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Our Top 10 Tax Tips
Recent legislation changed
several parts of the tax laws affecting individuals. Every year, it's wise to
consider how tax planning will be affected, so here are our Top 10 individual
tax planning tips for this year.
RATE REDUCTIONS
1. Accelerate income. Deferred compensation is attractive when future top rates
will be significantly lower than current rates. That is no longer the case.
Regular income tax rates now start at 10 percent, and the top rate in 2006 will
be 35 percent. Those are historically low rates. Who knows what the future will
bring? Take the money now!
2. Seek investments that pay ordinary dividends or distribute long-term capital
gains. The maximum tax rate on both is only 15 percent in 2006.
3. Shift income to children and grandchildren. In 2006, the lowest income tax
bracket is 10 percent, 25 percent lower than the highest bracket. Be sure that
each child and or grandchild has enough income to take full advantage of the
$800 exemption and low rates without becoming subject to the tax on investment
income of a child under age 18.
HEALTH SAVINGS ACCOUNTS
4. Investigate the availability of High Deductible Health Plan (HDHP) coverage
combined with a Health Savings Account (HSA). Contributions to the HSA are tax
deductible and withdrawals to pay medical expenses are not taxed. The Bush
administration is determined to encourage the broadest use possible of this new
tax-favored medical care benefit, and we expect many insurance companies and
banks to offer these plans at competitive rates in early 2006.
NEW IRA CONTRIBUTION LIMITS
In 2006, IRA contributions of up to $4,000 are permitted for anyone with
sufficient earned income, and the limit increases to $5,000 for a person that
has attained age 50 before year-end. The limits
continue to increase in years after 2006.
5. Make your maximum allowable IRA contribution as early as possible each year.
Tax deferred accumulation of income begins the day you fund the IRA, and early
funding will provide greater account value at retirement. You can make your 2006
IRA contribution as early as January 2, 2005. Consider funding your IRA account
with fixed income securities such as bonds. This way you will be deferring taxes
on what would be otherwise be taxed at ordinary income tax rates. By contrast,
if you fund your IRA account with stocks or equity based mutual funds, you could
be converting long term capital gains which are taxed at low rates into ordinary
income taxed at higher rates when you begin to take IRA distributions.
NEW 401(k) DEFERRAL LIMITS
Participants in 401(k), 403(b), and 457 plans can take advantage of expanded
limits on contributions. The general limit on contributions to such plans in
2006 is $15,000 with an extra $5,000 allowed for individuals over age 50 by
year-end.
6. Defer the maximum allowed by your employer's 401(k) plan - that should also
assure you of receiving maximum benefit from any employer matching contribution
and will help you receive the maximum tax advantage possible.
7. A non-working spouse might consider working to boost the family retirement
assets - reentering the work force for the primary purpose of making a maximum
401(k) deferral, the lesser of $15,000 or total compensation in 2006, and making
a significant improvement in the family retirement assets.
EXPANDED EDUCATION INCENTIVES
Coordinated rules for Section 529 plans, Coverdell Accounts, Hope credits and
Lifetime Learning credits allow all of those sources of funding higher education
expenses to be of greater utility to many families. Planning which education
costs to pay from what funding source, and when to pay them, is necessary in
order to gain maximum benefit from all available tax advantaged education
assistance programs.
8. Take advantage of the Education Expense Deduction. In addition to all other
assistance provisions, and requiring careful coordination with them for maximum
benefit, a deduction of up to $3,000 is allowed for college tuition costs. If
your adjusted gross income does not exceed $65,000 for singles, or $130,000 for
married taxpayers filing joint returns, you qualify. No deduction can be claimed
for expenses of a student for whom a Hope or Lifetime Learning credit is also
claimed.
9. Fully fund Coverdell Education Savings Accounts - Contributions of up to
$2,000 per child are allowed each year, and the benefit is not phased out until
contributors have adjusted gross income in a joint return between $190,000 and
$220,000. Tax-free withdrawals are also allowed for qualified elementary and
secondary education expenses. If you begin funding early enough, and maximum
fund all available programs, you can use the Coverdell account for pre-college
costs and coordinate a Section 529 Plan with the Hope credit and Lifetime
Learning credit for higher education expenses.
10. Fund a Section 529, Qualified Tuition Program (QTP) - tax-free distributions
can pay for many higher education expenses. In addition, QTP distributions can
be coordinated with Hope and Lifetime Learning credits as long as each is used
to cover different expenses.
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