Small Business Taxes & Management

News On The Tax Front--The latest tax news.

Year-End Planning for Individuals

Year-End Planning for Businesses

In Brief:--Tax, business, and personal finance tips.

News On The Tax Front

Previously Reported In Daily Update

In recent years, the booming real-estate market has helped increase mortgage fraud and other phony real estate-related schemes. The perpetrators of these schemes range from mortgage brokers looking to make a fast buck to drug dealers laundering their ill-gotten gains. Every year, these fraudulent schemes victimize individuals and businesses from many walks of life, including struggling low-income families lured into home loans they can't afford, legitimate lenders saddled with over-inflated mortgages and honest real-estate investors fleeced out of their investment dollars. Through federal tax-fraud investigations and money-laundering charges, the IRS is playing a key role in the fight against real-estate fraud. The number of real-estate fraud investigations initiated by IRS Criminal Investigation (CI) doubled in just two years (from 107 during the 2001 Federal Fiscal Year to 215 during FY 2003, which ended Sept. 30). In addition, the IRS has more than 4,000 returns under audit involving individuals and entities associated with the real-estate business. Some of the more common schemes seen by IRS criminal investigators include:

• Property flipping--A buyer pays a low price for the property, then resells it quickly for a much higher price. When this involves false statements to the lender, the transaction is not legal.
  
• Two sets of settlement statements--One settlement statement is prepared and provided to the seller accurately reflecting the true selling price of the property. A second fraudulent statement is given to the lender showing a highly- inflated purported selling price. The lender provides a loan in excess of the property value, and after the loans are settled, the proceeds are divided among the conspirators.
  
• Fraudulent qualifications--Real estate agents assist buyers who would not otherwise qualify by fabricating their employment history or credit record.

In these real estate fraud cases, money laundering is often the mechanism used to hide income from the government. Many criminal tax investigations focus on money laundering because it is often inseparable from tax evasion. For additional information, see IRS fact sheet FS-2003-18.

If you're making a deal with the IRS, make sure you understand it fully. In Stanley R. Harbaugh, et ux. (T.C. Memo. 2003-316) the taxpayer believed that after calling the IRS he entered into an agreement under which he would be required to pay a total amount that was less than he owed. That is, after making 36 payments, he would owe nothing more. The IRS contended that an installment agreement, not an offer in compromise, was made. The IRS argued that, according to guidelines set forth in the Internal Revenue Manual, amounts that were accrued but unassessed at the time of the first call, such as interest and penalties, would not be covered by the installment payments, and would remain due even after all of the installment payments had been made. The Court noted the taxpayers did not submit a written offer in compromise to the IRS. They also do not claim to have received a written acceptance of the purported agreement from the IRS. Without satisfaction of these procedural elements, the Court held it could not find that a valid compromise was made. The Court also said the employee with whom the taxpayer spoke did not have the authority to compromise the taxpayer's liabilities. The Court did find that the IRS employee mislead the taxpayer and, for that reason, a portion of the total interest on the principal amount should be abated.

Who is the taxpayer, corporation or sole proprietorship? If you set up a corporation (or other entity) through which to transact your business, make sure you follow the rules. In Peter Wood (T.C. Memo. 2003-315) the IRS used the bank deposits method to reconstruct the taxpayer's income from his jewelry business. The taxpayer claimed to have conducted business through a corporation. However, the Court noted that during the years at issue, the corporation, Native Skies, Inc., was inactive. During those years, no corporate bylaws and no minutes of any meetings of Native Skies, Inc., existed. During two of the years, the corporation did not file an annual registration form with the Secretary of State and was not in good standing in the State of Minnesota. The corporation did not file any federal income tax return, any federal employment tax return, or any information return with the IRS for any of the years at issue. Nor did Native Skies, Inc., issue any Form W-2 or any Form 1099 for any of those years. The Court found that the business was operated as a sole proprietorship, and not through a corporation. In addition, the Court found the taxpayer liable for failure to pay estimated taxes and failure to file.

Interest on business debts is generally deductible. But personal interest, with a few exceptions is not deductible. In Daniel V. Alfaro, et ux. (2003-2 USTC 50,715; U.S. Court of Appeals, 5th Circuit) the taxpayer challenged the Temporary Regulations (1.163-9T(b)(2)(i)A)) and argued that interest on a tax deficiency attributed to his sole proprietorship should be deductible. The Court affirmed the Tax Court's decision, held the interest not deductible and cited the decision in E.A. Robinson III.

No matter how valid your deductions, without documentation substantiating them, the IRS and Courts can disallow them. In Herbert C. Buck (T.C. Memo. 2003-314) the Court found the taxpayer did not comply with the substantiation and recordkeeping requirements. The Court found the taxpayer's testimony to be general, conclusory, vague, self-serving, and uncorroborated in material respects and refused to rely on his testimony to support his position with respect to the claimed deductions. In addition, the Court found the taxpayer liable for the accuracy-related penalty because of negligence or disregard of the rules or regulations with respect to his recordkeeping.

Form 2848, Power of Attorney and Declaration of Representative, is used to authorize a person to represent a taxpayer before the IRS. This person must be eligible to practice before the IRS--in other words, be an attorney, CPA, enrolled agent, enrolled actuary, or one of the other individuals identified on the form. Taxpayers occasionally submit Forms 2848 listing ineligible representatives. IRS practice has been to treat these invalid powers of attorney as tax information authorizations, which permit third parties to receive information about the taxpayer's account but not to represent the taxpayer before the IRS. This practice was permitted, but not required, under the disclosure regulations. Beginning January 1, 2004, the IRS will discontinue this practice and will reject a Form 2848 listing an ineligible representative. Taxpayers should use Form 8821, Tax Information Authorization, if they want the IRS to disclose their tax account information to a third party.

You may be able to recover your administrative and litigation costs if you win your case against the IRS. However, one of the requirements is that you must show the IRS was not substantially justified in the position it took. In Hung N. Nguyen (T.C. Memo. 2003-313) the taxpayer was able to show he was entitled to various tax benefits with respect to two children. But the Court noted that, based on the facts available to the IRS at the time the notice of deficiency was issued and the answer was filed, as well as long-standing legal precedent regarding the availability of tax deductions and credits, the Service's position had a reasonable basis in both law and fact and therefore was substantially justified. The Court also noted that, just because the IRS eventually concedes, or even loses, a case does not establish that its position was unreasonable.

Once your tax liability is ascertained, you can't argue that point at a Collection Due Process hearing. In Catherine Peters Bartolomeo (2003-2 USTC 50,706; U.S. District Court, West. Dist. Pa.) the Court held that, because the taxpayer did not file a Tax Court petition contesting her liability after receiving a deficiency notice, she could not bring up the issue at a Collection Due Process hearing.

The IRS can bring criminal or civil action or both. (And the double jeopardy rules don't bar the IRS from bringing criminal and civil charges.) The rules for securing records are different in criminal and civil cases. In Jeffrey Heubusch (2003-2 USTC 50,708; U.S. District Court, West. Dist. N.Y.) the IRS received a tip from an informant and seized a taxpayer's records. The taxpayer was indicted on several counts of tax fraud. He made a motion to suppress the documents seized pursuant to the search warrant. The motion was granted for several reasons. The documents were returned to the taxpayer at which time he was served with the administrative summons at issue in this case. The Court noted the IRS met the requirements for an administrative summons and allowed the Service to use those records.

Damage awards received on account of personal injury or sickness are generally not taxable. But this rule only applies to the actual damage award. In Chad Anthony Chamberlain (2003-2 USTC 50,711; U.S. District Court, East. Dist. La.) the taxpayer received over $3.5 million in interest on the award. The IRS contended the interest was taxable. The taxpayer argued that under Louisiana law prejudgment interest is deemed part of a damages award. The Court held that despite state law, federal law controls how such payments are treated for tax purposes and that the IRS was correct in taxing the interest received.

The IRS has announced (IR-2003-135) that Publication 17, Your Federal Income Tax, is now available online. You can download a version (caution, it's a big file) at www.irs.ustreas.gov/formspubs/lists/0,,id=97819,00.html. The printed version will be available in January. You can call 1-800-829-3676 for the print edition.

If you get a Form 1099-MISC you better report the income. If the 1099 is wrong, have the issuer correct it. In Vivian C. Kerr (T.C. Memo. 2003-311) the IRS claimed the taxpayer failed to report some $21,552 of nonemployee compensation contained on a 1099-MISC issued to him. The taxpayer argued he cashed the checks and returned the proceeds to the company for whom he was an independent contractor. He further argued he was an employee of the company, not an independent contractor. The Court found that it could not rule on the taxpayer's employment status and held that the Service's determination that he received $21,552 of nonemployee compensation was correct. The Court also found the taxpayer liable for the accuracy-related penalty. Note, a 1099 is generally prima facie evidence that you received the compensation, dividends, rents, etc. indicated.

Buildings, other than those for residential rental, are generally depreciable over 39 years. Special rules apply to some structures, including a retail motor fuels outlet (gas stations). Qualifying retail motor fuels outlets can be depreciated over 15 years. In order to qualify, more than 50% of the floor space or gross revenue from the facility must be from petroleum sales. In IA 80 Group, Inc. (2003-2 USTC 50,703; U.S. Court of Appeals, 8th Circuit) the taxpayer tried to argue that the main buildings qualify under the gross revenue test, based on the contention that gross revenue is calculated by considering the revenue attributable to the entire installation, not by dividing revenue on a building-by-building basis and that tenant related income should be ignored. The Court did not agree and sided with the IRS.

The IRS has announced that it is aware of certain transactions that use contested liability trusts improperly to attempt to accelerate deductions for contested liabilities under Sec. 461(f). This notice (Notice 2003-77; IRB 2003-49) alerts taxpayers and their representatives that these transactions are tax avoidance transactions and identifies these transactions, and substantially similar transactions, as listed transactions for purposes of Reg. Sec.1.6011-4(b)(2) and Secs. 301.6111-2(b)(2) and 301.6112-1(b)(2) of the Procedure and Administration Regulations. This notice also alerts parties involved with these transactions of certain responsibilities that may arise from their involvement with these transactions.

