Joan Rivers always started off a really good monologue with the phrase, "Can we talk?" Now I ask you, what kind of question is, "Can we talk?" If we're both in the same room and words are coming out of our mouths, doesn't that mean we are talking? Not necessarily. We all know that really talking entails listening and that's a bit trickier than the talking part.

Well, we really want to talk with you about tax planning in this section. We'll tell you a lot of things you can start doing now that might ease your tax pain come April 2004 and perhaps April 2005. We'll even try to make it interesting, but we know you'd rather have a root canal than read about taxes. Unfortunately, the only way to avoid tax traps is to know about them, so you might as well endure the boredom to position yourself to keep as much money in your pocket as you can.

Note that we said might. Sometimes, there is simply no way to avoid paying taxes on a transaction, and assuming you pocket the cash you're taxed on, that's not all bad. Still, we live by the philosophy that money is better in our clients' pockets than the United States Treasury. Before you do anything significant, though, give us a call so we can help you navigate the tricky tax waters a bit better.


What is tax planning?

Now that you know we are here to help, not hurt; let's define a few terms.

Tax planning is anything legal that you do to keep your money in your pocket, not the Uncle Sam's. Sometimes this means avoiding taxes altogether, but most of the time, it means putting off paying taxes until some later year.

We don't want to confuse you. There are still some ways to avoid paying tax and they are even legal. Unfortunately, they are few and far between. We will discuss them where we can, but most of our discussion will be structured to achieve an income deferral.

Income deferral means just what it says. When we defer income, we also defer the income tax due on that income. This can be advantageous since you'll have the money to invest, not the Uncle Sam.

If you're one of those folks who think we don't pay enough taxes, you can look at deferring payment of taxes as a benefit to the government. Think about it, if you pay less tax, you have more to invest. If you invest more, that means you have more income (make sure it's taxable). If you have more taxable income, Uncle Sam gets more taxes. It's a win-win situation!

Income deferral can sometimes be counterproductive. In times like that, tax planners may recommend you accelerate income and the related tax. This will generally be the case when accelerating income will put most if not all of your income in a lower bracket than you would have if you didn't accelerate the income.

When we talk about your tax bracket or marginal rate, we are talking about the top rate of tax you pay. Currently, there are six basic tax rates; 10%, 15%, 25%, 28%, 33% and 35%. These brackets are the same for 2003 through 2010. Then they return to pre-2001 levels in 2011. There are other rates for capital gains and we will discuss those later.

Depending on your estimate of total income, you may find it advantageous to accelerate expenses, which has same effect as deferring income, or defer expenses, which has the same effect as accelerating income.

The preceding techniques can work wonders on your overall tax bill, but because Congress did not want anyone with good tax planning abilities to feel as though they were paying too little tax, it created a parallel system called the Alternative Minimum Tax ("AMT"). AMT is Congress' way of making sure everyone pays some level of tax. In general, there are fewer available deductions for AMT purposes and this drives Alternative Minimum Taxable Income up. The higher AMT brackets of 26% and 28% can undo even the most careful tax planning and must be considered in every tax planning scenario.

A standard deduction is the amount the government allows you to take against income, in arriving at taxable income. You get to deduct this amount even if you didn't spend it during the year. The standard deduction varies based on your filing status of which there are basically four: single, head of household, married filing jointly and married filing separately. Qualifying widows and widowers also get a break if they meet certain requirements.

A personal exemption is the amount the government will allow you to deduct from income prior to determining your income tax. The more dependents you have, the higher the personal exemption, but don't forget the AMT. For AMT purposes, personal exemptions don't exist.

So let's get on with it!

Some stuff that makes sense.

Now that we're familiar with some of the more basic terms, let's look at some ways to defer income since that's our favorite way of saving taxes. A lot of what you can do here depends on how you earn your income.

