With 2008 drawing to a close, now is an ideal time to review your financial situation and evaluate what strategies are available to help reduce your 2008 income tax bill. With a little advance planning you can effectively minimize or defer your taxable income, and thus the taxes you owe on that income. While tax planning for any individual must be customized to their particular circumstances, there are several fundamental tax planning techniques, as well as new changes to the tax laws, that should be on everyone's minds as the year end approaches.

The Basics

Estimate your AGI

A key component of fundamental tax planning involves estimating your 2008 and 2009 adjusted gross income (AGI). Estimating your AGI is essential because many tax breaks are tied to or limited by what AGI range you fall into. When you know your tax bracket you can better predict the tax effects of certain planning strategies. You can get a good idea of what your 2008 AGI will be by looking at your 2007 income tax return and 2008 pay stubs.

Defer Income to 2009

By delaying taxable income you defer taxes. Therefore, look to even-out taxable income between 2008 and 2009 by accelerating or postponing transactions that either produce income or yield deductible expenses. Delaying taxable income may also prevent you from losing lucrative tax breaks that can be reduced or eliminated altogether as your income level rises. If you think that your adjusted gross income will be higher this year than in 2009, or if you predict being in the same or higher tax bracket in 2008, you may benefit by delaying receipt of taxable income until 2009.

Accelerate Income in 2008

Under certain circumstances, it may be more advantageous for you to accelerate income in 2008. If, for example, you need additional income in order to take advantage of offsetting deductions or credits that are set to expire by the end of 2008, or you project being in a higher tax bracket in 2009, you may want to consider accelerating your taxable income in 2008 rather than deferring it until 2009.

Determine your Deductions

Accelerating or deferring income from one year also impacts your ability to take deductions. Deduction planning can become complicated, as your ability to take deductions depends on your filing status (i.e. single, head of household, etc.) as well as income level; as your income level rises, your ability to claim deductions is reduced or eliminated altogether. Determine whether taking the standard deduction, or itemizing deductions, will put you in the best tax position. For 2008, the standard deduction rates are: Single ($5,450); Head of Household ($8,50); Married Filing Jointly ($10,900).

If itemizing deductions may be more beneficial, remember that adjusted gross income limits on itemized deductions will affect your deduction planning. Consider "bunching" deductible expenses into one year or the next depending upon whether the standard deduction may be taken in one of the years, or whether the adjusted gross income limits for medical (7.5 percent), or miscellaneous itemized deductions (2 percent), may be more easily met.

Alternative Minimum Tax (AMT)

Don't forget to calculate both your regular income tax and your AMT. For 2008, the AMT exemption amounts have been slashed to only $33,750 for individuals, and $45,000 for married couples filing jointly. Whether Congress will pass yet another AMT "patch" or more comprehensive reform by year end makes tax planning more uncertain and complicated for many taxpayers who may be hit by the AMT. Therefore, year end tax planning must include calculating your potential AMT liability. While it is anticipated that Congress will enact another round of temporary relief, there is no guarantee that this in fact will happen.

To start planning around the AMT, project your income for the rest of the 2008, as well as 2009. The AMT calculation includes certain items of income that would otherwise be excluded under the regular rules. Items that may affect your AMT liability, because they become "tax preference" items no longer deductible under the ATM include:

• Personal exemptions;
• Deductions for state and local taxes;
• Home equity loans and other mortgage interest not incurred in buying, building or improving your principal residence;
• Incentive stock options (which may generate AMT income even when sold at a loss);
• Large capital gains;
• "Private activity" bonds (such as tax-exempt interest from private activity municipal bonds);
• Deductions for unreimbursed business expenses; and
• Other itemized deductions.

Review your investment portfolio

The end of the year is an ideal time to examine your investments (winners and losers) in order to take the steps necessary to minimize your capital gains income and thus your taxable income. Consider taking the following steps to maximize your tax position:

• Sell off investments that have been consistently underperforming so that you can use the losses to offset gains from winning investments.
• Consider selling long-term investments, such as stocks held longer than 12 months. Long-term capital losses can be used to fully offset long-term capital gains. Losses taken in excess of gains can also be used to offset up to $3,000 in ordinary income (or $1,500 for a married couple filing separately).
• Consider offloading short-term holdings that are underperforming. Short-term losses can be used to offset short-term gains that are otherwise taxable at your ordinary income tax rate (which can reach as high as 35 percent).

