Action Now = Tax Savings in April
Military.com and TurboTax
3. Beware of the Alternative Minimum Tax
Sometimes accelerating deductions can cost you money… if you’re already in the alternative minimum tax (AMT) or you inadvertently trigger it. Originally designed to make sure wealthy people could not use legal deductions and congressionally created loopholes to drive their tax bill to zero, or close to it, the AMT is now increasingly affecting the middle class.
And that can be a particular problem for people who are not used to figuring out sticky tax issues.
The AMT is figured separately from your regular tax liability — with different rules — and you have to pay whichever tax bill is higher.
This is a year-end issue because certain expenses that are deductible under the regular rules — and therefore it might make sense to accelerate payments — are not deductible in AMT-land. State and local income taxes and property taxes, for example, are not deductible when figuring the AMT. Thus, if you expect to be subject to the AMT in 2008, don’t pay in 2008 the installment that’s due in January of 2009. Also, while medical expenses that exceed 7.5% of your adjusted gross income can be deducted under the regular rules, the threshold is 10% for the AMT. Interest on up to $100,000 of home-equity loan debt is deductible under the regular rules, no matter how you use the money — so you want to be sure you’re up to date paying that interest. But under the AMT, home-equity loan interest is only deductible if the money was used to buy or improve your primary or second home.
In recent years, lots of taxpayers fell into the claws of the AMT because of the AMT’s special treatment of incentive stock options. Sometimes, though, selling stock acquired via options before the end of the year can get you out of AMT-land.
4. Sell Loser Stocks to Offset Gains
Your portfolio cries out for special attention as the year draws to an end. Since it’s up to you when to sell securities — and convert paper gains and losses to real ones — you can mix and match your trades to deliver the tax outcome you desire. Begin with an outline of exactly where you stand. Draw up a list of your trades so far and the gains or losses on each. Make another list showing your current holdings and the paper gain or loss to date. In other words, if you sold the securities today, what would your profit or loss be? Because the tax law treats different kinds of gains differently, you need to segregate your long-term (for securities owned more than one year) and short-term sales (for securities owned one year or less) so far this year and your open positions that would produce each kind of gain or loss. If you invest in mutual funds, check with the fund about how coming year-end distributions might add to your capital gains for the year.
A strategy for net gain
If you are fortunate enough that your trades so far in 2008 have resulted in a net gain, take a hard look at the securities in your portfolio that show paper losses. Maybe now is the time to unload some of those stocks, using the loss to sop up the gain on other deals and pull down your tax bill. It’s not a cockamamie idea to realize losses to save on taxes. After all, you suffered the loss when the securities fell in value. Selling just makes it official… and makes the IRS pick up part of the loss. What if you have a net short-term gain, which will be taxed at your top tax bracket? Taking any kind of loss — short or long term — can offset that gain dollar for dollar. And, although long-term gains get favorable tax treatment, net losses from either category can be deducted in full against other income such as your salary, up to a $3,000 annual maximum write-off. Any net losses beyond the $3,000 write-off are carried over to cut your tax bill in the future.
A strategy for net loss
On the other hand, if your sales so far have produced a net loss, perhaps you should go in for some year-end profit-taking. As noted, only $3,000 of net losses a year can be used to offset income other than capital gains, so if you have a bigger loss, you have an incentive to cash in some of your other profits. Because the loss will offset additional gains dollar for dollar, you can add to your income without adding to your tax bill.
Of course you don’t want to let the “tax tail wag the investment dog” by allowing the search for tax savings to lead you into bad investment decisions. Your investment goals must be paramount. But if a particular investment is on the sell-or-hold borderline, perhaps the tax consequences can be decisive.
Since it takes several days to settle a trade — between the time you order the sale to the time you get your money — sales during the last few days of the year often straddle year-end. As far as the IRS is concerned, a gain or loss should be reported on the return for the year the trade occurs, regardless of when settlement takes place. That means profits and losses taken as late as the closing bell on New Year’s Eve go on the current year’s return.