TAX PLANNING

No one likes to pay more than their fair share of income taxes. But in order to minimize your income tax bill, you need to plan for that result. To help, we have included several articles on the topic:

If you have any questions or would like to discuss tax planning in more detail, please contact us at:
1-800-553-6700 or CSIC@CapitalSecurities.com

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Tax Planning Tips

Contribute the maximum amount to your 401(k) plan. Your contributions, up to a maximum of $10,500 in 2000, are deducted from your gross pay, so you don't pay current income taxes on the contributions (although you still pay Social Security and Medicare taxes). In addition, earnings and capital gains on your investments grow tax deferred until withdrawal. When you make withdrawals, you'll have to pay ordinary income taxes on the contributions and earnings (and possibly a 10% federal income tax penalty if withdrawals are made before age 59 1/2), but this tax-deferred growth typically means that you could have a larger nest egg than if you had been paying taxes currently during the years.

Decide which type of individual retirement account (IRA) to contribute to and then do so early in the year. Find out whether you're eligible to contribute to a traditional deductible or Roth IRA and then decide which is the better alternative for you. Make your contribution early in the year to allow your funds to compound tax deferred or tax free for a longer time.

Consider investing in municipal bonds if bonds comprise a portion of your investment portfolio. Interest income from municipal bonds is generally exempt from federal, and sometimes state and local, income taxes. (Income for some investors may be subject to the federal alternative minimum tax (AMT) and are subject to the bond premium and market discount rules.) In general, the higher your marginal tax rate, the more advantageous you'll find investing in municipal bonds. Before investing, compare the yield on the municipal bond to the after-tax yield of other types of bonds.

Investigate investments that generate capital gains, such as growth stocks. Capital gains on investments held over one year are subject to the 20% capital gains tax rate (10% if you are in the 15% tax bracket), compared to the top ordinary income tax rate of 39.6%. Also, you do not pay the tax until the investment is sold, allowing you to plan when to recognize the gain.

Replace loans that generate personal interest with mortgage loans or home-equity loans. Personal interest cannot be deducted on your tax return, while mortgage interest and home-equity loan interest typically can, as long as the mortgage does not exceed $1,000,000 and the home-equity loan does not exceed $100,000.

Make gifts of income-producing assets up to $10,000 per year ($20,000 if you split the gift with your spouse) to your children tax free. Doing so shifts the income from the assets to your children, who may be in a lower tax bracket. If your child is under age 14, be aware that the "kiddie tax" rules apply. In 2000, the first $700 of investment income is tax free, the second $700 is taxed at the child's tax rate (typically 15%), and any remaining interest income is taxed at the parents' marginal tax rate. Thus, you may want to utilize tax-free or tax-deferred investments for at least a portion of the child's investments until the child turns 14. All investment income of children aged 14 or older is taxed at the child's marginal tax rate.

Take advantage of education tax breaks. If eligible, make sure to document and claim the Hope Scholarship or Lifetime Learning credits. Be aware that you may be able to deduct a portion of the interest paid on student loans if you meet certain of the eligibility requirements. Also, decide whether you want to save for college with an Education IRA or a state prepaid tuition plan.

Obtain a receipt for any household goods donated to a charity. You may be able to deduct those contributions on your tax return. Also, keep track of any out-of-pocket expenses incurred while you are performing charitable work; those may also be deducted.

Keep track of your expenses if you are looking for a new job. Items like resume preparation, mileage, air fare, and hotels may be deducted as miscellaneous itemized deductions. If you get a new job in the same field and relocate more than 50 miles from your current home, you can deduct all your unreimbursed moving expenses. You don't even have to itemize to do so.

Start planning now. This gives you time to consider various tax planning strategies and ensure that you have adequate time to implement those strategies this year.

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Tax Strategies for Your Investments

Although you shouldn't make investment decisions solely for tax reasons, using proper strategies can help reduce your income taxes:

General

Carefully consider which investments to hold in tax-advantaged and taxable accounts. Gains from investments held in retirement accounts, such as 401(k) plans and traditional individual retirement accounts (IRAs), are taxed at ordinary income tax rates when withdrawn, rather than the lower capital gain tax rates. While it may make sense to hold investments that produce ordinary income in retirement accounts and investments that produce capital gains in taxable accounts, there are non-tax factors to consider, including your investment period.

Capital losses offset capital gains on a dollar-for-dollar basis, plus up to $3,000 of excess losses can be deducted against ordinary income. If you have excess capital losses above that amount, you can carry the loss forward or consider selling investments with gains to take advantage of the loss. You may also want to sell assets with a loss to offset large capital gains.

Use the proper basis when calculating gains from assets you inherited, which is generally the market value on the date the previous owner died.

Stocks

Keep in mind that the capital gain tax rate on assets held for more than one year is now 20% (10% for taxpayers in the 15% tax bracket). That makes stocks seem more attractive than investments that generate ordinary income, but don't purchase stocks unless they fit in with your specific goals and you are willing to hold them for the long term.

Donate appreciated stock that you have held for over a year to a charity so you can deduct the fair market value. (The donation amount is subject to limitation, based on a percentage of your adjusted gross income.) Not only will you get a charitable contribution deduction, but you avoid paying capital gain taxes on the gain.

If you are planning to make an annual gift of $10,000 ($20,000 if split with your spouse) to a child, consider gifting appreciated stock. While your child retains your basis in the stock, he/she may only pay 10% capital gain tax if he/she is in the 15% tax bracket.

