Think of year-end tax planning as the pre-season, one that actually counts (unlike, say, professional football's). For the financial advisor, recommending moves before the ball drops in Times Square has a readily measurable impact on clients' tax returns come April 15-game day. Tax year 2002 brings new rules plus a downtrodden market and anemic economy, which provide a different backdrop to year-end strategizing than we've seen in a while.

For example, some clients' incomes-and tax brackets-are down. So income acceleration, rather than the usual deferral tack, can make sense if 2003 projects to be richer. Clients who can stand more 2002 earnings can ask for bonuses in December or consider selling restricted stock, says Denver CPA Mira Fine, a partner at Hein & Associates. Suffering business owners (clients and planners) should work their receivables.

A year with reduced income offers clients a chance to convert a traditional individual retirement account into a Roth IRA, says David M. Spitzberg, a CPA in Jenkintown, Pa. Converted funds that stay in a Roth at least five years can be withdrawn tax- and penalty-free after age 591/2, and there are no required distributions at 701/2. In order to convert, the client's adjusted gross income (as modified) must be $100,000 or less and the amount converted gets taxed at ordinary rates, which is why a mediocre year is a good opportunity to convert. Clients may convert all of a traditional IRA or just part of it, Spitzberg says. Each conversion has its own 5-year waiting period.

If income acceleration is appropriate, deduction deferral may be, too. A higher bracket in 2003 means greater tax savings by deducting next year. "But you have to be wary of the alternative minimum tax (AMT) implications in anything you do," says Thomas J. Kleinschmidt, head of the tax team at Stirtz, Bernards, Boyden, Surdel & Larter, a Minneapolis CPA firm. State income taxes, miscellaneous itemizations, et al are non-deductible for clients in AMT, and medical deductions may be taken only if they are more than 10% of income (vs. 7.5% regularly). Don't dance deductions between years without considering the potential AMT impact on each year, Kleinschmidt says..

For 2002, itemized deductions phase out when adjusted gross income exceeds $137,300, costing the typical client 3% of income above that. Singles earning more than $137,300 (joint filers $206,000) also lose personal exemptions.

The $130,000 Cliff

A new deduction for college tuition bills is available to couples with adjusted gross income (AGI) of $130,000 or less, and to all other taxpayers with incomes of $65,000 or less. Oddly, this above-the-line deduction (clients don't have to itemize to take it) does not phase out. It falls off a cliff, says CPA/Certified College Planning Specialist Rick Darvis, president of College Funding Inc. ( A client gets the full $3,000 deduction-or nothing. "One dollar of income makes a big difference," Darvis says. The tuition deduction is reduced by any tax-free earnings withdrawn from a 529 plan during the year.

Alert Clients

Year-end is always a good time to issue reminders to clients, and this year three nudges are in order. One is ensuring that clients (particularly new ones) have contributed the maximum to their retirement plans. Many workers are on auto mode, stashing a fixed amount per pay period, but the ceilings on contributions were raised in January. "If clients didn't adjust to the higher limitations, they'll lose out," says CPA/Personal Financial Specialist Mitchell Freedman of MFAC Financial Advisors in Sherman Oaks, California.

Although the typical qualified plan asserts that changes to contributions can be made only at certain times, such as the beginning of the calendar quarter, those rules can be bent. "It depends on whether the plan administrator will cooperate, but I have seen situations where individuals were permitted to put away the entire amount on the last day of the year," Freedman says.

Self-employed individuals can establish a Keogh plan by New Year's Eve, wait until October 15, 2003, to fund it, and still get a deduction on their 2002 return of up to $40,000 ($41,000 if 50 or older), says James Barry, a corporate vice-president in New York Life's Nautilus Group, which advises agents with high-net-worth clients. Those who miss the deadline to set up a Keogh have until October 15, 2003, to establish a SEP (simplified employee pension) plan, although a SEP's contribution limits are lower, Barry says.

Reminder No. 2 in this environment is that job-hunting expenses are deductible as a miscellaneous itemized expense. To qualify, the client must be seeking employment in his current occupation, not a new field. According to Spitzberg, deductible expenses include fees paid to an employment or outplacement agency, travel while looking for work (including 36.5 cents per mile for car mileage, with proper documentation), resume preparation and mailing costs, and long-distance phone calls to potential employers.