When it comes to claiming a deduction or other tax benefit, it's not only important to have the facts on your side, you may also have to perform all required procedures. In Norman W. Brissett (T.C. Memo. 2003-310) the taxpayer was denied a dependency exemption for his two children for the year at issue. The separation agreement provided that "In 1995 and thereafter, Husband shall be entitled to claim both children as his dependents provided Husband is current on his child support payments. If Husband is in arrears with regard to his child support payments Wife shall be entitled to claim the children as her dependents. The parties agree to mutually execute and provide all tax forms necessary in this regard for the other." A noncustodial parent is entitled to the dependency exemption only if he or she attaches Form 8332 (Release of Claim to Exemption for Child of Divorced or Separated Parents), which the taxpayer failed to do. The taxpayer argued he was current on the child support. While the Court sympathized, it said the letter of the law was clear and held the taxpayer was not entitled to a dependency exemption because he did not attach Form 8332 to the return.

In limited situations, taxpayers filing joint federal income tax returns may be relieved from joint and several liability pursuant to section 6015. Known as innocent spouse relief, the taxpayer must satisfy a number of requirements. In Nora Aranda (T.C. Memo. 2003-306) the wife sought innocent spouse treatment. The taxpayer failed to meet all the requirements. The Court noted that while the notice of determination is ambiguous regarding the nature of, and basis for, respondent's determination that petitioner is entitled to partial relief from joint and several liability for assessments for two years, the notice of determination is clear that the IRS granted partial relief only. The Court also noted the taxpayer introduced no evidence beyond the stipulated facts to prove she had no knowledge or reason to know that here returns for the two years at issue had understated their tax liability or that it would be inequitable to hold her liable for the assessments.

Arguing the law is inequitable or that the court isn't fair isn't worthwhile. In Lawrence Moore (T.C. Memo. 2003-307) the taxpayer made various arguments as to why he should not be liable for the AMT (alternative minimum tax). In these arguments, he called into question the integrity and fairness of the Court,and made various generalized assertions that the IRS acted inappropriately, both with respect to him and with respect to society as a whole. The Court found the taxpayer's arguments to be unfounded and frivolous. Despite the fact that this was the second time the taxpayer brought this issue to the Court and lost (he also took the case to the Court of Appeals and lost), the Tax Court did not assess any of the potential $25,000 penalty where it appears that proceedings before the Court have been instituted or maintained by the taxpayer primarily for delay or that the taxpayer's position is frivolous or groundless.

The IRS has issued guidance on information reporting on dividends from foreign corporations under the provisions of the Jobs and Growth Tax Relief Reconciliation Act of 2003, which provides for a 15-percent (5-percent for taxpayers in the 10 and 15-percent tax brackets) tax rate for certain dividends received by individuals. Notice 2003-79 provides guidance for persons required to prepare Form 1099-DIV and other information reporting with respect to dividends from foreign corporations and for individuals receiving such forms. Form 1099-DIV for 2003 includes a separate box identifying the amount of dividends eligible for the 15-percent (or 5-percent) tax rate. A dividend paid by a foreign corporation is eligible for the reduced tax rate if it satisfies the special rules applicable to foreign dividends under the 2003 Act. For 2003 information reporting, the Notice provides simplified procedures for applying these special rules in connection with the reporting of foreign dividends on Form 1099-DIV.

Before leaving for Thanksgiving, Congress sent to President Bush the Medicare bill with $24 in tax cuts. The bill establishes a new type of tax-free savings account, the Health Savings Account or HSA, that allows individuals with high-deductible health insurance plans to save for medical expenses. The plans are similar to MSAs, but can be used by any individual, unlike MSAs which are limited to self-employed and small business employees. Individuals with annual deductibles of $1,000 (individual coverage) or $2,000 or more for family coverage can contributed between $1,000 and $5,000 for self-coverage or between $2,000 and $10,000 for family coverage in pretax income during a year. Withdrawals for qualified medical expenses, over-the-counter drugs, long-term care services and COBRA insurance would not be taxed. Unqualified distributions would be taxable income and subject to a 10% penalty tax. The bill would also create a subsidy designed to encourage employers to continue to fund drug benefit plans for retirees. The maximum subsidy would be $1,330 for each beneficiary.

The U.S. and Japan have signed a convention (JS-975) that eliminates the withholding taxes on royalty income, certain interest income, and dividends paid to a parent company, as well as ensuring treaty benefits for investments made through partnerships.

Year-End Planning for Individuals

Introduction

You still have some time left if you want to do some serious year-end tax planning. However, you can't wait too much longer. We'll deal with your personal return first, then cover business planning. If you have your own business please read both sections before taking any action.

Don't underestimate the importance of year-end planning. You can save big tax dollars by deferring or shifting income from one year to another. Next year is too late; even the end of December may be too late for some techniques.

Caution--Before taking any tax action, evaluate all the factors surrounding the decision. Don't risk an economic loss for a small tax saving. Even if you're in the highest bracket (figure federal and state), a $1 tax deduction won't save more than about 40 cents in taxes.

New For This Year

Long-term capital gains realized on or after May 6, 2003 are taxed at 15%. For taxpayers in the 10% or 15% bracket, the rate is 5%. Capital gains realized before that date are taxed at 20%, 10%, or 8% (if held 5 years).

Qualifying dividends are taxed at the same rate as capital gains--15% for most taxpayers; 5% for those in the 10% or 15% bracket. This rule applies for all qualifying dividends received in 2003. Most dividends from domestic corporations qualify. For more details see Part III of our update on the Jobs and Growth Tax Relief Reconciliation Act of 2003.

The new law lowered the income tax rates for all taxes. The new rates are reflected in our Tax Tables.

Getting Started

Estimating your income. This is the first step. You can't take action if you don't know where you stand now. Assemble your records for the first 10 or 11 months of the year. If you record income and expenses on a regular basis, this should be a snap. If not, doing it now is vital for tax planning and will make tax filing easier next spring.

• Interest and dividends. You won't have 1099s, but you should have a good idea of your interest and dividend income. Check your last statements from your broker, mutual fund, etc. and annualize the amount (use the year-to-date amount, divide by the number of months the statement covers, then multiply by 12). Caution. Annualizing may not work for dividend income. Alternatively, use last year's amounts and adjust up or down. Don't forget about any trust income, or passthroughs from S corporations and partnerships.

• Salary income. This one is easy. You should have cumulative pay stubs that show gross income and taxes withheld. Annualize them as described above. Adjust for bonuses.

• Business income. If you have income from a Schedule C (sole proprietorship), S corporation, or partnership, you'll need those numbers. We'll deal with this in our next issue.

• Rental income. If you have rental properties, you'll need to come up with an income estimate. Before annualizing the income or loss for the first 10 or 11 months, be sure there are no unusual factors. For example, if you incurred big repairs earlier in the year, you may have to adjust for that. Not sure of how much depreciation to use? You won't be too far off if you use last year's number (unless 2002 was a partial year).

• Pensions, etc. If you're receiving pension income, be sure to factor it in. Also include IRA or other qualified plan withdrawals that you didn't roll over. These can be significant.

• Capital gains. For many taxpayers this is an important factor and difficult to predict. Moreover, this is where you can do considerable tax planning. Get all your buy/sell tickets and match them up to find your gain or loss on every transaction. Total short-term gains and losses, then long-term gains and losses (property held more than 12 months). You'll also have to split the gains and losses into pre-May 6, 2003 ones and those on and after May 6, 2003.

• Also check for distributions from mutual funds. While a large distribution this year is unlikely (many funds have carryforward losses), if you have significant interests in funds, you can't ignore the possibility. You may also be able to call the fund to see what the year-end distribution will be.

• Other income. Did you sell your main or vacation home, win any prizes or awards, settle a lawsuit, receive alimony, etc.? Get a state or local income or real estate tax refund? You could have additional taxable income. Also consider insurance reimbursements you received this year for medical expenses you deducted in an earlier year.

• Principal residence sale. If you sold your principal residence, there's a good chance you'll owe no tax on the sale. If you're single, the first $250,000 of gain should be exempt. If you're married, you can exclude the first $500,000. However, before you go to the next topic, think again. If you're a long-time home owner, you could have broken this threshold. Remember, you'll have to consider gains deferred on prior sales in the past. The exclusion also contains a number of restrictions. Finally, even if you don't owe any federal taxes, you still could be liable for state income taxes on the sale.

• Nontaxable income. Some income escapes taxes. That includes gifts and inheritances, interest on most municipal bonds, returns of capital (e.g., principal repayments on a loan), reimbursements from your employer for business expenses, etc. Make sure you don't count any items as income if they're not.

• Check last year's return. Many items repeat year after year. You may find some income you hadn't considered.

Estimating your expenses and deductions. You've also got to come up with an estimate of your deductions. The items below are common deductible expenses.

• Alimony. If your divorce was structured properly it should be deductible. However, payments that are really part of a property settlement or child support aren't deductible. Conversely, alimony is taxable to the recipient; property settlements and child support aren't.

• Contributions to SEP, IRA, Keogh, etc.

• If you're self-employed or a shareholder in an S corporation, you may be entitled to deduct 100% of health insurance premiums you paid. The remainder may be deductible as an itemized deduction.

• Medical expenses. Add up all your expenses. Include medical insurance premiums not deducted elsewhere, doctors, dentists, hospitals, travel to and from the doctor, etc. Also include medical appliances such as glasses, hearing aids, etc. Of course, reduce the amount by any reimbursement from insurance. Your deduction is limited to the amount that exceeds 7.5% of your adjusted gross income (AGI).

• Taxes. Include real estate taxes, state income taxes paid in 2003, and personal property taxes. When adding your taxes be sure to include any payments made when you filed your 2002 state return.

