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Time for Income Tax Planning

For the individual who wants to make sure they are managing their taxes in the most efficient manner, time is of the essence. Depending on your situation there could be multiple things that you can do prior to year end. Once the New Year begins, your options narrow considerably.

What I’ve suggested in the past is conducting a mock tax return. By this time of the year, most of you can get a pretty good idea of where you stand in your tax projections based on the income, deduction and credit items that you’ve already incurred year to date as well as what you expect to incur in the remaining weeks of the year. And now that most of the tax software programs have just been released, this makes the endeavor pretty easy to conduct. Some people with simple tax circumstances can do this by hand by going to the IRS website for forms and reviewing the inflation adjusted revisions that were recently released.

Once you come up with a tentative tax figure, then you review your options to make your tax situation as efficient as possible. For those whose tax circumstances aren’t expected to change dramatically from this year to next, from a time value of money perspective it makes sense to maximize your deductible items before year end and if possible, defer any income items until after year end. In essence, this will put more money in your pocket now (in the form of a bigger refund or a lower amount due) rather than next year. For those who expect to have a lower tax burden next year, they may want to take similar action as well. If you are expected to be in a more burdensome tax situation next year, you may want to do the opposite, maximizing income this year and deferring on deductible items until next year.

And there are a bevy of things you can do prior to year end such as paying January’s mortgage or home equity payment, real estate taxes that are due in 2007, making charitable donations, making an estimated state income tax payment or conduct year end investing strategies. A small business on a cash basis can accelerate deductions by pre-paying on accounts payable due after year end or accelerating some capital purchases that are eligible for immediate expensing. You may even be eligible for the retirement savings tax credit or the tax credit for energy efficient purchases.

Also the projection can help you reflect on other things that may help your tax situation. For example, it can show that you are withholding too much in your pay-check. If you are getting a large refund and essentially are giving the government an interest free loan over the year, you may want to decrease the withholding in your paycheck for the upcoming year. It also may prompt you to put more away towards your tax-deferred employer based retirement plan or even start a health or dependent care reimbursement plan. Also, if eligible you may want to consider a Roth conversion.

There are a few things to be careful of. First, with the rising stock markets, I would expect mutual funds to make large taxable distributions towards the end of the year. If you have a significant amount of money in mutual funds within taxable accounts, you may want to go to the funds website to see if they posted estimated distributions yet as this can alter your tax projection significantly Also, you have to be wary of the Alternative Minimum Tax (AMT) as some strategies under normal circumstances don’t work as well if you are subject to this parallel tax system. In addition if Congress doesn’t enact any changes to the AMT, the exemption amounts will become lower in 2007; making a larger amount of people subject to the AMT and quite a few unpleasantly surprised come the beginning of 2008 when they prepare their taxes. Finally if you are using a tax software program, just make sure to periodically check for updates as this can identify any glitches with the software or update the tax code if the lame duck Congress passes any measures before year end.

The above just touches the surface on what you can thinking about and your situation will dictate the opportunities that are available to you. By being proactive about your taxes, it may take a little effort on your part. But it also can reap some big rewards.

Is Something Stopping You From Making the Right Financial Choices In Life? The Answer May Lie In Your Money Script

Do you have a credit card balance that you know you should pay off, but fail to do? You know that you need to save for retirement or want to provide for your child’s college education, but can’t seem to start a dedicated savings plan? Are you in a job where you are grossly underpaid, but don’t have the courage to ask for a raise or look for a better paying job? Do you make a tremendous amount of money but fail to save a dime? Continue to be a workaholic when you don’t need to be? The answer may lie in our past.

In the book, The Financial Wisdom of Ebenezer Scrooge : Five Principles to Transform Your Relationship With Money, co-authors Ted Klontz, Rick Kahler, and Brad Klontz discuss the concept of how we are shaped by our money scripts. Money scripts are internalized messages that we develop during our early childhood years towards money from what we see and hear about it. Since as a child we can’t comprehend on an adult level, these messages may only represent half-truths or a distorted view on how money works. Some classic money scripts are:

• “Money is the root of all evil”
• “If I work harder, I will make more money”
• “Charity begins at home”
• “If I had more money, things would be better”
• “Don’t trust anyone with your money”

As the authors indicate, money scripts are not universally right or wrong, good or bad. The problem is that when we grow into an adult, we begin behaving as these are absolute truths and we apply them subconsciously. In some situations they can serve us well, but under the wrong circumstances it can create destructive behavior that blocks you from the life that you want to live.

