Tax planning is a year-round game; start now

Tax planning is a year-round game; start now

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If you knew you could deduct more of your expenses and save more tax-free, you would, right? Well, for 2006, you can -- if you get started now. There are even a few things you can do now to reduce your 2005 taxes.

By Jeff Schnepper

Every year, Congress tinkers with the tax code. Every year, your life changes. That makes tax planning an all-year activity.

There are a few tax-saving moves you can make until April 15 that will affect your 2005 taxes The rest of your moves must be made by Dec. 31 to benefit you for 2006.

So, this brings us to my most profound advice for 2006: An aggressive tax planning strategy may be to accelerate income into the shelter of lower rates this year, especially if you can take refuge under the special 5%-to-15% rates on dividends and long-term capital gains. Here what to think about.

Use those larger retirement deferrals
A wise man once told me that if I lived below my means, someday I be a wealthy man. It was good advice.

Put some more money aside for retirement. Extensive changes were made to the rules relating to IRAs and qualified pension plans by the 2001 tax law. Looking for a loan?
Check out MSN Money's
Loan Center



For 2005, you still have until April 17 to make contributions that may qualify for tax breaks on your 2005 taxes. These deadlines apply to contributions to individual retirement accounts, SEP-IRAs and Keogh accounts. If you didn't establish a Keogh by Dec. 31, 2005, however, you won't be able to deduct any contributions made between now and April 17 until you file your 2006 return next year. Check with a tax pro to be sure.

Contribution limits rise again for 2005 and 2006. maximum 2005 contributions to defined contribution plans and 401(k) plans are both up $1,000 from 2004 and will rise again in 2006:

Changes in retirement plan contributions
Plan type 2005 2006

Defined contribution plans $42,000 $44,000.
Simple IRA plans $10,000 $10,000
401 (k) contributions $14,000 $15,000
IRA contributions $4,000 $4,000



Special additional contributions are now available if youe age 50 or older. Here's a rundown:


IRA accounts. You can contribute an additional $500 (for a total of $4,500 for 2005) into an IRA and $1,000 in 2006.


Section 401(k), 403 (b) annuities and Section 457 plans. These now allow for additional $4,000 contributions in 2005 and $5,000 in 2006.


SIMPLE plans. If you contribute to a SIMPLE plan, you get another $2,000 for 2005 and $2,500 in 2006 once you hit the half-century mark.
Contribution limits weren the only things changed. You can now borrow from your qualified plans if youe self-employed or an employee shareholder of an S corporation. Now only loans from IRAs are prohibited.

But, consider this: Distributions from such plans will always be taxed at your highest marginal ordinary rate. Depending on your assumptions, rate of growth and age, it may be better to invest for growth outside your retirement plans.

With all of these retirement changes, youe going to need some good direction. The good news is that your employer can provide you with retirement planning advice on a tax-free basis. The bad news is that this doesn cover tax preparation, accounting, legal or brokerage services.

Students and parents: Use your education breaks
Students and their parents make out for 2005 and 2006.

If youe single and made less than $65,000 ($130,000 on a joint return) in 2005, you can get an above-the-line college tuition deduction of as much as $4,000 in 2005 for yourself or a dependent child. That unchanged from 2004 but up $1,000 from 2003. If you have a college-age child, watch this provision. It expires after 2005, and Congress has not yet renewed it for 2006.

If you meet the 2005 income qualifications, you can take the Hope or Lifetime Learning tax credits, which may be even more valuable tax breaks. (A warning: You can't claim the tuition deduction and either of these tax credits.) If you file single or head of household, the credits start phasing out if your adjusted gross income (AGI) is above $43,000 and disappear if you make more than $53,000. If youe married and file jointly, the credit is phased out for incomes from $87,000 to $107,000.


Get more information on the Hope and Lifetime Learning credits here and here.

If youe graduated from college, your employer can give you as much as $5,200 per year in tax-free graduate school assistance.

The old IRA for education, now known as the Coverdell Education Account, allows tax-free withdrawals for use in grades K-12 to pay for tutoring, computer equipment, room, board, uniforms, tuition and extended-day programs. The annual contribution limit is $2,000 per child in 2005 and 2006.

Distributions from Section 529 accounts for college expenses are currently tax-free. In the past, they were taxed at the child rate.

The Section 529 contribution limits also were raised recently. Under prior law, there was a special five-year gift tax election, which allowed you to contribute as much as $50,000 per child. In effect, you were accelerating five $10,000 per-year exclusions into a single year.

Since the annual gift tax exclusion has increased to $11,000, you can now contribute as much as $55,000 per child in a single year.

Whew! Teachers get to keep a nice break
Our Congress just loves learning; 2005, like 2004, has plenty of benefits for kids and education.

If youe a teacher, you get one special benefit. You can deduct as much as $250 of your classroom expenses from 2005 without itemization or reduction.

This applies if you are a teacher, instructor, counselor, principal or aide and worked in kindergarten or through grade 12.

This nice little tax break was supposed to die in 2004, but Congress reinstated the provision to apply to both 2004 and 2005. So, enjoy. And hope the break is renewed for 2006.

