 projected return, be sure to determine if you will be subject to AMT and plan your strategies accordingly.

8) When preparing your projected return, you should review the performance of your investment portfolio for the year. Add up all your realized gains and losses from the actual sales of stocks, bonds, and mutual fund shares for the first 10 months of the year, with separate net totals for the short-term (held one year or less) and long-term (held more than one year) activity. Gains and losses from inherited property are always considered in the long term. Include in the long-term calculation any “capital gains distributions” from mutual funds.

Now do a similar calculation for the unrealized “paper” gains and losses on the investments you still have. You may want to sell some of your investments before the end of the year at a loss to eliminate year-to-date gains, or with a profit to take advantage of year-to-date losses in excess of $3,000.00.

There are no set-in-stone year-end tax planning rules that apply to all taxpayers in all cases. As with any other transaction, year-end strategies must be evaluated in the context of the special facts and circumstances of your individual situation. You may want to review your year-end situation with your tax professional.

And remember: your first criteria in evaluating any financial transaction you are considering should always be affordability. Taxes are second.