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TIME TO HARVEST THE FALL TAX DEDUCTIONS

November 03, 2005

The leaves are gone, the harvest is ending, the gray skies of November close in. For some, it’s a time to think of hot chocolate, apple cider, and the approaching warmth of the Thanksgiving holiday. We prefer to ponder taxes.

By mid-November, most taxpayers can have a pretty good idea what their income will be, and we still have six weeks or so to do something about it. Where to start?

Are you feeling really charitable?

In response to Hurricane Katrina, Congress is allowing taxpayers to deduct cash charitable contributions up to 100% of their taxable income for 2005 only. In most years, this limit is 50%.

You ask: why would I want to do such a silly thing? Well, few people are interested in giving away so much cash, but this 100% limit might be useful is if you want to donate a large IRA to charity -- perhaps as part of your estate planning. You could cash out the IRA and donate the entire balance to charity, with the charitable donation eliminating almost all of the tax on the IRA withdrawal. (You’d have about a 1% net tax in most situations, for technical reasons too revolting to review here).

O.K., are you just feeling somewhat charitable?

2005 has been a banner year for disasters. The Tsunami, Hurricanes Katrina and Rita, and the South Asian Earthquake have touched hearts everywhere. If you are looking to make a charitable contribution before year-end, look to your investment portfolio. If you donate publicly-traded securities before year-end, you may deduct the fair market value of the stock without ever paying tax on the appreciation. Just remember: you have to have held the stock for over one year. You should also get started with such donations right away. While most national charities handle contributions of securities promptly and efficiently, local charities may need extra time to process the contributions. If you wait too long, your deduction might not get completed before year-end.

Consider Alternative Minimum Tax.

More and more of us are becoming acquainted with the alternative minimum tax, or AMT. This tax was originally touted as a way to keep the wealthy from avoiding all taxes. If paying AMT means you are wealthy, Iowa is a rich state indeed.

The AMT is a sort of shadow tax, computed alongside the regular income tax. It is computed with a large exemption that disappears as income increases. It has a lower top rate (28%) than regular tax (35%), but fewer deductions. The biggest deductions missing from the AMT are the deduction for state and local income and property taxes and the personal exemptions for yourself and your dependents. This makes residents of high-tax states, like Iowa, and parents with large families, most vulnerable to AMT.

AMT matters because many tax planning tools don’t work when AMT applies. If you have family income between $100,000 and $500,000, large capital gains, or more than two or three children, you are a likely AMT candidate. The only way to tell for sure is to run the numbers -- that is, estimate what your income for the year will be and compute your projected regular tax and AMT. Your tax advisor can help you out here. This process works best if you can also project your 2006 tax picture.

Once you know whether you will have AMT in 2005, you can consider some additional tax planning moves:

Prepay state and local taxes. If you expect to owe income taxes to Iowa next April, you might want to pay them now so you can deduct them this year. You might also want to get your March 2006 property tax payments in by year-end. But this won’t work if you have AMT in 2005.

Bunch up your “miscellaneous” deductions.
You can deduct tax return preparation fees, union dues, certain unreimbursed employee business expenses, and fees to investment advisors and financial planners, but only if these “miscellaneous” deductions exceed 2% of your adjusted gross income. By bunching these expenses into one year – say, by prepaying them – you can sometimes cross the 2% barrier and get a tax benefit. Your tax preparer will be happy to discuss a “2% of AGI billing plan to help you get there (just kidding!). But beware – these deductions aren’t allowed for AMT.

Hybrid Cars. Maybe you’ve had your eye on a Prius or that Lexus hybrid SUV. If you are in AMT, and will continue to be in AMT indefinitely, this is the year to buy. For 2005, you can deduct up to $2,000 of the cost of a hybrid car “above the line,” without itemizing. This deduction works for AMT, too. Next year, the deduction becomes a credit, and the credit doesn’t work if you are paying AMT.

(Note: a version of this piece is slated to appear in the December issue of "50-plus Lifestyles." )

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