As 1998 draws to a close, there is still time to reduce your 1998 tax bill and plan
ahead for 1999. This letter outlines several strategies for you to consider.
Income Planning
A key aspect of tax planning is to estimate both your 1998 and 1999 adjusted gross income
(AGI). Time-honored strategies of accelerating deductions and deferring income must be
evaluated carefully because they are tied to AGI. When considering whether to accelerate
income and deductions or postpone income and deductions, be aware of the impact that such
action may have on your adjusted gross income and your ability to maximize itemized
deductions that are tied to AGI. Your 1997 tax return and 1998 paystubs and other income
and deduction related materials are a good starting point for estimating your AGI.
Accelerating Income Into 1998
If you are anticipate being in a higher tax bracket in 1999, you may benefit from
accelerating income into 1998. To accomplish this:
• Accelerate Collection of Accounts Receivables: If you are self-employed and report
income and expenses on a cash basis, issue bills and attempt collection before the end of
1998. Also see if some of your clients or customers might be willing to pay for January
1999 goods or services in advance.
• Year-End Bonuses: If your employer generally pays such bonuses after the end of the
current year, negotiate to have your bonus paid to you before the beginning of 1999.
• Retirement Plan Distributions: If you are over age 59 1/2 and you participate in an
employer's retirement plan or have an IRA, consider making withdrawals before 1999. You
may also want to consider making a Roth IRA rollover distribution, as discussed below.
Deferring Income Into 1999
If you expect your AGI to be higher in 1998 than in 1999, or you anticipate being in a
higher tax bracket in 1998, you may benefit by deferring income into 1999. To accomplish
this:
• Delay Collection: If you are self-employed, delay year-end billing to clients so
that payments will not be received until 1999.
• Interest and Dividends: Interest income earned on Treasury securities and bank
certificates of deposit with maturities of one year or less is not includible in income
until received. To defer interest income, consider buying short-term bonds or certificates
that won't mature until next year. If you have control as to when dividends are paid,
arrange to have them paid to you after the end of the year.
• Investments: Many mutual funds attempt to "dress up" performance by
selling stocks and other holdings before the end of the year, resulting in ordinary income
and capital gains being recognized by shareholders. Avoid having to recognize such income
by deferring your investment decision until the beginning of 1999.
Deduction Planning
Deduction timing is also an important element of year-end tax planning. Deduction planning
may be complex, however, due to factors such as adjusted gross income levels and filing
status.
Deduction planning is impacted by the limits on itemized deductions that are tied to
adjusted gross income (AGI), For 1998 returns, overall itemized deductions are reduced by
3% of the AGI exceeding $124,500 for married taxpayers filling jointly ($62,250 if married
filing separate). Similarly, certain deductions may be claimed only if they exceed a
certain percentage of AGI: 7.5% for medical expenses; 2% for miscellaneous itemized
deductions; and 10% for casualty losses.
Deduction planning is also impacted by the standard deduction. For 1998 returns, the
standard deduction is $7,100 for married taxpayers filing jointly, $4,250 for single
taxpayers, $6,250 for head of household, and $3,550 for married taxpayers filing
separately. In cases where your itemized deductions are relatively constant and are close
to the standard deduction amount, you might consider adjusting the timing of your expenses
so that they are higher in one year and lower in the following year.
A significant new deduction is available beginning with this year's return. You may be
eligible to deduct student loan interest on any qualified education loan, applicable to
interest paid after Dec. 31, 1997. (Interest payments on loans that were taken out before
Dec. 31, 1997, but which otherwise meet the requirements can qualify for the deduction).
The deduction is allowed only for interest paid during the first 60 months in which
interest payments are required. The maximum deduction is $1,000 in 1998. The deduction is
phased out at a modified adjusted gross income level of between $60,000 and $75,000 for
joint filers, and between $40,000 and $55,000 for all other taxpayers.
Other deduction strategies are discussed below. If you are a cash-method taxpayer,
remember to keep the following in mind:
• Deduction In Year Paid: An expense is only deductible in the year in which it is
actually paid.
• Payment By Check: Date checks before the end of the year and mail them before
January 1, 1999.
• Promise To Pay: A promise to pay or providing a note does not permit you to deduct
the expense.
Highlighted below are some of the more common itemized deductions and strategies for
maximizing their benefit:
• Medical Expenses: Medical expenses, including amounts paid as health insurance
premiums, are deductible only to the extent that they exceed 7.5% of AGI. Consider
bunching medical expenses into years when your AGI is lower.
• State Taxes: If you anticipate a state income tax liability for 1998 and plan to
make an estimated payment, consider making such payment before the end of 1998.
• Charitable Contributions: Consider making your charitable contributions at the end
of the year. This will give you use of the money during the year and simultaneously permit
you to claim a deduction for that year. You can use a credit card to charge donations in
1998 even though you will not pay the bill until 1999. A mere pledge to make a donation is
not deductible, however, unless it is paid by the end of the year.
• Equipment Purchases: If you're in business, careful timing of equipment purchases
can result in favorable depreciation deductions in 1998. In general, under the
"half-year convention," you may deduct six months worth of depreciation for
equipment that is placed in service on or before the last day of the tax year. If more
than 40% of the cost of all personal property placed in service occurs during the last
quarter of the year, however, a "mid-quarter convention" applies, and thus you
would only be entitled to one and one-half months' worth of depreciation for assets placed
in service during the other three quarters of the year. This would mean that assets placed
in service during the first quarter of the year would be subject to only ten and one-half
months' worth of depreciation.
