With Deal Done, It’s Back to Basics in Tax Land
While many tax planners may have been biting their nails for the last few months, Harry Harrison, a partner at the accounting firm Aronson & Company in Rockville, Maryland, wasn’t among them.
It’s not that Harrison didn’t care what Congress was going to do. It’s just that in his mind, planning decisions should be driven by economics as well as tax rates.
So for Harrison, the three main issues this year, as they were last year, and the one before that, are: defer, convert and eliminate taxes.
While the Obama-GOP compromise has answered the big questions about personal income, capital gains and dividends, and estate rates, Harrison says, even if the Bush cuts were allowed to sunset, accelerating income to pay a lower tax now might not have been the most prudent move.
“My perception is that cash is king. Generally speaking, you are always better off deferring to next year.”
Barbara Lane, Partner in Citrin Cooperman in White Plains, New York agrees. “Why pay a tax when you can wait a year? It’s the time value of money.”
In other words, a bird in hand is worth two in the bush.
Another way to defer, says Lane, is to maximize pension contributions. The principal here is that you postpone the tax on the amount contributed, plus all the earnings, until they are withdrawn.
Along the same lines, when conducting a basic year-end review, look at the best time to take a deduction. Prepaying expenses such as real estate or state income taxes, medical, or miscellaneous deductions may be a good idea.
For example, says Lane, medical expenses can be deducted when they reach 7.5 percent of your adjusted gross income. If that income is $100,000 and you're looking at $10,000 in medical, instead of paying them as they occur—say, $5,000 this year and $5,000 next—it’s better to pay the $10,000 all at once this year to hit the deduction threshold.
Another basic in year-end tax planning is convert.
If you have held an asset for at least a year, you are eligible to convert from the ordinary rate of 35 percent to the capital gains rate of 15 percent. Let’s say, you bought stock in Hewlett Packard today and it moved from 40 to 44 dollars a share, suggests Harrison. If you sold in less than a year and took the gain, you’d pay the ordinary rate of 35 percent. However, if you had held it for at least 12 months, you would pay the capital gains rate of 15 percent. Clearly, this can be a big deal, even if the stock price slips a bit.
A year-end review of capital gains and losses with an eye for whether or not to sell assets is always appropriate, adds Lane. If you made money on the sale of certain stock and you’re going to have to pay taxes, you might consider selling another stock that you lost money to offset your gain.
How about eliminating taxes? It’s possible, says Harrison, by doing things like offering fringe benefits to employees. There are many things that employers can provide employees including health insurance, life insurance, and dependent care coverage that can eliminate taxes because they are non-taxable. The list is exhaustive and there a lot of changes especially with the Health Care Reform Act.
At the end of the day, don’t be tax-obsessed. Taxes are a cost of doing business. You’re not going to go out of business or retire, so you can pay less taxes.
If all else fails, says Harrison, "Make a lot of money in the next two years and pay taxes at really low historical rates before they go up and we fix the deficit.”