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End of year brings finish to tax break opportunities

Editor’s Note: First of a two-part series.

Although your federal income tax return won’t come due until April 16, 2007 (because April 15 falls on a Sunday), most of the opportunities for limiting your 2006 taxes vanish at the end of the year. Here’s a look at some of the steps to consider taking before December 31 to keep your tax bill as low as possible.

As the saying goes, it’s usually better to pay taxes later rather than sooner. Under that theory, you should try to postpone the receipt of any income that you can until next year. Unfortunately, for many taxpayers there is little room to maneuver. One possibility: If you are planning to sell an asset near the end of the year and can wait a bit, you may avoid having to pay tax on the gain until 2008.

That strategy can work well for investments such as U.S. Savings Bonds. For example, you can delay until January cashing bonds that mature late in this year. The bonds still will earn income until you redeem them, but the tax on the income will not be due by April 16, 2007, but by April 15, 2008.

Professionals and self-employed individuals who operate on a cash basis may be able to push income forward into the year 2007 by delaying some year-end billings. However, salaried individuals should avoid this kind of approach. The IRS is known to scrutinize bonuses that are payable at year-end but not received until the beginning of the next year.

If you expect that your marginal tax rate will be higher this year than next, any itemized deductions that you can take will be more valuable this year. Even if your marginal rate will be the same, you can receive the tax benefit of the deduction sooner.

Homeowners may want to make their January mortgage payment in December. Some states allow you to prepay some property taxes. If you are in the process of buying a home and itemize your deductions, and can close by year-end, you may harvest additional writeoffs.

Some itemized deductions are available only when you cross a certain minimum threshold of expenses, usually measured by your adjusted gross income (AGI). Thus, for example, medical expenses are deductible only to the extent that they exceed 7.5% of AGI; certain miscellaneous expenses, two percent of AGI.

When you have some degree of control over when you incur and pay these kinds of expenses, you may be able to “bunch” them in a way that allows you to cross the threshold and obtain a deduction for expenses that exceed the threshold amount.

For instance, if your medical expenses are likely to be close to the threshold amount this year, try scheduling routine doctor, dentist or other appointments before year-end. Similarly, bunch miscellaneous expenses — the cost of tax advice, custodial fees, professional dues and other work-related items — when you can.

If you are a business owner, you can follow the same general rules when it comes to accelerating deductions. Many businesses and independent contractors can make business-related purchases by Dec. 31. If you are self-employed, the lower reportable income reduces not only your income tax, but also your self-employment tax. Also, consider purchasing depreciable equipment and putting it into use by Dec. 31. Making these purchases by year-end moves up the depreciation schedule by one year. In the long run, your business saves money by depreciating expenses faster.

It’s always a good idea if you are a business owner or self-employed to do a trial-run tax return yourself or with your accountant. With that approach you can pinpoint the trouble spots and take the last-minute steps necessary to minimize tax.

Don’t automatically follow the above techniques every year. There are times when they may backfire. For instance, if you expect your income to be a great deal higher next year, you will want to report as much income as you can this year and delay as many of your deductible expenses as possible into the following year. And, if you believe that next year is likely to bring an increase in income tax rates, you will want to take this “reverse” approach as well. Also keep in mind the alternative minimum tax. If you will fall under the AMT, your tax strategies may need to be adjusted significantly.

In another article we will look at year-end tax considerations for your investments, retirement plan contributions and charitable gifts.

Jeff Francis is senior vice president and senior investment officer for First Tennessee Brokerage. For more information about this and other personal finance issues, call



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