2000 Year-End Tax Planning for Individuals

As 2000 draws to a close, there is still time to reduce your 2000 tax bill and plan ahead for 2001. This letter outlines several strategies for you to consider. You should consult with a professional tax advisor before taking any action.

Income Planning

A key aspect of tax planning is to estimate both your 2000 and 2001 adjusted gross income (AGI). Time-honored strategies of accelerating deductions and deferring income must be evaluated carefully because they are tied to AGI. When considering whether to accelerate income and deductions or postpone income and deductions, be aware of the impact that such action may have on your adjusted gross income and your ability to maximize itemized deductions that are tied to AGI. Your 1999 tax return and 2000 paystubs and other income and deduction related materials are a good starting point for estimating your AGI.

Accelerating Income Into 2000

If you are anticipate being in a higher tax bracket in 2001, you may benefit from accelerating income into 2000. To accomplish this:

• Accelerate Collection of Accounts Receivables: If you are self-employed and report income and expenses on a cash basis, issue bills and attempt collection before the end of 2000. Also see if some of your clients or customers might be willing to pay for January 2001 goods or services in advance.

• Year-End Bonuses: If your employer generally pays such bonuses after the end of the current year, negotiate to have your bonus paid to you before the beginning of 2001.

• Retirement Plan Distributions: If you are over age 59 1/2 and you participate in an employer's retirement plan or have an IRA, consider making withdrawals before 2001. You may also want to consider making a Roth IRA rollover distribution, as discussed below.

Deferring Income Into 2001

If you expect your AGI to be higher in 2000 than in 2001, or you anticipate being in a higher tax bracket in 2000, you may benefit by deferring income into 2001. To accomplish this:

• Delay Collection: If you are self-employed, delay year-end billing to clients so that payments will not be received until 2001.

• Interest and Dividends: Interest income earned on Treasury securities and bank certificates of deposit with maturities of one year or less is not includible in income until received. To defer interest income, consider buying short-term bonds or certificates that won't mature until next year. If you have control as to when dividends are paid, arrange to have them paid to you after the end of the year.

• Investments: Many mutual funds attempt to "dress up" performance by selling stocks and other holdings before the end of the year, resulting in ordinary income and capital gains being recognized by shareholders. Avoid having to recognize such income by deferring your investment decision until the beginning of 2001.

Deduction Planning

Deduction timing is also an important element of year-end tax planning. Deduction planning may be complex, however, due to factors such as adjusted gross income levels and filing status.

Deduction planning is impacted by the limits on itemized deductions that are tied to adjusted gross income (AGI), For 2000 returns, overall itemized deductions are reduced by 3% of the AGI exceeding $128,950 for married taxpayers filling jointly ($64,475 if married filing separate). Similarly, certain deductions may be claimed only if they exceed a certain percentage of AGI: 7.5% for medical expenses; 2% for miscellaneous itemized deductions; and 10% for casualty losses.

Deduction planning is also impacted by the standard deduction. For 2000 returns, the standard deduction is $7,350 for married taxpayers filing jointly, $4,400 for single taxpayers, $6,450 for head of household, and $3,675 for married taxpayers filing separately. In cases where your itemized deductions are relatively constant and are close to the standard deduction amount, you might consider adjusting the timing of your expenses so that they are higher in one year and lower in the following year.

You may be eligible to deduct student loan interest on any qualified education loan, applicable to interest paid after December 31, 1999. The deduction is allowed only for interest paid during the first 60 months in which interest payments are required. The maximum deduction is $2,000 in 2000. The deduction is phased out at a modified adjusted gross income level of between $60,000 and $75,000 for joint filers, and between $40,000 and $55,000 for all other taxpayers.

Other deduction strategies are discussed below. If you are a cash-method taxpayer, remember to keep the following in mind:

• Deduction In Year Paid: An expense is only deductible in the year in which it is actually paid.

• Payment By Check: Date checks before the end of the year and mail them before January 1, 2001.

• Promise To Pay: A promise to pay or providing a note does not permit you to deduct the expense.

Highlighted below are some of the more common itemized deductions and strategies for maximizing their benefit:

• Medical Expenses: Medical expenses, including amounts paid as health insurance premiums, are deductible only to the extent that they exceed 7.5% of AGI. Consider bunching medical expenses into years when your AGI is lower.

• State Taxes: If you anticipate a state income tax liability for 2000 and plan to make an estimated payment, consider making such payment before the end of 2000.

• Charitable Contributions: Consider making your charitable contributions at the end of the year. This will give you use of the money during the year and simultaneously permit you to claim a deduction for that year. You can use a credit card to charge donations in 2000 even though you will not pay the bill until 2001. A mere pledge to make a donation is not deductible, however, unless it is paid by the end of the year.

• Equipment Purchases: If you're in business, careful timing of equipment purchases can result in favorable depreciation deductions in 2000. In general, under the "half-year convention," you may deduct six months worth of depreciation for equipment that is placed in service on or before the last day of the tax year. If more than 40% of the cost of all personal property placed in service occurs during the last quarter of the year, however, a "mid-quarter convention" applies, and thus you would only be entitled to one and one-half months' worth of depreciation for assets placed in service during the other three quarters of the year. This would mean that assets placed in service during the first quarter of the year would be subject to only ten and one-half months' worth of depreciation.

