Time’s running out. And I don’t just mean time for finding the right sweater for Mom, computer game for Junior or collar for Fido.
You’ll suffer taxpayer remorse next April 15 if you don’t make necessary financial maneuvers for the 2003 tax year now. Sit down to project what you’ll most likely owe in taxes, since this year’s tax law rewrote many rules on investments and income.
Here are some important differences for this tax year:
– Reductions in income tax rates on ordinary income and short-term capital gains are retroactive to Jan. 1, 2003. The highest marginal tax rate is now 35 percent.
– There’s a reduction in the top individual rate on most long-term capital gains realized after May 5, 2003, to 15 percent from 20 percent.
– Qualified dividend income is capped at a 15 percent rate retroactive to Jan. 1, 2003, rather than the ordinary income tax rates.
– The participant pre-tax contribution limit for 401(k) and 403(b) plans has increased to $12,000 from $11,000, or to $14,000 for individuals age 50 or older.
Your last-minute scramble begins on the job. Maximize your contribution to tax-deferred plans, and if you have a cafeteria-style health plan, use up the amounts you set aside before year’s end. Employers began using revised IRS tables to compute payroll withholding on July 1, so your employer may have overwithheld the first half of the year.
“Even though there was a tax reduction in the middle of the year, still make sure you had enough withheld for tax purposes,” said Mark Balasa, co-president of Balasa Diverno Foltz & Hoffman financial advisers in Schaumburg.
Meanwhile, with a burgeoning stock market, considerable maneuvering is taking place in retirement accounts.
“Many people have been converting traditional IRAs into Roth IRAs because they believe the value of their IRAs was as low as it was going to go,” said Phil Behnen, certified financial planner and manager of tax and financial planning services for A.G. Edwards in St. Louis. “Converting to a non-deductible Roth before the stock market goes much higher means you’ll be paying less tax on a smaller account.”
Now that investors are finally experiencing gains in investment accounts, keep in mind that capital loss carry-forwards from past years can be used to offset gains in taxable accounts, said Behnen. Taxpayers can use capital losses in excess of capital gains to offset up to $3,000 of ordinary income each year. Any unused capital losses are carried forward for use in future tax years.
If you have investments that became worthless during the past year, the IRS considers you to have realized a loss as of the last day of the year.
“This tax year is going to be a little more complicated because the new capital gains rate of 15 percent only applies to trades made on or after May 6, 2003,” added Behnen. “Having two different rates could get confusing for people who trade a lot.”
Deferring income and accelerating deductions usually makes sense for many taxpayers. “You can bunch your miscellaneous itemized deductions and medical expenses in order to increase the deductible amounts,” said John Dyer, certified financial planner with Peter Shannon & Co. in Hinsdale. “Also arrange with your employer to defer any bonus until 2004.”
Year-end charitable contributions also require some thought.
“If you’re going to make charitable contributions before Dec. 31, you must get the correct documentation,” said Donald Bendix, certified financial planner with Bendix Financial Group in Garden City, N.Y. “It’s not based on the honor system, so you can’t just drop your clothing donations in a bin and write in any amount.”
Other year-end tax thoughts:
– Calculate to see if you’ll fall under the alternative minimum tax, which is designed to kick in if you have hefty tax deductions. That’s a crucial consideration if you have a lot of municipal bond interest or incentive stock options, said Balasa.
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– Use home equity lines of credit to pay off high-interest credit card debt, said Bendix. Home equity rates are in the 4 percent rate and the interest is deductible.
– Delay any late-year mutual fund purchases until after the fund declares its December dividend, usually around mid-month, so you won’t take a taxable income hit this year, Dyer said.
“However, because so many mutual funds still have a lot of embedded losses, capital gains distributions may be low this year,” concluded Behnen, pondering the bright side. “That should be helpful to taxpayers.”