Business owners should be advised that while the feds permit 30% "bonus" depreciation for the first year that a new asset is utilized, not all states do. Only one third had conformed to the Internal Revenue Service's new bonus depreciation rules as of mid-summer, according to CCH Inc., a business-information provider in Riverwoods, Ill. Therefore, clients making year-end equipment purchases can't automatically assume state tax savings.

Not For Business Owners Only

Although bonus depreciation was ostensibly legislated to aid businesses, others can take it, too. Minneapolis CPA Mark Sellner has a client who plunked down $65,000 for a large Lexus SUV, in part because the salesman pitched that he could immediately write-off $24,000 with Section 179 depreciation. The client is not an entrepreneur but rather an employee who uses his personal vehicle 80% for work and therefore qualifies to deduct that portion of its cost-including Section 179 depreciation-as an unreimbursed employee business expense (a type of miscellaneous itemized deduction). But as noted earlier, miscellaneous deductions are quashed by AMT (the car dealer didn't mention that), which this client pays. Enter the code provision that says bonus depreciation is allowable under the AMT. "He lost the $24,000 expensing deduction [under Section 179] in the AMT calculation, so instead we took the 30% bonus depreciation, because the law says it applies for both regular and alternative minimum tax," says Sellner, managing principal of tax services at Larson, Allen, Weishair & Co.

To preclude IRS computers from rejecting the return, Sellner added the client's entire miscellaneous itemized deduction to income as required on Line 5 of Form 6251, the AMT schedule. "Then, as a 'related adjustment' on Line 14o, we subtracted the bonus depreciation, which we don't have to add back, and wrote on the return, '30% bonus depreciation not subject to AMT under new Section 168(k),'" Sellner says.

Harvesting Losses

With the stock market in a funk, it may be easy for clients to recognize losses in their taxable portfolios (despite your expert investment advice). Up to $3,000 of net capital losses for the year can offset ordinary income, although at the time of this writing Capitol Hill was making noises about upping the maximum, says Susan Hirshman, a vice president at JP Morgan Fleming Asset Management, in New York. For clients intent on deducting the max, be sure you understand how the netting rules work so that you don't leave potential deductions on the table, Hirshman advises. All short-term gains and losses are netted against each other, as are long-term gains and losses. The net short-term and net long-term figures are then combined to produce net gain or loss for the year, Hirshman says.

For advisors eager to make year-end portfolio rebalancing a tax-efficient endeavor, consider how Freedman is approaching it this year for his clients who own bonds. "We recently made an economic decision to eliminate long-term bonds from clients' portfolios, to pare back intermediate-term bonds, and to go into short-term instruments," Freedman says, explaining that he thinks interest rates are more likely to rise than fall. "If interest rates go up, a lot of the appreciation that people have gathered in bonds over the past couple of years will dissipate. I'm not a market timer, but by re-positioning, we are realizing gains in bonds and offsetting the tax consequences by harvesting losses in equities," Freedman says.

Gift-Tax Planning

Stuck at $10,000 for years, the annual gift-tax-free amount that one individual can transfer to another has risen to $11,000 per donee for 2002, thanks to a 1997 tax act that adjusts the annual exclusion for inflation. This means, among other things, that a client may now gift $55,000 (i.e., five years' exclusions) to a beneficiary's Section 529 plan. "Grandma and Grandpa can put in $110,000 [$55,000 each] for each grandchild," says New York Life's Barry. A state income tax deduction may be available, too, yielding additional bang for the buck. New Mexico, for example, offers residents an unlimited deduction for 529 contributions.

Clients can also leverage the annual exclusion by gifting assets which qualify for valuation discounts, such as limited partnership interests, non-voting shares in a closely-held corporation, or shares that represent less than voting control. "Instead of $11,000, the family might be able to move over fifteen or sixteen thousand in true net worth," Barry says. "Conservatively, discounts of 20% to 30% are not unreasonable."

Clients with a habit of writing gift checks very late in the year should tell recipients to cash the check immediately, Barry advises. "If the donee doesn't cash it before the end of the year, it's not a gift in 2002. It's a gift in the year cashed." So urge clients to communicate with their youngsters.