Moreover, in 2008 through 2010, the net capital gains rate is zero percent for taxpayers in the 10 or 15 percent tax bracket. Thus, accelerating income into 2007 in order to qualify for the zero percent rate in 2008 and/or delaying the sale of long-term capital assets until 2008 if you are within the 15 percent bracket should be a consideration.

Retirement planning

Maximizing contributions to your retirement plan enables you to reduce your adjusted gross income in direct proportion to the amount of the contributions you make. End of the year 2007 tax planning should entail maximizing the annual contributions you make to a retirement plan account, since one year's limit cannot be added to the next year's if not taken in time.

It's also not too early to think about a Roth IRA conversion plan. Although this tax break is not available until 2010, you should consider rolling over 401(k) balances to an IRA if leaving employment, or investing in a traditional IRA in anticipation of a conversion to Roth IRAs.

Moreover, taxpayers age 70 and 1/2 or older and who own an IRA or Roth IRA can exclude a charitable contribution of up to $100,000 if the donation is made directly from the IRA to a qualified charity. Additionally, the amount contributed will count toward your required minimum distribution. This opportunity expires at the end of 2007, so if you think this may be a lucrative strategy for you, contact our office and we can discuss how such a contribution fits into your overall year end tax planning goals.

Gift-giving

Take advantage of the 2007 annual and lifetime gift-giving limits to reduce your income and estate tax liabilities. For 2007 and 2008, you can transfer $12,000 per person, per year, without paying gift tax on the amounts transferred. Married couples can gift $24,000 per person, per year without tax liability on the amounts transferred.

New-for-2007 opportunities (and Pitfalls)

Tax law changes constantly, and therefore so must individual tax planning. The year 2007 is no exception. While the fundamental techniques above should never be overlooked, you must also consider how legislation passed in 2007 and before, and what yet remains to be enacted, may impact your year end tax techniques.

Kiddie Tax

For 2007, a child under the age of 18 is subject to the "kiddie tax" (and thus pays tax at his or her parents' highest marginal tax rate on unearned income in excess of $1,700). But in 2008, courtesy of the Small Business and Work Opportunity Tax Act of 2007, the applicable age rises and the kiddie tax will apply to a child under the age of 19 and full-time students under the age of 24. In light of this development, parents should consider selling appreciated stock and other assets belonging to their children now, especially if their children will fall into the one of these age categories in 2008.

Expiring Provisions

A variety of popular tax credits are set to expire at the end of 2007, unless Congress extends them. However, don't wait to see what Congress does. Assess your tax situation as if Congress won't extend the tax breaks that apply to you. Tax breaks set to expire at the end of 2007 include the following:

State and local sales tax deduction. The American Jobs Creation Act of 2004 gave taxpayers who itemize deductions the option of claiming either state and local income taxes or state and local general sales taxes. Therefore, if you have been contemplating the purchase of a big-ticket item, such as a car or boat, you should consider making it sooner rather than later because the deduction for state and local general sales taxes expires at the end of 2007. However, first compute what any potential state and local income tax deductions will amount to and then compare it to your potential sales tax deduction.

Mortgage insurance premiums. Premiums paid or accrued in 2007 for qualified mortgage insurance are deductible as qualified residence interest. The insurance must be carried on acquisition indebtedness for a qualified residence. A "qualified residence" is the principal residence and one other residence that is not treated as business property. Acquisition indebtedness is debt incurred to acquire, construct, or substantially improve a qualified residence.

Tuition and fees deduction. Taxpayers may deduct qualifying tuition and fees paid in 2007 that are required for the student's enrollment or attendance at a post-secondary school. The tuition and fees deduction can reduce the amount of a taxpayer's income subject to tax by up to $4,000 if your modified adjusted gross income does not exceed $65,000 (single taxpayers) or $130,000 (married filing jointly). For single taxpayers with an income of up to $80,000 ($160,000 if married filing jointly) the deduction is capped at $2,000. No deduction is available for taxpayers with incomes higher than these amounts.

Educator deduction. Teachers, instructors, counselors and other educators can deduct up to $250 worth of books, supplies, software, and other qualifying expenses. To be eligible for the deduction, a qualifying taxpayer must work at least 900 hours during a school year as a teacher, instructor, counselor, principal or aide in a public or private elementary or secondary school. The deduction is set to expire at the end of 2007, unless Congress extends it.

