2003 Year End Tax Planning

As year end approaches, the number of chores on "to do" lists seems to increase vastly out of proportion to the number of available days.  When it comes to taxes, waiting until tomorrow (that is, January 1 and after) is just not good enough.  Your 2003 tax liability can be materially affected by steps taken between now and year's end.  Don't treat your tax life like a surprise, not to be peeked at until tax time next March or April.

The Jobs and Growth Tax Relief Reconciliation Act of 2003 (the "2003 Tax Act") profoundly changed the tax landscape by providing across the board rate reductions for individuals (including new 15% rates for capital gains and dividends), as well as numerous provisions intended to spur the economy by incentivizing business spending.  Counterbalancing the federal rate cuts are lesser publicized increases in New York State and City income taxes (new maximum rates:  7.7% NYS, 4.45% NYC).  Year end tax planning obviously needs to take all of the 2003 tax law changes into account. Click here for our article on the 2003 Tax Act.

Take Stock Now:  Run 2003 Tax Projections Today
The first action step in all year end tax planning strategies is to take stock now of where you stand today vis-à-vis 2003 taxes.  How does 2003 look?  How do you expect 2004 to look?  Call your tax professional (or pull out some 2003 tax preparation software) and do a draft 2003 tax return based on the year to date and reasonable estimates through the end of the year.

In doing your draft 2003 return, pay particular attention to the alternative minimum tax (AMT) and how close you are to being (or not being) an AMT taxpayer.  Much year end tax planning involves trying to steer clear of that stealth tax.  Click here for our article on the AMT.  Also pay attention to your projected adjusted gross income (AGI); many tax benefits phase out or are eliminated if you are even $1 over some threshold AGI amount.  Your 2003 draft tax return then can be tinkered with using various "what if" scenarios. 

Because taxes affect your personal, business and investment life in different ways, year end tax planning needs to focus separately on these matters.

Business Planning
Businesses have much to gain from year end tax planning.  Even for businesses on the accrual method of accounting, accelerating deductions and deferring income often is the key year-end tax planning strategy.  Consider paying the bills today, but sending out the invoices tomorrow in January.

For partners, members of LLCs or owners of S corporations, personal tax planning and business tax planning merges.  Since the income and deductions from these flow through entities appear on Form 1040, year end tax planning becomes a real high wire act – a misstep in business planning can screw up sure footed personal or investment tax planning.  For example, planning to be below some AGI threshold that entitles you to obtain some education related tax benefit for your kids can be thwarted by your business failing to properly qualify for some deduction or by a client unexpectedly paying an invoice early.

Of particular note for businesses this year are the 2003 Tax Act provisions that (i) increase the Internal Revenue Code Section 179 expensing election to $100,000 per year (up from $25,000) and (ii) allow 50% bonus first year depreciation for new machinery, equipment and other assets.  Both provisions are available for eligible property purchased and placed in service before year end. 

Personal Planning
Your year end personal tax planning needs to address not only income taxes, but also estate and gift taxes.  Many gift and estate planning strategies (such as charitable lead trusts) are most effective in the current low interest rate environment.  Benefits available now will not be available in future months if interest rates increase.  In any event, get money out of your taxable estate by making those fully exempt gifts of up to $11,000 per donee ($22,000 per donee for a married couple) before December 31.  Do it now. 

Traditional year end planning steps for personal income taxes involve deferring income and accelerating deductions.  Deferring a few dollars of income (or claiming a capital loss or deduction that reduces AGI) may make you eligible for hundreds or thousands of dollars of tax reductions.  Tax benefits that phase out if your AGI increases over a threshold level include the deduction of up to $3,000 of qualified higher education expenses, deductible and nondeductible IRA contributions, the $1,000 per child tax credit and various education related tax benefits. 

For owners and employees alike, this year's taxable income may be reduced by increasing elective deferrals in 401(k) plans and similar plans or by deferring year end bonuses into next year.  Employees need to look at next year now – adjust W-4 withholding, retirement plan elections and cafeteria plan benefits.

Two items of personal year end tax planning are particularly worth noting.  Charitable contributions, especially contributions of appreciated property, are a great way of reducing taxes (including AMT) while doing good.  A check to your favorite charity mailed New Year's Eve gives you a deduction for this year.