While the jury is still out on whether the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) is stimulating the economy, the act’s provisions have certainly altered the tax-planning landscape. Signed into law on May 28, 2003,
JGTRRA accelerated reductions in the marginal income tax rates, lowered rates for long-term capital gains and qualifying dividends, expanded the 10% tax bracket (and the 15% bracket for married individuals filing jointly), and increased the basic standard deduction amount for married individuals filing jointly. The act also significantly increased the first-year depreciation allowance and the ?179 expense limit for businesses, and bumped up the child tax credit.
Like the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) before it, JGTRRA contains provisions that sunset its changes, with many expiring as early as 2004. In effect, many JGTRRA changes are scheduled to return to
EGTRRA levels in the next two years, and EGTRRA changes are themselves scheduled to expire at the end of 2010. The end result is a strange patchwork of tax benefits and changes that make long-term planning a challenge. The alternative minimum tax (AMT) adds yet another layer of uncertainty. While JGTRRA’s temporary increase in AMT exemption amounts will prevent a spike in the number of taxpayers subject to AMT (which would otherwise be likely, given the overall reduction in tax rates), these provisions expire at the end of 2004, setting up 2005 as the year of the AMT if no further action is taken. Add in some of the legislation that’s been proposed, and there’s a lot to think about.
In case you need reminders, here are 10 issues that you should address with your clients during the final quarter of the year, while there’s still time for you to help them lighten their tax burden. You are no doubt familiar with most of them. Recent changes, however, have added some new twists to these tried-and-true maneuvers, and the down-then-up behavior of the stock market may have changed your clients’ financial situations during this year of (we hope) economic recovery.
1. Assess each client’s current situation
Most tax tips, suggestions, and strategies are of little practical help without a good understanding of a client’s current tax situation. This is particularly true when it comes to planning at or around year end.
Encourage each client, either individually or together with you, to review last year’s tax return, along with current pay stubs and account statements, and to do a few quick projections to come up with an estimate of his or her 2003 tax situation. This is a year in which nothing should be taken for granted. Lower tax rates, a larger standard deduction for married individuals filing jointly, the new rates for capital gains and qualifying dividends, and advanced child tax credit checks all need to be taken into account. At the very least, such a review can identify any glaring issues that need to be addressed before year end, while there’s still time.
2. Address obvious shortfalls
Clients who project that they’re going to owe significant amounts can have their employers increase their federal income tax withholding (by completing a new IRS Form W-4), or make estimated payments (via IRS Form 1040-ES). Other strategies can also be implemented to reduce overall tax. Clients who project that they will have significantly overpaid and will be receiving large refund checks can, of course, reduce withholding accordingly.
Clients who have both wage income (receiving a W-2 as an employee at year end) and consulting income (reported on IRS Form 1099-MISC) can make up shortfalls in estimated tax payments through increased withholding between now and the end of the year. There’s an added benefit in doing this: Even though the additional federal income tax withholding may have come from the individual’s last few paychecks, it’s generally treated as having been withheld evenly throughout the year. This may negate a possible estimated tax penalty.
This is also a good time to find out if clients have household employees. In addition to filing Schedule H with their 2003 tax returns and possibly paying employment taxes, a client who has one or more household employees during the year will generally have to obtain an employer identification number (EIN), provide the employee with a Form W-2 by January 31, 2004, and submit a copy of the Form W-2 with a Form W-3 to the Social Security Administration by the end of February.
3. Determine whether or not the AMT will apply
It’s important for your clients to know whether or not the AMT may apply. Those subject to the AMT will have a very different planning approach during the last few months of the year.
The AMT results from a set of separate tax rules that exist in parallel to the regular income tax system. Originally intended to prevent the very wealthy from utilizing tax deductions and credits to pay little or no federal income tax, the AMT is exactly what its name implies: an alternative minimum amount of tax that some individuals are required to pay in addition to regular income tax.
