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2004 Year-End Tax Planning Newsletter
November 18, 2004
As 2004 draws to a close, there is still time to reduce your 2004 tax bill and
plan ahead for 2005. This newsletter highlights several potential tax-saving
opportunities for you to consider. Although not all of the following strategies
will apply, this newsletter provides some general tax planning opportunities for
2004.
Basic Numbers You Need To Know
Because many tax benefits are tied to or limited by adjusted gross income (AGI)—IRA
deductions, for example—a key aspect of tax planning is to estimate both your
2004 and 2005 AGI. Also, when considering whether to accelerate or defer income
or deductions, you should be aware of the impact this action may have on your
AGI and your ability to maximize itemized deductions that are tied to AGI. Your
2003 tax return and your 2004 pay stubs and other income- and deduction-related
materials are a good starting point for estimating your AGI.
Another important number is your "tax bracket," i.e., the rate at which your
last dollar of income is taxed. The tax rates for 2004 are 10%, 15%, 25%, 28%,
33%, and 35%.
IRA, Retirement Savings Rules for 2004
More tax-saving opportunities continue for retirement planning in 2004 than in
previous years due to the availability of Roth IRAs, changes that make regular
IRAs more attractive, and other retirement savings incentives.
Traditional IRAs:
Individuals who are not active participants in an employer pension plan may make
deductible contributions to an IRA. The annual deductible contribution limit for
an IRA for 2004 is $3,000. Depending on AGI, individuals who are active
participants in a plan may make deductible contributions to an IRA. For 2004,
the AGI phase-out range for deductibility of IRA contributions is between
$45,000 and $55,000 of modified AGI for single persons and between $65,000 and
$75,000 of modified AGI for married filing jointly. Above these ranges, no
deduction is allowed.
For 2004, a $500 "catch-up" contribution deduction is allowed for taxpayers age
50 or older by the close of the taxable year who meet the other qualifications
for IRA deductions. Thus, the total deductible limit for these individuals may
be as high as $3,500.
In addition, an individual will not be considered an "active participant" in an
employer plan simply because the individual's spouse is an active participant
for part of a plan year. Thus, you may be able to take the full deduction for an
IRA contribution regardless of whether your spouse is covered by a plan at work,
subject to a phase-out if your joint modified AGI is $150,000 to $160,000. Above
this range, no deduction is allowed.
Roth IRA:
This type of IRA permits nondeductible contributions of up to $3,000 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 single filers (including heads of
households). For 2004, a $500 "catch-up" contribution is allowed for taxpayers
age 50 or older by the close of the taxable year, making the total limit $3,500
for these individuals.
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.
A taxpayer's AGI (whether married filing jointly or single) is limited to
$100,000 to make such a conversion.
401(k) Contribution:
The 401(k) elective deferral limit is $13,000 for 2004, up from $12,000 in 2003.
If your 401(k) plan has been amended to allow for catch-up contributions for
2004 and you will be 50 years old by December 31, 2004, you may contribute an additional $3,000 to your 401(k) account,
for a total maximum contribution of $16,000 ($13,000 in regular contributions
plus $3,000 in catch-up contributions).
SIMPLE Plan Contribution: The SIMPLE plan deferral limit is $9,000 for 2004, up from $8,000
in 2003. If your SIMPLE plan has been amended to allow for catch-up
contributions for 2004 and you will be 50 years old by December 31, 2004, you may contribute an
additional $1,500.
Catch-Up Contributions for Other Plans: If you will be 50 years
old by December 31, 2004, you may also contribute
an additional $3,000 to your 403(b) plan or SEP.
Saver's Credit:
A nonrefundable tax credit is available based on the qualified retirement
savings contributions to an employer plan made by an eligible individual. Only
taxpayers filing joint returns with AGI of $50,000 or less, or single returns
with AGI of $25,000 or less, are eligible for the credit. The amount of the
credit is equal to the applicable percentage (10% to 50%, based on filing status
and AGI) of qualified retirement savings contributions up to $2,000.
Maximize Retirement Savings:
In many cases, employers will require you to set your 2005 retirement
contribution levels before January 2005. You may want to increase your
contribution to lower your AGI in order to take advantage of some of the tax
breaks described above. In addition, maximizing your contribution is generally a
good tax-saving move.
Deferring Income to 2005
If you expect your AGI to be higher in 2004 than in 2005, or if you anticipate
being in the same or a higher tax bracket in 2004, you may benefit by deferring
income into 2005. Deferring income will be advantageous so long as the deferral
does not bump your income to the next bracket. Some ways to defer income
include:
Delay Billing: If you are self-employed, delay year-end billing to clients so
that payments will not be received until 2005.
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
will not 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.
