Plan Now to Save Taxes
Stewart H. Welch, III, CFP, AEP
Founder,The Welch Group, LLC Birmingham, Alabama
When we examine where our hard-earned money goes, it does not take long to discover that income taxes take a large bite out of our wallet or purse. Yet my experience is that most people will begin looking at their taxes shortly before April 2007 for the 2006 tax year, which is too late to do much to reduce your tax bite. At The Welch Group, we make a point to do client tax planning in November and December each year and so should you. Here are some key areas you should consider:
Accelerate expensesand postpone income.
If you own your own dental practice or other business, consider the advantages of accelerating expenses and postponing income to the greatest extent possible. In a dental practice, it is easy to stock up on supplies that will be needed next year. Postponing income can be more challenging, but is still possible. If you are an associate in a practice, the dental practice owner may be willing to pay your 2006 bonus in January 2007, allowing you to postpone taxes until next year.
Establish a retirement plan.
If you own your practice, consider whether it is worthwhile to set up a retirement plan for you and your employees. Depending on the size of your payroll and the number of eligible employees, a retirement plan could be beneficial to you or it could create a net expense. There are a number of options available, including a 401k plan, a profit sharing plan, a defined benefit plan, a simplified employee pension plan, or a savings incentive match plan for employees of small employers. Each has pros and cons and some require that they be set up (not necessarily funded) before December 31st. Meet with your financial or tax advisor to discuss which plan may be best for your practice.
Postpone mutual fund investing. Mutual funds are required by law to pay out all interest, dividends, and capital gains by the end of each calendar year. This often results in the shareholders receiving taxable income on a fund they just invested in (and sometimes even have a loss in). The mutual fund companies typically will not divulge any information on this subject, so The Welch Group typically recommends postponing new investments until January.
Match your gains and losses.
Review your personal investments and determine if your trading activity during 2006 has resulting in net realized gains or losses. Next, review your portfolio to determine if you can sell securities to reduce your taxes. For example, if your activity during the year has resulted in a $4,000 short-term gain (taxable at your highest marginal income tax rate), identify securities that have a $4,000 loss. If they are sold to realize the loss, you will have effectively eliminated the taxes. If you like the security you just sold, wait 31 days and buy it back. Remember that net realized losses may be used to offset up to $3,000 of ordinary income.
Give to charities.
If you are thinking about making a donation to a charity, you must do so by December 31 to receive the tax deduction. Remember that this can add up. For example, if you donate $1,000 (in cash, securities, clothes, etc), you will receive a $150 savings if you are in the 15% tax bracket and $280 if you are in the 28% tax bracket. If you charge your donation this year but pay your credit card in January, you can still take the charitable deduction this year. Do not forget that you will need proper documentation from the charity specifying the amount of your donation. (Your cancelled check will not be sufficient proof for the Internal Revenue Service.) If you have highly appreciated stock, it is often a better choice than cash because it allows you to “give away” the tax problem as well. If you like the stock you just gave away, you can use your cash to purchase the stock and at the same time establish a new higher cost basis. This will save taxes if you decide to sell the stock at a future date.
To make certain you do not miss any opportunities, have a tax strategy meeting with your financial or tax advisor before year-end. They are trained to identify a complete range of possible opportunities.
Stewart H. Welch, III, CFP®, AEP, is the founder of The Welch Group, LLC, which specializes in providing fee-only wealth management services to affluent retirees and healthcare professionals throughout the United States. Mr. Welch has been recognized by Money, Worth, Mutual Funds Magazine, and Medical Economics as one of the top financial advisors in the country. He is the co-author of The Complete Idiot’s Guide to Getting Rich (Alpha Books) and J.K. Lasser’s New Rules for Estate and Tax Planning (John Wiley & Sons, Inc.). Visit his Web Site www.welchgroup.com. Consult your financial advisor before acting on this advice.