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The Voice of Business,
Industry & the Professions Since 1942
North Carolina's largest
business group proudly serves as the state chamber of commerce
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| Personal
Finances
Yule Save!
Give yourself an expensive
holiday present with these
proven tax-reduction strategies
By Lisa H. Towle |
Learn more:
Try these seven successful
tax strategies
How the new federal tax law impacts you
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Not
long ago, a 70 1/2 year-old business owner began withdrawing money from
his retirement account. Instead of withdrawing just the minimum amount,
and aware of the plan’s rules, he accelerated the withdrawals and
incurred a larger tax bill than necessary. The move startled his
attorney, Keith Wood of the Greensboro firm Carruthers & Roth.
However, the man explained to Wood that he’d taken stock and was
convinced that tax rates would increase dramatically in 2005 to pay down
the country’s vast debt. That cold-eyed analysis led him to conclude
he’d rather pay at the existing rate than a higher one. |
Now,
one may agree or disagree with this conclusion, but, says Wood, what
can’t be argued is that the client’s “move wasn’t rash after
all. It came from rational thought and forethought.” And it’s those
two things – rationality and premeditation – that are the keys to
successful financial planning, particularly year-end strategizing around
the issues of investments and taxes.
Many financial experts say it’s ironic that executives who got to the
top by relying on such skills don’t employ them to manage personal
finances. Why? There’s a disinclination to deal with anything
perceived as a hassle. Second, there’s denial. “Two things in life
are certain, death and taxes. And what are the two things no one wants
to deal with? Death and taxes,” states Randy Robason, the
Charlotte-based Carolinas Tax Practice Leader for Grant Thornton, an
accounting, tax and business advisory organization dedicated to mid-size
companies.
“Planning for your financial future should be as important to you as
almost anything else in your life,” continues Robason, a CPA, MBA and
attorney. “Not to put too fine a point on it, but you can’t wait
until the last minute to plan because you don’t know when the last
minute will be.” He suggests reviewing portfolio assets quarterly and
readjusting as appropriate, usually annually.
That said, the 2004 calendar year is about to end and there are a host
of people just turning their attention to how best to protect
investments while deflecting a tax bite prior to the start of another
year. Things get even more complicated, not to mention emotional, when
personal and business transactions are intertwined – say when the
majority of net worth is tied up in a business. Here are some tips:
Conduct an Inventory
Which to address first, taxes or investments? The fact of the matter is
they’re inextricably linked, though you certainly don’t want to make
final decisions concerning personal finances without consulting a tax
adviser. Keith Wood says that when “somebody calls this time of year
and asks, ‘what should I do?’ there are two things I immediately
suggest: call a CPA and schedule an appointment, because no one knows
the ins and outs of tax rules better. Then call a financial planner or
the person in charge of your retirement plan and find out how much more
you can sock away in 2004. There’s no bigger tax giveaway than an
IRA.”
John O’Hara, chief operating officer of Franklin Street Partners, a
private investment management firm in Chapel Hill, cautions against a
common pitfall: letting the search for tax savings lead into bad
investment decisions. “Too often, tax issues end up being the tail
wagging the dog; investment issues should be the main consideration.”
He suggests conducting an inventory. “Sit down and ask yourself, ‘do
I have the right amount of money in the right buckets? I’m a year
older, but am I a year closer to my goals? Are my kids doing anything
different? How’s my job?’ The answers may change how money is
allocated.” For example, instead of a 50-50 split between bonds and
equities, it may make more sense to invest 70 percent in equities and 30
percent in bonds.
Minimize Capital Gains
With the inventory complete and advisers at the ready, it’s
decision-making time. Andy Culpepper, director of investments for
Culpepper Investment Group of Wachovia Securities, notes that strategic
thinkers understand that effective financial planning involves more than
scrambling in March or April to defer income and boost deductions.
“No one in this business has a crystal ball or a magic bullet. What we
do have is reality. While you always want to be aware of what could
happen, it’s best to act on investment rules and tax laws as they are
today, not what they may be,” says Culpepper, who has offices in
Kinston and Greenville.
For instance, Culpepper continues, minimizing capital gains taxes,
reducing the year-end tax bill and giving less of your estate to Uncle
Sam means taking advantage of all the opportunities to save money before
taxes. Those include maximizing contributions to a 401(k) or deductible
IRA. Also, consider investing in tax-free CDs, bonds and money market
funds, but first make sure to compare your after-tax return on taxable
investment with the return on a tax-free investment. Generally speaking,
someone in a top tax bracket benefits more from tax-free investments
because the yield on a taxable investment would have to be very high to
match the return in a tax-exempt instrument.