• Interest. You're generally limited to interest on a home mortgage, including a mortgage on a second home and a home equity loan with a principal amount of no more than $100,000. Interest to purchase an interest in an S corporation or partnership is also fully deductible (but not on Schedule A). Interest on other investments may or may not be deductible. Compute the total amount; we'll discuss planning later.

• Charitable contributions. Go through your receipts and checkbook. You may receive a notice from your church at the end of the year. For now you can use an estimate.

• Casualty or theft loss. It's got to be a big one. Only losses that exceed 10% of your AGI, plus $100 per casualty are deductible.

• Miscellaneous deductions. Include professional or union dues not reimbursed by your employer, tax preparation fees and books or software to help you prepare your return, investment expenses, safe deposit box rental, job-related education, and unreimbursed employee business expenses. If you work out of your home that can include a second telephone line, etc. Remember, only the amount over 2% of your AGI is deductible.

Finding your tax bracket. If you've got a good handle on your income and expenses you can net the two to arrive at your taxable income. Be sure to also subtract out personal exemptions ($3,050 each for yourself and spouse and dependent children). If your AGI exceeds $139,500 your itemized deductions may be limited.

If you're pretty confident of your computations, you can find your tax bracket by using the Tax Tables in our Reference File. Keep in mind that long-term capital gains are taxed at a lower rate. The rules for 2003 depend on when the sale took place. Go to our Tax Tables for the details.

Also consider your filing status this year and next. If you're going to get married or divorced next year, that can drastically affect your tax bracket. (If you'll be single with a dependent child you'll be able to file for head of household status.)

If things look too complicated, and you don't want to talk to your tax adviser, get a computer program. Final or planning versions of popular programs should be available by now.

Taking Action

Tax rate differences. This is a basic tax-planning strategy. If you're in a high bracket this year but expect to be in a lower one in 2004, you want to defer income to next year (or accelerate deductions to this year). CAUTION. Be careful not to overdo it. You could end up pushing yourself into a higher bracket next year. Conversely, if you expect to be in a higher bracket next year, you may want to accelerate income into 2003 and delay deductions. The rates for this year are lower than last, but they won't go down again until 2006.

Another point. Many benefits are phased out for taxpayers above certain AGI thresholds. For example, if both you and your spouse are covered by a pension plan, you can't make deductible contributions to an IRA if your modified AGI exceeds $70,000. (Phaseout begins at $60,000.) Because there are a number of these phaseouts, and they occur at various AGI amounts, you can't plan for all of them. However, you should be especially careful as your income approaches $100,000. And one phaseout can be critical. For married taxpayers filing jointly, the Hope and lifetime learning credits are phased out for AGI levels between $83,000 and $103,000. If you have two children in college and they would both qualify for the Hope credit of $1,500 each, you could lose $3,000. You may want to defer income from this year into next, (or vice versa if they'll be starting school next year) to maximize use of the credit.

Example--For 2003 you're in the 25% bracket. Because you expect to close a big deal in 2004 you anticipate being in the 33% bracket, but you project falling back to the 25% bracket in 2005. Accelerating income into 2003 might make sense. Use caution. You can overdo it.

How big can the saving be? The difference between 33% and 25% is 8%. If you can shift $10,000 from the high tax year to the low one, the saving is $800. Shift $25,000 and the saving would be $2,000. Business owners might be able to save more. If the rate differential is 20%, (e.g., from the 35% bracket to the 15% one) shifting $25,000 of income can result in a tax saving of $5,000.

Deferring income. How do you defer income? (The discussion here doesn't include business income on a Schedule C. We'll deal with that in the next article.) There aren't too many options on your individual return, especially this late in the year. And keep in mind that you can't avoid income by simply not cashing the check.

• Delay collections where possible. If you have rental income, don't bill the tenant until it's too late for the check to arrive in 2003. (See below if you rent property to your business.) If you're self-employed you can use the same approach for clients (if you're on the cash basis of accounting).

• Defer compensation. If you receive a salary you may be able to defer some year-end compensation to next year. Talk to your employer. Get a written agreement. There's a danger here. Because the arrangement cannot be secured, you could lose if your employer has financial difficulties.

  If you have a stake in the company, it gets trickier. Deferring compensation may not have any effect if you're a shareholder in an S corporation. Deferring $20,000 of salary will only mean you'll have that much less salary income and the S corporation will have $20,000 less in deductions. The additional net income will be passed through to you. So if you're the only shareholder, it's a wash.

  In the case of a regular corporation, the corporation will lose the deduction if you have more than a 50% interest in the business. The amount will only be deductible when paid.

• Year-end bonuses. The same advice applies here as to deferring compensation. The business can generally deduct an accrued bonus to employees if paid within 2-1/2 months of the end of the year. However, that doesn't apply if you're a more than 50% shareholder in a regular corporation or if you have any ownership interest in an S corporation or partnership. In that case, the business gets a deduction in 2003 only if the amount is paid this year.

• Stock options. If you receive incentive stock options (ISOs), you don't have any taxable income until you sell the stock, so you might consider delaying a sale till next year. CAUTION. The bargain element of the option (the difference between the option price and the market value at the time of exercise) must be recognized this year for alternative minimum tax purposes. The alternative minimum tax is likely to be more of an issue this year.

  If you received any nonqualified options, it's generally unlikely that the receipt will result in taxable income (but check with your tax advisor or your employer to be sure). You will, however, have taxable income when you exercise the option. Thus, consider delaying exercise till next year.

• Longer term planning. It's really too late to defer interest and dividend income. However, a commercial annuity will defer tax on any future income. You might also consider Treasury bills or bank certificates of deposit with a term of one year or less as a way to defer interest for a year. (E.g., all the interest on a T-bill purchased on January 15, 2004 that matures January 14, 2005 would be taxable on your 2005 return. You may be able to defer payment of the taxes to 2006.

Accelerating deductions. In addition to deferring income, one way to lower your taxable income in 2003 is to accelerate deductions. Here are some options.

• Pay all taxes due in 2003 before the end of the year. For example, you're billed for your real estate taxes in December, 2003. You can pay them as late as January 31, 2004 without penalty. Pay them in 2003.

  The same applies to personal property and state income taxes. Estimate your 2003 state income tax liability. If you're underwithheld or haven't made enough in estimated payments, pay any shortfall before December 31.

• Pay all interest due before the end of the year. CAUTION. You can't prepay interest that's actually due next year.

• While most taxpayers can't deduct miscellaneous itemized deductions because only the amount in excess of 2% of your AGI is deductible, you may be able to vault that threshold by bunching some expenses. For example, you may be billed for professional dues in December, but you usually pay them in January. Pay it in December. The closer you are to the 2% threshold, the more diligently you should search for additional expenses. For example, the $25 for a safe deposit box, investment newsletters and magazines, fees for financial advice, tax preparation, etc.

• Bunching makes even more sense for medical expenses. Here there's a 7.5% threshold. Take that physical before the end of the year, get new glasses, pay off the orthodontia bill early, etc. If you, your spouse or a dependent has a physical handicap, the cost of a wheelchair ramp, lowered cabinets, special bathroom fixtures, etc. may be tax deductible. Check with your tax advisor. The amount can be substantial and could easily put you over the 7.5% floor. When doing your calculations be sure to include any medical insurance premiums (that can't be deducted as a self-employed individual).

  Conversely, if there's little chance of making the threshold, but there's a good chance of busting the limit next year, put off elective medical expenses.

• Maximize any pension plan contributions. That includes IRA, SEP, Keogh plan, 401(k) plan. Make the maximum contribution possible. You can wait until tax filing time to set up an IRA or SEP, but a Keogh plan must be set up before December 31. Any one with self-employment income (e.g., a sole proprietorship) can set up an SEP or Keogh.

  If you do business as an S or regular corporation you can set up a regular qualified pension, profit-sharing or 401(k) plan. However, you must act quickly here. This can take time to set up and must be done before yearend.

• Home office expenses. If you can claim a deduction for an office in the home fill the oil tank, pay homeowner's insurance premiums, do repairs (capital improvements must be depreciated), pay utility bills on time, etc. If you have your own business or your employer asked you to work from home, you may qualify.

• Charitable contributions. Cash and credit card payments before the end of the year count; pledges don't. You've got considerable opportunity here to accelerate deductions.

  Cash, check or credit card payments are best. If the contribution is over $250, get a receipt. If you make charitable donations of property of more than $500 you'll have to file a special form. Donate more than $5,000 of similar property and you'll need an appraisal. You might want to avoid those thresholds.

  You might investigate a charitable lead or unitrust. You can deduct much more, but this is not a planning move to be taken lightly. Get good advice.

• The big bunch. You're entitled to a standard deduction of $9,500 if married; $4,750 for a single individual (check our reference tables for other filing situations). If you don't normally itemize, but may exceed the threshold by bunching expenses this year, consider doing so. The idea is to use the standard deduction and defer deductions in a year when you won't break the standard deduction threshold (e.g., you don't have more than $9,500 in deductions if married) or just exceed it by a little. Save those deductions for a year when you can use them. All expenditures count here--medical (only those over the 7.5% threshold), taxes, interest, charitable contributions, etc.

Caution--Your itemized deductions are reduced by 3% of the amount by which your AGI exceeds $139,500. For example, if your AGI is $170,000, you must reduce your itemized deductions by $915. If you may fall into this trap this year, but not next, accelerating deductions may not make as much sense.

Caution--Some items are not deductible for alternative minimum tax (AMT) purposes. They include taxes, certain interest on a home mortgage, and miscellaneous itemized deductions. In addition, only medical expenses that exceed 10% of your AGI are deductible. So taking big deductions for taxes could trigger an alternative minimum tax problem. See below for a more detailed discussion of the AMT.

How to pay. If you're a cash-basis taxpayer (almost all individuals are), you can deduct payments made by December 31. There's no problem with cash (get a receipt). Checks must be in the mail by December 31. Do it a few days earlier to avoid having to prove the mailing date. Credit card payments are considered made when you sign the authorization slip, even if you don't pay off the card for some time. IOUs or notes don't count until they're actually paid.