An alternative planning technique is to make a "Section 179 Election," which
allows you to expense (i.e. currently deduct) otherwise depreciable business property. In
general, you may elect to expense up to $18,500 of equipment costs if the asset was placed
in service during 1998.
Tax Credit Planning
Child Tax Credit
A nonrefundable tax credit of $400 ($500 after 1998) per qualifying child under the
age of 17 is available on this year's return. The credit is phased out at a rate of $50
for each $1,000 (or fraction of $1,000) of modified AGI exceeding the following amounts:
$110,000 for married filing joint; $55,000 for married filing separate; and $75,000 for
all other taxpayers.
HOPE Credit and Lifetime Learning Credit
For 1998, two education credits are available - the HOPE Scholarship credit and the
Lifetime Learning credit. The maximum HOPE credit is $1,500 (100% on the first $1,000,
plus 50% of the next $1,000) per student for qualified tuition and fees paid on behalf of
a student (i.e., the taxpayer, the taxpayer's spouse, or a dependent) who is enrolled on
at least a half-time basis. The credit is available for only the first two years of the
student's post-secondary education, beginning with expenses incurred on or after Jan. 1,
1998, for education furnished in academic periods beginning after that date.
The Lifetime Learning credit maximum in 1998 is $1,000 (20% of qualified tuition and fees
up to $5,000). A student need not be enrolled on at least a half-time basis so long as he
or she is taking post-secondary classes to acquire or improve job skills. As with the HOPE
credit, eligible students include the taxpayer, the taxpayer's spouse, or a dependent. The
credit is available for expenses paid after June 30, 1998, for education furnished in
academic periods beginning after that date.
Both the HOPE credit and the Lifetime Learning credit are phased out at modified AGI
levels between $80,000 and $100,000 for joint filers, and between $40,000 and $50,000 for
all other taxpayers.
Investment Planning
Legislation enacted in July should help simplify some of the complex capital gains rules
enacted in 1997 with its myriad of different rates and holding periods, including the
"more than 18 months" rule.
Effective for sales after Dec. 31, 1997, the following rules apply fo
r most capital assets:
• Capital gains on property held 12 months or less are taxed at an individual's
ordinary income tax rate.
• Capital gains on property held for more than 12 months is taxed at a maximum rate
of 20% (10% if an individual is in the 15% marginal tax bracket).
To avoid capital gains altogether, you may want to consider gifting shares of stock to
children or grandchildren if they are in a lower tax bracket than your own.
Capital losses also require special attention. In general, when you take losses, you must
first match your long-term losses against your long-term gains, and short term losses
against short-term gains. If there are any remaining losses, you may use them to offset
any remaining long-term or short-term gains, or up to $3,000 of ordinary income. When and
whether to recognize such losses should be analyzed in light of the changes in the capital
gains rates applicable to your specific investments.
Retirement Planning
Retirement Planning for 1998 is made more complex with the introduction of the Roth IRA
and other changes to regular IRAs.
• Traditional IRAs: For 1998, an individual will not be considered an "active
participant" in an employer's plan simply because the individual's spouse is an
active participant for any part of a plan year. Thus, you may be able to take a full
$2,000 deduction for an IRA contribution regardless of whether your spouse is covered by a
plan at work. Beginning in 1998, the AGI phase-out range for determining the deductibility
of a contribution for an otherwise eligible person whose spouse participates in an
employer's qualified plan is $150,000 to $160,000.
Also for 1998, the AGI phase-out ranges for determining deductibility of IRA contributions
increases. For single persons (including head of household), the deduction phaseout range
is between $30,000 and $40,000 of modified AGI, and for joint filers the modified AGI
phase-out range is between $50,000 and $60,000.
• Roth IRA: This new type of IRA permits nondeductible contributions of up to $2,000
a year. Earnings grow tax-free, and distributions are tax-free provided no distributions
are made until more than five years after the first contribution and the individual has
reached age 59 1/2. Distributions may be made earlier on account of the individual's
disability or death. The maximum contribution is phased out for persons with AGI above
certain amounts: $150,000 to $160,000 for joint filers; and $95,000 to $110,000 for all
other taxpayers.
• Special 1998 Roth IRA Conversion Rule: Beginning in 1998, funds in a traditional
IRA may be rolled over into a Roth IRA. Such a rollover, however, is treated as a taxable
event, and you will pay tax on the amount converted. No penalties will apply if all the
requirements for such a transfer are satisfied.
For 1998 only, you may be eligible to convert traditional IRA funds into a Roth IRA and
pay the resulting tax over a four-year period. For example, a rollover of $100,000 in 1998
would allow you to take $25,000 into income and pay the additional tax in 1998, and take
the remaining $75,000 into income and pay the additional tax incrementally in 1999, 2000,
and 2001, respectively. To qualify, your adjusted gross income cannot exceed $100,000 if
filing jointly or otherwise, and you cannot be married and filing a separate return. The
rollover transaction must be completed before Jan. 1, 1999.
While you may be eligible for the special four-year rule, you may elect to pay the entire
tax in 1998. You should consider this option if your income will be higher in future
years.
Retirement Plan Contributions
In many cases, employers will require you to set your 1999 retirement contribution levels
before January 1999. You may want to increase your contribution to lower your AGI to take
advantage of some of the new tax breaks described above. In addition, maximizing your 1998
contribution is always a good tax-saving move.
If you have any questions, please don't hesitate to call. I'll be happy to meet with you
to discuss year-end planning for 1998 and strategies for minimizing your 1998 tax
liability.
Very truly yours,
Bob Parrish CPA