As fall turns to winter, it's more important than ever to review your current tax issues and plan for the end of the year. Why? First, there is very little you can do after Dec. 31 to reduce your taxes for the current year. So take stock of your tax issues before the end of the year to see what you can do about them -- how you can pay Uncle Sam only what he is legally due, and not a penny more. Secondly, virtually all of you will feel the impact of the new tax law changes that were ushered in by Congress and the president just a few short months ago.

Keep one eye on your AGI
There are many tax deductions and credits that are phased out (i.e., you lose the deduction) when your adjusted gross income (AGI) exceeds certain limits. Some of those deductions and credits include the following:

• The Child Tax Credit
• The education credits (both the Hope and Lifetime credits)
• Traditional IRA contributions
• The student loan interest deduction
• The new tuition deduction
• Reduction of allowable itemized deductions
• The Earned Income Credit
• Deductible medical expenses
• Allowable miscellaneous itemized deductions
• Passive rental loss deductions (the $25,000 exception)
• Taxation of Social Security benefits

While it would be lovely if all of the phase-out amounts were consistent, that's not the case. They're different for each separate deduction and/or credit. So if there is a deduction or credit out there that you hope to claim on your return this year, make sure that you know if there is an AGI limitation. If you find that your AGI is greater than allowed, you still have time to reduce your AGI and keep it under the required amount.

Keep your other eye on the AMT
More and more folks are becoming subjected to the dreaded alternative minimum tax. This is a completely separate tax, with different rules used to calculate your AMT. You compare your normal tax to your AMT, and your "alternative" is to pay the greater of the two. It's not much of an alternative, but it's one to be aware of since the IRS computers can catch this overlooked tax.

You could be subject to the AMT If you have any of the following: a large number of personal exemptions; large amounts of state and local taxes paid; large amounts of miscellaneous itemized deductions; large deductible medical expenses; the bargain element of incentive stock options (ISOs); and/or large capital gains.

Planning for the AMT is even more difficult than for your normal taxes because each situation is unique. But if you see yourself in the AMT zone, make sure that you understand the impact on your bottom line. Even if you can't do anything to reduce your AMT, at least know it's there so you won't make any year-end moves that would make matters worse.

Review your portfolio
The 2003 Tax Act reduced the maximum long-term capital gain rate from 20% to 15%, effective for sales after May 5, 2003, and changed the tax on dividends so they, too, are taxed at the favorable capital gain rates. For sales of stock, the long-term capital gain rate applies when the stock is held more than one year -- so watch your holding periods and take advantage of the lower rate when practical. You might also consider whether dividend-paying stocks make more sense in light of the lower rate on dividends. Finally, now is a good time to prune your portfolio of losing stocks so that you can get the tax benefit sooner rather than later.

Larger depreciation deductions for business owners
If you own a business, be it small or large, make sure you're familiar with the new rules regarding depreciation of business assets effective for 2003. The 2003 Tax Act included two provisions especially attractive to business owners. The Section 179 deduction increased from $25,000 to $100,000 beginning in 2003. Businesses now can deduct up to $100,000 of equipment, machinery, furniture, fixtures, and other tangible property.

Even if new property additions don't qualify for the Section 179 deduction, favorable depreciation rules may apply. For property acquired and placed in service after May 5, 2003, the 2003 Tax Act increased the up-front bonus depreciation rate from 30% to 50%. That's an immediate deduction equal to 50% of the cost, which is in addition to regular deprecation on the remaining cost.

Contributions to your favorite charity
If you have appreciated stock that you've held for more than one year, you might want to keep the cash in your pocket and donate the stock. You'll avoid paying tax on the appreciation, but will still be able to deduct the full value of the stock. You win, your charity wins, and the only loser is Uncle Sam (but he doesn't really mind, which is why this tax break has been written into the law). You might also consider the donation of appreciated stock into a "donor-advised fund."

If you still love the stock and want to maintain a position in the shares after your charitable contribution, you can simply buy new shares in the company. The dreaded "wash sale" rules don't come into play for shares that you sell for a gain or contribute to a charity. Your favorite charity will be more than happy to help you with stock-donation transactions, so don't be afraid to contact them directly. But don't wait until the last minute -- you'll need some lead time to make sure that all of the transfers take place this year.

Use your credit card
What was that? I thought the Fool was all about getting out of debt? Well, you're absolutely correct. We're not talking about running up your credit card unnecessarily. Here is a way you can use a credit card to your advantage: If you have deductible expenses (such as business expenses, medical expenses, miscellaneous itemized deductions, charitable contributions, etc.) that for some reason you don't want to pay for now, you can use your credit card to make the purchase this year, take the deduction this year, and pay your credit card bill next year. When you pay with a credit card, the IRS considers the expense deductible in the year that the charge is incurred, not necessarily when you pay the credit card charge.

Of course, it's important that you pay off the loan quickly enough so the interest you pay doesn't offset the benefit of the tax deduction. If you have the right credit card, you can receive a 30-day "float" that amounts to an interest-free use of the bank's money if you pay it off when the bill comes.

So don't wait until it's too late to cut your 2003 tax bill. There are just a few ideas that you might be able to put to use. But they really only scratch the surface. So take a look at your situation to determine some tax savings moves that you can make by the end of the year to take a bicuspid out of your tax bite.

Related Links:
The New Tax Changes and You
Alternative Minimum Tax Planning
New Capital Gains Tax Rates
The New, Lower Tax on Dividends

If you like the way Roy Lewis simplifies confusing tax issues, check out his just-published book, The Motley Fool's Investment Tax Guide 2002: Smart Tax Strategies for Investors. This handy 360+ page guide covers just about every tax aspect of a typical Fool's life: investing, marriage, children, education, homes, home offices, retirement accounts, medical expenses, and much more.)

October 31, 2003

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