Economist Reminds Producers:
Keep Tax In Mind At Year End

By Jose G. Peña
Extension economist

As the end of the year approaches, it becomes important to review planned financial activities in an attempt to reduce tax liability, not only for 1999 but also for years into the future.

While the tentative Taxpayer Refund and Relief Act of 1999 failed to pass in September, and none of the many tax changes proposed by this bill will take place this year, major tax legislation enacted in 1996, 1997 and 1998 continues to play a key role in year-end tax planning. Some provisions in the latter two bills became effective this year, while others will come into play in 2000. It is necessary to initiate a tax management program now to allow sufficient time to take advantage of the provisions before the end of this year.

Keep in mind, however, that even though 1996, 1997 and 1998 saw the enactment of significant tax legislation, dramatic changes in the federal income tax system are still being considered in Washington. Effective tax planning requires an individual to keep up with changes and determine how they impact higher tax planning.

— The Alternative Minimum Tax (AMT) has become a strong income tax planning consideration. It should be estimated early since it is an add-on tax over and above regular taxes due.

— Tax Rates - While the income tax brackets increased slightly, the marginal income tax rates remain essentially the same as last year.

— Regular IRA - The $2000 IRA deduction per taxpayer is allowed for participants in retirement plans. This deduction is phased out for adjusted gross income of $50,000-$60,000 for married filing jointly ($30,000-$40,000 for single). The IRA deduction is allowed above the upper AGI limits for a spouse not covered by a company retirement plan, even if the other spouse is actively participating in an employer-sponsored retirement plan.

— Roth IRAs - $2000 contribution per taxpayer from after tax income is allowed as late as April 15 and tax-free earnings and withdrawals are allowed after a five-year holding period and age 59½. Roth IRA participation eligibility is phased out for taxpayers married filing jointly with AGI $150,000-$160,000 ($95,000-$110,000 single). After 1998, IRA roll-overs into Roth IRAs are taxable in the year that they are rolled over.

— Education IRAs - A new class of education IRAs, similar to the Roth IRA, was added by the 1997 act. A non-deductible contribution of up to $500 per dependent child under 18 years old may be made starting in 1998. The earnings may be distributed tax-free to pay for under graduate or graduate college tuition, books and room and board. The deduction is phased out with AGI $150,000-$160,000 for married filing jointly ($95,000-$110,000 single).

— Gift and Estate Tax Credit Equivalent was increased to $650,000, up from $625,000 last year.

— Child Tax Credit was increased to $500/dependent child less than 17 years old at close of the year, up from $400/child last year. The credit starts to phase out for joint filers with adjusted gross income of $110,000 ($75,000 single).

— Capital gains - 20 percent tax rate (10 percent if 15 percent bracket) with a 12-month holding period, retroactive to Jan. 1, 1998. After 1999, lower rates may apply to certain taxpayers for assets held over five years.

— Education credits - A "Hope credit" of up to $1500 (100 percent of first $1000; 50 percent of second $1000) and a lifetime learning credit (up to 20 percent of $5000 or $1000/year; 2003 and later goes to 20 percent of first $10,000) were instituted starting in 1998 for the educational expenses associated with tuition and fees required for enrollment per student. NOTE: Same expenses cannot be used to claim both credits. Student must be claimed as a dependent; if not claimed he/she may claim credits for expenses paid by the student. Lifetime credit is allowed only for the year in which the Hope credit is not claimed for the same student.

— Standard deductions - With a $7200 standard deduction for married, filing jointly ($4300 singles) it will be difficult to find enough items to itemize unless the taxpayer has a large mortgage deduction. Taxpayers should consider lumping i.e., alternating the paying of deductible items, such as state/local property taxes, mortgage interest and charitable contributions, between years. Keep in mind the two percent of AGI rule for miscellaneous itemized deductions and the 7.5 percent of AGI rule for medical expenses.

— Retirement plan contributions - Up to $10,000 per year contribution are allowed for retirement plans such as the 401K.

— Cash basis of tax reporting - Taxpayers may consider accelerating or deferring deductible expenses or income into the next tax year and don't forget that as long as credit card and check payments are dated this year, they are deductible.

— Section 179 deductions - Up to $19,000 may be written-off subject to limitation before the end of the year for business equipment additions, but keep in mind that the items must be placed in service before end of year.

— Children employment - Sole proprietor or husband/wife partnership may employ their children under 18 without having to pay Social Security, Medicare or federal employment tax. In addition to reducing income taxes, this reduces employer self-employment tax, and since each child is entitled to the $4300 standard deduction, no taxes will be paid if each child is paid less than this amount.

— Company-provided meals - starting in 1998, 100 percent of all expenses for employee meals on premise may be deducted as long as the meals are available to all employees. Non-cash gifts less than $25 may be deducted without having to show them as income to the employee.

— Home office deduction — starting in 1999, the home office deduction rules for self-employed with office at home have been liberalized as long as the home space is used regularly and exclusively for businesses and the taxpayer does not have another fixed location to conduct business.

— Three-year income averaging for farm income was implemented starting in 1998, and taxpayers whose principal business is farming and/or ranching may now carry-back net operating losses five years (instead of the normal two years).