With the end of 2008 in sight, it’s time to think about ways to lower this year’s tax bill. The tricky part: to avoid making tax-saving moves this year that will backfire next year. Unfortunately, these are rough waters to navigate. The tax picture for 2009 is extremely unclear for many taxpayers due to two big questions:
* What will President-elect Obama do once in office? Will he insist on raising tax rates on higher-income individuals, as promised, or stay with the status quo in recognition of the stressed-out economy? Right after the election, I opined that Obama would increase the top two — or maybe even three — rates for 2009. Now, after an onslaught of horrible economic data, I think there’s an even chance that the scheduled 2009 tax parameters (shown in the table below) will remain in place. But who can really know at this point?
* Will you make as much or more money next year? Given the rising number of layoffs and employer cutbacks, that’s the $64,000 question for many folks. The answer will determine your marginal federal income tax bracket for 2009. Guessing is encouraged here.
Keeping those two key questions in mind, here’s the first installment in our two-part series on year-end tax planning ideas to consider:
1. Sell Loser Stocks
It’s safe to say that most investors are holding their fair share of losers in taxable brokerage accounts these days. Selling dogs before yearend can lower your 2008 tax bill because you can deduct the resulting capital losses against any capital gains from earlier in the year. Plus you can deduct up to another $3,000 of capital losses against ordinary income from salary, self-employment activities, alimony, interest, or whatever. Any excess capital losses are carried forward to future years and can put you in position for big tax savings in 2009 and beyond. So I don’t think you should hesitate to unload shares you want to get rid of anyway. Read my recent column for more details.
2. Prepay Deductible Expenditures
Early payments for some deductible expenditures that are made this year — instead of in early 2009 — will produce higher write-offs for your 2008 tax return. This strategy makes sense if you expect to be in the same or lower tax bracket next year. Of course, that’s a big “if,” but let’s assume it’s the case.
Monthly mortgage payment
Perhaps the easiest expense to prepay is your house payment due Jan. 1. By paying it this year, you’ll have 13 months’ worth of mortgage interest to write off for 2008. You can pull the same prepayment trick with a vacation home. By prepaying this year, you’ll have to continue the policy for next year and beyond. Otherwise, you’ll only have 11 months of interest to deduct for the first year you stop.
State and local income and property taxes
Next up on the prepayment menu: state and local income and property taxes that aren’t actually due until early next year. Thanks to a new tax-law provision, even non-itemizers can deduct real property taxes paid during 2008. However, the maximum write-off under the new rule is $1,000 for married joint-filing couples and $500 for others — and the deduction can’t exceed the amount you actually pay by year’s end.
One major caveat: Don’t do these prepayment drills if you know you’ll owe the dreaded alternative minimum tax (AMT) for this year. Write-offs for state and local income and property taxes are completely disallowed under the AMT rules. Therefore, prepaying these expenses will do little or no tax-saving good for AMT victims.
Medical expenses and itemized deductions
Next, consider prepaying expenses that are subject to limits based on your adjusted gross income (AGI). The two prime candidates are unreimbursed medical expenses and miscellaneous itemized deductions. Medical costs are deductible only to the extent they exceed 7.5% of AGI. Miscellaneous deductions — for investment expenses, fees for tax preparation and advice, and unreimbursed employee business expenses — count only to the extent that they exceed 2% of AGI. If you can bunch these kinds of expenditures into a single calendar year, you’ll have a fighting chance of clearing the AGI hurdles and getting some write-offs.
Warning: Unfortunately, this strategy may not work for AMT victims. Under the AMT rules, medical expenses must exceed 10% of AGI to be deductible and miscellaneous itemized deductions are completely disallowed.
3. Prepay College Tuition
If your 2008 adjusted gross income (AGI) allows you to qualify for the Hope Scholarship or Lifetime Learning higher education tax credits, consider prepaying college tuition bills for 2009 if that would result in a bigger credit on this year’s Form 1040. Specifically, you can claim a 2008 credit based on prepaying tuition for academic periods that begin in January through March of next year.
If your 2008 AGI is too high to be eligible for the Hope or Lifetime credits, you might still qualify to deduct up to $2,000 or $4,000 of college tuition costs. If so, consider prepaying tuition bills for academic periods that begin in the first three months of 2009 if that would result in a bigger write-off on this year’s Form 1040.
See the College Tax Savings Superpage for eligibility rules.
4. Game the Standard Deduction
If your total annual itemized deductions are usually close to the standard deduction amount, consider bunching together expenditures for itemized deduction items every other year. Itemize in those years to deduct more than the standard deduction figure. Then claim the standard deduction in the intervening years. Over time, this drill can save hundreds or even thousands of dollars in taxes by increasing your cumulative write-offs. Why? Because you’ll bag higher itemized deductions in alternating years and relatively generous standard deductions in the other years. So regardless of what happens with tax rates, you’ll come out ahead. For 2008, the standard deduction is $10,900 for married joint-filing couples vs. $5,450 for singles and $8,000 for heads of households. For next year, the standard deductions will be $11,400, $5,700, and $8,350, respectively.
2009 Tax Figures (Assuming No Changes):
Income Tax Rate Brackets Tax Bracket Single Joint HOH*
* Head of household
10% tax bracket $0-$8,350 $0-$16,700 $0-$11,950
Beginning of 15% bracket 8,351 16,701 11,951
Beginning of 25% bracket 33,951 67,901 45,501
Beginning of 28% bracket 82,251 137,051 117,451
Beginning of 33% bracket 171,551 208,851 190,201
Beginning of 35% bracket 372,951 372,951 372,951
Standard Deduction and Personal Exemption Amounts Deduction / Exemption Single Joint HOH*
Standard Deduction $5,700 $11,400 $8,350
Personal Exemption 3,650 3,650 3,650
Retirement Account Contribution Limits
Maximum contribution to traditional or Roth IRA: $ 5,000
Maximum IRA contribution if age 50 or older: 6,000
Maximum 401(k) salary deferral contribution: 16,500
Maximum 401(k) contribution if age 50 or older: 22,000
Maximum 403(b) salary deferral contribution: 16,500
Maximum 403(b) contribution if age 50 or older: 22,000
Maximum deductible SEP account contribution: 49,000
Maximum profit-sharing account contribution: 49,000
Maximum SIMPLE IRA salary deferral contribution: 11,500
Maximum SIMPLE contribution if age 50 or older: 14,000
Other Key Tax Figures
Cap on Social Security tax (based on wages
or self-employment income) $106,800
Annual federal gift tax exclusion $13,000
Federal estate tax exemption $3,500,000