Year-End Tax Planning

It’s that time of year again.  No, I don’t mean it’s time to start preparing holiday fixings or shopping for festive attire.  I mean it’s time for year-end tax planning. Steps taken between now and the end of the year can materially affect your 2005 tax liability.  Don’t treat your tax life like a surprise, not to be peeked at until next March or April.

When to start?  Now.  How to start? With a copy of your 2004 tax return and an inventory of your personal, business and investment life for 2005 to date.  Good tax planning starts with a little organization, mostly involving financial records. Look at your 2004 tax return and think for a few moments about any year-end planning you might have done last year.  Did you move any income or deductions from 2004 into 2005?  Make any business purchases in late 2004 that continue to give tax benefits in 2005?

For the first time in many years, no major tax legislation was enacted this year. However, major tax legislation enacted in 2003 and 2004 continues to have an impact on taxes and tax planning.  For example, 2004 tax legislation provides that beginning in 2005, businesses that are involved in manufacturing or other production activities undertaken in the U.S. are able to deduct up to 3% (increasing in future years to 9%) of their “qualified production activities income” (see “Does Your Business Qualify for a New Tax Break?” in the May/June 2005 issue of the Report).

Take Stock Now: Fill Out a 2005 Tax Return Today

The first step in all year-end tax planning strategies is to take stock of where you stand today vis-à-vis 2005 taxes. How does 2005 look? How do you expect 2006 to look?  Call your tax professional (or pull out some 2005 tax preparation software) and do a draft 2005 tax return based on the year to date and reasonable estimates through the end of the year.

In doing your draft 2005 return, pay particular attention to the alternative minimum tax (AMT) and how close you are to being (or not being) an AMT taxpayer.  Much yearend tax planning involves trying to steer clear of that stealth tax. The federal income tax rate cuts enacted in 2003, when taken together with counterbalancing state and local income tax rate increases, make it increasingly likely that you will be subject to AMT. Remember, residents of New Jersey earning more than $500,000 are subject to income tax rates up to a maximum of 8.970%, and New York’s top rates are now 7.7% state and 4.45% city.  These high state and local rates will complicate AMT planning.

You should note that 2004 legislation has extended temporary allowances of AMT offsetting credits (for certain nonrefundable personal tax credits, such as the child tax credit, the dependent care credit, credits for home mortgage interest and others) and temporarily increased AMT exemption amounts through 2005.  Also, pay attention to your projected adjusted gross income (AGI); many tax benefits phase out over a specified range of AGI, but some are eliminated entirely if you are even $1 over some threshold AGI amount.

For example, eligible individuals may deduct up to $4,000 of qualified higher education expenses if their modified AGI does not exceed $65,000 ($130,000 for joint returns) and $2,000 if it does not exceed $80,000 ($160,000 for joint returns).