An alternative planning technique is to make a "Section 179 Election," which allows you to expense (i.e. currently deduct) otherwise depreciable business property. In general, you may elect to expense up to $20,000 of equipment costs if the asset was placed in service during 2000.

Tax Credit Planning

Child Tax Credit

A nonrefundable tax credit of $500 per qualifying child under the age of 17 is available on this year's return. The credit is phased out at a rate of $50 for each $1,000 (or fraction of $1,000) of modified AGI exceeding the following amounts: $110,000 for married filing joint; $55,000 for married filing separate; and $75,000 for all other taxpayers.

HOPE Credit and Lifetime Learning Credit

For 2000, two education credits are available - the HOPE Scholarship credit and the Lifetime Learning credit. The maximum HOPE credit is $1,500 (100% on the first $1,000, plus 50% of the next $1,000) per student for qualified tuition and fees paid on behalf of a student ( i.e., the taxpayer, the taxpayer's spouse, or a dependent) who is enrolled on at least a half-time basis. The credit is available for only the first two years of the student's post-secondary education.

The Lifetime Learning credit maximum in 2000 is $1,000 (20% of qualified tuition and fees up to $5,000). A student need not be enrolled on at least a half-time basis so long as he or she is taking post-secondary classes to acquire or improve job skills. As with the HOPE credit, eligible students include the taxpayer, the taxpayer's spouse, or a dependent.

Both the HOPE credit and the Lifetime Learning credit are phased out at modified AGI levels between $80,000 and $100,000 for joint filers, and between $40,000 and $50,000 for all other taxpayers.

Investment Planning

Effective for sales after December 31, 1998, the following rules apply for most capital assets:

• Capital gains on property held 12 months or less are taxed at an individual's ordinary income tax rate.

• Capital gains on property held for more than 12 months are taxed at a maximum rate of 20% (10% if an individual is in the 15% marginal tax bracket).

Effective for sales after December 31, 2000, capital gains on property held for more than five years will be taxed at a maximum rate of 18% (8% for individuals in the 15% marginal tax bracket). For this special lower rate to apply, individuals in a marginal tax bracket above 15% must acquire the property after December 31, 2000, or may elect to treat property purchased before January 1, 2001 as acquired on January 1, 2001. Individuals in the 15% marginal tax bracket need not acquire the property after December 31, 2000, for the special lower rate to apply.

To avoid capital gains altogether, you may want to consider gifting shares of stock to children or grandchildren if they are in a lower tax bracket than your own.

Capital losses also require special attention. In general, when you take losses, you must first match your long-term losses against your long-term gains, and short term losses against short-term gains. If there are any remaining losses, you may use them to offset any remaining long-term or short-term gains, or up to $3,000 of ordinary income. When and whether to recognize such losses should be analyzed in light of the changes in the capital gains rates applicable to your specific investments.

Retirement Planning

More choices exist for retirement planning in 2000 due to the availability of Roth IRAs and changes that make regular IRAs more attractive.

• Traditional IRAs: For 2000, an individual will not be considered an "active participant" in an employer's plan simply because the individual's spouse is an active participant for any part of a plan year. Thus, you may be able to take a full $2,000 deduction for an IRA contribution regardless of whether your spouse is covered by a plan at work. Beginning in 2000, the AGI phase-out range for determining the deductibility of a contribution for an otherwise eligible person whose spouse participates in an employer's qualified plan is $150,000 to $160,000.

Also for 2000, the AGI phase-out ranges for determining deductibility of IRA contributions increases. For single persons (including head of household), the deduction phaseout range is between $32,000 and $42,000 of modified AGI, and for joint filers the modified AGI phase-out range is between $52,000 and $62,000.

• Roth IRA: This type of IRA permits nondeductible contributions of up to $2,000 a year. Earnings grow tax-free, and distributions are tax-free provided no distributions are made until more than five years after the first contribution and the individual has reached age 59 1/2. Distributions may be made earlier on account of the individual's disability or death. The maximum contribution is phased out for persons with AGI above certain amounts: $150,000 to $160,000 for joint filers; and $95,000 to $110,000 for all other taxpayers.

• 2000 Roth IRA Conversion Rule: Funds in a traditional IRA may be rolled over into a Roth IRA. Such a rollover, however, is treated as a taxable event, and you will pay tax on the amount converted. No penalties will apply if all the requirements for such a transfer are satisfied.

Retirement Plan Contributions

In many cases, employers will require you to set your 2001 retirement contribution levels before January 2001. You may want to increase your contribution to lower your AGI to take advantage of some of the new tax breaks described above. In addition, maximizing your 2000 contribution is always a good tax-saving move.

If you have any questions, please don't hesitate to call. 

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IRS targets fraudulent trusts

The criminal investigation division of the Internal Revenue Service is targeting abusive trust schemes – both promoters of illegal trusts and taxpayers who utilize them. Both domestic trusts and foreign (offshore) trusts are used by promoters. The basic scheme is to have a series of vertically layered trusts with each trust distributing income to the next layer. The result is to illegally reduce the taxpayer’s taxable income to next to nothing. 

There are many legal trusts, typically used for estate planning and charitable purposes, but fraudulent trusts are tax evasion schemes which are illegal. To find out more about the kinds of trusts considered fraudulent, visit the IRS web site at www.treas.gov/irs/ci.Also read about the IRS Employment Tax Enforcement Program  [12/00]