Still Time for Tax Planning

As 2008 comes to a close, everyone is focused on our faltering economy and declining stock market. However, it would be a mistake to miss the opportunity of doing tax planning before the end of the year. Here are my top strategies for you to consider:

  • Convert to a Roth IRA. One benefit of a huge stock market decline is that the tax cost of converting your IRA to a Roth is much less expensive. For example, let’s assume your IRA in January of this year was valued at $100,000 but is now valued at $50,000. If you are in a 28% federal tax bracket, a conversion in January would have cost you $28,000 in income taxes. By converting now, your costs are $14,000. Believe me when I say stocks will return to their former glory and when they do you will have moved your retirement money to a tax-free environment for minimal tax costs. It’s still important that you pay the income taxes with personal funds rather than from your retirement account. This allows you to maximize deferrals. If you did a conversion earlier this year, you should consider ‘reversing’ the transaction and then converting in early January of 2009.
  • Give to charity. If you are over 70½, you are allowed to make a direct transfer of up to $100,000 from your retirement account to a charity or religious organization. This is an extension of a law passed in the aftermath of Hurricane Katrina and allows you to avoid having to take a retirement plan distribution, report it as income, then make a tax deductible charitable gift. Or give clothes, cash or securities before year-end to receive a deduction. The IRS now requires good recordkeeping in order to receive your deduction.
  • Manage your capital gains. This may seem strange since the market is down so much but many people have sold stocks held for decades that still had gains. Even more frustrating, many mutual funds have had to sell profitable stock positions to meet redemptions from shareholders. As a shareholder, you must report your share of these profits even if you have nothing but losses in the mutual fund. Contact the mutual fund company now to find out what, if any, capital gains will be distributed for 2008. Then look for losses in other holdings that you can take to offset gains. Also, avoid buying new shares of mutual funds until after they have distributed capital gains. Remember that up to $3,000 of losses taken in excess of gains are deductible against ordinary income taxes.
  • Buy a home. First-time home buyers receive a whopping $7,500 tax credit that is repaid over 15 years. Combine this with very low mortgage interest rates (currently under 5% for a 30-year fixed mortgage) and great housing deals and this may be the best tax strategy of 2008.
  • Invest in your retirement. There’s still time to max-out your company retirement contribution and receive a company matching contribution. And you have until April 15, 2009 to contribute to an IRA. 
Consult with your own tax advisor before December 31 to discuss your particular facts and circumstances because many tax strategies are no longer available after the end of the year.