Then the authors proceed to use the classic Dickens novel, A Christmas Carol as the example to show us how we can identify our money scripts, to understand their meaning and modify them to make positive change in our lives. The authors share their own personal money scripts as well as those of others and there are exercises that you can work on as you progress through the book.

The book is a very easy read and for those who feel that they are financially “stuck” and want to make positive change in their lives, I think it is a must read. Even for those who feel comfortable with their money lives, I think they would find value in this book. I even gained some valuable insight on my own money scripts.

For Those Over Age 70 ½ with an IRA: A Charitable Planning Opportunity

In a new tax law enacted this year, someone who reaches 70 ½ before year end and has an IRA is now allowed to make a transfer directly from their IRA to a qualified charitable organization of up to $100,000 for the 2006 and 2007 tax year.

To be eligible, you must:

• Have reached age 70 ½ at the time of the transfer
• The transfer must be from a IRA or Roth IRA, not a SIMPLE or a SEP
• The charity must be a qualified organization as designated as a public 501(c)(3) charity or an operating foundation. Private foundations may qualify if it makes the election requiring the entire contribution to be distributed in the same year it was received, in addition to the 5% grant rule. Donor advised funds and supporting organizations do not qualify.
• The taxpayer must not receive any benefit whatsoever from the charity
• The taxpayer must receive an acknowledgement from the charity stating that the taxpayer received no benefit.

All you would need to do is contact your IRA custodian and instruct them to make a payment directly from the IRA to the charity. Custodians are not required to comply with the rules, so check with them in advance if they allow this. If allowed, the distribution won’t be counted as taxable income nor could it be used for an itemized deduction.

The true value of this technique is with a Regular IRA, not the Roth IRA. Why? It really not that advantageous to use tax-free dollars while not having an allowable deduction at the same time. The trick here is if in the past you make a charitable contribution out of regular IRA funds, this would need to be recognized as taxable income first. And with that, an increased adjusted gross income could lead to higher stealth taxes. For example, a higher percentage of Social Security could be taxable, less itemized deductions on specific items (such as deductible medical expenses) could be deducted or aggregate itemized deductions could be partially phased out. Or you could become subject to the alternative minimum tax. In addition, this technique is available for those who are already maximizing their deduction limits for charitable contributions. They could also benefit someone who wasn’t able to in the past because they didn’t itemize deductions.

This is also included as part of your annual required minimum distributions for the year. So there are a lot of cases where the individual ends off better in the end because it isn’t included as income, even without the deduction.

For the right person who is charitably inclined, this may be a great opportunity to give in a tax efficient manner.

It’s Back: Enrollment Period for Medicare Part D

Starting on November 15th, the open enrollment period for Medicare Part D Prescription Drug Coverage begins. Although you may be totally happy with your current plan, it is still worth to take a look at as more cost effective options may be available to you. Also you may have had a change in your prescriptions over the year that merits a review. For those who are newly eligible; either because they are eligible for Medicare or are eligible for Medicare and no longer have employer based prescription coverage that is better (or no coverage at all), you should definitely take a look to see if this coverage makes sense to you.

Although open enrollment lasts until December 31st, I wouldn’t wait to do this at the last moment. Matter of fact, it would be probably be better to get this done before December comes around.

The best place to start is Medicare’s website, which has a tool that you can use to find the best plan for your situation. You will need to compile a list of what prescriptions you are currently taking beforehand and detail on dosage and cost. For most guidance on the subject, feel free to check out the entry that I made a year ago about this.

Don’t think that shopping around doesn’t make sense? I got this e-mail the following morning from someone after I originally posted this:

I just did my shopping and found out that if I did nothing and I allowed Humana to just renew me, my annual costs would jump by 42%. The best plan I found for 2007 will increase my annual expenses by 10%.

If that doesn’t motivate you to act, I don’t know what will.

Seeking Healthcare Abroad

If faced with a major medical expense, would you consider going abroad to seek treatment?

In the article Global Healthcare in the November edition of Financial Planning magazine, Russell Wild discusses that this may be a viable option, given that some procedures abroad could cost 80% less than what they would cost in the United States. At the same time, you need to do your due diligence because the quality of the care received should be a priority. The article goes into some real life circumstances, what physicians think about it, corporations that are encouraging it and agencies that help assist people in finding global care.

Even though this is in a professional journal, I think this is a pretty interesting article and wanted to share this will you. For those who are uninsured or where their insurance doesn’t cover the procedure, going abroad may mean the difference between reaching one’s lifetime goals and going bankrupt.