Some of the more common types of income are as follows:

• Wages;


• Income earned from a trade or business;


• Gains received on sale of investments;


• Rental income;


• Interest and dividends;


• Farming income;


• Royalties from mineral interests;


• Alimony and separate maintenance payments if deductible by the payor;


• Annuity and pension income;


• Income from your portion of a partnership, estate or trust;


• Prizes and awards;


• For some taxpayers, up to 85% of social security income can be taxable;


• Many other receipts of cash or property qualify as taxable income. A general rule is, "If there is no specific exclusion in the Internal Revenue Code, it's probably taxable."

Not all income you receive is taxable. Here is a partial list of what may escape taxes:

• The first $250,000 of gain on the sale of your home; $500,000 if you are married filing jointly. The rules in this area can get complex. Partial business use and depreciation of the home, divorces and remarriages and living in the home for less than two years may have a significant effect on taxability;


• Gifts and/or inheritances;


• Interest earned on state, municipal and tribal bonds. However, some interest has to be added back to AMT income if the bonds are private activity bonds;


• The principal portion of loan repayments and other returns of capital;


• Some or all of your social security benefits, depending on your other income;


• Compensation for injury or sickness, including workers compensation and certain disability payments;


• Minister's housing allowance (but includible in self-employment income);


• And other specifically exempted income.

Your head should be spinning now with all the possibilities, but there is one thing to remember - if you have questions, call your CPA. Your CPA will not only tell you whether a receipt constitutes income or not, you will also get help in determining how to mitigate, if possible, the tax impact. By the way, if you don't have a good CPA, we'd be more than happy to recommend our firm.

As we said earlier, moving income from one year to or from another year is the most effective way to manage taxable income. Some ways to do this are:

• Delaying receipt of income through postponing billing, if you are self-employed and 1) control billing and 2) don't need the cash immediately;
  
• Setup a Deferred Compensation arrangement with your employer. This only works if you agree to the terms before the income is earned. Generally, this means at the beginning of a year. While this is a good technique, because the deferred income remains in the hands of your employer, you may wish to evaluate the risk of not receiving the income when agreed;


• Delay receipt of year-end bonuses. Since year-end bonuses do not have to be paid by an accrual basis employer until 2 ½ months after year-end, asking or allowing your employer to pay you after year-end effectively puts off paying tax on that income for a year;


• Where possible, delay receipt of income. Since you most likely report income when you receive it (cash basis), putting off receipt of interest where possible will reduce income. You can structure CDs so they don't mature until the following year or setting up notes receivable so the interest is payable at the beginning of a month are two ways of shifting some interest income to a following year;


• Make the most of your employer sponsored retirement plans. Contribute the maximum amount you can to your 401(k), Simple or SEP plan. If you are a business owner, in the right set of circumstances you can put away significant dollars to a defined benefit plan while minimizing the amount deposited on behalf of employees. If your employer doesn't sponsor a plan, contribute to your IRA.


• If you are 50 or over, you are also allowed to make an additional "catch-up" contribution. Be careful, though, while this process is straightforward for an IRA, certain requirements have to be met for the payment to be deductible in the case of other plans;


• Defer receipt of the proceeds of sales of capital assets through installment sales. If you sell an asset, but don't need the money right away, let the buyer purchase the asset over two or more years. This allows you to postpone recognition of any gains until later years and does you no harm assuming you charge a reasonable interest rate. Be careful, though. On sales involving depreciated assets, depreciation recapture is recognized on the sale date regardless of how much cash you receive. Make sure you collect enough to cover the taxes on depreciation recapture;


• If you have Series EE Savings Bonds issued in 1963, interest will be taxable in 2003 regardless of whether you cash them in or not. However, if you exchange them for Series HH Savings Bonds, you will be able to defer the income for a while longer.


• Consider investing in T-Bills with short maturities. For these type investments, the interest is not recognized until the T-Bill matures.


• If you want to get out of your present property and move somewhere else, consider a tax-free 1031 exchange. This type exchange can be very tricky, so be very careful.

