Markets go up, markets go down, but taxes are forever. No matter how your investments are faring, now's the time to take yearend steps that will shrink the check you write to the Internal Revenue Service next April. Despite the brave talk in Washington about surpluses and massive tax cuts, there's no relief coming from that quarter. So it's up to you. Peruse our guide, give your taxes a checkup, and act before Dec. 31 to lock in your savings.
SELL THOSE LOSERS
Fall is when you need to give your stocks, bonds, and mutual funds a tax review. The first step is to estimate capital gains you earned if you sold investments during 1999. Don't overlook the gains that your mutual funds will be distributing to you, probably in December: Call your funds or check their Web sites for an estimate of the gains they'll credit. If you have net gains so far, scan your portfolios for losers. Tax planning shouldn't force you to make bad investment decisions. But the search for losses might give you just the push you need to dump some dogs.
The biggest savings come from claiming short-term losses to offset short-term gains, because the IRS levies rates up to 39.6% on profits from investments you owned less than 12 months. Gains on investments held more than a year are taxed at no more than 20%. If you end up with more losses than gains, you can use the excess to wipe out tax on up to $3,000 in wage, interest, or dividend income.
If you sell stocks or funds for losses, be careful not to buy the same securities (or their options) within 30 days. If you do, the IRS will conclude you're dodging taxes through a "wash sale" and will disallow your loss. You can get around that by buying similar securities--a fund with like goals, or Advanced Micro Devices instead of Intel.
If you're a long-term investor, you're due for another tax break in just over a year. Starting in 2001, the top rate on gains from property held five years drops from 20% to 18%. The catch: You can't get that rate on investments purchased before Jan. 1, 2001, so the new rate has no real impact until 2006.
WATCH OUT FOR THE AMT
It's not enough to worry about one tax code. High-income taxpayers have to fret over the alternative minimum tax (AMT) as well. This parallel system was designed to catch heavy users of tax shelters and other dodges, but now mostly catches unwary investors. The AMT stands traditional tax planning on its head. If you fall into the AMT, you'll lose the benefit of many deductions and credits. Normally, you can cut your taxes by deferring income and accelerating deductions--prepaying any state taxes you'll owe in April, for example. But if 1999 is likely to be an AMT year for you, you'll want to do the opposite--claim as much income as you can, and delay deductions.
How can you tell if you'll face the AMT? Exercising a lot of tax-favored incentive stock options can trip you up. (The more common nonqualified options, which oblige you to pay taxes when you execute them, don't trigger the AMT.) Big itemized deductions, particularly state and local taxes and miscellaneous deductions (such as legal fees and unreimbursed employee expenses), can also create an AMT trap. Business owners and partners, along with shareholders in Subchapter S companies, can get stuck with an AMT tab if their companies have net operating losses or claim lots of accelerated depreciation, research expenses, or credits.
The risk rises if your family income tops $150,000 ($112,500 for singles). If this sounds like you, call an accountant.
The congressional budget battles have put more taxpayers at risk of owing AMT. The credits created in the 1997 tax cut--the $500 child credit, the Hope Scholarship, and the Lifetime Learning Credit--will cut regular taxes, but they don't count against the AMT. Those credits were applicable to the AMT for 1998 taxes, but that exemption has expired. On Nov. 17, Congress and the White House agreed to extend that exemption through 2001.
UNDO AN IRA CONVERSION?
Washington's best gift to retirement savers, the Roth individual retirement account, keeps on giving. The IRS is giving taxpayers who converted traditional IRAs to the new Roth accounts in 1998 until Dec. 31 to reconsider.
With a Roth IRA, an investor pays no tax on earnings and no tax on withdrawals if they're taken after the owner turns 59 1/2 and the account has been open five years. Those breaks drew millions of savers to convert traditional IRAs (in which earnings are taxed upon withdrawal) to Roth accounts in 1998. But some 20,000 erred: They switched even though their income exceeded $100,000, rendering them ineligible. Rather than punish them--they'd face an annual penalty of 6% of the account--the IRS is extending the chance to undo a conversion until Dec. 31.
That rule can benefit others as well. Say the value of your IRA, worth $100,000 when you converted it to a Roth account in 1998, has been battered down by the market to $80,000. Rather than pay the conversion tax on $100,000, you could cut that taxable income to $80,000 by undoing the conversion, then reconverting at the lower value. The catches: Your 1999 income must be less than $100,000, and you'll have to pay all the tax on the conversion in one year. A switch in 1998 let you spread the tax over four years.
Is this worth the effort? If your Roth IRA's value has fallen sharply since you converted and you can afford to pay extra taxes next April, yes. If you can't face the tax bite, you could undo the switch, then spread out the pain: Reconvert your traditional IRA to a Roth IRA over several years.
You can make 1999 contributions to a Roth or traditional IRA until Apr. 17, 2000. You can deposit up to $2,000, depending on your income.
NEW HOME OFFICE RULES
For owners of home-based businesses, 1999 tax returns promise sweet rewards. It's the first time many can deduct home office expenses. But the joy may fade when people run the numbers.
For one thing, the room you claim as an office must be used solely for business. And tax savings are likely to be small. Since you're already deducting mortgage interest and property taxes, the extra expenses you can claim are depreciation and part of your maintenance and utility bills. But houses depreciate slowly. So unless you have heavy upkeep and heating costs, the savings may not be worth the extra IRS scrutiny.
Self-employed taxpayers and small-business owners debating when to buy PCs or other equipment should check out Section 179, which specifies how much of the purchase can be written off right away. You can expense $19,000 in gear bought in 1999; for 2000, the limit will rise to $20,000.
ESTIMATE YOUR TAXES
Investors, retirees, and self-employed workers facing the pain of quarterly estimated tax payments need to keep an eye on Congress. If your 1998 income exceeded $150,000, you'll face an underpayment penalty unless your 1999 payments (including withholdings) exceed 105% of your 1998 tax tab. Chances are, if you use tax software or IRS forms to calculate your payments, you're on track to hit that goal by the Jan. 15 payment. And be extra careful next year. Congress has agreed to raise the 105% safe harbor to 108.6%, so you'll have to refigure your estimated taxes for payments beginning in April, 2000.
BREAK FOR ESTATES
Finally, the ultimate tax-planning tip: Hang in there as long as you can. The amount of your estate you can shelter from estate taxes is rising from $650,000 to $675,000 in 2000, on its way to $1 million in 2006. The longer you live, the more your heirs will thank you.