If you're like me, you're stunned to find that the Thanksgiving holiday is right around the corner. Christmas songs will soon be in the air, and before you know it, we'll be celebrating another new year. So the time has come to take one final look at your financial situation and make your last-minute moves to minimize your tax bill for the year. Here is a very brief overview of some of the moves you might want to consider before the ball drops in Times Square.
Investment planning
Lower taxes on dividends: You might find that the more favorable tax rates now in place on dividends (15% or 5%) might make dividend-paying stocks more attractive than ever. You'll want to be careful, though, since there are holding-period restrictions on those dividend payers, and since not all dividends are given the favorable tax rates.
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. If you find that you have more losses than gains, you can deduct up to $3,000 of those losses in one year. You'll have to carry forward any losses in excess of $3,000 against future gains or future ordinary income. But don't overlook the wash sale rule, which 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 gains rate, you must hold the capital asset being sold 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 later.
Education planning
Tuition deduction: In 2005, you can deduct up to $4,000 of your 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 you can still claim a $2,000 deduction if your AGI is higher but doesn't exceed $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 2005 (for yourself, your spouse, or dependent children), consider monitoring your AGI to keep it under the limits.
Education credits: Don't overlook either the HOPE or Lifetime Learning credits, which 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. And while you can mix and match these credits on your return, you can not claim different credits for the same expenses. It may be to your advantage you to monitor your AGI to remain under these limits. You may also benefit from accelerating qualified education expenses into 2005 so you can 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 $105,000 of the cost of qualifying property placed into service in 2005. The property can be new or used and includes "off the shelf" computer software. If you plan to purchase business furnishings, equipment, computers, or other business assets, consider doing so before the end of the year to maximize your deductions. But remember that this higher limit no longer applies to business-use vehicles with a gross vehicle weight in excess of 6,000 pounds. SUVs weighing between 6,000 and 14,000 pounds now have a maximum expensing deduction of only $25,000.
Bonus depreciation: You can get an additional 50% bonus depreciation on qualifying assets put into service in 2005. This 50% bonus provision was set to expire at the end of 2004, but the passage of the American Jobs Creation Act of 2004 extended it until the end of 2005. However, unless there is another extension, the provision will expire completely when this year ends.
Personal planning
The alternative minimum tax (AMT): More and more people are subject to the AMT every year, especially those living in states with high income taxes. There are other deductions that could trigger the AMT, too, such as exercising incentive stock options, taking in large capital gains, deducting for a plethora of children, experiencing significant deductible medical expenses, or deducting for miscellaneous itemized subtractions (such as employee business expenses). Since many of the strategies that are used for reducing your regular taxes will backfire when it comes to the AMT, you really should know your current exposure to the AMT.
Deduction acceleration and income deferral: This is an all-time favorite. The tax 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.
AGI management: 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.
Sales tax monitoring: The American Jobs Creation Act of 2004 also added a new twist for those of you living in states with low or no income taxes: a new itemized deduction for sales taxes. This is a continuation of a brand-new deduction for 2004, and it also applies to 2005. It allows you to deduct sales taxes from an IRS table supplemented with "large ticket" items. So if you bought a car, a boat, furnishings, or any other big items, dig out those sales receipts now for your deduction. But, as with many other tax provisions, this one is also scheduled to expire at the end of 2005.
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 2005 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 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. 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.
