Fall is in the air and with it comes what some might say is the scariest time of year – Halloween. Yes, Halloween was a night of ghosts, goblins, witches, vampires and other assorted ghouls, perhaps with a few fairy princesses and other assorted happy creatures, but if your neighborhood is anything like ours, the ghouls outnumbered the good fairy folk.
Now if you’re one of those who think that the scary time is over, let us mention one word to you – taxes. If that word doesn’t strike fear in your heart, we applaud you. For the rest of the crowd, we thought this month would be the perfect time to remind you that April 15 need not be the worst day of your financial life. In fact, if you can’t make it an almost pleasant day, at least you can minimize your pain with a little planning in the next two months.
First things first
In a moment, we will discuss a few ways to plan your tax life for the next two years, but first we want to remind you that the key to the value of this article is what you do when your finished reading. Every year we speak to numerous clients about various options they have to minimize taxes. Every year, we are told what great ideas we have and every year, many of those same people fail to follow through on the opportunities they’re given. Unfortunately, despite their best intentions, life just gets in the way. So, whatever you do, please do not fail to act if you see an opportunity in this article to minimize your tax bill.
2003 Tax Law Changes
If you read this column often, you already know many of the things we might suggest. While we will go over these again, what we really want to do is focus on how the 2003 changes will affect your tax planning thoughts over the next two months. The 2003 Act affected many areas of the Internal Revenue Code (the “Code”) from tax rates applicable to ordinary and capital gain income to the allowance of larger tax credits. The new laws even provide some relief for simply being married.
As we have said before, much of tax planning revolves around shifting income into the lowest possible tax bracket. Sometimes that means shifting income between years to take advantage of lower tax rates; sometimes the only effective shifting technique is to give income-producing property to other family members. Under the new Code, Congress and the President have managed to throw a few wrinkles into the income tax planning arena.
First, you will have to remember that the lower tax rates scheduled for future years will take effect in 2003 and this is a very good thing. For example, prior to the new law, the maximum tax rate for 2003 was 38.6 percent. Now, the maximum rate is 35 percent through 2010. If you deferred income into 2003 hoping for a lower tax rate due either to the old law’s phase-in rules or because you expected to be in a lower income range in 2003, you hit the jackpot! While the best news is we now have lower rates across the board, a side benefit is we have a fairly static list of tax rates for the next few years – if Congress doesn’t make changes.
The changes in tax rates to help offset the so-called “marriage penalty” will also need to be factored into your planning. For example, the new law expands the amount of income that will be in the 10 percent bracket by $1,000 for single filers and $2,000 for married taxpayers filing joint returns. The law also increases the amount of income subject to the 15 percent bracket to 200 percent of the single filer amount for married taxpayers filing joint returns. This will have the effect of immediately reducing a portion of your tax liability with no action on your part. While this change in itself won’t necessarily get you where you want to be, it can put you closer and may minimize other income shifting needs.
Perhaps one of the biggest changes for those with high dividend income is the reduction in the rates for certain dividend income. Depending on the tax bracket you fall in, your rate on qualifying dividend income will drop to either 15 percent or 5 percent for 2003-2008. Again, this could factor significantly into how much tax you can expect and how other tax strategies will interplay with the rate reductions.
These are only a few of the ways in which the 2003 act will affect your need to shift income. Even so, you may well benefit from income shifting, but now more than ever, a good projection is necessary to help you make the right decision.
Just like income shifting is a good idea, so is expense shifting. This generally takes the form of accelerating business and other deductions into the current year if you will be in a higher tax bracket than next year. The converse is also true if it looks like you might be in a higher bracket next year. Again, the new law gives us some great opportunities for 2003-2004, especially if you earn self-employment income through an unincorporated business.
For example, prior to the 2003 Act, the maximum Code Section 179 deduction (immediate expensing of depreciable assets) was $25,000. For 2003-2005, this has increased to a maximum of $100,000. Recognizing that this level of expenditure might bump up close to the prior law’s maximum of $200,000 in asset additions before starting to lose the deduction, Congress doubled the limit to $400,000. If you are in a growth mode, accelerating your fixed asset purchases may save you big bucks. At the same time, instead of allowing a bonus depreciation of 30 percent for assets bought before September 11, 2004, the rate has now climbed to 50 percent. Since this is an immediate write-off, you don’t even have to adjust it when computing Alternative Minimum Taxable Income. Finally, canned software even qualifies for the 179 deduction now.
While the new may help many married taxpayers move income to lower tax rates, if you are married, you may or may not benefit from the increase in the standard deduction for married taxpayers filing jointly. The 2003 Act basically takes the single taxpayer’s standard deduction and doubles it. This could make your present tax deductions worth less. For example, under the prior law, the standard deduction for a married taxpayer filing jointly for 2003 was expected to be $7,950 and the single filer’s deduction would be $4,750. For married taxpayers, that meant that each dollar of deduction over $7,950 would be deductible to some extent. If their deductions were in the $7,951-$9,499, every dollar they spent would save some taxes. Now, in order for a contribution or other itemized deduction to be valuable, those deductions will need to exceed $9,500. This will make deduction “bunching” more difficult for some taxpayers.
As with income shifting, much of the time, expense shifting will also benefit taxpayers with the capacity to time their deductions. However, the new law will have an impact on both the amount and timing of deductions; therefore, careful projections should be made early to provide the best possible opportunity to minimize taxes.
You didn’t think we were going to leave our favorite income shifting technique out of this article did you?
Good, because maximizing contributions to 401(k) and other qualified retirement plans is still one of your best ways to minimize income taxes. Here are a few things you need to remember:
- If you are under 50, you can generally contribute up to $3,000 for all types of IRA contributions in 2003. If you are over 50, you can contribute an additional $500 in 2003. There are limitations if you are a participant in an employer’s plan or if your Modified Adjusted Gross Income exceeds certain levels.
- If you are involved in a salary reduction SEP, 401(k), 403(b), or 457 plan, you can defer up to $12,000 if you are less than 50 and add an additional $2,000 to that if you are over 50. Even better, in some cases you can defer up to 100% of your income if you make less than the maximum allowable annual deferral.
- If your employer has a SIMPLE plan, you can defer $8,000 if you are less than 50 years old and add $1,000 to that number if you are 50 years old or older.
The rules governing retirement plans and contributions are complicated. If your employer has a plan established, you will need to know the plan provisions for changing deferral rates before making any moves. If you are the employer and wish to set up a new plan, act fast as some plans must be established prior to December 31, 2003 to allow for a deduction. The plans don’t necessarily need to be funded by year-end, but they do need to be in force.
The changes in the Code over the last few years are enough to make your head spin like the main character in the Exorcist. With the changes in 2003, though, the Code has added new levels of complexity and, frankly, you just have to run the numbers to make sure you make the best decisions. If you think you or your business might benefit from one of the many tax savings strategies available, we urge you to sit down now and plot your tax course for the rest of 2003 and 2004; two months is enough time, but not by much, to put effective strategies in place. Give us a call if you need help. We are here to help you use your money for you and your family, not the U.S. Treasury.
Have a wonderful Thanksgiving and keep everyone who is or ever has fought for our freedom in your thoughts and prayers!