Finally, be aware of AMT's ramifications for investing. You'll want to keep private-activity municipal bonds issued after August 7, 1986, out of the portfolios of alt min clients, since the interest income is taxable under the alternative regime.
It's also probably wise to revisit the benefit of muni investing for clients who pay a lower marginal rate under AMT than when the regular tax applies. Suppose a client historically in the 35% regular bracket is struck by AMT and falls in its 28% bracket. Ignoring state taxes, the taxable equivalent yield of a muni paying 4.75% is only 6.60% when this client is in AMT (4.75% tax-free yield, divided by 100% minus 28% tax rate paid), versus 7.31% under the regular tax. Depending on bond market conditions, that could influence how you invest.
Rising Deficit, Rising Taxes?
Whether you're a Bush backer or a Bush whacker, it's no secret that the long-term capital gains rate and top ordinary tax bracket are at their lowest in most clients' lifetimes-15% and 35%, respectively. "The question is, what do you believe is going to happen to rates in the future?" says Susan Hirshman, a managing director and planning strategist at JP Morgan Fleming Asset Management, in New York. Like many planners, Hirshman believes taxes are more likely than not to rise as Washington grapples with war and a record deficit.
This camp of advisors touts acting to take advantage of the historically cheap rates. For instance, in some circumstances it may be worth accelerating ordinary income into 2004 "to lock in a lower tax rate," Hirshman says. Other practitioners are recommending that clients consider realizing gains on low-basis assets.
Freedman, for example, recently recommended that a new client, age 62, sell an appreciated real estate investment rather than defer the tax with a Section 1031 exchange, which the client had done in the past. Freedman says, "I delved into his goals and risk tolerance and said to him, 'The opportunity to pay about 23% combined federal and state tax on significant gains is a small price for ending up with $700,000 of after-tax money that can be diversified.'"
Not all planners agree, however. "I'm not going to make recommendations based on a hunch about tax rates," scoffs one. You and your clients will have to make up your own minds.
Tax Planning Tidbits
Parents' medical costs. With many middle-aged clients now caring for elderly parents, you should be aware that a taxpayer can deduct medical expenses paid for someone who is not a dependent-provided the only reason the individual cannot be claimed as a dependent is due to earning more than $3,100 in 2004, according to Thomas. But of course, to be deductible the total medical expenses paid by the client must exceed 7.5% of AGI (10% when alt min applies), so plan the timing of payments carefully. To avoid gift-tax issues, the client should pay the medical provider directly, Thomas advises.
The $160,000 cliff. The above-the-line deduction for college tuition is now available to joint filers with incomes as high as $160,000 and singles earning $80,000 (vs. $130,000 and $65,000, respectively, last year). One dollar of income above the threshold eliminates the deduction entirely. Don't go there.
Rethink qualifying dividends for margin clients. Itemizers may deduct investment interest up to the amount of their investment income, a category that does not include dividends taxed at the 15% rate introduced by the 2003 tax act, says Jon S. Chernila, managing partner of Chernila & Pesin LLP, a CPA and business consulting firm in Fountain Valley, Calif. Chernila had one client who fared better last year by electing to forego the 15% rate on $1,000 of dividends (and instead pay tax at his ordinary rate) in order to deduct $1,000 of margin interest. Opting out of the 15% rate saved the client $150 in federal income tax, demonstrating that the break isn't always beneficial for margin investors. Keep that in mind when devising investment plans.
Last call for bonus depreciation. Business owners who place new equipment in service by year-end are entitled to deduct 50% of its cost-so-called bonus depreciation. This is the final year this goodie is allowed.