Enjoy the lower rates
Nobody has started to tinker with tax rates yet this year. Enjoy them. Our tax rates are the lowest I can remember -- and Ie been around for a while. Compare our 2005 rates to those only four years ago.

Tax rate changes between 2001 and 2005
2005 2001 % change from
2001 to 2005
10% 10% 0.00%
15% 15% 0.00%
25% 27.5% -9.09%
28% 30.5% -8.20%
33% 36% -8.33%
35% 39.1% -10.49%


In addition, amounts in each bracket are automatically increased for inflation. The combination of larger brackets and lower marginal rates -- especially for upper-income taxpayers -- has put more dollars in your pocket in the last few years and will continue to do so.

The practical effect of the change is this: If you and your spouse file jointly and had taxable income of $80,000 in 2001 and expect the same in 2005, your federal income tax bill drops from $16,350 to $13,330 -- a savings of $3,020.

If your taxable income is $150,000, the tax bill falls from $36,822.50 to $31,731.50, a savings of $5,091.

And that starting with taxable income. When you add in all the new deductions and expanded credits, there should be a lot more money in our pockets after tax than three years ago.

Let put that in perspective. In early 2004, a Congressional Budget Office study showed the typical American household had a smaller income tax burden in 2001 than in any other year back to 1979. 2001 is now our high tax year!

Enjoy it while you can. Does anyone believe the rates won be moving higher? Congress and the White House seem to be intent on proving that the ig bang?theory really works. The cash to pay for increased defense and other spending has to come from somewhere.

Some tax-planning moves for 2006
Defer income if you can. Let say we don expect tax rates to rise in 2006. The betting is they'll at least stay constant for a while. If you don't have to take the income in calendar 2005, defer it into 2006. That way, the income is off your 2005 tax return. Postpone the pain.

Use the tax laws to minimize any stock market pain. Yes, the market up, but, as the past few weeks have shown, it is still volatile. So, you may have some investments that have generated deductible losses while others have (hopefully) major gains. You can use your losses to offset any gains. On a net basis, all capital losses, regardless of whether theye short or long term, offset capital gains on a dollar-for-dollar basis. You can use $3,000 of net capital losses in excess of capital gains to offset ordinary income. Any excess left over can be carried forward to 2006.

But watch out for the wash-sale rules. The IRS disallows losses on securities sold if substantially identical securities are bought within 30 days before or after the loss sale. Best case: Buy 31 days later.

Bunch your medical expenses if you can. Only medical expenses in excess of 7.5% of your adjusted gross income are allowed as deductions. So, if your adjusted gross income is $100,000, you get no deduction for the first $7,500 of your medical expenses. But there are some medical expenses you can defer or accelerate, depending on whether you expect to exceed this floor. Elective surgery, orthodontia or the payment of your medical insurance premiums can all be advanced or postponed to meet your minimum floor.

Miscellaneous itemized deductions. These are only allowed to the extent they exceed 2% of your adjusted gross income. If youe going to exceed the 2% floor, then accelerate your deductions. Prepay your accountant in 2006 to do the tax return that you don have to file until April 2007. Renew and pay for your investment publications before the end of the year. If you don have the cash, charge these expenses. The charges are allowed in the year of the charge, not when you actually pay your credit card bill.

Accelerate payments that can produce tax deductions. If you write your January 2007 mortgage check or the check for your property taxes on or before Dec. 31 2006, you can claim the interest deduction or real estate tax deduction in 2006.

Get the most out of non-cash charitable contributions. Give your old clothes, furniture, equipment, etc. to your church, synagogue, Salvation Army or Goodwill before Jan. 1, 2007 and take a deduction for the fair market value. Make sure you get a receipt: No receipt means no deduction.

Plan your tax payments. An MSN Money survey on taxes found that more than 53% of the respondents expected a refund of more than $1,000. That a whole lot of money left interest-free with the IRS.

You want a big refund? Send me your money. I be happy to send it back to you, interest-free, prior to April 15.

Otherwise, shoot for the safe harbors -- 90% of the current year total tax or 100% of your prior year total tax (110% if you prior year adjusted gross income was more than $150,000). Hit those targets and, no matter how much you owe next April 15, there won be any interest or penalties if you timely pay the balance.

Adjust your withholdings to meet these targets. If you expect to pay next year, put the withholding difference in a money market account. At least then, youl be picking up any interest.

Plan for the alternative minimum tax
This awfully mean tax has been destroying my clients?refunds this year. What can be done?

If you expect to be hit by the AMT, reverse many of your typical planning strategies. Defer, rather than accelerate, those items that aren allowed as deductions for the AMT. Such expenses include taxes, employee business expenses, investment expenses, job search expenses, etc.

The AMT is a flat 26%/28% tax. If youe normally in a higher bracket than that, accelerate your income. Such income will then be subject to the lower AMT rates. For more on this, see "Don't get bitten by this Awfully Mean Tax."

Meanwhile, the U.S. tax law is going to change. Congress is considering a Value Added Tax (VAT) or even a consumption tax. Plan your tax year under current rules. But keep on eye out and watch here for updates. The law will change. And, when it does, MSN Money will be here to guide you through the new rules.