Accelerate income--defer deductions. What if you think you'll be in a higher bracket next year? For example, you know you'll be closing on a big deal, or you're selling a business and you'll have a lot of ordinary income on the sale. Another twist involves the alternative minimum tax (AMT). If you're going to be hit with it no matter what you do, accelerate income into 2003. The AMT tax rates are 26% and 28%. (This requires careful planning.) You may want to bring as much income into 2003 as possible. Some techniques are just the reverse of what we've discussed above. Here are some other thoughts.

• If you do business as a sole proprietorship or have rental properties, make sure all bills are out early. Talk to your customers; offer a discount for early payment. The same advice applies to S corporations, partnerships, and LLCs since the income is passed through to the owners.

• If you do business through a regular corporation and your tax advisor has suggested taking a dividend, this might be a good time. Particularly if you're in the 10% or 15% bracket.

• Should you reduce or avoid making contributions to your IRA, Keogh, or other type of qualified plan? Generally, no. Once you pass up on a year, it's gone forever. The exception might be if you're young or can make up for it by making a much larger contribution next year.

• While it's pretty drastic, you might want to take money out of your IRA or other qualified plan. That may make sense if you're currently in the 15% bracket, won't owe the 10% penalty on early withdrawals, will be in a higher bracket in future years, and would be taking money out of the plan soon anyway (e.g., for business needs). However, if you owe the penalty, you might want to consider other options. There are a number of exceptions to the early withdrawal penalty. One is for college tuition payments.

• Convert some or all of your regular IRA to a Roth IRA. You'll pay tax on the income, but there's no penalty. Future withdrawals from the Roth will be tax free.

• If you're currently in the 10% or 15% bracket consider selling stock with a gain. If you're in this bracket, capital gains are taxed at no more than 5% (post May 5, 2003), if held more than 12 months. CAUTION. Capital gains may receive favorable treatment from a rate standpoint, but they still affect your AGI. Thus, the income could affect your ability to claim itemized deductions, contribute to an IRA, etc.

• Take a bonus. If you work for someone else, ask if you can get your bonus early. If you do business as a C corporation, increase your salary. But be careful here. See the discussion below on marginal tax rates.

• Stock options and restricted stock. If you received restricted stock you can make an election to be taxed on the amount currently. Get expert advice here. You can't undo the election and it could backfire. If you received incentive stock options, exercise the option and dispose of the stock.

• Cash in savings bonds and take the interest. Watch the maturity dates. Cashing in at the wrong time can be costly.

• Installment notes. If you made a sale on the installment basis in a prior year, you might consider taking the deferred gain now. You might be able to take part now and leave a portion deferred.

Caution--A significant portion or even all of the gain may be capital in nature. Capital gains will be taxed at no more than 15% (possibly as low as 5% if you're in the 10% or 15% bracket). Keep that in mind when doing your analysis.

How do you collect on the installment notes? The most straightforward way is to ask the buyer to pay the balance of the note before the end of the year. If that doesn't work, you might be able to sell the note to a third party. Unless the interest rate is attractive, you may have to take a discount. Factor that into your analysis. Finally, if you pledge the note as collateral for a loan, the note will be deemed to be paid.

Delaying deductions may be fairly easy to do. Just don't pay the bills. If real estate taxes are due late in the year you might delay payment to next year. Take into account any late payment penalty. It's best not to delay paying your home mortgage. You don't want to hurt your credit rating. Charitable contributions can be put off till next year.

You might also delay some medical expenses such as a routine physical, payment of medical insurance, etc. However, if you might make the 7.5% threshold this year, but not next, it makes sense to take the deduction this year. A deduction at 15% is still worth more than no deduction at all.

Before taking action also consider any potential changes in your life that could affect your taxes. A divorce or marriage can significantly affect your tax bracket. So can the loss of exemptions, e.g., children leaving the nest--or a new addition. Retirement, loss of a job, an inheritance (IRAs, pensions, etc. left to you can be taxable) all can affect your bracket and taxes.

Generating cash. If you need cash for your business, a new home, college tuition, etc. planning ahead can save you taxes.

• IRA withdrawals can escape the penalty tax if the money is used for college tuition. You need the cash early in 2004 but don't want the income next year. Or you need $20,000 and that will put you into a new bracket. Consider taking some of the funds this year, some next.

• You can avoid paying tax on IRA withdrawals if you can replace the money within 60 days. You might be able to extend that by taking money from another account to replace the first.

• If you want to accelerate installment payments, pledge or sell some of the notes this year, some next. That'll spread the income and might allow you to put capital gains in more than one year. Those gains may be useful for offsetting market losses next year.

Alternative minimum tax. The idea behind this tax (AMT) is to make sure even taxpayers with big deductions pay at least a minimum amount of tax. The tax rate is 26% on the first $175,000 of alternative minimum taxable income (AMTI), and 28% on amounts above that level. While the rate sounds attractive, your AMTI is sure to be higher than your regular taxable income. That's because you can't deduct taxes, some home mortgage interest and miscellaneous itemized deductions. Your deduction for investment interest may be limited and your deduction for medical expenses is only the amount that exceeds 10% (not 7.5%) of your AGI. Income from certain municipal bonds that's tax- exempt for regular income tax purposes may be taxable for AMT purposes.

In addition, you may have to increase your AMTI for excess depreciation from rental properties, S corporations, partnerships, or a Schedule C (sole proprietorship). Other adjustments include income from the exercise of incentive stock options, any difference between regular taxable income and AMTI from certain passive activities, and adjustments for depletion and intangible drilling costs. While there are some other adjustments, you're unlikely to encounter them.

Most of these adjustments will increase your AMTI. You're allowed an exemption ($58,000 married, filing jointly; $40,250 for a single individual or head of household), but it's phased out if your income exceeds $150,000 (married, joint) or $112,500 (single). Finally, if you pay the AMT as a result of a timing adjustment (e.g., depreciation), you may be entitled to a credit on next year's tax.

Sounds complicated? It is. It's pretty tough to plan for this tax without going carefully through the math or using a computer program. There's a lot of interaction. Here are some thoughts:

• If you're definitely going to get hit by the tax this year, and will be in a higher bracket for regular taxes next year, you might want to postpone some deductions such as taxes, interest, etc. Save the deductions for when they can be used.

• For a similar reason, you might want to accelerate income into this year, when it will be taxed at a lower rate. Careful. If you over do it, you could end up paying tax using the regular system at higher rates. And, it could create a minimum tax problem next year.

• If you exercised incentive stock options that will trigger the AMT, consider disposing of them before the end of the year. Evaluate all the pros and cons carefully, however.

Investment Strategies

The is one of the best areas for tax planning. And, you've generally got till nearly the end of the year to act. There are plenty of good ideas in the discussion below. Just keep in mind that investment objectives should take precedence over tax saving motives.

Assess your positions. The first step is to find out where you stand. That is, list all your positions (stocks, bonds, and any other investments that you might consider selling). Include the date purchased, the purchase price, adjustments (reinvestment of dividends increase your basis, stock dividends and splits affect your basis, etc.), your adjusted cost basis, and the current market value. Then you can determine whether you have a gain or loss and how much. Here's a summary of the rates:

• Property held no more than 12 months is taxed at ordinary income rates.
  
• Property held more than 12 months is taxed at no more than 15% (5% if you're in the 10 or 15% bracket. (Sales made before May 6, 2003 are taxed at 20% and 10% (8% if held more than 5 years.))
  
• Collectibles (antiques, etc.) are taxed at no more than 28% if held more than 12 months.
  
• Depreciation recapture on real property is taxed at 25%.

Note. If you sold property on an installment basis, the tax rate is based on when the money is received, not when the sale was made. That is, you'll get the benefit of the new rates on property you sold on the installment basis some years ago.

Check your mutual fund or brokerage statement carefully. Some gain may be taxed at 25% (the depreciation recapture) if you invested in a REIT (real estate investment trust) or you or your S corporation or partnership sold real estate.

Within each rate group, gains and losses are netted to arrive at a net gain or loss. The following additional netting and ordering rules apply. Short-term capital losses (including short-term capital loss carryovers) are applied first to reduce short-term capital gains, if any, otherwise taxable at ordinary income rates. A net short-term loss is then applied to reduce any net long-term gains from the 28% group, then to reduce gain in the 25% group, and finally to reduce net gain from taxed at 20% or 15%.

For long-term gains and losses, a net loss from the 28% group (including long-term capital loss carryovers) is used first to reduce gain from the 25% group, then to reduce gain from the 20% or 15% group. A net loss from the 20% or 15% group is used first to reduce net gain from the 28% group, then to reduce gain from the 25% group. Any resulting net capital gain that's attributable to a particular rate group is taxed at that group's marginal tax rate.

Fortunately, you're likely to only have to worry about short-term gains and losses and long-term ones. That will make planning easier.

Careful timing of your capital gains could produce some permanent tax savings. For example, you've got some stock with potentially (you haven't sold it yet) $3,000 of long-term (15%) gains. You've already sold stock that generated $3,000 in short-term losses. You don't think you can generate any short-term profits to offset the loss. It might make sense to hold off on taking the long-term gain. You can use the $3,000 loss to offset ordinary income this year. Then take the long-term gain next year and pay taxes at only 15%. In other words, you're taking a deduction at, say 35%, and paying taxes at 15%.

Unfortunately, the market may not cooperate. You don't want to risk holding onto a stock that could decline in price, just to save some tax dollars. On the other hand, if you're selling real estate, it may be easy to postpone the sale into the following year. If you sell or sold property using an installment sale, you may also have some options in recognizing the income. Minimizing your tax bite isn't as easy as before. You'll have to work through the numbers. If the gains are substantial, consult your financial or tax adviser.