And he offers something else, an intriguing real estate strategy that
doesn’t involve capital gains tax. Very simply, say someone was willed
farm land that is now worth $200,000. However, they’re not in the
business of farming and have no other use for the land. Instead,
they’d rather spend time at a condominium on the beach. What they do
then is find another person willing to part with a beach place, someone
who could put the land to use. Both agree to an exchange of like-kind
property (the farm was rented out for crops, the condo was rental
property for tax benefits, and both are similarly valued). Any cash
difference is negotiated. There are no capital gains to worry about
because the deal is a swap not a sale. This scenario of like-minded real
property owners could hold for many different situations, says
Culpepper, including, say, a shopping center and an office building.
Review New Federal Tax Laws
Jeff Martin, a CPA and attorney who heads the Financial Planning Group
for Wachovia Wealth Management out of Charlotte, agrees that an
examination of all financial options and an ensuing consultation with
investment and tax professionals today means making tax time less taxing
come April. “People shouldn’t be shy about asking, ‘what last
minute income tax maneuvers are available to me?’”
For instance, if you haven’t already done so, Martin advises plumbing
the depths of the American Jobs Creation Act, which was signed into law
in October. The fourth major tax act in as many years, the AJCA was
originally intended to repeal the extraterritorial income exclusion,
which had triggered tariffs by the European Union. It then expanded to
cover a wide range of business tax issues. In addition to a new
incentive tax deduction for domestic production activities, the act
significantly revises the taxation of U.S. companies doing business
abroad. It also fundamentally changes the rules applicable to deferred
compensation, addresses tax shelter and penalty issues, and modifies a
variety of other business and individual tax rules (see story, page 13).
Wood, who’s also a member of the North Carolina Association of CPAs,
points to other rules to drive home the argument that a little time
spent on year-end strategizing can save you from a lot of confusion
later. To wit:
 Next year, the policy
regarding deducting the gift of a car to charity will tighten. So if
you’re of a mind to donate an automobile it might be wise to do it
now.
If you’re a business
owner, the “real juicy” bonus depreciations and write-offs for
business machinery goes away at the end of 2004.
If you’re a
shareholder of an S corporation or a partner in a partnership, you’re
allowed to deduct the losses attributable to that against income.
However, you may only take deductions to the extent of your income tax
basis in that business. “What is amazing,” says Wood, “is that
some people don’t figure out until April 15 that they didn’t have
enough basis in S-corp stock or partnership interest to take a
deduction. If you’re thinking ahead, you’ll know that in 2004 you
can make loans to the S-corp or partnership – put cash in, do a lot of
things – to beef up your tax basis and get credit for loss
deduction.”
Parting Words
“No one can make good decisions in a vacuum. All taxpayers have
different scenarios, different needs. The key to successful investment
and tax planning is think long term, but be flexible for the short
term,” offers Randy Robason of Grant Thornton. Adds John O’Hara of
Franklin Street Partners: “Don’t wait until the last week of
December to address your finances. Procrastinating means you end up with
rushed decisions, and rushed decisions are bad decisions. Think December
1 is really December 31. Act now.”
How
AJCA Impacts You
Because
we have a state income tax, North Carolinians won’t benefit from the
biggest piece of the American Job Creation Act (AJCA), the pivotal tax
law revision passed by Congress this fall. People who live in states
without a state income tax now will be able to deduct their state and
local sales taxes (whichever is greater) in 2004 and 2005. This will
benefit taxpayers in Alaska, Texas, Tennessee, Florida, Washington,
South Dakota, Nevada and Wyoming.
Here is a summary of the AJCA provisions that do apply in North
Carolina:
Tax incentives: The legislation provides $4 billion of relief
from the Alternative Minimum Tax, including AMT relief for farmers. The
90 percent limitation on the use of AMT foreign tax credits is repealed;
the tax break for manufacturers applies to AMT payers.
Tax deductions: The law provides a tax deduction for a portion of
income from domestic production activities, limited to 50 percent of
wages; 9 percent deduction fully phased-in by 2010; applies to
Subchapter C corporations, S corporations, sole proprietorships,
partnerships, cooperatives, and estates and trusts.
Repeal of ETI: The current export tax provisions (ETI) are
repealed; a three-year transition period is provided for current
beneficiaries; and binding contract rule applies to agreements in effect
on Sept. 17, 2003.
Homeland investment: Generally effective on the date of
enactment, the legislation offers a one-year temporary reduction in the
U.S. tax rate on foreign profits earned by U.S. multinationals that are
reinvested in the United States.
International tax reforms: A package of provisions with varying
effective dates helps alleviate the double taxation of foreign source
income earned by multinational corporations; specific provisions include
modified interest expense allocation rules, a 10-year carry forward and
one-year carryback of foreign tax credits, recharacterization of overall
domestic loss, a reduction in foreign tax credit baskets and a study on
earnings stripping provisions.
Investment incentive for small businesses: Extends through 2007
the current provision allowing smaller companies to deduct up to
$100,000 of capital expenses annually.
Reforms of rules for Subchapter S corps: AJCA increases the
maximum number of eligible shareholders from 75 to 100 and family
members can elect to be counted as one shareholder for determining
number of shareholders in the corporation; other provisions address IRA
shareholders, small business and qualified Subchapter S trusts and other
issues.