Take advantage of a stock loss, even if you think the stock has the potential to increase in value. First, purchase the same number of shares of the stock. Wait at least 31 days and then sell the original shares at a loss. You still own the same number of shares, but can deduct the loss on your tax return. You must wait at least 31 days before selling so that you can recognize the loss in the year of sale for tax purposes.

Make sure to deduct reinvested dividends from your calculation of gains. You already paid ordinary income taxes on those dividends in prior years.

You can deduct losses from worthless securities in the year they become worthless.

Fifty percent of the gain from the sale of qualified small business stock issued after August 10, 1993 and acquired at its original issue can be excluded if the stock was held for more than five years. There are limits on the amount of gain eligible for the exclusion.

Capital gains from the sale of publicly traded stock can be deferred if the proceeds are used to purchase an interest in a specialized small business investment company within 60 days. There are limits on the amount of gain eligible for deferral.

Bonds

Consider investing in municipal bonds since their interest income in most cases is exempt from federal income taxes and possibly state income taxes. First consider the after-tax rate of return of municipal bonds and taxable bonds to see which is better suited for your situation. The federal alternative minimum tax may apply.

If you have bonds that have declined in value, consider a tax swap, which involves selling those bonds and purchasing other, similar bonds. The loss can then be used to offset other capital gains. Be sure to follow the wash sale rules or your loss may not be deductible in the year of the sale.

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Your Children and Your Taxes

Looking for ways to reduce your income tax bill? If you're not opposed to transferring assets to your children, consider these strategies which may help lower your tax bill:

Make gifts of up to $10,000 per year ($20,000 with your spouse if you elect gift splitting) to each child gift-tax free. Any income attributable to these gifts then becomes taxable to your child. However, be aware of tax laws regarding investment income for minors. If the child is under age 14, he/she is subject to the "kiddie tax" - in 2000, the first $700 of investment income is tax-free, the second $700 is taxed at the child's income tax rate (usually 15%), and any remaining investment income is taxed at the parent's marginal tax rate. Thus, you may want to utilize tax-free or tax-advantaged investments for a portion of the child's investments until the child turns 14. Once the child is 14, all investment income is taxed at his/her marginal tax rate.

Consider gifting appreciated securities to your children over age 14 as part of your annual $10,000 gift. Instead of selling the securities and giving your child the cash proceeds, gift the securities to your child and have the child sell the securities. The capital gain will then be taxed at the child's tax rate instead of yours. If your child is in the 15% tax bracket, a gain on assets held over 18 months will be taxed at 10% instead of your 20% rate.

Pay your child's college tuition bills directly to the college. These payments can be made without paying gift taxes and can be made in addition to the $10,000 annual gift. These payments may also allow you to claim a Hope Scholarship Credit or a Lifetime Learning Credit, if you meet all criteria.

Place your child on your company's payroll. Wages and other earned income are not subject to the kiddie tax. Your children's salaries are deductible by the business and their income will be taxed at their low marginal rate after a generous exemption. Unincorporated businesses do not have to pay Social Security taxes on wages of children under age 21.

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Worse than Paying Taxes

No one likes paying income taxes, but paying penalties with those taxes is even worse. Since a large percentage of penalties result from improper payment of estimated taxes, make sure you understand those rules.

Estimated tax payments are required if your tax liability will be $1,000 or more than amounts withheld from your income. Typically, individuals who receive significant income from sources that don't withhold taxes, such as dividends, interest, capital gains, self-employment, rent, alimony, partnership interests, and S Corporation interests, must make estimated tax payments.

In 2000, individuals with adjusted gross income (AGI) in excess of $150,000 in the preceding year must pay either 90% of the current year's tax liability or 106% of the prior year's tax liability. That 106% figure also applies to 2001, but changes to 112% in 2002 and 110% starting in 2003. Individuals with AGI not exceeding $150,000 must pay either 90% of the current year's tax liability or 100% of the prior year's tax liability. These provisions allow individuals who cannot easily estimate their income before year end to avoid penalties by basing estimated tax payments on the prior year's tax liability.

Individuals who earn a significant portion of their gross income from fishing or farming are subject to special rules.

Estimated tax payments are generally made in four equal installments on April 15, June 15, September 15, and January 15. However, if you do not receive income evenly throughout the year, you can make estimated tax payments based on actual income for the period. Be careful to pay the proper amount with each installment, since paying additional amounts in subsequent periods will not exempt you from penalties for underpayments in earlier periods.

If you are also subject to withholding, you can increase your withholdings to help cover underpayments. Amounts withheld from salaries are assumed to be withheld evenly throughout the year.

Review your tax situation early in the year so you can make proper estimated tax payments. That way, you won't pay more than your fair share of the tax burden in the form of penalties.

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Tax Planning Is a Year-Round Process

Tax planning is often confused with tax preparation, with thought given to the subject only when preparing your annual tax return. However, little can be done to actually lower your tax bill at that point. If your goal is to reduce taxes, you need to be aware of tax planning opportunities throughout the year.

Take time early in the year, perhaps as part of the tax preparation process, to assess your tax situation, looking for ways to reduce your tax bill. Consider a host of items, such as what kinds of debt you owe, how you're saving for retirement and education expenses, which investments you own, and what tax-deductible expenses you incur. It often helps to discuss these items with a professional who can review strategies you might not have considered.

During the year, consider the tax consequences before making important financial decisions. This will prevent you from finding out later that there was a better way to handle the transaction.

Look at your tax situation again in the fall, which gives you plenty of time before year end to implement any additional tax planning strategies. At that point, you'll also have a better idea of your expected income and expenses for the year. You may then want to use strategies you hadn't considered earlier in the year, such as selling investments at a loss to offset capital gains.

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FR2000-0110-0012