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November 2000
Vol. 9, No. 11, 55, 57, 59,
Personal Business
“Hop To” These Year-End Tax Savers

hopscotch of tax breaksAlso: Creating a legacy through planned giving

Have you ever approached the April 15 tax deadline with a knot in your stomach? Once January 1 passes, it’s too late to change what you did last year even though you may realize that a lack of planning has cost you money. The good news is that you still have time in 2000 to take actions that may make your tax burden lighter in the true new millennium. The following are five such actions to consider.

Invest in an IRA. If you haven’t revisited the idea of contributing to an IRA in the past couple of years, you’re in for a pleasant surprise. The Taxpayer Relief Act of 1997 created some attractive changes.

The Roth IRA allows qualifying taxpayers to contribute up to $2000 for singles and $4000 for married couples. Even though your contributions aren’t tax-deductible, withdrawals are tax-free, provided certain requirements are met. In addition, if neither you nor your spouse participates in an employer’s plan, both of you may be able to fully deduct contributions to traditional IRAs, even if one spouse doesn’t work outside the home. Furthermore, if one spouse is covered by an employer’s plan, the other spouse may be able to make a deductible IRA contribution if the couple’s adjusted gross income is less than $150,000. You have until April 16, 2001 (April 17 for Massachusetts residents), to fund your 2000 IRA, but remember that the sooner you make your contribution, the longer you’ll have to accumulate potential investment earnings.

Take Advantage of Lower Long-Term Capital Gains Rates. The capital gains tax rate for most investments held more than one year is 20% (10% for taxpayers in or below the 15% federal income tax bracket). The gain on an investment held one year or less is taxed at the taxpayer’s ordinary income tax rate—which could be as high as 39.6%. That’s why it may make sense to sell appreciated assets that you’ve held more than one year if you plan to liquidate assets.

Offset Capital Gains with Losses. An individual’s capital losses are fully deductible against gains, but any capital losses that exceed the capital gains can offset a maximum of only $3000 in ordinary income each year. It’s important to remember, though, that you can carry excess losses forward for an unlimited number of years until the losses are exhausted.

If you have large capital gains in 2000, it may make sense to realize some offsetting losses on investments you no longer want to hold. On the other hand, if you expect losses in 2001, you could postpone realizing gains until then.

Take Advantage of Tax Credits. In 2000, qualifying taxpayers can claim a child tax credit of $500 for each child under age 18. Another nonrefundable credit is available for 20% or more (up to certain limits) of eligible expenses for employment-related dependent care for children under 13 or other dependents. Note that the credit isn’t limited to children. If an elderly parent is your dependent and requires day care, the cost of that care may also qualify.

There are also two credits that you may be able to use to help with higher education expenses. The Hope Scholarship credit is available for payment of any student’s first two years of postsecondary tuition and related expenses. The credit is 100% of the first $1000 of expenses and 50% of the next $1000 for each student in your family who is enrolled at least half-time.

The Lifetime Learning Credit can be used for qualifying expenses for training to acquire job skills as well as for undergraduate and graduate coursework at eligible institutions. The credit is 20% of up to $5000 worth of expenses, with a maximum credit of $1000 per return. After 2002, the 20% credit will apply to up to $10,000 in expenses. Keep in mind that all credits have income qualifications.

Save Taxes with Gifting Strategies. This year, you can transfer as much as $10,000 ($20,000 for married couples) to as many individuals as you want—without gift tax. This strategy works especially well if you transfer assets that have appreciated significantly. Here’s why: Rather than sell appreciated assets and pay tax on your gain, you can transfer the asset to a child or grandchild age 14 or older. When the child sells the asset, the gain is realized at the child’s income tax rate—which is most likely lower than yours.

As part of your tax-reduction strategy, you may also want to consider making a year-end gift of appreciated assets—which have been held for more than one year—to a charitable organization. By doing so, you not only avoid paying tax on your gain, but you can deduct the fully appreciated value of the gift from your income.

Don’t wait until after the new year rolls in to make tax reduction a high priority. Now’s a good time to consult a knowledgeable financial adviser and your attorney to make sure your tax strategy is in line with your other financial goals.

Creating a Legacy
A mature couple (let’s call them the Jacobsons), feeling grateful for all they had accumulated over the years, were anxious to share some assets with their heirs during their lifetime. After talking with a financial adviser about gifting to their children and grandchildren, they found they could give as much as $10,000 a year each to an unlimited number of people without triggering a gift tax.

Better yet, because the Jacobsons are married, they can each give $10,000—making a tax-free gift of $20,000 a year to each heir possible. And because two grandchildren are college students, the Jacobsons can also exceed the $10,000 limit by paying tuition bills. They can make these gifts of larger amounts as long as the tuition checks are made payable to the college.

By making their gifts now, the Jacobsons found they could reduce their estate tax liability—and make this year’s holiday extra pleasant for family members.

While the Jacobsons found several advantages to family member gifting, other taxpayers have jumped on the planned-giving bandwagon with charitable organizations as beneficiaries. That way, they can contribute to the causes they choose while reducing their income and estate tax burdens. If you’re planning a charitable giving strategy, here are a few techniques to consider.

Donation of Assets. There’s no limit to how much you can give to charities, and your contributions are generally not subject to gift or estate tax. During your lifetime, you may want to take advantage of additional tax breaks by giving appreciated assets such as stocks or stock fund shares that you’ve held at least a year. You not only avoid capital gains tax on such assets, but you also get a tax deduction for their full appreciated value, subject to certain IRS limitations.

Life Insurance. Gifts of life insurance provide your favorite charities with the security of future bequests. Upon your death, the charities you have designated receive the policy proceeds without tax liability or administrative costs. By purchasing a life insurance policy and naming a charity as owner and beneficiary, you may be eligible for a current income tax deduction and for tax deductions in the future.

Charitable Remainder Trusts (CRTs). CRTs are gaining in popularity because they can provide both income and estate tax advantages. Here’s how they typically work:

  1. The donor gives assets to a qualified charity through a tax-exempt CRT.
  2. The donor, spouse, or other beneficiaries receive regularly scheduled payments (from the interest generated by the assets) for life or for a term of years.
  3. Assets can grow tax-exempt inside the trust. When they are sold, they generate no capital gains tax in the trust.
  4. Because a charitable tax deduction reduces current income taxes, the donor may be in a more favorable tax situation as a result of the donation.
  5. The charity receives the assets at the end of the term of years or at the death of the last remaining beneficiary.

In some cases, assets given to the CRT can be replaced for the heirs by using life insurance in a Wealth Replacement Irrevocable Trust. Your tax savings from the CRT can fund a policy in an amount you select, free of income and estate taxes.

You can see that when it comes to gifting strategies, you have a variety of options. Depending on your priorities and your personal situation, planned giving can be an important part of your legacy. Because not all techniques are appropriate for everyone, it’s best to consult your attorney and your tax and financial advisers.

Dickinson J. Miller is a senior financial adviser and managing principal at American Express Financial Advisers in Bethesda, MD.

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