So far in our discussion of reducing taxable income, we have concentrated on the income portion of the equation. However, equally as important is the expense side. This includes both personal deductions and business deductions. Let's look at some ways to reduce your taxes.

• The time honored and tested way to increase expenses is simply to pay them by year-end. Medical deductions, state income taxes in many states, property taxes, investment interest, interest on your first or second home, donations and miscellaneous itemized deductions like fees for tax and investment advice, union dues and employee business expenses are all personal deductions. While we could talk about what qualifies as a deduction in each category for the remainder of the year, let's just say that if you have a question, you have our number.


• What if you don't have enough money at year-end to take advantage of a deduction. Don't worry. As long as you have a major credit card that is not maxed out, you will be able to pay your medical bills, income taxes and contributions if the organizations you contribute to accept credit cards. Even if they don't, if you have checks you can write on you credit card account, you will be able to pay and take the deduction. Almost every entity takes checks these days.


• There are just a few things you need to be careful about in this area. Don't charge the deductions if you won't be able to pay them in the near future. Even if you want a deduction, it's not worth taking if you lose sleep over how you'll pay your credit card bill.


• Don't pay a bill to get a deduction if it won't help. Remember, only medical expenses over 7.5% of you income are deductible. Investment interest is limited to your investment income. Only miscellaneous itemized deductions that exceed 2% of your income are deductible. If paying a bill won't take you above these limits, keep your cash and credit for another day.


• Don't make a contribution or incur any other deductible expenses if you are only looking for tax savings. You will still come out behind. For example, say you are in the 25% bracket. If you make a donation of $100, you will save $25 in taxes; however, you will still be out a net of $75. You will only lose in this situation;


• One really nice way of saving taxes by making a deductible contribution is to give away appreciated assets. Say that you have a piece of land you bought for $100 and it is now worth $100,000. Say also that you want to give your favorite charity $100,000 this year. If you sell the stock and give the proceeds to the charity, they will get the $100,000 and you'll pay $15,000 in tax based on a 15% long-term capital gain tax rate. If you choose instead to give the land to the charity, income tax law will allow you to take a deduction of $100,000 without paying tax on the gain. You will be required to have an appraisal and meet certain reporting requirements, but you won't have a $20,000 tax bill either. Also, these type donations are deductible only to the extent of 30% of your income as opposed to 50% in normal circumstances;


• Another way of maximizing deductions is to "bunch" deductions. This is basically a way to fully utilize the standard deductions and itemized deductions over a two-year period. As an example, assume your itemized deductions are $7,000 per year, of which, $3,000 is home mortgage interest and the rest contributions. Assume also that you are married and your standard deduction is $7,800 per year. If you just paid your itemized deductions as normal each year, you would be able to take the higher of itemized deductions or the standard deduction. In this case, you would get deductions totaling $15,600 ($7,800 times 2). Suppose for a minute that your contributions are all made at year-end. If you waited until year two to make your contributions, you would get a total two-year deduction of $18,800. Since the first year itemized deductions are less than the standard deduction, the IRS allows you to deduct $7,800. In the second year, your deductions will be $11,000 ($3,000 interest and $8,000 contributions). Just by changing the timing of your payments, you gain $3,200 in deductions at no cost.

Another way to reduce your tax bill is to change the nature of your income. Suppose you bought a tract of land on January 1, 2003. If you sell it within a year, the gain will be considered short-term ordinary gain, which can be taxed at 35%. If you held it over a year and sell it on January 2, 2004, the maximum rate would be 15%. A 20% swing is, by any definition, significant.

From a business perspective, there are a few more maneuvers you can make. However, the one thing you don't want to do is to commit your assets if the only reason is for taxes. The first thing you should always do is make sure your purchases and sales make economic sense. Then, if they do, try to structure the deal to give you the best possible tax advantage.

