Income Tax Planning under the New Law

Article excerpt

THEY'VE DONE IT AGAIN. For the 35th time in the last 37 years, Congress has enacted a new tax law, one containing changes each year for the next 10 years! Then, at the end of the 10-year period, in 2011, everything reverts to pre-Tax Relief Act of 2001 status. Regardless of the projected blowout, you need to plan under the provisions of the new law. Effective tax planning is a year-long process. Accordingly, here are some ideas that you can use now to minimize your potential hurt next year:

Enjoy your refund. Not only did Congress reduce your taxes, but you are getting the savings in advance. The act carves a new 10% bracket out of part of the current 15% bracket. This 10% bracket covers the first $6,000 in taxable income for singles, $10,000 for head of household filers, and $12,000 for joint returns. The change is retroactive to Jan. 1, 2001, and payable in the form of a check, rather than a bracket change. Next year, the difference will be reflected directly in a bracket change.

According to the IRS, if you didn't have any income tax liability for 2000 but have one for 2001, you'll be able to claim the tax credit on your 2001 return--to the extent you're eligible. If the rebate received is less than the credit amount computed on your 2001 return, you'll be able to claim the rest of the credit when you file your 2001 return. For example, if your taxable income as a single filer in 2000 was just $5,000, you'll only get a check for five percent of the $5,000, or $250. If you have taxable income of $6,000 or more in 2001, though, you pick up the $50 difference as a credit against your 2001 tax return. Amazing, but true, according to the IRS, if the opposite is true, and you receive a larger rebate than you should (your 2000 income was higher than your 2001 income, within the targeted brackets amounts), you can keep the difference!

Play the rate change game. Because the rates are going down, an expense this year is worth more than one in 2001. Alternatively, income should be deferred as long as possible because it'll be taxed at lower rates.

Don't get hit by penalties for underwithholding. Project your income and expenses for the rest of the year. How much did you defer from last year? Are you due for a big raise or scheduled for a major bonus for extraordinary work? Recognize the safe harbor amounts and make sure you have paid sufficient dollars into the system to meet those targets. If your 2001 withholdings and estimated payments (made on a timely basis) are equal to 100% of 2000 Total Tax (line 57 on your 2000 Form 1040), no matter how much you owe on Apr. 15, 2002, you won't be subject to any interest or penalties. If your 2000 Adjusted Gross Income was more than $150,000, then you need to pay in 110%, rather than 100%, of your 2000 Total Tax.

Since the rates will be even lower next year, try to accelerate expenses into 2001 (where the deduction will give you a bigger benefit) and try to defer income until 2001 (where it'll be taxed at a lower rate). But don't forget those safe harbors to avoid interest and penalties for underwithholding. For 2002, the 110% safe harbor increases to 112% of your 2001 Total Tax.

Review your capital gains/loss positions. …