In our final installment of this series, we'll hit the highlights of various issues that should be important to your year-end tax planning. Ready? Here they come....
Recharacterization of a Prior Roth IRA Conversion
Did you convert a traditional IRA to a Roth IRA this year, prior to a market downturn? If you did, you know that you'll have to recognize taxable income on that conversion based on the fair market value of the stock that you transferred.
But, what if the value of your investments has declined significantly since the time of the conversion? Are you still stuck with all of that conversion income? Not necessarily. You can recharacterize your Roth IRA back to a traditional IRA and completely avoid the conversion income this year.
If you decide to recharacterize your Roth IRA before the end of the year, you'll be required to wait until next year before you can make any future conversions from your traditional IRA to a Roth IRA. However, you don't necessarily have to act before the end of the year -- you have until October 15th of the following year, to recharacterize any conversions that you originally made this year.
Whatever you decide, make sure that you are up to speed on the rules before you make your final decision to recharacterize your Roth IRA back to a traditional IRA.
The Wash Sale Rules
We have previously discussed selling some of the "losers" in your portfolio to offset the gains on your "winners" as a tax-reduction strategy. But, if you decide to go this route, remember the wash sale rules. If you take a loss on a sale and then repurchase that same security within 30 days before or after the date of the loss sale, you could have a wash sale and your loss could be disallowed. Remember that these rules are out there... just waiting for you to trip over them.
Holding Period
Remember that when you buy and sell stocks and mutual funds, the important date for tax purposes is the trade date -- not the settlement date. The trade date fixes both your holding period (for short-term and long-term purposes), and the year in which the sale must be reported. Many people are still under the mistaken impression that the "settlement" date controls the trade. It's simply not true. When planning your tax moves for stock and mutual fund transactions, make sure to focus on the trade date.
Constructive Sales
Many of the "old" ways to defer gains on stock sales no longer work. Going "short against the box" could run you afoul of the constructive sale rules. If you do get hit with those rules, your appreciated "long" position might be deemed a sale by Uncle Sammy, and you might have unexpected taxes to pay. Ouch. If you use some of the more sophisticated hedging techniques, make sure you're familiar with the constructive sale rules.
Investment Interest
Remember that both short-term and elected long-term gains create investment interest income -- and investment interest income (which also includes interest and dividend income) is the benchmark you must use to determine if any (or all) of the investment interest you paid during the year will be deductible.
Investment interest is generally the interest that you pay on debts, the proceeds of which were used to purchase investments. Margin interest is one component of investment interest. So, in many cases, increasing your capital gains could allow you to boost your deductible investment interest.
But, be very careful: should you elect to use long-term gains as a form of investment income, you'll lose your preferred 20% top-end tax rate on those gains. That might not be a bad thing -- it very well might be something you want to do, depending on your specific circumstances -- but you could get tripped up if you're not careful (so, by all means, be careful).
Deductions and Credits for Non-Itemizers
Just because you don't itemize your deductions doesn't mean that there aren't deductions out there for you to use. Alimony paid, pension plan deductions (Keogh, SEP, SIMPLE, IRA, etc.), student-loan interest, job-related moving expenses, medical insurance for the self-employed, penalty for early savings withdrawal, and deductions for self-employment taxes are all available to you -- regardless of whether you itemize deductions.
Don't forget that there are a plethora of tax credits available to you, even if you don't itemize your deductions.
Business Deductions
For all of you business owners out there, don't forget the impact that a "Section 179 election" can have on your taxes.
As you know, when you purchase assets for your business, you're required to depreciate those assets and claim the depreciation deduction over a number of years. But, the Section 179 election (the section of the IRS code that allows this treatment) permits you to "expense" the entire cost of the asset in the year purchased.
For 2001-2002, the Section 179 election amount equals $24,000 and after 2002 it's $25,000 -- which means that you can immediately expense up to that amount of assets that you've purchased during the year. So, if you've laid out a few bucks on computers, office furnishings, or other business equipment, don't overlook this important provision.
I hope that you've enjoyed our tax planning series. I'm sure that you've found at least one tip that will reduce your taxes this year... which is what we were hoping to accomplish. More for you and less for Uncle Sammy. Nothing wrong with that, eh? And, don't forget, if you would like to read more about many of the issues discussed over the last four weeks, you can do so in the All About Taxes area.
This forum and the information provided here should not be relied on as a substitute for independent research to original sources of authority. The Motley Fool does not render legal, accounting, tax, or other professional advice. If legal, tax, or other expert assistance is required, the services of a competent professional should be sought. In other words, if you get audited, don't blame us.
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