• Assuming you plan on purchasing equipment in early 2004, why not purchase it in late 2003? In the first place, if you haven't used all of your $100,000 expensing election, you will at least be able to write a portion of your purchase off immediately. In addition, tax legislation passed in the wake of September 11 and a sluggish economy allows an initial 50% bonus write off of any new equipment purchased (used equipment does not qualify) after May 5,2003 and before September 11, 2004. There are a few exceptions, so if you need further information, give us a call.
  
  As an example, let's look at a $200,000 saw you'll need in January 2004 that qualifies as a 5-year asset for taxes. It is now December 2003. If you haven't bought anything else in the year, here's what you will gain. First, you will be able to take the $100,000 expense allowed by the tax code. Next, you will be able to expense 50% of the remaining $100,000 or $50,000. Finally, the remaining basis will be depreciated over 5-years. Using the mid-quarter convention, you will get depreciation of $2,500 in 2003. You will get a total of $152,500 in deductions this year or 76.25%. If you are in a 35% tax bracket, that adds up to a $53,375 reduction in your tax bill. Just make sure the equipment is up and running by December 31, 2003.



• If you don't have a retirement plan in your business, think about establishing one. There are many types of retirement plans ranging from SIMPLE plans to full-fledged defined benefit plans. Each has its own strengths and weaknesses.
  
  For example, Savings Incentive Match Plans for Employees are relatively simple (no pun intended) to administer, but the maximum an employee can put in is $8,000 for 2003 and the employer can only put in up to 3% of the employee's compensation for the year. If an employee doesn't choose to defer any income, the employer is not obligated to make any contributions on behalf of the employee.
  
  SIMPLE plans are also relatively inexpensive since they are defined contribution plans. Defined contribution plans are plans that only require a specified deposit each year rather than trying to achieve a certain benefit payment upon retirement. When an employee leaves, they are entitled only to distributions equaling the value of their account. In general, you can only establish a SIMPLE plan between January 1 and October 1 of each year. The only exception is if your business started after October 1. In that case, you must establish the SIMPLE plan as soon as administratively feasible, but no later than December 31 of the first year of existence.
  
  By contrast, if your business has high turnover, relatively young employees and you are nearing retirement, you can put away a great deal of money under a defined-benefit plan. It is not unheard of to see contributions for owners in the $150,000 range.
  
  However, these plans are difficult to administer, require actuaries to determine the proper contributions and lock the employer into a potentially expensive long-term commitment. This happens because defined benefit plans are designed to pay retirees a set income. Therefore, employers must fund the plan to provide enough assets to meet the future liability. While it is possible to terminate the plan down the road, you will have to take into account the effect on employee morale more so than if you terminate a 401(k) or similar plan.
  
  For business owners, retirement planning can be a very effective way to manage your tax liability (legally). Unfortunately, there are numerous types of plans with different contribution limits and other requirements. Because of this complexity, we strongly suggest you contact your financial advisor or us prior to deciding on which route you wish to take. If you think that you may wish to take advantage of a retirement account, contact us as soon as possible. Some plans must be set up prior to December 31 to be deductible for 2003.
  
  Even if you are not a business owner, check with the company to see if your company has a plan and how much, if any, you will be able to defer by year-end. Also, don't forget that you may be eligible to make deductible IRA contributions depending on your income and/or your participation in an employer sponsored plan.

Here's one of life's paradoxes.

Sometimes, it makes sense to increase your income rather than defer it. It may be that you expect your income to increase so much next year to put you in a higher bracket, you will be getting married and the marriage penalty will hit you or your itemized deductions are so high that you won't be able to fully use them. In these type situations, you may wish to accelerate income into 2003.

For example, let's assume you are married and filing a joint return with your spouse and we are talking about the 2003 tax year. Your taxable income in 2003 is $125,000, but because of a $40,000 windfall in January and generally better economic conditions, your 2004 taxable income will be $210,000. Based on current tax brackets, your tax for the two years would be approximately $76,000 and your 2003 top rate would be 33%. If you could have pushed the $40,000 into 2002, your tax on the same income would be approximately $74,000. That's a $2,000 savings because of timing your income so your top rate in 2004 would be 28%, not 33%. Unless you make 16% or more on your money in 2004, you come out ahead.