Even if you can't play the rate game described above, some approaches still work:

Sell capital gain property. If you've already realized some losses during the year, you might want to take enough in capital gains to offset the losses. If unused, the losses can be carried forward indefinitely and used to offset gains or up to $3,000 can be used to offset ordinary income in any one year. That may be small comfort if you've got a substantial loss carryforward. Analyze your positions to decide if you'll continue to have substantial gains in the future. If not, consider selling stock at a gain now to use the loss.

Generate losses to offset gains. If you've realized gains during the year, consider selling positions where you have a loss, but only after assessing the investment's potential. Don't forget that any mutual fund holdings (other than those in an IRA, Keogh, etc.) will probably generate some long-term capital gains through distributions.

Converting short-term into long-term gains. Gains on property held more than 12 months are taxed at no more than 15% now; stock or other investments held 12 months or less produce short-term gains taxed at ordinary income rates, up to 35%.

If you're near the critical 12-month mark, you might want to consider holding on for just a little longer to take advantage of the lower rates. You've got to balance that against the chance that the price could fall. Generally, the closer you are to the 12-month threshold, the more you should consider holding out. The extra return could be substantial.

Selling different lots. If you purchased shares at different times you can specify (do it in writing) to your broker which lot to sell. If you don't, the IRS assumes a FIFO (first- in, first-out rule applies). Selling the right lots can save considerable tax dollars.

Example--You bought 100 shares of Madison in 1990 for $4,000 and 100 shares in 1994 for $21,000. Madison's now trading at $100 a share so 100 shares are worth $10,000. You want to sell only 100 shares. If you tell your broker to sell the 1994 shares you'll have an $11,000 loss. If you don't specify which lot to sell, the shares bought for $4,000 in 1990 are the ones assumed sold and you'll have a gain of $6,000.

In the example above you could sell half your investment, take a loss, and still have a position in Madison, should a move to higher ground seem possible. The same rules apply to determine the length of the holding period. Sell one lot and you might have a short-term gain; sell a lot you held longer and you could have a long-term gain.

Another point. Even if both positions showed a gain, selling the one with the higher cost basis could reduce your position with the minimum amount of tax liability.

Caution--The rules are more complicated when it comes to mutual funds. There are several methods of computing cost basis. That topic is beyond the scope of this article. Mutual fund companies now provide cost basis information on year-end statements or will give you that information if requested by phone. But that's only one of your options.

Take the loss, regardless. If there's no chance of a comeback for the investment, consider taking at least some of the loss, even if you have no offsetting gains. Up to $3,000 of losses can be used against ordinary income. Additional losses can be carried forward to use against future gains or up to $3,000 a year can offset ordinary income. On the other hand, gains have to be reported in the year of the sale.

Collect bad debts. You cannot take a bad debt deduction for nonbusiness bad debts unless the debt is totally worthless. We can't go into details here, but most debts held by individuals are considered nonbusiness. You must be able to show you tried to collect the debt, but were unable to. This could take some time. Don't wait till the last minute.

Worthless stock. You can't just claim the stock is worthless. You have to be able to prove it. Even if the stock isn't quoted and the company is in bankruptcy, the IRS will claim it could recover. Sell the stock through your broker. If you can't, sell it to a colleague (get documentation).

Installment sale. An installment sale can spread a gain over several years. That may keep you out of a higher tax bracket and/or allow you to defer the gain to years when you might be in a lower bracket. In addition, that capital gain may be useful in later years to offset any capital losses. All that's necessary is that at least one payment is received in the next tax year.

Three cautions. You can't use the installment method for publicly traded stock and you've got be careful if you're selling tangible property. In the latter situation, any depreciation recapture is fully taxable in the year of the sale. It can't be deferred. Finally, you can't use the installment method if you're a dealer in that property. For example, you can sell a machine tool used in your business on the installment basis. On the other hand, if you're a dealer that sells such tools, you can't use the installment method.

Charitable contribution of appreciated stock. This is an old technique, but it works so well it's worth mentioning again. If you make a charitable contribution of stock that's appreciated in value you get to deduct the full fair market value as a charitable contribution. That's better than selling the stock and contributing the cash since you avoid paying capital gains tax and you also avoid increasing your adjusted gross income by the amount of the gain. The latter is important since many exemptions (e.g., the $25,000 rental real estate exemption) are based on your AGI. Caution. There are some special rules. The most important is that your deduction is limited to 30% of your AGI. Any excess can be carried forward, but only for 5 years. So don't overdo it. Consider a charitable lead or remainder trust.

Bond swaps. The idea is to sell bonds where you've got an unrealized loss, take the money and invest in bonds or other securities with a higher yield. This approach generally only makes sense if you can use the loss to offset other gains. The tax savings can be added back to the proceeds of the bond sale to provide additional capital.

Wash sales. You may have a loss in a position and want to take the loss this year, but like the stock and want to hold on. If you sell the stock (or bond) and purchase the identical security within 30 days (before or after), the loss will be disallowed. For example, you sell 100 shares of Madison Inc. at a loss on November 30, 2003. If you bought 100 shares of Madison Inc. on November 10, 2003 or December 20, 2003, the loss would not be allowed for tax purposes.

The easiest way out of this situation is to wait 31 days before repurchasing the same securities. The second approach is to buy stock of another company in the same industry that is expected to perform similarly. Later you can buy back into your original holding. And one emerging growth mutual fund is not the same as another emerging growth mutual fund. CAUTION. A S&P 500 Index fund run by Madison is the same as a S&P 500 Index fund run by Chatham.

Selling short against the box. In the past this technique could be used to effectively sell the stock (you got the cash and locked in the gain), without paying the tax. Moreover, you could defer the tax virtually indefinitely. That won't work any more. You can use the approach to postpone a gain for 30 days into the following year. However, after you close the position you'll have to hold the stock for 60 days. That can expose you to substantial risk. Talk to your broker or financial adviser before considering this approach.

Passive activities. Do you own an interest in a partnership or S corporation that is a passive activity in your hands? The general rule is that passive losses can only be used to offset passive income, or deducted in full when the passive activity is disposed of completely.

You've got several options. The first is to do nothing. Any unused losses can be carried forward. That may be small comfort since the losses are worth less and less each year because of the time value of money.

You might try selling the investment. There is now a fairly active market for some old tax shelter partnerships. That may be a smart move if it's unlikely the prospects for the investment will improve. Make sure you understand the basis rules when calculating your gain or loss. Those losses you took on your tax return in prior years reduced your basis. You could have a gain, or much less of a loss.

Try to generate offsetting passive income. This is a longer-term strategy. The income could come from rental properties, a regular business partnership or S corporation where you don't materially participate, etc.

Investment interest. As an individual, your interest deduction is generally limited to interest on a home mortgage, a home equity loan, and investment interest. Investment interest is interest incurred to buy investment property--usually stocks, bonds, etc. (But not tax-exempt bonds. You can't deduct any interest associated with them.) The rule is that any investment interest is limited to your investment income for the year. Any excess can be carried forward. Investment income includes interest, dividends, short-term gains, and, if a special election is made, long-term capital gains.

Example--You had $2,000 of margin interest during 2003. You had $700 of interest income from bank accounts and $800 of dividend income. That's a total of $1,500 of investment income. You can deduct $1,500 of the margin interest. The unused $500 of interest expense can be carried forward and deducted next year, if you have sufficient investment income.

It may be too late in the year to generate interest or dividend income, but you could create some net short-term capital gains by selling stock or bonds at a profit. Long-term capital gains can also be considered investment income, but only if you make an election to have them taxed at ordinary income rates. In some cases this election works, but you've got to run the numbers.

Investment interest doesn't have to come from a margin account, but you must be able to show the interest expense applies to the investments.

If you're a small business owner that operates through a regular corporation you may find yourself concerned about this trap if you borrowed money to purchase stock in the corporation, advanced equity capital, or loaned it additional funds.

Example--You borrowed $150,000 to purchase stock in Madison Inc. a regular corporation in which you have a 50% interest. You borrowed another $50,000 which you loaned to the corporation at 6%. During the year the corporation paid you $3,000 of interest on the loan. You paid interest of $25,000 on the $200,000 you borrowed. You have no other interest, dividend, or capital gain income. Since you only have $3,000 of investment income (the interest the corporation paid you) you can only deduct $3,000 of the interest. The remaining $22,000 can be carried forward.

Often the situation described in the example above won't reverse for several years. If the interest rate on the loan to the corporation were higher, you'd be able to deduct more of your investment interest. In some situations it might even make sense to pay a taxable dividend. There's no general rule here. Work through the numbers with your tax advisor.

S corporations and partnerships don't have this problem. Any such interest expense is deductible on Schedule E.

Other Strategies

Here's a list of other tax saving strategies.

• If your estate is substantial consider making gifts to your children or other relatives to use your annual $11,000 exclusion. Better yet, pay medical or tuition bills of a relative directly. That will reduce your estate without cutting into the $11,000 annual exemption.

• Analyze the spread between your tax rate and your children's. If they're in a lower bracket gifting appreciated assets to them and letting them sell them can save taxes. If you're in the 35% bracket and they're in the 10% bracket, you can save $250 on a $1,000 of short-term gain. On long-term gain property the savings will be less, but could still be significant. Remember, though, if they're not age 14 by December 31, their income is taxed at your rate.

• Make use of that same spread for interest and dividend income. Give your children income producing assets.

• December 31 is the last day to take gains or losses.

• Check your estimated tax payments. Refigure both state and federal taxes to make sure you've paid in enough to avoid a penalty. Generally, it makes sense to pay state taxes before the end of the year to get the deduction this year. If you're underpaid for federal purposes, have additional amounts withheld from your last paychecks. Withholdings are deemed to be spread throughout the year. That's a better approach than making a large estimated payment. It might allow you to avoid a penalty for underpayments earlier in the year.

• Can a side business be attacked by the IRS as a hobby? You can generally avoid the hobby loss taint if the business produces profits in any 3 of 5 consecutive years. You might want to defer some expenses to another year if you're close in 2003.

• If you incurred a casualty loss related to a Presidentially declared disaster this year, you may file an amended return and take the loss on last year's return.

