Year-end Tax Planning for 2002

Before the new year begins, take some time to review your 2002 tax situation. If you act quickly, you may be able to take steps to lower your 2002 tax liability.

The impact of the Economic Growth and Tax Relief Reconciliation Act of 2001 will be felt by taxpayers this year and for several years to come. And this year’s Job Creation and Worker Assistance Act of 2002 included several provisions designed to stimulate business investment. Are you taking advantage of the new opportunities to cut your taxes?

Individual Tax Changes

Here are several beneficial changes that could affect your individual taxes.

• The requirements have eased for claiming a deduction for up to $2,500 of student loan interest paid.
  
  
• IRA contributions for 2002 can total as much as $3,000 — $3,500 if you are age 50 or older. You have until April 15, 2003 to contribute. We can help you determine whether a contribution to a traditional IRA would be tax deductible and explain how traditional and Roth IRAs differ.
  
  
• The 2002 limit for pretax salary deferrals to a 401(k), 403(b), or 457 plan is $11,000. (Plan limits also may apply.) As much as $7,000 may be contributed to a SIMPLE plan. Additional catch-up contributions may be allowed if you are age 50 or over. Check with your employer to find out how much you can contribute for 2002.
  
  
• A new deduction for the payment of up to $3,000 of higher education expenses is available this year. Income limits and other restrictions apply.

If you are interested in saving for education expenses, consider opening a Coverdell Education Savings Account (formerly called an Education IRA). If you are eligible, you can contribute up to $2,000 a year (per beneficiary). You won’t see an immediate tax saving this year because contributions are not deductible. But future investment earnings will be tax deferred, and withdrawals from the account will be tax free if the money is used for qualified education expenses. Note that these accounts can now be used for qualified elementary and secondary school expenses (including computers and extended day program costs) as well as for various higher education expenses. The $2,000 annual contribution limit is phased out above certain income thresholds.

Also consider a state-sponsored Section 529 college savings plan. There are no income limits on contributing and, as with the Coverdell Education Savings Account, distributions or education benefits received will be tax free.

A Matter of Timing

The fundamental issue of timing will undoubtedly remain an important part of your planning. Traditional wisdom says to defer income and accelerate deductions whenever you expect to be in the same marginal tax bracket from one year to the next, or if you expect your bracket to decrease. On the other hand, if you expect your bracket to increase next year, the opposite approach may prove more beneficial.

For the most part, these rules-of-thumb will probably hold true for you. But it’s important to review your personal tax situation to determine the most appropriate strategy. Note that all the individual tax rates over 15 percent have dropped by half a percentage point for 2002. They will remain the same for 2003, then drop again in 2004 and 2006.

So far, 2002 has not been kind to the stock market. If you are showing a paper loss on an investment held outside of a tax-deferred account and you’ve made a decision to sell the investment, doing so before December 31 may cut your 2002 taxes. Capital losses offset capital gains and up to $3,000 of your ordinary income, such as wages and interest ($1,500 if married filing separately). Unused losses may be carried forward for deduction in future years subject to the same limitations.

If you itemize deductions, think about paying deductible expenses before the end of the year to lower your 2002 taxes. (Caution: If you are a high earner facing a limitation on your itemized deductions or if you expect to be in a much higher tax bracket in 2003, this strategy may not be beneficial.)

Expenses you might pay before December 31 include:

• Your January 2003 mortgage payment;
  
  
• Any remaining estimated state income taxes for 2002; and,
  
  
• A charitable donation. If you write a check to the charity, your contribution is deductible in the year you deliver the check or mail it (the postmark date). If you make a credit card charge, the contribution is deductible in the year you make the charge, no matter when you pay the bill.

Also take a good look at your year’s medical and dental expenses. Do your expenses to date total more than 7.5 percent of your expected 2002 adjusted gross income (AGI)? If they do, paying as many additional expenses as possible in 2002 will increase your deduction. If your expenses are falling substantially short of the mark, you may be better off delaying payments to 2003 whenever possible. Only expenses that top the 7.5 percent floor are deductible.

Similarly, deductions for miscellaneous and unreimbursed employee business expenses are subject to a 2 percent-of-AGI floor. Some examples of expenses in this category are professional dues and publications, investment expenses, union dues, and work uniforms.

Business Strategies

Looking for opportunities to lower taxes on business income? Some items to consider:

• The 2002 cap on the cost of equipment that may be expensed currently instead of depreciated over time is $24,000 (phased out for asset additions over $200,000). You can’t expense more than your income from all your trades and businesses. Wages, even from a side job, count as business income. If you are planning a purchase and haven’t already exceeded the $24,000 cap, think about buying before the end of the year to get a deduction in 2002.
  
  
• An asset purchase before year-end may qualify for a 30 percent depreciation "bonus" under the new tax law. Ask us for details.
  
  
• If the business reports on the cash basis, you can push taxable income into 2003 by waiting to bill clients or customers so that payment will be received in the new year. Accrual basis businesses might delay shipping products and/or providing services until early 2003.
  
  
• To bump up your deductions, buy any needed supplies and get repairs done before the end of the year. Also sell or get rid of any obsolete equipment and inventory. From a tax viewpoint, accelerating deductions (and deferring income) is generally most beneficial when you’ll be in the same or a lower tax bracket next year.
  
  
• If you expect your partnership to show a loss for 2002, make sure you have enough "basis" in your partnership interest to deduct the loss. A contribution of capital to the partnership before the end of the year is one way to increase your basis.
  
  
• Your deduction for any S corporation loss passed through to you as a shareholder is limited to your basis in your stock and any loans you’ve made to the company. If you anticipate a 2002 loss, we can help you determine where you stand in terms of deducting it.
  
  
• If you are self-employed and don’t yet have a retirement plan in place, you may want to investigate starting a plan. A Keogh plan is one possibility. Start the plan by December 31, 2002, and you’ll have until the due date of your tax return (plus filing extensions) to make a tax-deductible contribution for 2002.
  
  
• Eligible small businesses that start retirement plans can claim a tax credit for 50 percent of the first $1,000 of administrative and retirement-education expenses connected with starting and maintaining the plan during each of the first three plan years.

Don’t Wait

The general strategies we’ve touched on may or may not be appropriate for you. We’re ready to assist you with more in-depth planning and to discuss your questions and concerns. Contact us soon.