In the last issue, I addressed the wisdom of doing tax planning before the calendar year ends. Particularly in challenging years for the investment markets (like this one), there are often strategies to make the best of a tough situation. Here are other ideas individuals may want to look at prior to the end of the year to potentially reduce their tax burden for 2008. As always, it is a good idea to consult with your tax advisor before proceeding.
One step that is practical for more and more people is to convert a portion of traditional IRA balances into Roth IRAs, particularly for those in one of the lowest two tax brackets. Assuming that the amount you convert will not trigger an increase in your tax bracket, moving the funds now will create a tremendous tax advantage for those who believe their tax brackets will be higher in the future.
The funds you move from a regular IRA to a Roth IRA will be taxable this year, but with the lower marginal rates created by President Bush's 2001 tax cut set to expire in two years, a partial conversion to a Roth IRA may be a wise idea. The concept is that the money you take out from a Roth IRA will not be taxed, so you are creating a healthy flow of future capital gains, dividends, and interest that will be tax free. This strategy is even better given the state of the market!
For those in one of the higher tax brackets, do not forget to maximize contributions to your tax-deductible retirement accounts! Of course, what it means to "maximize" your contributions will depend on your budget and cash flow. However, 401(k) accounts have to be funded by Dec. 31 to lower taxable income for 2008, while IRA accounts have until April 15, 2009, to be funded.
Many married couples assume that if one spouse participates in an employer-sponsored retirement plan such as a 401(k) or pension plan, then they are not eligible to do IRA or Roth IRA funding. This is not always correct! Eligibility for contributions to a Roth IRA are always dependent on income thresholds, regardless of whether one contributes to a 401(k). And for many households, an IRA contribution for a non-working spouse is still completely allowed depending on the adjusted gross income of the household. This is not just a wise savings strategy, but its tax advantages include current income deductions and tax-deferred growth on the gains inside the account.
A few final strategies to consider: Most taxpayers live in states with property taxes on their real estate. If cash flow allows for it, consider paying the second installment of your 2008 property taxes (generally not due until the spring of 2009) before Dec. 31, as property taxes are deductible against your federal income tax liability. If, for whatever reason, 2008 stands to create an abnormally high tax liability, or if you see 2009 perhaps being a less burdensome year tax-wise, it may benefit you to take this extra deduction now.
Though Congress did pass another year of delay on the pending AMT nightmare (Alternative Minimum Tax-a complicated and bizarre tax that more and more taxpayers fall into), it is still very much worth talking to your tax advisor before year-end to see where you stand. AMT catches a lot of taxpayers by surprise, so it may be that by knowing ahead of time where you are, you may be able to take some actions to help defer or avoid this.
Finally, I know many charitable organizations and churches would appreciate your "tax planning" that results in tax-deductible contributions of cash or investment holdings. Checks need to be written by Dec. 31 to be eligible for a 2008 deduction, and appreciated stock needs to be transferred by Dec. 31 as well to be eligible. The latter strategy not only gives you an income tax deduction on the market value of the gift, but it also avoids capital gains taxes on the unrealized appreciation of the asset!
The last thing investors want to do in a year where they have seen their portfolios decline in value is pay more taxes than they need to. These simple and legal strategies may provide you a bit of relief.