• If you're a participant in a cafeteria or flexible spending arrangement, be sure to use any remaining balance in your account before the end of the year.

• Shareholder in S corporation? Partner in partnership? You can only deduct losses up to your basis. In an S corporation that's your equity investment plus any qualifying loans you made to the corporation, plus accumulated earnings, less distributions. If you don't have enough basis to use the losses, you might want to make an equity investment or loan the corporation funds. You should also check your basis before making any distributions or receiving any loan repayments. In some situations these can generate taxable income. Note. Any unused losses can be carried forward to later years. For partners, many of the rules are similar, but more complicated. Check with your tax advisor. For help in computing your basis, see our articles in recent issues and our S Corporation Basis and Partnership Basis forms.

• Year-end is also a good time to check on your savings bonds. They mature in 30 years. After that time the interest stops accumulating and all past interest is immediately taxable. Chances are you've got some old bonds floating around somewhere.

Other Considerations

IRA rules. You may be able make a contribution to a deductible IRA even though your spouse is covered by a qualified plan, just as long as you're not. Of course, if your AGI is below the threshold, you can make a deductible contribution regardless.

You can still convert a regular IRA to a Roth. But remember, the conversion will be taxable. Conversion makes sense if you're in a low bracket this year (e.g., your S corporation or partnership had a bad year). There are many tax implications. Talk to your advisor.

Credits. If you've got a child under age 17 you may be entitled to a $1,000 credit. There isn't much planning involved here. In fact, you may have gotten a $400 per child check recently. That means you'll only get another $600 when filing your return.

The Hope and lifetime learning credits are more significant, and you can do some planning. The Hope credit is allowed only on the first two years of college tuition. It's equal to 100% of the first $1,000 of qualifying expenses and 50% of the second $1,000, a total of $1,500 per child. There's no limit on the number of household members who can qualify at any time. The lifetime learning credit is limited to 20% of the first $10,000 of qualifying expenses (again, basically tuition) per year, per household.

Year-End Planning For Businesses

Introduction

The theory behind business tax planning is similar to planning for your personal return. You want to defer the income to a low tax rate year. If you do business as a sole proprietorship (i.e., file a Schedule C), S corporation, partnership, or LLC (limited liability company), income and losses of the business are passed through and reported on your personal tax return. Thus, your approach to year-end planning is similar to that for individual planning. (There are some factors that can complicate the issue; they're discussed below.)

The discussion below assumes you're business is on a December 31 fiscal yearend.

New For 2003

There are some changes for 2003 that could affect many business taxpayers:

• The Section 179 expense limit has increased to $100,000; the phaseout begins with $400,000 of qualifying purchases.
  
• The additional first-year depreciation is increased to 50% (from 30%) for qualifying property (new, tangible personal property and leasehold improvements) placed in service on or after May 6, 2003.
  
• First-year depreciation limits on vehicles have increased. In addition, higher first-year limits apply to trucks and vans.
  
• Dividends received by individuals will be taxed at no more than 15% (5% for those in the 10% and 15% bracket).
  
• The accumulated earnings tax and personal holding company tax rate has been reduced to 15%.

Keep in mind that businesses organized as S corporations, partnerships and LLCs pass their income and losses thru to the owners. Thus, the lower tax rates for individuals affect business planning for these entities.

C Corporations

Things get more complicated, and there's a chance to save more tax dollars, if you do business as a C (regular) corporation. Unlike an S corporation or a partnership, a C corporation is taxed as a separate entity. Moreover, the first $50,000 of income is taxed at only 15%. The next $25,000 is taxed at 25%; the next $25,000 is taxed at 34%. Taxable income from $100,000 to $335,000 is taxed at 39%. (That's to eliminate the graduated rates on income below $100,000.) You may be able to take advantage of the graduated rates to substantially reduce this year's tax bite. The approach is called 'marginal tax rate analysis' and it's very effective.

Example--Fred Flood is an employee and the sole shareholder of Madison Inc., a C corporation. Based on Fred's best estimates, Madison will have taxable income of $125,000 during 2003. So far this year, Fred has taken only $65,000 in salary. Fred and his wife together have taxable income of $70,000. That puts them at the lower end of the 25% bracket. On the other hand, the last $25,000 of income of Madison will be taxed at 39%. If Fred increases his salary by $25,000 Madison's income will decrease by that amount, saving $9,750 in taxes. His personal income will go up by the same amount, resulting in an additional $6,250 in taxes. The difference, $3,500 ($9,750 reduction in corporate taxes less $6,250 increase in personal taxes), is a permanent tax saving.

It may be advantageous to shift income in the other direction.

Example--Fred is an employee and sole shareholder of Madison. Fred normally takes a big salary, $200,000, and has other sources of income. If he does that this year, Madison will have only $20,000 of income, all taxed at 15%. Meanwhile, Fred's individual marginal tax rate will be 33%. Assume Fred can forego $25,000 of salary. The difference in the tax rates is 18%. Multiply that by $25,000 and the dollar saving is $4,500.

There are some other points.

• Don't forget to consider state taxes. They can be significant.
  
• You can't arbitrarily increase or decrease your salary. Too high a salary could allow an unreasonable compensation challenge by the IRS. Too low a salary can also be challenged. Check with your tax advisor and consider longer-term effects.
  
• You can't just compare your individual rate to your corporate one. You've also got to look at your projected personal and corporate rate for 2004.
  
• Look around for other possible consequences. For example, if you have outstanding net operating losses you may want to use them up before shifting income.
  
• In the past, C corporations would rarely pay dividends because the corporation gets no deduction but the income is taxed at the shareholder's highest rate. In 2003 and later years, paying a dividend won't be as onerous since it'll be taxed at no more than 15%.

See below for an example on S corporations that will also apply to a C corporation.

Projecting Your Income

Before going any further you've got to have a good handle on the income from the business. Your accounting records are a good starting point, but more than likely you'll have to adjust them to conform to the tax accounting rules. Here are some possible adjustments:

• Depreciation. The depreciation reported on your books may be higher or lower than that used for tax.
  
• Writeoffs. Bad debt reserves and many book writeoffs are not allowed for tax purposes. That may increase current year taxable income. On the other hand, book writeoffs taken in prior years may be reversing this year and may be deductible for tax purposes.
  
• Like-kind exchanges.
  
• Meal and entertainment expenses were fully expensed for book purposes, but generally only 50% of the amounts can be deducted for taxes.
  
• Installment sales. Tax law doesn't allow the installment method for accounting for sales of goods that are inventory property. For example, if you sell furniture as a business, you can't use the installment sale for those items. On the other hand, you can use the installment method for the sale of store fixtures, office equipment, etc.
  
• Amortization. You may have capitalized some expenses for book purposes in the past and are currently taking a deduction while you immediately expensed the item for tax purposes. That means your tax income will be higher than book. It's possible for some items to go in the reverse direction. That is, tax income could be lower than book.
  
• Tax law has some pretty specific rules as to when you can record income and expenses. If you're a manufacturer you'll also have to contend with the uniform capitalization rules. In short, many costs that you may have expensed for book purposes will have to be capitalized for taxes.

Check with your accountant on these issues. Hopefully, the differences will be slight, and, if so, can be ignored. Annualize your income to figure your full-year profit or loss. Don't forget to account for any variations during the year. For example, if you're a retailer, the Christmas season is important and annualizing won't work.

S Corporations, Partnerships, etc.

If you do business as an S corporation, partnership, sole proprietorship, etc. the net income (or loss) of the business is passed through to the you and reported on your individual tax return. You want to defer income to next year if you anticipate being in a lower tax bracket. Conversely, you want to accelerate income into 2003 if you think you'll be in a higher bracket next year.

That's the same objective as with your individual return. However, when planning for a business, you can encounter much wider income swings than if your income is from salary, interest, dividends, etc. A bad year for the business can produce a substantial loss. Fortunately, a net operating loss can be carried back two years or forward 20. Unfortunately, that adds some complexity to your planning.

Example--You're the sole shareholder of Madison Inc., an S corporation. You anticipate a loss of $100,000 in 2003 and a profit of $120,000 in 2004. You and your wife have very little other income. At first glance you'd want to accelerate income into 2003 or defer deductions to 2004. But in 2001 Madison had an outstanding year, netting $250,000. You might want to increase your 2003 loss and carry it back to 2001 when you were in a high bracket. An added plus is that you'd get back cash from an earlier year.

Not only is the net income or loss of the business passed through to the owner, so are certain 'separately stated items'. For example, if a partnership has $1,000 of interest income from bank accounts, that item is passed through and reported as interest income on your personal return. That interest or dividend income will help you use any investment interest expense you have. Capital gains and losses will also be passed through. They should be taken into account in your personal tax planning. Income or losses on real estate rental properties held by the S corporation is treated in the same way as if you owned the property in your own name.

We're assuming in the discussion below that you materially participate in the business. If you don't, the income, but not the losses, can be passed through to you. We can't define material participation in detail here, but you'd better talk to your accountant if you spend less than 500 hours per year in the business. And simply checking the books at the end of the week doesn't qualify. If you don't materially participate, planning is trickier. Losses can be carried forward, but profits can't.

Whether or not you can deduct a loss from an S corporation, partnership, or LLC on your personal return depends on your basis and amount at risk in the business. If you don't have enough basis in the business and want to take the losses this year, contribute equity capital or loan the business money. (Partnerships and LLCs may have some other options.) On the other hand, if the losses would be better utilized next year (you anticipate being in a much higher bracket), don't increase your basis. This can be a tricky issue. Check with your tax advisor.

Some activities generate adjustments for the alternative minimum tax (AMT). Again, a complex subject. Large depreciation deductions are the most common item to trigger an AMT problem. Farm activities are another one.

Deferring Income--Accelerating Deductions

By now you should have a good idea of which way you're headed. If 2003 is a big year and '04 won't be as good, you want to push income into 2004. If it's a tossup, you should probably still defer income; it'll improve your cash flow by delaying tax payments. Here are some strategies.