Stock options: The new law clarifies that employee stock purchase
plans and incentive stock options are not subject to payroll taxes.
Restrictions on executive compensation: Amounts deferred under
“nonqualified deferred compensation plans” are subject to immediate
taxation unless certain requirements are met.
— Steve Tuttle
Seven
Successful Tax Strategies
As an
assistant vice president of Davenport & Company, Beth Wheeler, CFP,
works with both existing and prospective clients of the independent
stock brokerage. She’s seen it all: clients who are on the ball when
it comes to every aspect of their finances; procrastinators; those in
crisis and in need of a specific fix.
No matter the circumstances, though, there are some things she will have
discussed with all clients by year’s end because they are sensible,
tax-savvy strategies that are useful in almost any circumstance yet
often overlooked.
In no particular order the strategies are:
Investments. Tote up investment gains and losses for the year. If trades
to date have resulted in a net gain, take a look at securities showing
paper losses. These can be sold and the loss used to offset the gains,
thus reducing the tax bill.
Remember, she adds, (and this is why waiting until the eleventh hour to
strategize gets tricky), you cannot deduct a loss on the sale of
securities within 30 days before or after the sale. The loss on such a
sale – a so-called “wash sale” – is added to the cost of the
securities you buy.
If all investments sold in 2004 lost more than they made, you can deduct
up to $3,000 of the losses to reduce taxable income. Any unused losses
may be carried over to future tax years until they are entirely used up.
Timing. Many mutual funds distribute the net profit realized on stocks,
bonds or other holdings the fund manager sold during the year in
December.
Therefore, investors should be careful about buying into a fund late in
the year lest they create a tax liability for themselves. You don’t
want to have to pay a year’s worth of taxes on something you’ve only
owned for a few days. It may pay to wait to buy into a mutual fund until
after the distribution is made.
Retirement. Contribute regularly and heavily to those tax-deferred
savings bonanzas known as individual retirement accounts. This will not
only allow you to retire in more comfortable circumstances, it reduces
taxable income for the year.
In 2004, the deferral limit is $13,000, and if you’re 50 or older, you
can make an additional “catch-up” contribution to the plan of
$3,000. Next year, those amounts will be $14,000 and $4,000
respectively.
You have until April 15, 2005, to make the 2004 contribution to a
traditional IRA or Roth IRA so long as it’s a personal account and
not, say, an employer plan.
But remember that the earlier you contribute, the longer your deferred
investment period.
Beneficiaries. Double-check beneficiary designations, including IRA’s,
life insurance policies, wills and employer plans. “Even if your will
stipulates otherwise,” explains Wheeler, “a person must be named
specifically because such designations override the will.”
It’s surprising, she adds, how often ex-spouses, former business
partners and the like remain on official documents because people
don’t make time for what is a simple chore.
Education. Contribute to a young adult’s higher education as well as
your own financial well being by participating in a “529 plan” or
the Coverdell program.
A 529 college savings plan is a special state administered college
savings program that adheres to various federal laws and IRS Section
529. These plans allow investors to save money in a special account in
which the earnings will grow income tax deferred, and when used to pay
for “qualified higher education expenses” will be federal income tax
free.
The money is controlled by the account owner, and anyone can contribute
on behalf of a beneficiary.
A special though under recognized feature of a 529 plan is “forward
averaging.” This allows you to average gifts over $11,000 per
beneficiary ($22,000 for married couples) over a five-year period
without incurring federal gift tax.
So an individual can contribute up to $55,000 per beneficiary in one
year and a couple up to $110,000 per beneficiary without incurring gift
tax. Warning: if you give the full amount, you will not be able to give
any gifts to the same individual during the five-year period without
incurring gift tax or using up a part of your lifetime exclusion.
Likewise, the Coverdell, formerly known as the Education IRA, is a
savings account program which allows you to contribute up to $2,000 a
year toward a child’s education via certificate IRA’s, money market
IRA’s or savings IRA’s. Earnings are free of federal taxes.
Gifting. If you’re looking to reduce your taxable estate by Dec. 31,
the rules allow you to make tax-free gifts up to $11,000 a year per
person.
This is especially useful to those “who have estate tax issues,”
says Wheeler. “It allows someone to lessen the estate tax bite because
(the money) compounds outside your estate and inside the estate of
another.”
In a move known as “gift splitting,” married couples can each give
$11,000 to one person. This kind of giving must be done only once a
year, though, otherwise the money may be subject to a gift tax.
Philanthropy. In order to
deduct the full value of a gift of a security to charity, that security
must have been held for more than a year.
If it was held for less than a year, you can only deduct its cost.
Further, a deduction is allowed if the gift is mailed by Dec. 31. It
doesn’t have to have been deposited by the end of the year in order to
get credit. -- Lisa H. Towle
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