Accelerating Income Into 2004
In limited circumstances, you may benefit by accelerating income into 2004. For
example, you may anticipate being in a higher tax bracket in 2005, or perhaps
you will need additional income in order to take advantage of an offsetting
deduction or credit that will not be available to you in future tax years. Note
however that accelerating income into 2004 will be disadvantageous if you expect
to be in the same or lower tax bracket for 2005. In any event, before you decide
to implement this strategy, we should help you estimate your income.
If accelerating income will be beneficial, here are some ways to accomplish
this:
Accelerate Collection of Accounts Receivable: If you are self-employed
and report income and expenses on a cash basis, issue bills and attempt
collection before the end of 2004. Also see if some of your clients or customers
might be willing to pay for January 2005 goods or services in advance. Any
income received using these steps will shift income from 2005 to 2004.
Year-End Bonuses:
If your employer generally pays year-end bonuses after the end of the current
year, ask to have your bonus paid to you before the beginning of 2005.
Retirement Plan Distributions:
If you are over age 59 1/2 and you participate in an employer retirement plan or
have an IRA, consider making taxable withdrawals before 2005.
You may also want to consider converting your traditional IRA to a Roth IRA, as
discussed above.
Deduction Planning
Deduction timing is also an important element of year-end tax planning.
Deduction planning is complex due to factors such as AGI levels, the alternative
minimum tax (AMT) and your filing status. 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, 2005.
• Promise To Pay: A promise to pay or providing a note does not permit you to
deduct the expense. But you can take a deduction if you pay with money borrowed
from a third party. Hence, if you pay by credit card in 2004, you can take the
deduction even though you won't pay your credit card bill until 2005.
AGI
Limits: The AGI limits on itemized deductions affect deduction planning.
For 2004 returns, overall itemized deductions are reduced by 3% of the AGI
exceeding $142,700. Similarly, certain deductions may be claimed only if they
exceed a percentage of AGI: 7.5% for medical expenses, 2% for miscellaneous
itemized deductions, and 10% for casualty losses.
Standard Deduction Planning:
Deduction planning is also affected by the standard deduction. For 2004 returns,
the standard deduction is $9,700 for married taxpayers filing jointly and $4,850
for single taxpayers. If your itemized deductions are relatively constant and
are close to the standard deduction amount, you will obtain little or no benefit
from itemizing your deductions each year. But simply taking the standard
deduction each year means you lose the benefit of your itemized deductions. To
maximize the benefits of both the standard deduction and itemized deductions,
consider adjusting the timing of your deductible expenses so that they are
higher in one year and lower in the following year.
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 2004 and plan to make an
estimated payment, consider making the payment before the end of 2004 if you are
not in AMT. Note that beginning with the 2004 tax year and ending with the
2005 tax year, you can choose to deduct as an itemized deduction state and
local sales taxes instead of income taxes.
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 2004 even though you will not pay the bill until 2005. A
mere pledge to make a donation is not deductible, however, unless it is paid by
the end of the year. Note, however, for claimed donations of cars, boats and
airplanes of more than $500 made after 2004, the amount available as a
deduction will depend on what the charity does with the donated property, not
just the fair market value of the donated property. If the organization sells
the property without any significant intervening use or material improvement to
the property, the amount of the charitable contribution deduction cannot exceed
the gross proceeds received from the sale. If you are planning to donate such
property in the near future, doing so by the end of 2004 could be a
significant tax savings strategy.
To avoid capital gains, you may want to consider giving appreciated property to
charity.
Business Deductions:
• Self-Employed Health Insurance Premiums: Self-employed individuals may be
allowed to claim 100% of the amount paid during the taxable year for insurance
that constitutes medical care for themselves, their spouses and dependents as an
above-the-line deduction, without regard to the 7.5% of AGI floor.
• Equipment Purchases: If you are in business and purchase equipment, you may
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 $102,000 of equipment costs (with a phase-out for purchases in
excess of $410,000) if the asset was placed in service during 2004.
A popular strategy in recent years is to purchase a vehicle (usually an SUV) for
business purposes that exceeds the depreciation limits set by statute (i.e., a
vehicle rated over 6,000 pounds). Doing so would not subject the purchase to the
statutory dollar limit, $2,960 for 2004. Therefore, the vehicle would qualify
for the full equipment expensing dollar amount. However, for SUVs (rated between
6,000 and 14,000 pounds gross vehicle weight) placed in service after October 22, 2004, the expensing amount is
limited to $25,000.
• First-Year Bonus Depreciation: For qualified property placed in service in
2004 only, you may take an additional depreciation allowance of 50% of the
adjusted basis of the property. The first-year §179 expensing amount described
above is computed before this additional allowance is computed. In general, the
50% allowance is scheduled to expire on December 31, 2004. If you have any plans to acquire and place into service eligible
property, it might be beneficial to do so before the end of 2004.
Education and Child Tax Benefits
Child Tax Credit:
A tax credit of $1,000 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 jointly and $75,000 for all other taxpayers. A
portion of the credit may be refundable.
