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| | The Small Business Think Tank Network is not currently active and cannot accept new posts | | 2008 Year-End Tax Planning Tips | Views: 671 | | Nov 25, 2008 3:36 pm | | 2008 Year-End Tax Planning Tips | # | 
Tim Ward | | WITH THE END OF 2008 in sight, it’s time to think about ways to lower this year’s tax bill. The tricky part: to avoid making tax-saving moves this year that will backfire next year. Unfortunately, these are rough waters to navigate. The tax picture for 2009 is extremely unclear for many taxpayers due to two big questions:
* What will President-elect Obama do once in office? Will he insist on raising tax rates on higher-income individuals, as promised, or stay with the status quo in recognition of the stressed-out economy?
* Will you make as much or more money next year? Given the rising number of layoffs and employer cutbacks, that’s the $64,000 question for many folks. The answer will determine your marginal federal income tax bracket for 2009. Guessing is encouraged here.
1. Sell Loser Stocks
It's safe to say that most investors are holding their fair share of losers in taxable brokerage accounts these days. Selling dogs before year-end can lower your 2008 tax bill because you can deduct the resulting capital losses against any capital gains from earlier in the year. Plus you can deduct up to another $3,000 of capital losses against ordinary income from salary, self-employment activities, alimony, interest, or whatever. Any excess capital losses are carried forward to future years and can put you in position for big tax savings in 2009 and beyond. So I don’t think you should hesitate to unload shares you want to get rid of anyway.
If you one of the very few that can sell stocks at a profit, you should also do so before year-end 2008 due to the uncertainty in the capital gains tax laws for 2009. The maximum capital gains tax rate is 15% for gains from the sale of qualifying assets held more than one year. In fact, taxpayers in the 10% and 15% ordinary tax brackets can take advantage of a 0% capital gains rate for the first time in 2008. The 15% maximum tax rate is available for both the regular and alternative minimum tax (AMT). In addition, qualifying dividends received during 2008 will generally be taxed at the 0% or 15% capital gain rates.
2. Prepay Deductible Expenditures
Early payments for some deductible expenditures that are made this year -- instead of in early 2009 -- will produce higher write-offs for your 2008 tax return. This strategy makes sense if you expect to be in the same or lower tax bracket next year. Of course, that’s a big "if," but let’s assume it’s the case.
Monthly mortgage payment
Perhaps the easiest expense to prepay is your house payment due Jan. 1. By paying it this year, you'll have 13 months' worth of mortgage interest to write off for 2008. You can pull the same prepayment trick with a vacation home. By prepaying this year, you’ll have to continue the policy for next year and beyond. Otherwise, you’ll only have 11 months of interest to deduct for the first year you stop.
State and local income and property taxes
Next up on the prepayment menu: state and local income and property taxes that aren't actually due until early next year. Thanks to a new tax-law provision, even non-itemizers can deduct real property taxes paid during 2008. However, the maximum write-off under the new rule is $1,000 for married joint-filing couples and $500 for others -- and the deduction can’t exceed the amount you actually pay by year's end.
One major caveat: Don’t do these prepayment drills if you know you’ll owe the dreaded alternative minimum tax (AMT) for this year. Write-offs for state and local income and property taxes are completely disallowed under the AMT rules. Therefore, prepaying these expenses will do little or no tax-saving good for AMT victims.
Medical expenses and itemized deductions
Next, consider prepaying expenses that are subject to limits based on your adjusted gross income (AGI). The two prime candidates are unreimbursed medical expenses and miscellaneous itemized deductions. Medical costs are deductible only to the extent they exceed 7.5% of AGI. Miscellaneous deductions -- for investment expenses, fees for tax preparation and advice, and unreimbursed employee business expenses -- count only to the extent that they exceed 2% of AGI. If you can bunch these kinds of expenditures into a single calendar year, you’ll have a fighting chance of clearing the AGI hurdles and getting some write-offs.
Warning: Unfortunately, this strategy may not work for AMT victims. Under the AMT rules, medical expenses must exceed 10% of AGI to be deductible and miscellaneous itemized deductions are completely disallowed.
3. Prepay College Tuition
If your 2008 adjusted gross income (AGI) allows you to qualify for the Hope Scholarship or Lifetime Learning higher education tax credits, consider prepaying college tuition bills for 2009 if that would result in a bigger credit on this year’s Form 1040. Specifically, you can claim a 2008 credit based on prepaying tuition for academic periods that begin in January through March of next year.
If your 2008 AGI is too high to be eligible for the Hope or Lifetime credits, you might still qualify to deduct up to $2,000 or $4,000 of college tuition costs. If so, consider prepaying tuition bills for academic periods that begin in the first three months of 2009 if that would result in a bigger write-off on this year’s Form 1040.
4. Game the Standard Deduction
If your total annual itemized deductions are usually close to the standard deduction amount, consider bunching together expenditures for itemized deduction items every other year. Itemize in those years to deduct more than the standard deduction figure. Then claim the standard deduction in the intervening years. Over time, this drill can save hundreds or even thousands of dollars in taxes by increasing your cumulative write-offs. Why? Because you’ll bag higher itemized deductions in alternating years and relatively generous standard deductions in the other years. So regardless of what happens with tax rates, you’ll come out ahead. For 2008, the standard deduction is $10,900 for married joint-filing couples vs. $5,450 for singles and $8,000 for heads of households. For next year, the standard deductions will be $11,400, $5,700, and $8,350, respectively.
