Pixar Looks Incredible

If you're like me, you're stunned to look at the calendar and find that the Thanksgiving holiday is right around the corner. Holiday songs will soon be in the air, and before you know it, another new year will be celebrated. So the time has come to take one final look at your tax situation and make any last-minute moves to minimize your 2004 taxes. Here is a very brief overview of some of the moves to consider before the ball drops in Times Square.

Investment planning
Lower taxes on dividends: The more favorable tax rates (15% or 5%) might make dividend-paying stocks more attractive than ever. You might want to reconsider the makeup of your current portfolio by investing in stocks that throw off a dividend. You'll want to be careful, since there are holding period restrictions on those dividend-paying stocks. Additionally, not all dividends are given the favorable tax rates, so you'll want to make sure that the dividend-paying stock selected for your portfolio pays a qualified dividend.

Offset gains and losses: If you decide to rebalance your portfolio before the end of the year, or if you simply decide to sell some shares at a profit, don't forget the pent-up power of your capital losses. You can use your losses to offset your gains. And, if you find that you have more losses than gains, you can deduct up to $3,000 of those losses in one year. Any losses in excess of $3,000 will be required to be carried forward (but not back) to be used against future gains or future ordinary income. But don't overlook the wash sale rule. This rule requires you to defer your loss if you purchase a "substantially identical" security within the period beginning 30 days before and ending 30 days after the date of the loss sale.

Long-term capital gains: To be eligible for the new, lower (15% or 5%) capital gain rate, the capital asset being sold must be held for more than one year. So when selling or otherwise disposing of your stocks, bonds, investment property, rental property, or other capital assets, pay close attention to your holding period. If you find that your holding period is less than one year, consider putting off the sale until a later date so that you can meet the long-term holding period rules.

Education planning
Tuition deduction: In 2004, you can deduct up to $4,000 of college tuition and related expenses if you meet certain income limits. Generally, your Adjusted Gross Income (AGI) can't be greater than $130,000 for married filers or $65,000 for other filers. But even if your AGI is greater then these limits, you can still claim a $2,000 deduction as long as your AGI doesn't exceed even higher limits ($160,000 for joint returns and $80,000 for all others). Unlike many of the other provisions in the tax code, this is not a "phase out" provision based upon your income. It's an "all or nothing" deduction. So if you have qualified tuition payments in 2004 (for yourself, your spouse, or dependent children), consider monitoring your AGI if at all possible in order to keep it under the limits.

Education credits: Don't overlook either the HOPE or Lifetime Learning credits. These credits reduce your taxes dollar for dollar (a credit is much more valuable than a deduction). But the credits begin to phase out when AGI exceeds $85,000 for married filers and $42,000 for all others. The credits are completely eliminated when AGI reaches $105,000 for married filers and $52,000 for other filers. The HOPE credit is available during the first two years of college and equals 100% of the first $1,000 of tuition and 50% of the next $1,000 for a maximum credit of $1,500 per student. The Lifetime Learning Credit is available for any year of study but is a "per return" rather than a "per student" credit. It's computed at the rate of 20% of up to $10,000 in qualifying expenses for a maximum annual credit of $2,000. Again, it may be to your advantage to monitor your AGI to remain under these limits if at all possible. And it might also be advantageous for you to accelerate qualified education expenses into 2004 in order to maximize your credits if you find that your AGI will be under the phase out limits.

Business planning
Section 179 depreciation expensing: This deduction allows business owners to deduct up to $100,000 of the cost of qualifying property placed in service in 2004. The property can be new or used and includes "off the shelf" computer software. If you have plans to purchase business furnishings, equipment, computers, or other business assets, consider doing so before the end of the year to maximize your deductions.

50% bonus depreciation: This allows for an additional 50% bonus depreciation on qualifying assets put into service in 2004. This 50% bonus provision was set to expire at the end of 2004, but the recent passage of the American Jobs Creation Act of 2004 extended the bonus depreciation provisions until the end of 2005.

Personal planning
Watch the Alternative Minimum Tax (AMT): More and more individuals are subject to the AMT each and every year, especially those living in high income tax states. There are other deductions that could trigger the AMT, such as the exercising of Incentive Stock Options, large capital gains, or the deduction of miscellaneous itemized deductions (such as employee business expenses). You really should know your current exposure to the AMT since many of the strategies used to reduce your regular taxes will backfire when it comes to the AMT.

Accelerate deductions and defer income: This is an all-time favorite. While it might simply defer taxes, that deferral actually saves you money in the long run. So take steps whenever possible to move income into later years and deductions into earlier years.

Manage your AGI: As pointed out above, many tax breaks are available only to taxpayers with AGI under certain limits. Make yourself aware of the breaks that might apply to you, and attempt to manage your AGI to keep it under the various phase-out limitations.

Watch those sales taxes: The American Jobs Creation Act of 2004 also added a new twist for those of you living in low (or no) income tax states: a new itemized deduction for sales taxes. This is a brand-new deduction for 2004 and allows you to deduct sales taxes from an IRS table supplemented with "large ticket" items. So if you bought a car, boat, furnishings, or any other big-ticket items, dig out those sales receipts now for your deduction.

Charitable contributions: Remember that donations charged to credit cards are deductible in the year charged, not in the year paid. So charging donations to your credit card before the end of the year will increase your 2004 deductions even if you're a bit short on cash. Additionally, if you're thinking about making a substantial charitable contribution before the end of the year, consider doing so with appreciated stock. You'll avoid taxes on the gain and receive a deduction for the full fair market value of the stock.

Retirement contribution credits: If you're a mid- to lower-income earner, you're allowed a credit against your taxes for making contributions to a retirement plan such as an IRA or your 401(k) plan at work. If you fall into the proper income categories and have the funds to save for your retirement, you'll be able to reduce your taxes at the same time.

These are but a few of the many moves that you can make to reduce your taxes before the end of the year. Don't overlook them.

Roy Lewis lives in a trailer down by the river and is a motivational speaker when not dealing with tax issues, and he understands that The Motley Fool is all about investors writing for investors. You can take a look at the stocks he owns as long as you promise not to ask him which stock to buy. He'll be glad to help you compute your gain or loss when you finally sell a stock, though.

Quote of Note

"You are not here merely to make a living. You are here to enable the world to live more amply, with greater vision, and with a finer spirit of hope and achievement. You are here to enrich the world. You impoverish yourself if you forget this errand." -- Woodrow Wilson

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For a list of all our stories from today, see our Today's Headlines page.