Financial Planners Offer Tax Planning Ideas to Consider Before Year End

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Reduce your tax liability with tips from one of the top wealth management firms in America.

December is a key month in which to focus on minimizing your income tax liability. The professionals at Mosaic Financial Partners, Inc. offer the following year-end tax planning tips. Since each person’s tax situation is different, consult with your tax advisor before taking any action.

If you are in the top income tax bracket and you expect to be in the same or lower bracket next year, consider the following:

  • Tax Payments – Prepay your 2005 state income tax liability by year end. You can do this by increasing your withholding (if you are an employee) or by increasing your fourth quarter estimated State tax payment. You also may wish to consider prepaying property taxes that are due in the first quarter of next year. An important note: Many taxpayers are now subject to the Alternative Minimum Tax (AMT). This can turn traditional tax planning on its head and requires careful consultation with your tax advisor. For example, if you are subject to the AMT, you may want to defer rather than accelerate state income and property tax payments.
  • Charitable Gifts – Accelerate charitable gifts through the use of a charitable Donor-Advised Fund. Donor-advised funds allow you to donate appreciated securities to a charitable account that you control. You receive a tax deduction for the fair market value of the securities in the year the transfer is made. However, donations you make from the fund to the charities of your choice can be made whenever you decide.

As a result of recent tax legislation known as “KETRA” arising from hurricane Katrina, tax payers have some unique opportunities that will expire after 2005. For wealthier persons with large retirement account balances (e.g., an IRA)_and a charitable intent, it is possible to withdraw funds from the retirement account and almost entirely write-off the income by donating the funds directly to a charity (not a Donor Advised Fund). Be sure to consult your tax advisor before acting on this one-time opportunity.

  • College Savings – Shift assets reserved for college education to your children or grandchildren through a College Savings (“529”) Plan. Investment earnings on assets that are placed in these Plans are generally exempt from federal and state income taxes — provided that the funds are used for qualified college expenses. One caveat: Congress still needs to address whether this tax benefit will be extended beyond the 2010 tax year.
  • Retirement Planning – If you have an IRA and your current year’s adjusted gross income will be less than $100,000, you may want to speak with your CPA to assess whether it makes sense for you to consider a Roth-IRA conversion. Even if you don’t normally fall into the “under $100,000 of income” category, one-time events (i.e. business losses, rental losses or capital losses) may reduce your income to an unusually low level. If so, you may be a candidate for a Roth-IRA conversion. In a conversion, some or all of your IRA is transferred to a Roth-IRA. Taxes are paid at ordinary income tax rates on the amount that is transferred. Conversions are best when the federal tax rate is 15% or lower, which keeps the upfront income tax cost low. However, since earnings on Roth-IRA assets will never be taxed, there is a huge long-term benefit of the conversion — for a small upfront tax payment, an individual can exempt thousands and thousands of dollars of future earnings from income tax. Roth conversions make the most sense if your future tax bracket will be higher than the 15% cost of the conversion.

If you are self-employed, you should consider:

  • Setting up a retirement plan for your business. If you have your own business or just this year generated self-employment income, having a retirement plan can save a good amount of current taxes. There are several retirement plan formats that you can choose from; each varies in terms of annual funding requirements and maximum contributions. Some plans need to be established by year end, so if you qualify, consult with your tax advisor as soon as possible. Note that for all plan formats, actual funding can be deferred into 2006 even though the deduction is still claimed on your 2005 return.
  • Accelerating expenditures for furniture, computers and other equipment for your business. The current tax law allows you to deduct up to $102,000 per year for purchases of certain business-related property and equipment. Keep in mind that this deduction is limited to the amount of your taxable trade or business income.

If you are working with an investment professional:

  • Your investment professional should always be looking for ways to minimize your taxable income tax liability. Specific actions might include:
  • Examining the tax efficiency of each new investment with a focus on its potential after-tax return relative to competing investment alternatives.
  • Avoiding selling investments that have large built-in gains unless necessary to maintain the portfolio’s asset allocation objective. When liquidating individual securities from a taxable portfolio, he/she might first sell those securities with any losses, followed by securities in order of their percentage gain, from lowest to highest.
  • Selling positions with built-in capital losses to offset realized gains.
  • Consider the benefits and risks of holding an investment until it qualifies for long-term capital gain treatment in taxable accounts. Less tax efficient investments should be placed in tax-deferred accounts (i.e., IRAs and other retirement accounts) when possible.

Your financial advisor should make every attempt to align his/her actions with your goals. One of the ways that he/she can do this is by assisting you in maximizing your after-tax returns as you work toward your long-term investment goals.

About Mosaic Financial Partners, Inc.

Mosaic Financial Partners currently has offices in San Francisco and Oakland. President Norman M. Boone, MBA, CFP®, and East Bay Managing Director Linda S. Lubitz, CFP®, have consistently been cited as two of “America's Best Financial Advisors” by Worth magazine since the inception of the list in 1994. They are also among those recognized as “Best Financial Advisors for Doctors” by Medical Economics magazine. Co-authors of the best selling industry book, Creating an Investment Policy Statement – Guidelines and Templates, they are active on a national and regional level within the Financial Planning Association. They are frequently quoted in both industry trade publications and consumer-oriented financial press.

Kevin Gahagan, CFP®, CIMC, a principal who works in the San Francisco office, is equally active and respected within the profession. An instructor at UC Berkeley, he educates other financial planners who are enrolled in the CERTIFIED FINANCIAL PLANNER™ certification program. Gahagan is also former president and chair of the East Bay Financial Planning Association (FPA), and serves on the board of directors for both the American Association of Individual Investors (AAII) and the Estate Planning Council of Diablo Valley.

For more information, contact Norman M. Boone at Mosaic Financial Partners, Inc. Phone 415.788.1952 or visit http://www.MosaicFP.com.

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Norman M. Boone, MBA, CFP®
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