Depreciation. Last-minute, year-end purchases may qualify for a depreciation deduction, but only if the asset is 'placed in service' in 2003. (See our Glossary for a definition.)

Caution--If you buy too much in the last quarter of the year (more than 40% of your purchases for the full year), you'll have to use the mid-quarter convention to compute depreciation on all assets put in service during the year. There's a slight chance you may come out ahead, but more than likely, you total depreciation for the year will be lower. Moreover, you'll have to endure depreciation computations more complex than usual. One approach is to try to keep your purchases below the 40% threshold. See below for another option.

Caution--Buying an expensive auto may not help you out much. The maximum depreciation for the first year is $10,710, no matter how expensive the car is. Depreciation in later years is also limited, $4,900 in year two, $2,950 in year three and $1775 in the fourth and subsequent years. Slightly higher limits apply to trucks and vans. This rule only applies to new vehicles. Used vehicles are subject to much lower limits. Vehicles built on a truck chassis that exceed 6,000 pounds gross vehicle weight aren't subject to this rule.

There's more to tax planning here that just purchasing expensive equipment to write off. Timing your purchase carefully can save tax dollars on your individual return. See our article Maximizing Depreciation Benefits for more details.

Accelerate purchases. Purchase office and operating supplies you might need next year, do repairs and maintenance on equipment, get started on that advertising program, etc. Be careful, however. Special rules apply to companies that must capitalize more costs into inventory. Manufacturers are especially vulnerable. And make sure the repairs are really repairs, not capital improvements.

Inventory purchases don't count. They're generally not deductible until the items are sold. (But see below for obsolete inventory.)

If you're on the cash basis, payments made by December 31 are generally deductible. Thus, make sure you pay any bills before the end of the year. Payments made in cash, by credit card, or a check mailed before the end of the year count.

If you're on the accrual basis, the rules become more complex. You may have to show that, by the end of the year, the liability was fixed, and the goods or services were provided. (There's more to this issue, but it's beyond the scope of this article.) You may be able to accelerate the deduction by cutting a check before the end of the year. Additionally, if there's any uncertainty as to the liability (for example, you contract to have a project done, but the price is contingent on a number of factors), firm it up before the end of the year.

Fringe benefits. You still have some time to set up a pension plan for this year. An SEP or a regular profit-sharing plan may make sense. This isn't a decision to be approached lightly. Check with your tax advisor.

Pay bonuses to employees. If it's been a good year, pay bonuses to employees. Be sure to warn them that it may be a one-time event. There are no special tax implications here. The bonuses are just like additional salary.

Expense accounts. Make sure all employees turn in their expense reports on time. If you're on the cash basis, consider an earlier cut off, say December 20, so that the reports can be processed and the checks cut before the end of the year. If you're on the accrual basis, beat up on those habitual late filers.

Writeoffs. You can write off any undepreciated value of equipment abandoned before the end of the year. In order to claim a loss you have to take some affirmative action. You can sell it for scrap (get a receipt), donate it, or sell it to another business. Leaving it in the corner of the shop won't do.

You can deduct business bad debts that are partially or wholly worthless, but, once again, proof is important. Make a concerted effort to collect the debt before the end of the year. Consider turning collection over to an attorney who specializes in this area. You may have to pay him 25% to 50% of what he recovers, but that's a small price to pay if he collects some cash for you and you get a tax deduction for the remainder.

Inventory writeoffs are trickier, but may produce much more in savings. You've got to be able to show the decrease in value. Not too much trouble if you use the 'lower of cost or market' method and can prove the market prices. But more likely than not, that option is not available. You can show the price is below carrying cost by actual (bona fide) sales within 30 days of the inventory date. Value the inventory at the selling price less costs of disposal. Inventory that may qualify for the writedown includes shopworn, obsolete, out of style, etc. goods. You can also write down the value of unsalable goods. For example, those damaged in processing, returns, etc. Figure the cost of reworking them. Check with your tax advisor on the details here.

Farmers and ranchers. Farmers and ranchers using the cash method can deduct prepaid feed costs in the year of payment if the expenditure is a payment and not a deposit; there's a business purpose for the payment; and deducting the amount doesn't materially distort income.

State income taxes. Compute and make any estimated state income taxes before the end of the year.

Charitable contributions. A C corporation can deduct charitable contributions accrued before the end of the year if paid within 2-1/2 months of yearend. The contribution must be authorized by the board of directors and a copy of the minutes must be attached to the tax return.

Related taxpayers. When related taxpayers use different accounting methods, the accrual basis payer is placed on a cash basis with respect to payments that generate income or deductions.

Example--Fred is a 60% shareholder in Madison Inc. Madison is a calendar-year taxpayer and uses the accrual method of accounting. At December 31, 2003 Madison owes Fred $1,200 for interest on a loan he made to the business and $4,000 for 2 months rent on a building Fred owns and rents to the business. Madison doesn't pay the $5,200 until 2004. Madison can't accrue the expenses in 2003; they're only deductible when paid in 2004.

What constitutes a related taxpayer? There's a long list, but the two most important ones are a more than 50% shareholder in a regular corporation or a shareholder (or partner) who owns any interest in an S corporation (or partnership). The constructive stock ownership rules apply. That is, your son, daughter, etc. is deemed to own whatever stock you own.

Personal service corporations. The related taxpayer rule is extended for personal service corporations. They can't deduct payments made to any shareholder/employees before the amounts are includible in the income of the recipient.

Example--Dr. Flood is a 5% shareholder in Madison Healthcare Inc., a regular corporation. At the end of 2003 Madison accrues $12,000 in salary to the doctor. If Madison doesn't pay the doctor before December 31 it can't deduct the amount until it's paid in 2004.

Second, you can immediately expense, rather than capitalize, costs to remove architectural and transportation barriers to elderly and disabled individuals. Careful. While there's some overlap with the disabled access credit, only expenditures to remove architectural barriers apply here. You can get the maximum benefit by taking the credit on some items and saving the expense election for others. There's an annual limit of $15,000 on these expenses.

There's still time this year to take advantage of both benefits, but you must act quickly.

Incentive stock options. If you've issued incentive stock options to employees and some of them have exercised, but not sold the stock, encourage them to make a disqualifying disposition. By selling the stock early, and before the end of the year, they avoid any alternative minimum tax treatment and the company gets a tax deduction.

Defer income. Cash-basis taxpayers can delay billing customers until it's too late to get the check before next year.

If you're on the accrual basis, deferring income is more difficult. Income is taxable when all events that determine the right to receive the income have occurred and the amount is determined with reasonable certainty. A complete discussion is beyond the scope of this article. However, you can't defer reporting the income by not billing. Delaying shipment of the goods till next year may not work either. Selling goods on consignment (if that's possible) can defer income.

You should also be careful with respect to customer deposits. If you have unrestricted use of the funds and you do not have to repay the amount, a deposit becomes taxable income when received. Similarly, amounts received before services have been provided or goods have been delivered are reportable.

This can quickly become a tricky issue. It gets even more complicated if you want to report an amount for financial statement purposes, but defer it for tax reporting. The ultimate outcome will depend heavily on the facts and circumstances. Best to discuss the details with your tax advisor.

Installment sale. You may be able to defer taxes with an installment sale. That won't work for stock in trade (i.e., inventory items), but can be helpful if you're selling equipment, real estate, etc. Careful. You can't defer recognition of any depreciation recapture. That's all income in the year of sale.

Like-kind exchange. If you need new equipment, trucks, etc. a like-kind exchange will defer any gain on the sale. That includes any depreciation recapture. CAUTION. The equipment must be of the same class. For example, a truck for a truck. You can't trade 5 computers for a truck.

Accelerating Income--Deferring Deductions

If you think you'll be in a higher bracket next year you should weigh accelerating income into 2003. Be careful not to overdo it. Fortunately, this is usually easier than deferring income.

Accelerating income. Cash-basis taxpayers can bill customers earlier. Many may want to pay before the end of the year. You might want to offer a discount for early payment.

Accrual-basis taxpayers can make sure income will be included in 2003 by finishing projects, delivering goods or services, or making sure that both the right to receive the income is fixed and the amount is determinable with reasonable accuracy. It should be pretty easy to word a contract or agreement in such a way as to guarantee the amount will be includible. Check with your accountant on the details.

Collapse installment sale. You can make all the unrecognized gain on an installment contract taxable in 2003 by pledging the installment note for a loan or by selling the note. This approach can have substantial costs (e.g., you may have to discount the note), so be sure to weigh all the pros and cons.

Equipment sales. If you got some equipment that's not being used, consider selling it. The sale will generate cash, only some of which will be offset by the tax. In most cases any gain will be ordinary income from depreciation recapture. You could also have a loss. Any loss is generally fully deductible, without the capital loss limitations. (See below for some capital gain/loss strategies for regular corporations.)

Another option is a sale and leaseback. This is usually used just to generate cash, but there's nothing wrong with using it to create taxable income. If the asset is fully depreciated or almost so, you may be able to generate deductions in future years. This option shouldn't be taken lightly. Work through the numbers with your accountant.

Defer depreciation. While you need take no action now, you can reduce your depreciation expense for 2003 by not electing the Sec. 179 expense allowance and by electing to forgo the 50% additional depreciation deduction or opting for a longer depreciation period for equipment.

You can defer any depreciation on new equipment to next year by delaying the purchase of the asset or at least making sure that it doesn't qualify as being placed in service (see the glossary) in 2003.

Delay writeoffs. You may not have to write off obsolete equipment or inventory this year. However, things are trickier for bad debts. You must generally write them off in the year they become worthless.

Defer expenses. You can defer expenses by not making repairs, delaying bonuses, waiting until 2004 to buy office supplies, stretching out some contractual payments, etc.

Casualties. If you suffered a casualty loss in 2003 that was fully reimbursed by insurance, and don't buy qualified replacement property during the applicable replacement period, you'll have to report a gain (or loss) as a result of the casualty.

