This is your last chance to take advantage of the old tax law using these helpful tax tips.
I know, it's five months until tax time, and you don't want to think about it right now. You're going to save a bundle with the new tax law anyway, right?
Maybe, maybe not. If you've itemized your deductions over the last few years, you may have a very unpleasant surprise waiting for you on April 15, 1988. There are ways to head off some of the pain, though. By taking advantage of being on the cusp of the tax law shift, you can save money using these tax tips.
A Dozen Last-Minute Tax Tips
Consider carefully the financial balance between the savings offered by the following methods and the lower marginal tax rates that will be in effect next year. (For example, if you're a farmer, you may want to purchase feed and seed this year for use next year, since your tax rate will be lower next year.)
My calculator has been running full speed since the tax law was finalized in late August (the proposed legislation hasn't actually been passed by Congress as MOTHER EARTH NEWS goes to press). Here are a few of the approaches I'm recommending to my customers.
1. Incorporate or become self-employed, if you can . Many of the deductions previously available to employees and individuals have been stripped from the new tax law. Only those employee business expenses in excess of 2% of adjusted gross income will be deductible, and those can only be used as itemized deductions. A number of items — including union dues and tax preparation fees—that you may have deducted on the line Miscellaneous Deductions from Schedule A (Itemized Deductions) will no longer be allowed. Sales tax will no longer be deductible for individuals. In fact, as of January 1, 1987, many cherished deductions of the citizen with one employer will disappear.
In order to optimize your deductions, you must be either self-employed or the employee of your own corporation. Bear in mind that this strategy is acceptable to the IRS only if you have more than one source of income. It may be time to do work on the side and arrange to be a consultant to your present employer.
Incorporation will be advantageous even to sole proprietors and partners, because it will allow you to defer income into the future, when tax rates will be lower. You can pay yourself a minimal salary and declare bonuses based on profits at a later date.
2. Realize capital gains. As of January 1, 1987, there will no longer be a 60% exclusion for capital gains income. If you've been holding stocks or other property for more than six months and if they've appreciated in value and you've been considering selling them, do so before the end of the year.
3. Consider prepaying medical expenses you're anticipating, or have the work done now. After December 31, 1986, the medical deduction threshold on Schedule A will be increased from 5% to 7.5%.
4. Make contributions before January 1, 1987. If you don't itemize deductions in 1987, contributions won't be deductible. Even if you do itemize, the deduction will be worth less because of lower marginal tax rates. (Many people who previously did itemize won't find it to their advantage in 1987.)
5. Make large purchases before the end of the year. If you're planning to buy an automobile, an airplane, a boat, or home construction materials, keep in mind that as of January 1, sales tax isn't deductible.
6. Prepay consumer loan payments or interest. Pay in December to the extent you're financially able. As of the first, consumer interest won't be deductible. If you can arrange with your lender to prepay interest rather than principal, it will be further to your advantage. (There's actually an interest phaseout: 35% is nondeductible in 1987, 60% in 1988, 80% in 1989, 90% in 1990.)
After December 31, 1986, consider taking a second mortgage to finance certain consumer credit purchases. Mortgage interest will still be deductible, and you can offer a second on your house as security.
Bear in mind, though, that mortgage interest will be deductible only to the extent of the original cost of your house plus improvements. If you borrow against its appreciated value, that interest won't be deductible, unless the funds are used for home improvement, education, or medical expenses.
7. Consider paying for a five-year rental on your safety deposit box. Storage of your financial papers (old tax forms) won't be deductible after January 1, 1987.
8. Make the maximum IRA contribution this year. As of 1987, people with employer pension plans will only be allowed a tax-deductible IRA if their income is less than $35,000 single or $50,000 married. A phaseout begins at $25,000 and $40,000.
9. If you've been considering buying rental property, do so before January 1, 1987. As of that date, the depreciation period for residential real property is extended from 19 years to 27 1/2 years. Watch out for passive loss restrictions if you're not managing the property. An exception to the buy-now policy applies if you're interested in buying or building low-income rental housing. New credits may make this a tax-shelter boon.
10. If you have high income, look into forming a 401(k) retirement plan and making a large contribution this year. If you have one already, make the maximum contribution. Next year it will be limited to $7,000.
11. If you have unused investment tax credit carryover, it may be wise to take income in 1986 instead of 1987 to use the credits. This credit will be reduced by 17.5% in 1987 and by 35% in 1988, and will be eliminated in 1989.
12. Prepay your accountant's fees (tee-hee). As of January 1, 1987, you're going to need me more than ever, but my charges won't be deductible.