It's time to start thinking about some year-end traditions: holiday shopping, Christmas trees, greeting cards, and tax planning. That last item may not be as fun as the others, but it could save more money than an after-Christmas sale. While aspects of the 1986 Tax Reform Act are still coming into place, it is possible to generate tax savings by making some business and investment moves before New Year's Day.
It's also possible to make moves that could turn out to be big mistakes later on.
``You need to take a much more careful look at your tax situation than in the past,'' says Joel M. Walters, tax supervisor with Grant Thornton International, accountants. In the past few years, the standard advice has been to take as many deductions as possible in the current year, when taxes are higher, and shift as much income as possible into the following year, when income tax rates are lower.
For many people, that will still be true. Tax rates will be lower next year, with a top rate of 28 percent for most people. Even those in the highest income levels won't pay more than 33 percent, down from this year's high of 38.5 percent.
Meanwhile, many deductions or tax credits have already been eliminated or will be when this year is over. Last year, for example, the consumer interest deduction was fully deductible; this year only 65 percent can be deducted, and by 1991 it will be zero.
But loading up too many deductions this year could be a mistake.
``This is the year that the alternative minimum tax kicks in for more people,'' says Vern Martens, vice-president of the tax advisory group at Merrill Lynch & Co. The AMT, as it is known, is meant to make sure everyone pays his fair share of taxes, and if someone has a large amount of deductions, investment losses, or adjustments to income, the AMT rules take over. While their tax bill may still be lower, many of those deductions could be wasted, especially if they could have been delayed until next year.
We won't take the time to explain all the ins and outs of the AMT here; suffice it to say that an investor with $50,000 in taxable income and $38,000 in deductible ``preference'' items and adjustments to income would probably be subject to the AMT in 1988. At $100,000 of income, the AMT level begins at $56,000, and at $200,000 of income, it's $70,000 of deductions and adjustments.
Clearly, the AMT is not a problem for most middle-income taxpayers, but those with upper incomes and heavily involved in investments - especially this year when there may be big losses - should be aware of the AMT limits. If you are subject to the AMT, it might be better to take more income this year, instead of deferring it, to take advantage of a slightly lower tax rate.
Another deduction trap concerns the ``2 percent floor.'' Starting this year, many individual deductions - including tax preparation fees, certain investment expenses, union dues, employee expenses, continuing education costs, and professional organization dues - can be deducted only to the extent they exceed 2 percent of adjusted gross income.
At $50,000 of income, that would mean that the first $1,000 of these expenses could not be deducted.
Although it might be hard to go over the 2 percent floor in any one year, bunching some of these expenses into one year or the other may give you deductions in alternate years. Caution: Don't try to pre-pay several years of business subscriptions, since these deductions can be taken only one year at a time.
If the AMT rates, the 2 percent floor, and other changes sound too complicated for you and your calculator, there is help.
``Most accounting and law firms have computers and tax programs to help you,'' Mr. Walters says. ``One way you can see the full impact of tax moves is to look at their impact over the next five years. What looks like a fairly good move today could turn out to be a bad move down the line.''
With these computer programs, Walters says, you can program in various income, tax, and deduction schedules and see what your final tax bill would be each year. You might take fewer deductions this year and save up miscellaneous deductions until 1988 or '89.
If you have a computer, you can buy your own tax preparation program and review your tax picture as your income, investments, and expenses change.
Not everyone needs a computer, even if he has one handy. ``I don't have to use a computer,'' Walters says. ``My tax situation is fairly simple, so I can scratch it out on a piece of paper.''