Credit for Adoption Expenses: For 2004, the adoption credit limitation is $10,390 of aggregate
expenditures for each child, except that the credit for an adoption of a child
with special needs is deemed to be $10,390 regardless of the amount of expenses.
The credit ratably phases out for taxpayers whose income is between $155,860 and
$195,860.
HOPE Credit and Lifetime Learning Credit:
The maximum HOPE credit is $1,500 (100% on the first $1,000, plus 50% of the
next $1,000) 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 2004 is $2,000 (20% of qualified tuition
and fees up to $10,000). 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.
For 2004, both the HOPE credit and the Lifetime Learning credit are phased out
at modified AGI levels between $85,000 and $105,000 for joint filers, and
between $42,000 and $52,000 for single taxpayers.
Coverdell Education Savings Account: Beginning in 2004, the aggregate
annual contribution limit to a Coverdell education savings account is $2,000 per
designated beneficiary of the account. This limit is phased out for individual
contributors with modified AGI between $95,000 and $110,000 and joint filers
with modified AGI between $190,000 and $220,000. The contributions to the
account are nondeductible but the earnings grow tax-free.
Student Loan Interest:
You may be eligible for an
above-the-line deduction for student loan interest paid on any "qualified
education loan." The maximum deduction is $2,500 in 2004. The deduction is
phased out at a modified AGI level between $100,000 and $130,000 for joint
filers in 2004, and between $50,000 and $65,000 for individual taxpayers.
Qualified Higher Education Expenses:
For 2004, you also may be eligible to deduct qualified tuition and related
expenses as an above-the-line deduction. In 2004, a taxpayer with modified AGI
of not more than $65,000 ($130,000 for a married couple filing jointly) who is
not claimed as a dependent on another person's return is entitled to a maximum
deduction of $4,000. For taxpayers with modified AGI of $65,000 or more but not
more than $80,000 ($130,000/$160,000 for a married couple filing jointly), the
maximum deduction is $2,000.
Rules are in effect to coordinate education provisions, such as the qualified
higher education expense deduction, the Hope and Lifetime Learning credits,
Coverdell education savings accounts, and qualified tuition plans, to prevent
double benefits.
Investment Planning and Gift Planning
The following rules apply for most capital assets in 2004:
• Capital gains on property held one year or less are taxed at an individual's
ordinary income tax rate.
• Capital gains on property held for more than one year are taxed at a maximum
rate of 15% (5% if an individual is in the 10% or 15% marginal tax bracket).
Timing of Sales:
You may want to time the sale of assets so as to have offsetting capital losses
and gains. Capital losses may be fully deducted against capital gains and also
may offset up to $3,000 of ordinary income. 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 (or $1,500) 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.
Dividends:
Qualifying dividends received in 2004 will be subject to rates similar to the
capital gains rates. Therefore, qualifying dividends will be taxed at a maximum
rate of 15%. Qualifying dividends includes dividends received from domestic and
certain foreign corporations.
Gifts:
To avoid capital gains, you may want to consider giving appreciated property to
children or grandchildren if they are in a lower tax bracket than your own. For
2004, each person is entitled each year to give gifts of $11,000 to an unlimited
number of donees without incurring any gift tax. For example, you can annually
give $11,000 to each of your children, their spouses, and your grandchildren
without utilizing any of your applicable credit amount. Your spouse can agree to
"gift-split" thus doubling the amount of these gifts. (The applicable credit
available against the gift tax is $1 million in 2004.)
Social Security:
Depending on the recipient's modified AGI and the amount of Social Security
benefits, a percentage—up to 85%—of Social Security benefits may be taxed. To
reduce that percentage, it may be beneficial to defer receipt of other
retirement income. One way to do so is to elect to receive a lump sum
distribution from a retirement plan and to rollover that distribution into an
IRA. Alternatively, it may be beneficial to accelerate income so as to reduce
the percentage of your Social Security taxed in 2005 and later years.
Other Tax Planning Opportunities:
We also can discuss the potential benefits to you
or your family members of other planning options available for 2004, including
§529 qualified tuition programs, the above-the-line deduction for
teachers for classroom-related expenses, and the deductions for qualified
electric vehicles and clean-fuel vehicle property.
Alternative Minimum Tax:
Some of the standard year-end planning ideas will
not reduce tax liability if you are subject to the alternative minimum tax (AMT)
because different rules apply. Because of the complexity of the AMT, it would be
wise for us to analyze your AMT exposure.
If you have any questions, please do not hesitate to call. We are happy to meet
with you at your convenience to discuss the strategies outlined above. There is
still time to implement these strategies to minimize your 2004 tax liability.
Very truly yours,
Hansen, Hunter
& Company, P.C.
Material discussed in this
Tax Newsletter is meant to provide general
information and should not be acted on without obtaining professional
advice appropriately tailored to your individual needs.
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