Strategic Tax Paying: Big Shifts At The Top

Compiling your holiday gift list may remind you that you need to take care of another, less popular yearend chore: taxes. Normally the next few weeks are your last chance to reduce your tax burden by shoveling as much income as possible into next year while roping as many deductions as you can into this one. But with a new Administration's tax changes on the horizon, you may want to do just the opposite.

President-elect Clinton has proposed raising the top marginal rate from 31% to 36% for single people who make at least $150,000 and married couples who earn $200,000 or more. He has also threatened to slap a 10% surtax on millionaires. To take advantage of 1992's lower rates, tax advisers are telling their clients to accelerate income into the current year and defer deductions into 1993. "All bets are off because we're looking at a new political environment," says Robert Garner, a tax partner at accountant Ernst & Young in Atlanta.

One way to accelerate income is to ask for any bonuses, consulting fees, or honoraria by yearend. You can also take the gain now on appreciated stock you've owned for less than a year, and if you still want to own the stock, you can use the proceeds to replace the shares. Executives with nonqualified stock options may want to exercise them this year, says Garner, because they're subject to taxation when exercised. If you're self-employed, you can bill for compensation earlier, or ask clients to pay up by yearend. Meanwhile, retirees and workers older than 5912 may want to take a larger distribution from their individual retirement accounts (IRAs) this year.

At the same time, top-bracketers should be deferring deductions to help offset a bigger tax bite next year. For example, if you're about to buy a house, postpone the closing until the new year, so you can deduct the points in 1993. Put off making charitable donations and pay real estate taxes after Jan. 1.

DEFERRED CHECKUPS. Postponing deductions on medical and miscellaneous expenses is particularly important if you are pumping up your income this year. Medical expenses must exceed 7.5% of your adjusted gross income, and miscellaneous expenses, such as tax advice and union dues, must total over 2% of your AGI to be deductible. Therefore, if your income is beefed up in 1992, it will be harder to reach those limits this year and easier next year. So, for instance, postpone discretionary medical expenses, such as elective surgery, checkups, and purchases of glasses.

Rick Taylor, a senior manager at KPGM Peat Marwick, has another idea about deductions. He thinks many are in danger of being scaled back or eliminated, so take advantage of them while you can. "Every year, they've been cutting back on them," he notes. For example, with political leaders talking about reducing the mortgage-interest deduction to raise additional revenues, he advises those homeowners who would normally make their December mortgage payment on Jan. 1 to send their check in before Dec. 31 so they can deduct the interest in 1992.

If you're in the 15% or 28% bracket and expect to stay there next year, you should do the usual accelerating of deductions and deferring of income. By delaying bonuses a few days to early January, the money goes into your pocket, but you don't get taxed on it until a full year later. Another ploy is to stash money in financial vehicles whose returns are payable in the future, such as certificates of deposit or ee bonds. On the deduction side, you can pay estimated fourth-quarter state income taxes by Dec. 31, rather than on the usual Jan. 15 due date.

GIFT SEASON. Remember, if your income is more than $210,500 for marrieds and $105,000 for singles, deductions on any income above that level are disallowed by 3%. That is, you lose $300 in deductions for every $10,000 that your adjusted gross income exceeds that limit. Medical expenses, casualty and theft claims, and investment interest are excluded from this rule.

Two tax-reducing tools that may be endangered next year are the gift-tax annual exclusion of $10,000 a year and the unified estate-and-gift tax credit, which allows you to give away $600,000 tax-free. Some advisers are therefore counseling clients to use it or lose it.

The annual gift-tax exclusion allows you to give away $10,000 in cash ($20,000 for a couple) per person tax-free. But to be on the safe side, make sure the recipient has time to deposit the check before the New Year so it will clearly fall into 1992 and you won't accidently use up your 1993 allotment. Taylor suggests making cash gifts by yearend, and doing it again as soon as possible in 1993, as it might not last the year.

Rumors of near-extinction also swirl around the unified estate-and-gift tax credit. It works this way: Normally, when you die and leave money to anyone other than your spouse, $600,000 of your estate is exempt from federal taxes. But you're also allowed to use up the exemption by giving away $600,000 tax-free before you die. This year, Congress suggested slashing the amount to $200,000 -- an effort that got nowhere but may be revived. Says Thomas Ross, tax partner in the personal financial-services group at Coopers & Lybrand: "If you have $600,000 today and don't give it away before yearend, Congress could reduce it to $200,000, and you'd only be able to give that much."

Of course, all this shuffling could lead you down the thorny path to the alternative minimum tax (AMT), warns Larry Elkin, senior financial- planning manager at Arthur Andersen. The AMT is a parallel tax designed to insure that people who make more than a certain level of income don't deduct their way out of paying a reasonable tax bill. Many regular deductions, such as state and local taxes and gifts of appreciated property, are disallowed under amt, which is a flat 24%. Clinton has talked about raising this to 27%. But Elkin says that if the top marginal rate is also raised, not much will change.

"If you moved a lot of income into 1992," says Elkin, "and then in '93, you have some unusual deductions that add up to be more than your income, you may trigger the AMT." But the only way to know if you fall under the amt is to do the paperwork as if you were subject to both sets of taxes. Whichever comes out higher is what you're obligated to pay. To help avoid the amt, Elkin suggests doing tax projections for two years at a time to insure that you're not creating a questionable scenario for the next year.

If you pay estimated taxes or have taxes withheld from your regular paycheck, there's a new booby trap to avoid. It no longer suffices to fork over 100% of last year's payments to avoid penalties on underpaid tax bills this year. Now, you have to pay 90% of what this year's taxes will be if your income is more than $75,000 and has increased by more than $40,000 in the prior year, and if you filed or should have filed estimated taxes in one of the past three years.

If you haven't done so already, stash as much money as possible in your 401(k) plan or another retirement vehicle to reduce taxable income. Although you can contribute to any Keogh, IRA, or simplified employee pension plan until Apr. 15, you must open a Keogh no later than Dec. 31. And if you're planning to leave your job or retire this year, be sure to avoid what Elkin calls that "nasty little provision" that allows Uncle Sam to withhold 20% of your 401(k) lump-sum distribution if you take the money in cash. Instead, either keep the money parked where it is or have your employer immediately roll it over into another tax-deferred account. Otherwise, you'll be making an interest-free loan to the federal government until you get a refund.

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