Some clients and advisors thought they were gone forever.
Advisor Ben Tobias was all smiles as he strolled out of his first year-end planning meeting with clients, on the last working day of August. "What was really nice was that we had capital gains to talk about this year. From the investment side, tax planning is going to be a much more pleasant experience for advisors than it has been recently," says the namesake of Tobias Financial Advisors in Plantation, Fla.
It may also be less rote. Certainly you (and your competitors) have read how the 2003 tax act's 15% levy on dividends and long-term gains argues for equity investing in taxable accounts. In client cases where that makes sense, year-end portfolio pruning is the ideal time to readjust allocations, says planner Diane Compardo, with Moneta Group in St. Louis. "If you're going to take losses, you may not want to simply reinvest back" in the same asset class, she says. But before loading up margin investors with dividend-payers, however, you should know that dividends taxed at the 15% rate do not qualify as investment income that allows deduction of margin interest. You have to determine whether the client is better off deducting the interest or paying tax at the favorable rate.
Of course, there's more to end-of-year tax planning than portfolio strategizing, particularly this time around. The checklist for 2003 includes important IRA deadlines (see sidebar) because this is the first year that clients are required to follow regulations issued by the Internal Revenue Service in 2002. There are also non-investment implications of the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), enacted in May. The good news is that advisors who take year-end planning seriously just might save the economy.
Begin preparations for the meetings by ensuring that your tax-projection software incorporates the latest federal law, acknowledging that you can't automatically assume state income tax savings. Many revenue-hungry states have disavowed changes enacted by Washington during the last few years, such as the bounteous depreciation write-offs for business owners. "Decoupling [from federal law] by the states seems to be the hallmark of the Bush tax cuts," says Mark Luscombe, principal federal tax analyst at CCH Inc., the Riverwoods, Ill., business-information provider.
As always, there are variables to consider before making any moves, such as financial aid possibilities. "Shifting income and assets to a child may save some taxes, but it could cost the kid a lot more in grant and scholarship money if he is eligible for aid," says Certified College Planning Specialist Rick Darvis, president of College Funding Inc., in Plentywood, Mont. "You've got to do financial aid planning at the same time you're doing tax planning."
And you can never count out AMT. Alternative minimum tax is likely to snare more clients this year because JGTRRA lowered the regular tax, improving the odds that the alternative minimum will be higher. You must be extremely careful to avoid recommendations that produce no benefit under alt min.
Setting The Agenda
Current goings-on call for revisiting moves that clients previously have tabled. JGTRRA's reduction of ordinary rates has led some to exercise their non-qualified stock options. For those who are leaving jobs, the drop in the capital gains tax has increased the attractiveness of taking distributions of employer stock from retirement plans, compared with rolling the shares to an IRA. With an in-kind distribution, the employee pays ordinary tax on the shares' basis and gets long-term treatment on the appreciation to date of distribution.
You should remind estate planning clients that while the exemption from estate tax rises by $500,000 on January 1, to $1.5 million per individual, there is no corresponding jump in the amount that is free from gift tax during lifetime, says Gayllis Ward, a senior vice president and head of the tax department at Fiduciary Trust Company International in New York. This contrasts with recent history, in which the exemptions changed in lock step. "Clients may have the misconception that since the (estate tax exemption) is rising, they should make additional lifetime gifts. You need to disabuse people of that notion," Ward says.
Review estimated taxes in the wake of JGTRRA to ensure that clients have not overpaid at year-end, advises Diane Pearson, a Certified Financial Planner licensee and director of planning at Legend Financial Advisors in Pittsburgh. "The law has dramatically lowered the quarterly estimates that some of our clients have to make," she says, particularly those receiving substantial dividends. Seniors who wait until year-end to take required IRA distributions "can't assume that the amount withheld in 2002 is going to be the same amount you need to withhold for 2003," Pearson says. The estimated tax paid in may be the lesser of 90% of 2003's projected tax or a safe-harbor amount based on the client's 2002 tax. But when relying on the current-year projection to avoid Internal Revenue Service penalties for underpaying, you have to consider AMT if the client will owe it, Ward points out.
While headlines have screamed about JGTRRA's depreciation provisions, it is knowledge of the finer points that's key to securing maximal benefit. The Section 179 election to expense purchases of equipment (including off-the-shelf software, per new rules) allows write-off of the first $100,000 spent in 2003. However, the deduction is phased out for businesses purchasing between $400,000 and $500,000 of property, and eliminated above that, says David M. Spitzberg, a CPA in Jenkintown, Pa. There is also an income limitation on the deduction, which essentially means the election can not be taken if it creates, or increases, a business loss. But sole proprietors can use the election to fashion a loss as long as it offsets other earned income that they have, including spousal earnings. See the Instructions to Form 4562, Line 11 for details.