Here are a few ways to accelerate income:

• Instead of billing late, do your best to collect outstanding receivables and bill at the normal time;


• Ask your boss if you can get your bonus this year instead of next year. If you're the boss, check with yourself, but don't expect an automatic "yes". You may be limited by the amount of cash on hand;


• If you receive restricted stock as compensation, you generally don't have to recognize income until you sell it. However, if it is to your advantage, you can elect to have the taxable portion taxed in the current year. This requires a filing with the IRS within 30 days of the day you receive the stock. Again, as many tech employees found in the last few years, whatever you do is not without risk. In the case of restricted stock, if you recognize income on the stock and later forfeit it, you will have paid tax when you shouldn't have;


• Incentive stock options that can be exercised in the current year may also be a source of accelerating income. However, consider your overall investment strategy before making this move;


• If you can take IRA or other pension plan distributions without paying a 10% penalty, take the withdrawal;


• Instead of deferring income on Series EE Savings Bonds, cash them in and recognize the income;


• Collect extra payments on installment notes if possible;


• If you are able to do so, have your closely held corporation pay a dividend in the current year;


• And there are numerous other possibilities we would like to share with you after a thorough review of your individual situation, including taking capital gains and accelerating other investment income and deferring payment of deductible expenses.

Breaking news for military families.

As we go to press with this guide, the U.S. Congress has just passed the Military Family Tax Relief Act of 2003 or MFTRA. President Bush is expected to sign it on November 11, 2003. Among other things, the Act:

• Increases the military death benefit from $6,000 to $12,000 retroactive to September 11, 2001 and also fixes a problem from 1991 that made ½ of the death benefit of $6,000 taxable;


• Creates a special exception to the two-out-of-five year residency requirement to be eligible to exclude $250,000 ($500,000 if married filing jointly) in gain from the sale of your home. In essence, it allows you to suspend the rule for up to five years if you are away from home on "qualified official extended duty," and is retroactive to May 6, 1997:


• Expands the combat zone filing requirements to include troops deployed in "contingency operations." A "contingency operation" is an operation designated as such by the Secretary of Defense and in which troops are, or may become, involved in hostilities against enemies the United States;


• Various other changes. For more information, you can go to the IRS website, but it will take a little time before the site is updated for the new law.

Helpful links.

The following links are to the Internal Revenue Service website. They are intended to give you quick access to some of the more important tax topics for businesses and individuals:

• 2003 Individual Income Tax Rates


• Internal Revenue Service Frequently Asked Questions - Individuals


• Internal Revenue Service Tax Guide for Businesses

First aid for your headache.

By now, you should be shaking your head in disbelief that there are so many ways to affect your taxable income. We're sorry to tell you, but we've only scratched the surface. We haven't even discussed, deducting higher education expenses, choosing different depreciation methods to avoid AMT tax, using flexible spending accounts and taking advantage of various available credits and a myriad of other available tax choices breaks and choices.

Let's face it; until there is a major change in the appetites of Americans for government services and the elected representatives desire to deliver for their constituents, we will be paying taxes. Not only that, but much of politics entails using the tax code to fine tune benefits flowing to various interest groups and also to redistribute income to reduce poverty rates.

Given that, we shouldn't expect the tax code to get less complicated and we don't profess to give you all the ways you can minimize your tax liability in 2004. The task would be impossible. That's why there are CPAs like us available to help you. Think of us as first aid to help you relieve your tax headache, but don't wait until you have to go to the emergency room at the end of the year. Instead, consider the consequences of your decisions throughout the year and let us help you make the tough decisions. You won't regret it.

There now, our discussion wasn't all that bad, was it? On second thought, don't answer that!