It’s not too late to help your bottom line
With tax reform as his first priority, President George W. Bush and Congress enacted the Economic Growth and Tax Relief Reconciliation Act of 2001 with promises of lowering rates, eliminating the marriage penalty and eliminating the estate tax. Included in the deal was an immediate rebate of taxes to the majority of taxpayers in the form of $600 or $300 checks mailed over last summer and early fall.
But experts warn that taxpayers shouldn’t make plans for huge refunds come April 2002, because most of the promised tax cuts are spread out over a 10-year period.
“I think people will be disappointed,” says Scott Schumacher, a tax manager with accounting firm Wipfli CPAs & Consultants in Wauwatosa. “I think the expectations were set that it was a big tax cut. But when you really look at it, it’s being phased in over a long time period. … The benefit this year is very minimal.”
The good news is, it’s December and taxpayers still have time to affect their income tax returns.
The Tax Act of 2001 did lower rates slightly, but since bigger cuts are scheduled for the next few years, it helps to defer as much income as possible this year to shelter it from higher rates, therefore increasing your tax savings. Maxing out 401(k) contributions and deferring bonus payments until January (if your company allows it) are good ways to defer salary income. Waiting to sell assets, whether it is stocks or other capital gain assets, is another way of deferring income.
“Conversely, if after projecting your 2002 income tax situation you believe that you might be in a higher tax bracket, you may be able to save tax by accelerating income into 2001,” says Debra Gahr, a tax manager with West Allis-based Kolb Lauwasser & Co. “The key is to analyze your expected taxable income levels for both 2001 and 2002.”
Bunching deductions makes sense in certain situations, too, according to Schumacher. Bunching deductions means to take expenses like real estate taxes or state income tax estimated payments for one year and pay it the following year (usually in January of the following year) or accelerate deductions, like charitable contributions into the current year that you intended to pay the following year. But this works better for some taxpayers than others.
“If your itemized deductions total close to the standard deduction, which is $7,600 for 2001 for married filing jointly, bunching makes sense because you can increase your itemized deductions the following year,” Schumacher said. “Usually that applies to people when they don’t have mortgage interest any more because that’s such a big deduction for everyone.”
Gahr suggests donating appreciated long-term capital gain property to charities. The taxpayer gets to deduct the fair market value of the property and doesn’t have to pay capital gains tax on the appreciation. However, if the stock has fallen in value and would generate a capital loss, sell it and donate the proceeds to charity. That way you get the capital loss to offset capital gains or other income, and you get the charitable contribution.
Both Gahr and Schumacher recommend taking advantage of “Section 529 plans,” also known as Qualified State Tuition Programs. This program expands on Education IRAs, which have annual contributions of only $500 per year through 2001 (in 2002 the amount goes up to $2,000).
Section 529 Plans make a huge step from the restrictive Education IRAs. Depending on the state, contributions to these plans could reach up to $250,000 of after-tax money. The contributions grow tax-free and distributions used to pay college expense are also tax-free.
The Wisconsin version of the 529 plan is called EdVest. Beginning Jan. 1, 2001, parents or legal guardians who can claim an account beneficiary as a dependent may deduct up to $3,000 from their Wisconsin taxable income per year per dependent for deposits made in an EdVest account, says Gahr. In addition, withdrawals used for education expenses are tax-free for Wisconsin tax purposes. (Others can contribute to the Section 529 plans, but only parents or legal guardians get the deduction.)
Congress is wrestling with a proposal that would allow businesses to expense 30% of asset additions currently and depreciate the balance. Already enacted is a new rule on how businesses depreciate those assets. In recent years businesses had to depreciate assets using mid-year or mid-quarter conventions, meaning new assets only receive a portion of the first year’s depreciation, depending on when assets are placed in service. If more than 40% of all additions are made in the fourth quarter, assets are placed on mid-quarter, which pro-rates depreciation over the entire fiscal year.
But due to the economic downturn and the events of Sept. 11, the IRS recently issued guidance on the elimination of the mid-quarter convention if a business’s third and fourth quarters include Sept. 11. Schumacher says that it seems like an easy choice to opt out of mid-quarter to the mid-year convention, businesses should look closely at the results.
“I don’t think that’s an automatic decision because to be in mid-quarter, more than 40% of your additions have to be placed in service in the fourth quarter,” Schumacher said. “But if you had the other 60% placed in service in the first quarter, it still might make sense to keep mid-quarter because those first assets would have more depreciation than if you use mid-year.”
The down market also provides an ideal time to convert IRAs into Roth IRAs. The amounts converted are taxed on an individual’s return as ordinary income currently because the contributions were on a pre-tax basis. A Roth IRA’s two main advantages are tax-free earnings and tax-free distributions. You don’t have to convert the whole IRA at once, so conversion can be accomplished in small chunks rather than all at once.
Dec. 3, 2001 Small Business Times, Milwaukee