Example--Your building was destroyed by a fire. At the time of the fire the building was worth $250,000, but your adjusted basis in the building was only $50,000. You got a check from the insurance company for $250,000. If you buy suitable replacement property you can avoid recognizing the $200,000 gain. However, because of the fire you'll have a $300,000 operating loss for the year. Because of losses in prior years you can't carry the loss back and it could take years to use it up as a carryforward. The best approach here would be to not replace the property. Report the gain. You'll still pay no taxes and can start fresh, using those depreciation deductions in future years when they'll do the most good.

Special Considerations

C Corporations.

C Corporations have some special problems and planning possibilities. Here's a review of some of the more frequently encountered ones.

Level income. Small corporations may be able to stay in the 15% or 25% bracket year after year by leveling income. If that's possible, try to do so.

Capital gains and losses. Capital gains of a C corporation are generally taxed at ordinary income rates, but no more than 35%. Capital losses can be carried back 3 years and forward 5. After that they're lost. If you have capital losses that may be expiring, try to generate offsetting capital gains.

Net operating losses. Net operating losses (NOLs) can be carried back 2 years and forward 20. If you have, or could have, an NOL this year, you may want to increase the loss if the year to which it will be carried was a high tax one. For example, you're usually in the 15% bracket, but in 2001 you were in the 35% bracket.

Paying dividends.You might want to consider paying a dividend out of the corporation. Such a move might reduce the risk of an accumulated earnings or unreasonable compensation issue in the future, or can reduce your accumulated earnings and profits if you're thinking of switching to a S corporation. With the tax rate on dividends for individuals now 15% (5% for those in the 10% or 15% bracket), the tax bite is much less than in the past. Since the corporation still won't get a deduction, paying a salary or other deductible expense to get cash into the shareholder's pockets generally still makes the most sense. Check with your tax advisor.

Alternative minimum tax. Preference items generated by an S corporation or partnership are passed through to the partners and reported on their individual income tax returns for alternative minimum tax (AMT) purposes. A C corporation files its own AMT, and it can be considerably more complicated. Check with your tax advisor.

S Corporations

There are also some special considerations for S corporations. Some of the points below are very technical in nature, but you can achieve considerable tax savings if you're careful. Check with your tax advisor before acting.

Basis problems. You can only deduct losses up to your basis in the S corporation. Unused losses can be carried forward and used later. If you're in a high bracket this year, you might want to consider adding equity capital or making a loan to the corporation to use the losses in 2003. If losses have used up all your equity and debt basis in an S corporation, repayment of debts the corporation owes you will generate taxable income. That may prove worthwhile in some situations.

C corporation history. If your S corporation was once a C corporation, there's a good chance that there's some accumulated earnings and profits from the C corporation. These 'tainted' amounts can cause problems. If your personal income is low this year, consider a dividend of some or all of these amounts. It'll provide benefits for the S corporation in the future. CAUTION. A special election must be made. Consult your tax advisor.

Deferred compensation. New rules apply to accrued vacation and similar deferred compensation transactions. You can accrued such payments at the end of 2003, but they'll only be deductible in 2003 if actually paid within 2-1/2 months of yearend. A note, letter of credit, etc. won't work.

Reconsider Entity Choice

While you're doing your year-end planning you should also take the time to reevaluate your choice of entity. If you do business as a sole proprietor you might want to incorporate or form an LLC. If you operate as a C corporation, you might want to consider electing S status. Yearend is a particularly convenient time to make the switch. Take the time to go through all of your options.

. In Brief:

Previously Reported In Daily Update

Extension to elect alternate valuation date granted . . . The value of the assets in a decedent's estate is based on the value on the date of death. The law allows you to use an alternate valuation date, either a date six months later or, if earlier, the value on the date the assets are disposed of by distribution, sale, etc. The executor must elect to use the alternate valuation date on the return. If the return is filed more than 1 year after the filing deadline (including extensions), the election can't be made. In a recent letter ruling (LR 200348010) the co-executors of the estate timely filed the estate tax return without making the election under Sec. 2032 to use the alternate valuation date. The preparer of Form 1041 (U.S. Income Tax Return for Estates and Trusts) reviewed the estate tax return and determined the election should have been made. By affidavit, the tax return preparer of the Form 706 stated that he failed to consider the effect of the election for alternate valuation by the estate at the time he prepared the return and did not discuss the election with either co-executor at any time prior to the return being filed. Subsequently, the co-executors were advised that the election under § 2032 should have been made on the original Form 706. A supplemental Form 706 reflecting the value of all assets included in the gross estate as of the applicable alternate valuation date was received on Date 4, more than 6 months after the due date of the original Form 706. Thus, the supplemental Form 706 was not filed in time to take advantage of the automatic 6 month extension provided under Sec. 301.9100-2(b). The filing was, however, within one year of the due date of the original Form 706. The value of the gross estate and the amount of federal estate tax due are less than the value of the gross estate and the amount of federal estate tax due on the original Form 706. The IRS granted an extension of time for making the alternate valuation election until the date the supplemental Form 706 was received.

Mutual fund capital gains . . . It's time to start thinking about year-end tax planning with respect to mutual fund dividends. Many funds have not paid dividends in the last two years because there have been no gains. You'll want to know if you'll have any gains for tax planning. (You generally want to take any losses to offset the gains.) And you don't want to purchase a fund in December only to receive a taxable dividend a few weeks later. What's the prospect for this year? While the market is up sharply, there's a good chance your fund won't be paying a dividend this year either. Funds can pass through gains, but not losses. Losses can be used by the fund to offset gains in the current year and, if not used, carried forward. (There's a time limit.) Many funds will probably be using losses from prior years to offset gains. Many fund companies announce in advance an estimate of the capital gain dividend they'll be reporting. And keep in mind that a dividend that's taxable in 2003 can be paid in January of 2004.

Disability payments includable in income . . . Amounts received under an accident and health plan to compensate an individual for the permanent loss or loss of use of a member or function of the body, permanent disfigurement, and that are not computed with respect to the nature of the injury without regard to the period the person is absent from work are nontaxable (Sec. 105(c)). For example, the loss of use of an appendage of the body, loss of an eye, the loss of substantial all of the vision of an eye, etc. On the other hand, one court has held that hypertension has varying degrees of severity, and if hypertension is not sufficiently severe then it does not constitute a loss of body function. Generally, worker's compensation awards are nontaxable. In a recent IRS Legal Memorandum (ILM 200336033) the taxpayer asked if the definition of total disability in the employer's plan met the requirements of Sec. 105(c). The taxpayer suffered a coronary artery spasm and was declared permanently disabled. The IRS noted that the plan did not meet all the requirements of the law. In addition, the plan also determines payments on lengths of service which is not permitted. Disability payments based on the taxpayer's length of service were includible in gross income.

Maximize tax benefit of gifts . . . With the estate tax threshold rising each year (it'll be $1,500,000 in 2004), there's a good chance you won't be subject to the tax when you die. That's the good news. The bad news is that gifts to charity, such as your church, alma mater, conservation organizations, etc. in your will won't produce any tax benefits. If that's the case, you'd be better off making a contribution while you're alive that will reduce your income taxes. If your taxable income fluctuates, time the contribution for a year when you're in a high bracket. If you're young and/or in good health, you might want to hold off to see what will happen to the estate tax in 2011 when it's scheduled to reappear in it's old form.

Clean that list! . . . If you do any direct mail, including announcements, etc. to current customers, make sure you clean your list periodically. Doing duplicate mailings to the same person or address is not only costly, it doesn't speak well about your company. It's not too difficult to pick up variations such as Fred Flood and Fred Flood, CPA or Fred Flood and Fred Floud. Catching the latter is even more important. You won't impress a customer by spelling their name wrong. If you don't know how to go about list maintenance, get some advice from an expert.

Check your rent bill . . . High vacancies in many areas have kept landlords from raising rents. But they may be doing so by the back door. While leases for small space often have provisions for only a base rent that may increase each year a certain dollar amount or percentage, leases in large buildings, shopping centers, etc. have more complex clauses. In office buildings, rent usually consists of a base rent and escalation. Escalation is computed by taking the increase in certain expenses (usually operating expenses, taxes, and electric) over a base year amount and allocating the increase to tenants based on their share of the building (the tenant's area divided by the area of the building). Some expenses may be directly allocated to tenants where only a limited number of tenants use the service. In smaller office buildings, electric is often separately metered. Computations can quickly become complex and there's room for both honest and dishonest error on the part of the landlord. You or your accountant may be able to check the computations, but in complex leases you might want to call in a professional to audit the rent bill. Since rent can be a substantial expense, paying a professional to look at several years' rent bills could pay off.

Can we save money by filing married, separate? . . . That's an often asked question of tax preparers. The free answer is generally, no. The only way to find the correct answer is to prepare the return both ways. But going through the numbers takes time and a professional preparer will charge for it. There are some situations where the odds of separate returns being better are higher. One of the prime ones is when one of the parties has very high medical expenses and applying the 7.5% threshold will result in no or only a small deduction if the couple files jointly.

Year-end payments . . . If you're trying to make a charitable contribution, pay a business expense (if you're on the cash basis of accounting), etc. at the end of the year do it by check or credit card. Giving the other party your IOU or note won't secure a deduction.

Small business is big business . . . We've known that for many years. Seems most of the major corporations have only recently figured out how much small business owners buy. Individually you may not purchase much, but collectively small businesses have substantial purchasing power. Moreover, small business owners may be easier to sway than large customers. More and more corporations are now catering to small business. Corporations like Staples, Office Depot, OfficeMax, the major personal computer manufacturers, etc. Sometimes it's just lip service, but frequently you can get a better deal by going through the small business sales division of the vendor. And don't forget to investigate any loyalty programs. Much like frequent flier miles for airlines, you may get credits on purchases above a certain level, etc. Caution. Don't automatically assume that loyalty credits will ensure the best deal. Don't stop comparison shopping. You've got leverage--use it.