Residential energy credit. Homeowners may be eligible to claim a credit of up to $500 for the costs of making certain energy-efficient improvements to their principal residence if the improvements are made before 2008.

Charitable Donations

Finally, taxpayers with the wherewithal and a charitable inclination, year end 2007 tax planning should account for the following recent developments:

Cash donations. Starting in 2007, cash donations of any size must be substantiated by paperwork that includes either a cancelled check or a written note from the charity indicating the amount, date and the name of the charity.

Qualified conservation contributions. Also set to expire in 2008 is the contribution of a real property interest exclusively for conservation purposes. A 50 percent contribution base limit applies, rather than the 30 percent limit for capital gain property.

Planning starts now

Effective tax planning involves preparation and thoughtfulness. Don't wait until the last minute to look at your tax situation. Year end tax planning starts now.

The earlier you assess your financial situation and put your tax plan into action this year, the more effective your tax-cutting efforts will be. So where do you start? Begin by focusing on your most important assets.

Your retirement

An important asset for many taxpayers is their retirement account. When it comes to retirement saving, rule number one is to contribute the maximum amount allowed every year.

In 2008, the IRA contribution limit rises to $5,000, and those 50 and older can contribute $6,000. Participants in a 401(k) plan can contribute as much as $15,500 ($20,500 if 50 or older). Here’s another tip: Start contributing at the beginning of the year to give your invested dollars more time to grow.

If you’ve been feeling shut out of the Roth IRA game, there is good news! Beginning in 2008, you can make a direct rollover from your qualified retirement plan, such as a 401(k) or 403(b), into a Roth IRA. Before you make the switch, you should know that the rollover will trigger income taxes, and taxpayers with adjusted gross income above $100,000 are ineligible to participate. However, the $100,000 limitation is set to expire in 2010, eventually letting everyone in on this opportunity.

Your home

Another significant asset for taxpayers is their home, and there are important tax issues at play here. Most homeowners understand the value of the mortgage interest deduction. Less understood are the tax ramifications of a refinanced home loan.

The interest deduction for a refinanced mortgage is limited to interest on the original loan amount plus $100,000. Interest you pay on the loan balance above this figure is not deductible, even though it is included in the figure reported to you on Form 1098. This rule can greatly minimize the tax benefit of a home-equity loan.

Homeowners have long enjoyed favored tax treatment on gains from the sale of their personal residence. If you have lived in your home for two years or more, you can exclude up to $250,000 in gain ($500,000 if married) from the sale.

But what about losses from the sale of your home? In this era of defaulted sub-prime loans and declining home values, this has suddenly become an important issue.

If you sell your house for less than you paid for it, you cannot deduct the loss.

Your investments

Those with significant investment portfolios also have tax planning decisions to make. Beginning in 2008, the new "kiddie tax" rule may require a full-time student age 23 and younger to pay tax on unearned income over $1,800 at their parents’ higher tax rate. The old rule only applied to students age 17 and younger. Shifting assets to a child’s account was once a popular college saving strategy, but this change lessens the advantage considerably. A good alternative may be a 529 college savings plan, where the funds grow tax-free, and subsequent withdrawals for qualified post-secondary education costs are tax-free as well.

Thinking of cashing in on some recent stock appreciation? If you have previous capital losses carried over from 2007, you can use those losses to offset capital gains in 2008. What’s more, you can reduce your ordinary taxable income by up to $3,000 in net capital losses each year. This is an important tax rule to keep in mind when you decide to sell stocks or rebalance your portfolio.

Your health

Some say good health is one’s greatest asset. Fortunately, there are some recent tax rule changes to help you feel your best. If you have a "high-deductible" health insurance policy, you can deduct contributions to a health savings account (HSA) and later make tax-free withdrawals to pay qualified medical expenses.

Employer flexible spending accounts (FSAs) are another tax-advantaged method to pay medical costs. If you already have an FSA, make the most of your account by planning ahead. Before your next plan year begins, add up your out-of-pocket medical costs for the last twelve months and calculate next year’s contribution accordingly. Then remember to fully draw down your account before the deadline.

Your tax plan

Effective tax planning means eliminating unpleasant surprises. Checking your 2008 paycheck withholdings and estimated tax payments is a good first step toward avoiding an April 15 tax surprise. Take into account events that you expect to occur in 2008. A new job, marriage, changes in dependents, and moving to a new home can all cause significant adjustments to your tax bill.