Personal Business: Your Taxes
TAX PLANNING: BETTER NOT WAIT ON CONGRESS
Higher 1994 taxes may be tempered by some good news in 1995. The new Republican-controlled Congress is likely to cut capital-gains taxes, establish a tax credit for middle-class parents, and revise individual retirement accounts, say tax specialists. But even assuming these changes pass, it may be hard to plan for them. So tried-and-true tax strategies remain your best bet.
Republicans propose to cut the capital-gains tax bite as much as 50% of your ordinary rate; that is, the rate for those in the top 39.6% bracket would be reduced to 19.8%, and the capital-gains rate for those in the 15% bracket would be 7.5%. "We're very comfortable that the capital-gains rate will change this year," says Ralph Anderson, a partner at accounting firm M.R. Weiser in New York. But since no one knows when the change will take effect or if it will be retroactive, he's advising clients to use strategies that defer realization of long-term gains.
For instance, you might buy a put option to sell your stock at a fixed price in July, when Congress is expected to vote on capital gains. If the stock drops, you'll be able to sell at the current price. But you will have deferred the sale until the put expires, usually in three to six months. An alternative would be to "sell short against the box," or borrow from a broker the same number of shares of a stock you already own, and then sell them to lock in your profit. By holding a long and short position in a stock simultaneously, you cancel out any fluctuations if the price rises or falls, and you defer the sale until you repay the broker. But beware of the costs of employing these delaying strategies. "You have to look at how much gain you'll wind up with after you pay the transaction fees," says Carl Duyck, a tax partner at Deloitte & Touche in Washington.
BE PREPARED. The GOP also would create a new back-loaded IRA. You wouldn't get a deduction for monies contributed to the account, but you could withdraw them tax-free at retirement. The tax-free growth and withdrawal would provide a "tremendous benefit later on," says Tom Ochsenschlager, a Washington partner at Grant Thornton. And both Republicans and Democrats are talking about loosening restrictions on IRAs so you could withdraw money without a penalty for expenses such as buying a home, paying for college, or certain medical bills.
One way to plan ahead is to have some cash on hand to put into a new, improved IRA. "If people are eligible to do IRAs and 401(k)s, and they don't, that's sort of not forgiven in the world of tax planning," says Clinton Stretch, a partner at Deloitte & Touche. "Come September, when they finally get around to passing this bill, it may be too late to start saving, and that would be a permanently lost opportunity."
In any event, you should be maximizing contributions to tax-deferred retirement plans such as current IRAs and 401(k)s now. Don't wait: The sooner you put the money away, the sooner it starts compounding tax-free.
There's also likely to be some kind of break for middle-class parents. The Republicans want a $500 tax credit for each child under age 18 for parents with incomes up to $200,000. The Democrats want $300 per child under 13 for parents making up to $100,000. Some version is likely to pass, says Stretch. This may not seem like much, but a $500 tax credit is equal to a $700 raise for those in the 15% bracket making up to $38,000 a year. There isn't very much taxpayers can do to plan for such a break--just don't spend the money in anticipation of the tax break, in case it doesn't pass, cautions Stretch.
TRIED AND TRUE. Don't forget the old standbys, meanwhile. If you're in a high tax bracket and want to buy bonds, consider tax-free municipals. Contribute to flexible spending accounts offered through work that allow you to pay for medical and child-care expenses in pretax dollars. Shift income-producing assets to your children under 14 years old: The first $600 in unearned income is tax-free, and an additional $600 would be taxed at only 15%. Anything more gets taxed at the parents' rate. If your kid is over 14, all his or her income will be taxed as an adult.
Make personal credit-card debt deductible by consolidating it with a home-equity loan. And make charitable gifts of appreciated stock or property, because you can write off the present market value without realizing the gain.
If you stick with these perennial strategies, any tax breaks that do manage to make it through the new Congress will be gravy down the line.By Pam Black EDITED BY ANY DUNKIN