Advisors put charitable strategies at the head
of this year's checklist.

    There is no shortage of things clients can do by December 31 to cut their 2006 taxes. Many of the strategies stem from two recent bills, the Tax Increase Prevention and Reconciliation Act (see "Tax Law Begets Opportunities," July Financial Advisor) and the Pension Protection Act, which was signed into law August 17 and addresses much more than just pensions.
    For example, thanks to PPA, individuals who are at least age 70 1/2 now can give as much as $100,000 annually to charity straight from their IRA and sidestep tax on the distribution. "Making a direct gift to charity from an individual retirement account during lifetime was never possible before," says Mark LaVangie, a retirement plan specialist with Bank of America's Global Wealth & Investment Management Group. These withdrawals, known as qualified charitable distributions, can count toward the client's required minimum distribution, yet they are not included in income. But no deduction is allowed for the donation.
    Keeping the distributions out of income is potentially beneficial in a number of ways. It could decrease the client's tax on Social Security payments, or increase the amount of deductible medical and miscellaneous itemized expenses. For clients subject to the alternative minimum tax, a lower income may mean less of the AMT exemption is lost to phase-out.
    There are hoops to jump through, of course. The money must go to a 501(c)(3) tax-exempt organization. "Donor-advised funds and private foundations don't qualify," says LaVangie. Nor can the IRA be a SEP or a SIMPLE, adds his colleague, Marvin Rotenberg, the large bank's director of individual retirement solutions. But the $100,000 maximum is per individual, so a married couple could give up to $200,000 for 2006, assuming each has a sufficient account balance.
    A direct transfer from the IRA provider to the charity is required. "The custodian will issue a check on the account made payable to the charity and then mail it to the charity, or perhaps to the account owner," Rotenberg says, adding that regulations delineating the finer points of the new rule have yet to be issued. The technique is available only for 2006 and 2007 (so far).
    The same time frame applies to the pension act's improvements to the income-tax deduction allowed property owners who donate a qualified conservation easement, another strategy worth mentioning to the right client. (To oversimplify, these easements, which are restrictions placed permanently on land, protect a habitat or preserve land, open space or historically significant structures.) Prior law capped the year-of-gift deduction at 30% of the donor's modified adjusted gross income, with a five-year carryforward. For 2006 and 2007, you can deduct as much as 50% of income, or 100% if you are a qualifying farmer or rancher, and carry forward any excess 15 years, says Margaret Wheeler, a land protection specialist at The Trustees of Reservations, a Massachusetts land conservation organization. The higher limitation can be used for 2006 transactions completed prior to PPA enactment, Wheeler observes.
    But the law that giveth, taketh away. Effective with the pension act's signing, charitable donations of used clothing and household goods are deductible only if in "good condition." The law's language may be vague, but its intent to restrict deductions is clear.
    One more charitable year-end tip: revisit CRATs. Tax deductions for transfers to charitable remainder annuity trusts rise with interest rates, says Gregg Parish, professor of estate planning at the College for Financial Planning. To understand how, recall that these trusts pay a set dollar amount to the donor (or someone she names) for life or a stated period, after which the trust assets go to charity. The value of that future gift today for tax purposes, explains Parish, equals the amount transferred minus the present value of the payments to the donor, discounted using the Code Section 7520 interest rate (6% in September). The higher the interest rate used to calculate present value, of course, the lower the resulting PV. With a CRAT, that leaves a larger charitable gift and hence a bigger deduction for the client. The income-tax deduction is limited to 30% of the client's adjusted gross income, with five-year carryforward, Parish says.

Look For Losses, And Tax-Cheap Gains
    Where to harvest tax losses? "With interest rates rising, clients who invested in fixed-income funds during the last few years when rates were low may now have some losses," says Benjamin Tobias, president of Tobias Financial Advisors in Plantation, Fla.
    Like other planners, Tobias uses exchange-traded funds as temporary substitutes for positions that are under water but which have bright long-term prospects. "We took losses in a new small-cap mutual fund, bought a Russell 2000 ETF which we'll hold until the wash sale rule is avoided, then we'll sell it and buy back the small-cap fund," he says. Because the number of ETFs has more than doubled over the past three years, according to Morningstar Inc., it may be wise to scour the universe of placeholder possibilities if you haven't recently.
    On the plus side of the ledger, don't forget that children 18 and older may be able to take advantage of the current 5% cap gains rate that's available to taxpayers in the 10% and 15% ordinary brackets. "Transferring low-basis assets to kids so they can sell still makes sense," says Curt Weil, managing partner of Lasecke Weil Wealth Advisory Group LLC, in Palo Alto.
    And by historic standards, even the 15% gains tax that most clients pay today is attractive-but potentially short-lived. "If [power in] one house of Congress changes in November, or if the Republican majority becomes razor thin, the low capital gains rates are likely to sunset as scheduled after 2010," says Gayllis Ward, senior vice president and director of tax strategy at Fiduciary Trust Co. International in New York. "A business owner looking to sell in the next few years might want to get out while the 15% rate is still available," says Ward.

Retirement Account Strategies
    The other new law, TIPRA, eliminated the income and filing status restrictions on converting an IRA to a tax-free Roth, starting in 2010. An immediate strategy for clients who expect to take advantage of this opportunity is to contribute the maximum to their traditional, SEP, and SIMPLE IRAs every year until then. That way more can be converted.
    For clients who have made both deductible and nondeductible contributions to their accounts, taxation at conversion takes a pro-rata approach based on all of the client's traditional, SEP and SIMPLE IRAs. Say she has a total of $250,000 in these IRAs, $50,000 of which came from nondeductible contributions, i.e., money that taxes have already been paid on. In that case, 20% ($50,000 divided by $250,000) of the amount converted is not taxed. The other 80% is.
    Beginning in 2007, an individual who inherits a qualified retirement plan from someone other than a spouse will be able to roll it to an inherited IRA. That will let them stretch withdrawals over life expectancy, says Robert Keebler, a partner in the accounting firm Virchow, Krause & Company LLP, in Green Bay, Wis. In the past, nonspouse beneficiaries were often forced by the plan to empty the account quickly, triggering immediate, and typically high, taxation. Qualified plans inherited prior to 2007 are eligible for rollover next year, Keebler says, assuming the plan doesn't require closing out the deceased's account before then.
    With this type of rollover, funds must move from the plan to the inherited IRA via a trustee-to-trustee transfer. The inherited IRA will be titled John Smith Sr., Deceased IRA, For the Benefit of John Smith Jr., according to Keebler.

Look Ahead
    Help clients get a jump on the new year by sharing what's new for '07, including this exasperating rule: Every cash gift must be documented with a bank statement or cancelled check, or a dated receipt showing the charity's name and amount given. Anonymous contributions to donation boxes won't be deductible, Keebler says.
    Business owners with defined-benefit plans who wish to reduce their involvement with the company and begin receiving benefits will be able to do it at age 62 rather than 65, says John Lowell, senior consultant at CCA Strategies, a Chicago-based consultancy. "A 62-year-old business owner who has been making $400,000 annually might be able to draw the maximum benefit, work a little more than half-time, and still enjoy the same income," Lowell says.
    Finally, clients participating in a 401(k) at work may soon find themselves the audience of new, employer-approved, plan-provider-supplied "fiduciary advisors." (See "Whose Advice Is It Anyway?" September Financial Advisor.) What, exactly, this will look like in practice is unknowable at this time. But for now, it might be a good idea to remind clients that they need all their financial advice integrated holistically under one coherent, objective-oriented plan.