In a nutshell, the AMT rules add certain items and adjustments back into a taxpayer’s income to arrive at alternative minimum taxable income (AMTI). An exemption amount that is based upon filing status is subtracted from AMTI and the result is multiplied by a flat tax rate of 26% (28% if AMTI exceeds a specified amount). The result is the taxpayer’s tentative minimum tax. If the taxpayer’s regular tax is greater than his or her tentative minimum tax, there is no additional AMT. If, however, a taxpayer’s tentative minimum tax is greater than his or her regular tax, the difference (the AMT) is added to the taxpayer’s regular tax in determining total tax due.
While a complete list of AMT preference items and adjustments can be found on IRS Form 6251, some of the more widely encountered AMT “triggers” include:
oMedical/dental expenses (a percentage of expenses may be added back)
oState and local taxes
oHome mortgage interest for a loan not used to buy, build, or improve a home
oMiscellaneous itemized deductions
oThe exercise of incentive stock options
Additionally, personal exemptions are not subtracted from income when calculating AMTI, so taxpayers with a large number of dependents may find themselves subject to the AMT.
Given the number and combinations of items that can cause a taxpayer to be subject to AMT, it’s very difficult to come up with a general rule about who is and isn’t subject to AMT, except to say that if a taxpayer’s AMTI (factoring in all preference items and adjustments) is less than the taxpayer’s AMT exemption amount, the taxpayer will not be subject to AMT. One caveat, though: the AMT exemption amounts phase out for higher incomes.
Clients should not make the mistake of assuming that only the wealthy are subject to AMT. Because key AMT figures aren’t indexed for inflation, more and more taxpayers are subject to the AMT each year. For example, for the 2002 tax year, a married couple filing jointly, each earning $50,000, with four dependent children and $26,000 in itemized deductions (including $10,000 in deductible taxes and $4,000 in miscellaneous itemized deductions), would have been subject to the AMT.
AMT is something of a showstopper when it comes to year-end tax planning. That’s because even some of the most basic year-end tax planning strategies can have unintended consequences under AMT rules. For example, individuals subject to AMT may find it counterproductive to accelerate deductions into this year since, along with other preference items, the AMT rules add back in certain itemized deductions, and individuals who have been subject to AMT in prior years may have assets that now have a basis for AMT purposes different (usually higher) than for regular tax purposes. Those subject to AMT will have to evaluate any strategy in the context of both regular tax and the AMT.
Had JGTRRA not addressed AMT at all, many of the tax breaks provided by the act would have been effectively nullified by the fact that a large number of new individuals would have been subject to the AMT (an overall lowering of tax rates tends to make more taxpayers subject to the AMT “floor”). However, JGTRRA did temporarily increase AMT exemption amounts, postponing an AMT crunch to 2005.
4. Consider the timing of income and deductions
During the last few months of the year, it’s often worth considering ways to manipulate the timing of income and deductions. However, while there are many ways to delay income and accelerate deductions (or, conversely, to accelerate income and postpone deductions), any such actions need to be analyzed not only in terms of the resulting benefit for 2003, but also in terms of the impact on the 2004 tax year. Manipulating the timing of income and deductions will generally be appropriate only in cases where a beneficial result is achieved in terms of the overall tax situation for both years. The fact that accelerating certain deductions will often increase the odds of being subject to the AMT should also be kept in mind.
Nevertheless, clients who expect to be in a different tax situation in 2004 (e.g., in a higher or lower income tax bracket) should consider the extent to which they can obtain an advantage by shifting income and deduction items from one year to another. In addition, clients who typically “lose” deductions because certain deductions (e.g., medical deductions, miscellaneous itemized deductions) approach but don’t regularly exceed AGI limitations, or because total itemized deductions come in slightly below the allowable standard deduction amount, will often experience an overall tax benefit by “bunching” income and deductions. Those who successfully implement a bunching strategy lower income and increase deductions in one year to maximize the itemized deductions in that year, and accept higher income and lower itemized deductions (or the allowable standard deduction) in the following year.
Here are some ways to delay income to the following year:
oDelay the collection of business debts, rents, and payments for ser-vices (cash method of accounting)
oDefer year-end bonuses
oExchange maturing E Treasury Bonds for HH bonds (delaying the recogni-tion of interest)
oDefer the sale of capital gain proper-ty or take installment payments instead of a lump-sum payment
oPostpone receipt of distributions that are over the required minimum from retirement accounts
Here are ways to accelerate
deductions into this year: