For the financial advisor making strategic tax moves for clients before year-end, the agenda includes new twists on old plots, a once-in-forever opportunity and a slate of things NOT to do before December 31.

Utilize New Capital Gains Rate

At the beginning of 2001, the capital gains rate for taxpayers in the 15% ordinary bracket fell to 8% (from 10%) for investments held more than five years. High-net-worth clients pondering sales of appreciated five-year holdings should consider gifting them to a 15%-bracket family member (14 or older, otherwise the parents' bracket applies) who can immediately liquidate and get the 8% rate now, since a donor's holding period carries over to the donee. The maneuver slices the family's cap-gains tax by 60%.

For five-year gains that raise a client's taxable income above the 15% ordinary bracket, the part that falls in it gets 8% treatment. So a partial benefit awaits clients able to sneak into the 15% bracket through income deferral and/or deduction acceleration.

Consider A Deemed Sale

Clients with investments expected to soar in 2006 or later are candidates for the short-lived deemed-sale election, says Sue Clark, a CPA and tax principal at Larson, Allen, Weishair & Co. in its Minneapolis office. Available only on this year's return, the deemed sale qualifies assets held at the beginning of 2001 for an 18%, five-year capital gains rate (versus the usual 20%) for taxpayers in the 27% and higher ordinary brackets.

The election lets taxpayers deem-pretend-to have sold an investment or business asset on January 1, 2001, (at the market close on January 2, in the case of stocks and mutual funds) and immediately repurchased it for the same price. Gain on the goof sale is taxable (so don't make the election on highly appreciated property, unless you're soaking up big losses), basis gets stepped-up to the January 2001 value and subsequent appreciation is taxed at 18%, assuming the asset is held more than five years after the deemed-sale date. The election is best chosen for assets clients will sell during their lifetimes: Since heirs receive property at its market value at death, any tax the client pays to step-up basis via a deemed sale is spent money that returns no benefit.

A loss from a deemed sale is not deductible, nor is the election allowed for any investment sold during 2001, Clark says.

Balance Investment Profits With Losses

"The bad news this year is that the gains are going to be somewhat limited," says Atlanta advisor Jack Harmon, founder and president of Harmon Financial Advisors. Look for gains in the small- and mid-cap areas, he suggests.

In all sectors, nag fund companies for year-end distribution information in advance. "Then you'll know what you have to work with automatically if you stay with the fund," Harmon says, explaining that capital losses can be applied against distributions the client receives.

Today's market-basket securities let advisors aggressively book tax losses, while steering clear of the Internal Revenue Service's wash-sale rule. Many exchange-traded funds and index funds are similar yet hardly substantially identical-the wash-sale criterion-so clients in loss territory on, say, the Nasdaq 100 tracking stock (AMEX: QQQ) can sell that and buy the Dow Jones technology-index iShare (AMEX: IYW) to maintain an allocation that's tax-efficient.

Tarbox Equity Inc., money managers in Newport Beach, Calif., suggest ETFs as placeholders for downtrodden large-caps, which look good long term. "Harvest losses on an individual stock by using an ETF in its place for 30 days [after the sale date], then move [back] into the stock," says Mike Nozzarella, a managing director at the firm. When an individual issue has a significant weighting in an ETF, the latter will participate in the stock's movement during the interim-a safer way to stay in the sector while harvesting losses than moving to a stock that could get hit with negative news, says Nozzarella.

Brace For The AMT

In the current tax environment, the accident waiting-and most likely-to happen is the alternative minimum tax. You need to project clients' scenarios now. (Taxpayers pay the higher of regular tax or AMT.)

The most common causes of AMT are a gain on incentive stock options (ISOs), high deductible taxes and high miscellaneous itemized deductions-$20,000 of these items routinely trigger AMT for clients earning $100,000 to $200,000, says Gerald Townsend, a personal financial specialist and registered investment advisor in Raleigh, N.C. AMT also rears its ugly head when income drops and stable deductions become disproportionately large. Bernard Kiely, a CPA and financial advisor in Morristown, N.J., cites the case of a salesman client who incurred AMT when his income dropped from $125,000 to $75,000 because unreimbursed employee-business expenses (a miscellaneous itemized deduction) remained flat at $8,000.

When large deductions are the culprit, it can make sense to increase income for regular-tax purposes until it catches up to the AMT. "That means you're effectively paying tax at AMT rates [26% or 28%], which may be lower than your regular-tax rate," says Townsend, who is president of Townsend Asset Management.

Raise regular income by exercising nonqualified stock options and taking short-term gains (actual or deemed). Delaying until next year the payment of a property-tax bill or estimated state taxes boosts 2001 regular income and simultaneously lowers AMT. However, this tactic could simply push the client's AMT problem into 2002, Townsend says. It's best to do multiyear AMT planning, he advises.

For clients who have exercised incentive stock options, a disqualifying disposition-that is, selling the shares received at exercise by December 31 of the year of exercise-makes AMT go away, literally. An ISO exercise adds to AMT income (the difference between the exercise price and the stock's market price), but that addition is nullified by a disqualifying disposition.

Pass Education Credits

High-income clients whose deductions for dependents are phased-out should consider passing disallowed Hope and Lifetime Learning credits to kids, says Clark. "Parents can forgo their children's dependency exemptions, and even though the kids can't claim themselves, they can take an education credit of up to $1,500" that is not available when income (e.g., the parents') exceeds $100,000, Clark says. It doesn't matter whether the parents or the student paid the educational expenses.

The child must have income tax to offset-before December 31, make sure Junior has some-and you've got to calculate the tax benefit that the parent loses (if any) by not deducting the dependent. "If the exemptions are phased out on the parents' tax return, this is a slam dunk," Clark says.

Support The Economy

One of the government's best gifts to business owners is the Section 179 deduction, which permits current-year deductions for equipment purchases. The deduction is better than ever right now. "The limit this year is $24,000," says attorney Barbara Weltman of Millwood, N.Y., author of J.K. Lasser's New Rules for Small Business Taxes.

Take It Later

Advise clients who participate in deferred-compensation plans to delay income until 2004, when the recently enacted tax act drops brackets by 1%, or until 2006, when they fall again, and the top bracket becomes to 35%.

Take It Right

Make sure clients withdrawing mandatory distributions at year-end have their IRA custodians use the new life-expectancy table the IRS issued in January. It reduces the required withdrawal in most cases. Adjusted gross income therefore also falls, opening the door to deducting more miscellaneous itemized expenses (your fees!) and medical expenses (pay bills before year end), AMT consequences notwithstanding.

Don't forget that clients who turned 701/2 in 2001 can choose by April 1 between taking their first required withdrawal this year or in 2002. Taking the initial distribution next year means they'll end up with two withdrawals in 2002-not necessarily a bad thing, says Neil Brown, with Abacus Planning Group in Columbia, S.C. "We have physician clients who turned 701/2 in 2000 and planned to retire in 2001," Brown says. "They were in the 39.6% bracket last year, but we knew they'd be in the 28% [now 27%] bracket for 2001, even if we doubled up on the distributions this year."

Wait Until Next Year

No longer simply the motto of losing teams in late season, delaying action until 2002 can cut next year's tax bill, which gets relief from several provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001:

Pay as you go. For college, that is. Next year, families earning less than $130,000 can take a new above-the-line deduction for $3,000 of college tuition.

There's no deduction now. Keep clients from paying early, even if their schools are wont to ask.

Bring home baby-and a bigger deduction. Supercharged with emotion, adoptions also can be costly. Helping to ease the financial strain is a boost to the complicated adoption credit in 2002, says Atlanta tax and estate-planning attorney John Jeffrey Scroggin. The credit jumps to $10,000 next year (up from 2001's $5,000 regular/$6,000 special-needs adoption), and clients earning $150,000 (versus $75,000 for 2001) can get the full credit. From purely a tax perspective, the choice for families who are close to finalizing adoptions is 1) finalize this year and get credit on the 2001 tax return, losing anything paid in excess of the 2001 limit, or 2) delay finalizing until 2002 and take the larger credit then (it doesn't matter whether the expenses were incurred in 2001 or 2002).

Get more for college. Earnings in Section 529 plans have accumulated tax-deferred, to date. Convert that to tax-free by delaying withdrawals until 2002, when they're free from federal income tax, says Colorado Springs personal financial specialist James Shambo, with Lifetime Planning Concepts. Earnings withdrawn in 2001 are taxed to the beneficiary. So wait already.