There are also other kinds of gifts you can make to reduce taxes for long-term estate planning. First, you can give up to $12,000 per donor per recipient to family members and others each year without triggering gift taxes. You can also give to your children’s or grandchildren’s education through 529 savings plans. You can gift $12,000 a year to a 529 plan tax-free — or better yet, take advantage of a law that allows you to give a single contribution, covering five years, to a 529 plan. That means you can give a maximum of $60,000 (five years of gifting) per donor per recipient tax-free in one year — and still be able to move that money between heirs’ education funds.
Contribute to Your IRA.
You can contribute up to $5,000 ($6,000 if you are age 50 or older by year-end) to your IRA in 2008 if certain conditions are met. For married couples, the combined contribution limits are $10,000 ($5,000 each) and $12,000 ($6,000 each if both are age 50 by year-end) when a joint return is filed, provided one or both spouses had at least that much earned income. In addition, contributions to traditional IRAs may be tax deductible subject to specific conditions and limitations. Please be careful before you make any investments, however.
Contribute to Your Employer-Sponsored Retirement Plan.
The 2008 annual deferral limit for qualified retirement plans is $15,500. If you are at least age 50 by year-end, you can contribute an additional $5,000 to 401(k), 403(b), and 457 plans. These contributions normally decrease your taxable income and the income taxes thereon. Again, caution is advised in making your investment decision.
Take Advantage of the $8,000 Additional Qualified Vehicle Deduction.
Qualified vehicles acquired and placed in service during calendar year 2008 only are eligible for an increased depreciation deduction of up to $8,000. This deduction is in addition to the normal maximum of $2,960 for qualified automobiles and $3,160 for qualified trucks or vans.
5. Provisions Ending in 2008
Several enhanced tax breaks, designed to jump-start economic recovery in 2008, have a shelf life that is about expire. Using them before Jan. 1, 2009, is a decision that should be made soon. These expiring tax breaks include:
50-percent bonus depreciation.
Made available by the Economic Stimulus Act, qualification for bonus depreciation is based on property that is originally used, purchased and placed in service after March 31, 2008, and before Jan. 1, 2009 (Jan. 1, 2010, for certain longer-lived and transportation property). "Placed in service" requires delivery and installation so that the equipment is operational. Businesses with customized equipment on order should be aware of this dual requirement.
Enhanced expensing.
Enhanced expensing, also made available by the Economic Stimulus Act, allows businesses to expense $250,000 of Code Sec. 179 property, reduced by the value of the property over $800,000. But it is only available for 2008; with 2009 levels set to drop to $133,000 (together with the $530,000 phase-out limit).
Businesses not on a calendar year, however, should note that the higher expensing limits apply to tax years beginning in 2008. Their higher expensing under the new law does not start until their new fiscal tax year starts. For example, a small business on a June 1-May 31 year would be limited for purchases for the year ending May 31, 2008, to a $125,000 deduction and a $500,000 threshold. The new $250,000/$800,000 amounts would kick in starting June 1, 2008, and continue through May 31, 2009.
Homesale exclusion for converted property.
The Housing Act's new income exclusion from the $250,000 ($500,000) homesale exclusion for the nonqualified-use period of a property converted from a second home to a principal residence applies to conversions taking place after Dec. 31, 2008. This provision makes 2008 the last year for vacation-property conversions that avoid the new rule entirely.
Limited $500 property tax deduction for non-itemizer.
Made available in the Housing Act, this above-the-line deduction is for 2008 only. It expires for individual homeowners on Dec. 31, 2008.
6.New Provisions
Certain tax provisions appear for the first time in 2008 and now need to be incorporated for the first time into year-end planning decisions. They include:
Discharge of principal residence mortgage debt.
The Mortgage Forgiveness Debt Relief Act of 2007 excludes from taxation under Section 108 discharges of up to $2 million of indebtedness that is secured by a principal residence and is incurred in the acquisition, construction or substantial improvement of the principal residence. While this special relief is available for three years beginning Jan. 1, 2007, and ending Dec. 31, 2009, its basis-reduction provision works on a calendar-year basis. Taxpayers who exclude indebtedness income under the principal residence exclusion under Section 108 are required to reduce the basis of their principal residence by the amount excluded from gross income. Unlike basis reductions required under Code Sec. 1017 for other Section 108 exclusions, the reduction for the principal residence exclusion is immediate, rather than postponed until the next tax year.
First-time homebuyer credit.
The Housing Act gives first-time homebuyers nationwide a temporary refundable tax credit equal to 10 percent of the purchase price of a home, up to $7,500 ($3,750 for married individuals filing separately). The credit begins to phase out for taxpayers with adjusted gross income in excess of $75,000 ($150,000 in the case of a joint return). While new, it does not carry a year-end deadline. The credit is effective for homes purchased on or after April 9, 2008, and before July 1, 2009.
7.Extenders
Unless Congress extends them, a long list of popular tax credits and deductions have already expired at the end of 2007. They include:
* The AMT "patch;"
* The state and local sales tax deduction;
* Energy tax incentives;
* The residential energy credit; and,
* The incremental research credit.
While an AMT patch for 2008 appears to be truly "must-pass" legislation, taxpayers and their advisors at press time should proceed at their own risk on assuming whether Congress will find the political stamina to beat the clock and pass an extenders measure before 2009. Meanwhile, an AMT patch has already been agreed upon in the Senate.
8. Conclusion
We do not pretend to be able to solve many of the uncertainties surrounding this year's year-end tax planning. If a lame-duck Congress is needed to consider an AMT patch and other possible extenders, we may not know until December how to react.
Our new president, too, likely won't begin to discuss tax plans until at least early December, making 2009 planning difficult, with longer-term planning requiring the knowledge to be gained from several months into 2009 before being effective.
Remaining nimble enough to react at the last possible moment this year may be the best advice we can give at this time.
Tim Ward - Trinity Accounting Solutions
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