December 20, 2002

Tax Planning Can’t Wait — There is very little you can do after December 31 to lower your tax bill for the current year

WMNS — Don’t wait until it’s too late to start thinking about strategies to reduce your 2002 tax liability. By starting now, you may be able to keep more dollars in your pocket. This article, written by the experts at William Blair Wealth Management Services, provides some tax planning tips to help you make informed decisions to reduce your tax bill.

Income Planning

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) provided the largest tax cut since 1981. One of the many income tax benefits that it provided for individuals was a gradual decrease in tax rates scheduled through 2010.

Since there are no tax rate changes between 2002 and 2003, it makes sense to use the traditional means of income planning for determining how best to reduce your income tax liability this year. Since rates will be reduced in 2004, these methods may not be valid for tax year 2003. With this in mind, the first step is to estimate what your tax bracket will be in 2002 compared with 2003. This is a tedious but necessary task that will surely save you tax dollars in the long run. Generally speaking, it makes sense to accelerate your income into the current year if you know that your tax bracket will be higher the following year. Although this will have the effect of increasing your income in 2002, you will pay less tax overall.

Tips to Accelerate Income

• Consider negotiating with your employer to accelerate the payment of your year-end bonus to the current year if it is typically paid early the following year.

• If you are taking distributions from a retirement plan, consider taking withdrawals in 2002 rather than waiting until next year even though you may not need the money until later (as long as there is no penalty).

• If you are self-employed, consider trying to receive payments from your customers before the end of the year by issuing your bills early or providing an incentive.

On the other hand, if you anticipate that your tax bracket will be greater this year compared with next, you should consider deferring income to the following year by reversing the aforementioned tips. For example, consider delaying bonus payments, retirement plan distributions, or customer bill payments until 2003.

Deduction Planning

The timing of when you take certain deductions also can have a great impact on your tax liability. Deduction planning follows the same principles as income planning. If you believe that your tax bracket will be higher this year compared with next year, you should consider accelerating deductions into this year’s tax return. The availability of some deduction planning techniques is determined by your adjusted gross income (AGI) and whether you itemize deductions on your tax return. It will be helpful to consult with your tax advisor to determine whether these methods are appropriate for you.

For cash-method taxpayers, it is important to keep in mind that an expense is only deductible in the year that it is paid. If you pay by check, the check needs to be dated and mailed before January 1, 2003. It does not matter whether the check has cleared before the end of the year. If you pay by credit card, the IRS considers the expense deductible in the year the charge is incurred and not in the year that the credit card bill is paid.

Tips to Accelerate Deductions

• If you anticipate a state income tax liability for 2002 and plan to make an estimated tax payment, consider making the state tax payment by the end of the year. Consider prepaying your local taxes as well.

• Consider making an extra mortgage payment or two before the end of the year to increase your interest deduction.

• Consider making your charitable contributions by the end of the year to claim a deduction in 2002.

If you anticipate your marginal tax rate to be higher next year, it may make more sense to delay deductions until 2003. Consider delaying payment of the aforementioned expenses until 2003 rather than in the current year.

Taxable Portfolio Planning

Portfolio planning from a tax perspective begins with reviewing your investment portfolio to check the status of taxable gains and losses realized over the course of the year. For investments in a tax-deferred vehicle, such as a 401(k), 403(b), IRA, etc., there are no tax consequences to selling at a gain or loss. However, selling investments that are not in a tax-deferred account could produce significant tax consequences. As you review your taxable portfolio, determine if you are in a net gain or loss position. To simplify the exercise, categorize your gains and losses by short- and long-term components. Capital gains on property held 12 months or less are considered short-term and are taxed at your ordinary income tax rate. Capital gains on property held for more than 12 months are considered long-term and are taxed at a maximum rate of 20% (10% if you are in the 15% marginal tax bracket). After categorizing your gains and losses, match your long-term losses against your long-term gains and short-term losses against short-term gains. If you have any remaining losses, they may be used to offset any remaining long-term and short-term gains or up to $3,000 of ordinary income (subject to change). If losses still exist, they can be carried over to later years.

Tips on Taxable Portfolio Planning

• If you determine that you are in a net gain position, you may want to harvest some losses to offset some or all of the gains, assuming you do not have any losses carried forward from prior years to offset them.

• If you are in a net loss position, you can be less hesitant about selling investments and recognizing gains to the extent that you have enough losses to offset them.

• As you determine which investments to sell, beware of the wash sale rules.

Wash Sale Rules

The wash sale rules state that if you recognize a loss on a sale and then repurchase the same security within 30 days before or after the date of the loss sale, you may have a wash sale and your loss cannot be immediately claimed for tax purposes. However, the disallowed amount from the wash sale is added to the cost of the repurchased security, which increases your basis in that security. The rules are designed to keep you from selling a security simply to claim the loss and then buy it back within a short period of time before or after the sale date to retain ownership. Another important factor to keep in mind is that the wash sale rules do not apply if you close out your entire position in the stock before the end of the year and remain out of the security for the required 30-day period before or after the date of the loss sale.

These rules are especially important for individuals who use separate accounts and multiple investment managers where there is potential for overlap of securities among the different accounts. Having various managed accounts that contain the same securities may result in inadvertent wash sales. The IRS does not care whether the wash sale occurred intentionally or not. If the IRS determines that the rules have been broken, it will require that you reverse any of the wash sale losses that you claimed on your return.

Tax-Deferred Portfolio Planning

The EGTRRA made extensive changes to the rules relating to IRAs and qualified pension plans. These changes include allowing individuals to save more for retirement through tax-advantaged accounts. Based on these changes, you may have the opportunity to reduce your taxable income and 2002 tax bill by putting additional money into your retirement accounts using pretax dollars.

Tip on Tax-deferred Portfolio Planning

• If you have not contributed the maximum amount to your retirement plans, consider increasing your contribution to lower your AGI to reduce your income tax. This may allow you take advantage of tax credits by potentially putting you below the AGI phaseout limits.

Please consult your tax advisor before utilizing any of the tax planning techniques to confirm whether they are applicable to your specific tax situation.

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