Tax Planning for the Coming Year

Now is the time to be taking steps to reduce next year's tax bite. Wait a few weeks and the gods of procrastination will take over as holiday preparations sweep down upon us like a winter storm from the north. While it may be too late to do much for this year, planning done now for next year can help to reduce the coming year's tax bill.

If you are fortunate enough to be able to regulate your taxable income (either as a self-employed individual or you derive income from a portfolio you can control) and you can plan a strategy to keep your adjusted gross income next year under $100,000, you may want to consider converting traditional IRA accounts into Roth IRAs. True, this will create taxable income now, but the Roth will grow untaxed and the money you withdraw after five years and age 59 ½ will come out entirely tax free. Remember, you do not have to convert all of your IRA account in one year. If you wanted to spread out the tax bite, convert just a portion each year for several years.

Plan on making your next year's IRA contribution early in the year rather than after the year has finished. This will give the money more time to work, tax-deferred.

Consider rearranging your investment portfolio to focus on assets that are likely to produce capital gains vs. current income. This is especially true if you do not spend all the dividends and interest your investments earn. Instead of paying the higher ordinary income tax rates on current income, you can either defer the income by not selling the investment or pay the lower capital gains rate when you do sell.

Now may be a good time to look at refinancing your home mortgage to take out money to replace loans that generate personal interest with mortgage or home-equity loans. Personal interest cannot be deducted on your tax return, while mortgage interest and home equity loan interest typically can, as long as the mortgage does not exceed $1,000,000 and the home-equity loan does not exceed $100,000.

Consider gifting income-producing assets to your children. Let them pay the tax on the income earned next year, rather than you pay at your tax rate. However, beware the "Kiddie Tax." In 2000, the first $700 of investment income is tax-free, the second $700 is taxed at the child's tax rate (typically 15%), and any remaining interest income is taxed at the parents' marginal tax rate. Thus, you may want to use tax-free or tax-deferred investments for at least a portion of the child's investments until the child turns 14. All investment income of children aged 14 or older is taxed at the child's marginal tax rate.

If you own a small business, try placing your child on your company's payroll. Wages and other earned income are not subject to the Kiddie Tax. Your children's salaries are deductible by the business and their income will be taxed at their low marginal rate after a generous exemption. Unincorporated businesses do not have to pay Social Security taxes on wages of children under age 21.

Finally, do that child a favor. Show him or her how to invest those earnings in a Roth IRA. They can put away up an amount equal to their earnings up to $2,000 per year. A child 12 years old who makes one Roth IRA deposit of $2,000, which averages a 10% return to his age 60, could have $194,000, tax free, to pay for retirement.