Arm Yourself with a Solid Strategy to Maximize Tax Returns

It's an all-too-familiar scene. In March of any givenyear, physicians, as well as other professionals, canbe found scurrying around looking for files, gatheringreceipts, and rifling through investment statements.Why are they scurrying? They're preparing to filetheir income tax statements. Unfortunately, once again,they've waited until the last minute.

It's too late to purchase that new medical equipmentand write off a significant portion of the cost. Thedefined-benefit plan you thought about setting up shouldhave been set up several months ago. And that charitablecontribution you procrastinated over won't benefityou in the current tax year. All of these things and moreshould have been done before the end of the previouscalendar year in October and November.

"There is certain planning that has to be done beforethe end of the year,"says Sy Bressler, CPA, CFE, ofBederson & Co LLP. "Don't wait until the last minute."The steps you take now will enable you to maximizeyour 2004 tax return next spring.

Examine Your Returns

The stock market has been a bit kinder lately, soyou might have large capital gains. If that's the case,check if you have any large capital losses in securitiesthat you want to get rid of, and then do so before theend of the year to offset gains. Even if you don't havesignificant capital losses, experts agree that now is agood time to take those capital gains.

"The long-term capital gains rate, which right now is15%, is as low as it's ever been,"explains Tim Swanson,chief information officer for National City's PrivateClient Group. "Given the country's current fiscal situationand the size of the deficit, regardless of who wins thepresidential election, you have to at least acknowledgethe possibility that future rates could be higher."

Another reason to examine your investment portfolioas part of your year-end tax preparation is tomake sure your investment strategy remains consistentwith the objective of maximizing after-taxreturns. Swanson explains that the difference betweenshort-and long-term investment strategies is significant from a tax perspective.

"Short-term gains are taxed at ordinary incomerates, while long-term gains are taxed at long-term capitalgains rates,"he points out. "A short-term strategycreates challenges from an investment and tax standpoint.If you can defer the realization of those gains untilthey become taxable at a long-term capital gains rate,the government is only going to take half as much. Sothink about your time horizon."

In other words, Swanson says, never lose sight of thebigger picture. Taxes are important, but don't makepoor investment decisions solely to be smart about taxes."Make sure tax is a component of the analysis,"Swanson advises, "but don't allow it to be the only thingyou look at in making your investment decisions. Forhigh-net-worth individuals, there are strong reasons totake the long-term approach."

Swanson also suggests meeting with your accountantto examine your overall asset allocation and discusshow you are dividing those assets among the vehiclesthat are available to you. For example, he pointsout that strategies that generate short-term gainsshouldn't be minimized in accounts that are subject totaxes. Instead, they should be used in tax-deferredvehicles such as IRAs. "So, think not only about whatvehicles you have available, but also how you allocateamong those vehicles,"Swanson says.

Beware of the AMT

A staple of year-end tax preparation has been theconsideration of deferring income and acceleratingexpenses, or vice versa. According to Mike Provine, JD,LLM, a tax and estate attorney with Tradition CapitalManagement (www.traditioncm.com), this is a decisionthat impacts tax returns for 2 years as opposed to 1 year."If you have the discretionary option of taking incomeor deferring it until next year, consider how both years'tax planning should work,"Provine advises. "Youshould always have 2 years in mind."

The other side of that equation, Provine says, is whatshould be done in terms of taking deductions."Frequently, what we see is that [investors] want to paytheir first quarter of next year's real estate taxes thisyear,"he explains. "It sounds like a very appealing thingto do because it creates a tax deduction. But you have toconsider what it does to your regular taxes and what itdoes to the alternative minimum tax (AMT)."

Smart Money

IRS fact:

According to an article in , the best wayto view the AMT is to think of it as a separate tax systemwith its own set of rates and rules. The original ideabehind the tax was to prevent high-income earners fromusing special tax benefits to pay little or no taxes.However, more and more people have been snagged bythe AMT each year. Only 19,000 people owedthe AMT in 1970, compared with 2.6 million today.

Basically, AMT rules determine a minimumamount of tax that individuals in certain incomebrackets should be required to pay. If you are alreadypaying at least that much in taxes because of the regularincome tax, you don't qualify for the AMT.However, if your regular tax falls below the minimum,you make up the difference by paying the AMT.

"Physicians earn a lot of money, so the deductionsthey take are usually okay in relation to the amount ofincome they have,"says Carol Katz, CPA, deputy taxdirector for Leonard J. Miller & Associates. "Butdepending on the state in which they live, taking certaindeductions might not get them the benefits they seek.That's why you need to sit down with your accountantin November and December and make some decisions."

When it comes to the AMT, you could be facedwith an unpleasant surprise next April if you don'tmeet with your accountant and run the numbers.That's because there are details that you could easilyoverlook, such as the timing of payments. "If you'remaking estimated payments, should you make them inDecember or wait until January?"Katz asks. "If youmake them in December to get the federal deduction,you could trigger the AMT."

Time Equipment Purchases

Bressler points out that stipulations for businesseshave been enhanced this year. For example, the bonusdepreciation created by the 2002 tax act has increasedfrom 30% to 50% for assets purchased between May6, 2003, and Dec. 31, 2004. In addition, for 2003through 2005, the small business expense allowance isincreased to $100,000. After 2005, it will drop back to$25,000. So, if you're considering making any largeequipment purchases for your practice, make thembefore the year runs out.

"The rules are changing in 2005,"Katz says."Today, you can still write off a good bit of equipment.As long as the purchases don't exceed $400,000, you canwrite off $100,000. Plus, you can take advantage of allthe special bonus depreciation rules."

Benjamin Bohlmann, CPA, a shareholder in theaccounting firm Mallah, Furman & Co, points out thatif your practice qualifies for good loan terms, you canbuy a new x-ray machine and reduce your tax bill bymore than the cash outlay. For example, if you acquirea $200,000 piece of equipment for a down payment of$40,000, you've created a first-year deduction of$160,000, resulting in tax savings of $55,000. In theend, you not only have a new x-ray machine for yourpractice, but you're also ahead cash wise.

Despite the clear tax benefits of making largeequipment purchases before the end of the 2004 calendaryear, Provine suggests talking with your accountantbefore you buy anything. They can help you determineexactly when these purchases should be made.

"It all has to do with income,"Provine explains."Even if the deduction would be great totake this year, if you're looking at a muchhigher income next year, that might bethe better time because you could amortizeequipment purchases and get a bettertax break and cash flow break next year."

The type of equipment you're goingto purchase also needs consideration. Areyou purchasing a new stethoscope orupgrading your copy machine? Sincethey're entirely different purchases withdifferent returns, talk with your accountantto see what makes sense for you.

Maximize Your Deductions

Fred Grant, a senior tax analyst withIntuit (www.intuit.com), says that one ofthe simplest ways to reap some big taxsavings is to clean out your closets anddonate items to charity. According to theIRS, each year more than 20 million taxpayerswho itemize on their income taxesdeduct donations such as clothing, toys,and household goods.

Bressler agrees with Grant. "If thevalue is under $5000, you don't need anoutside appraiser. But you can't gocrazy,"he warns. "There are IRS guidelineson noncash contributions in theclothing and furnishing area, andthey're accessible from the IRS Web site(www.irs.gov)."

You can also make use of softwarecalled ItsDeductible from Intuit, whichcalculates the value of donated items incompliance with IRS guidelines andmaximizes charitable deductions. Andif you want to accelerate some deductions,Provine suggests combining acharitable contribution with an investmentplanning component.

"What we suggest at the end of theyear, but also as an ongoing processthroughout the year, is to think aboutthe type of charitable deduction youwant to take,"Provine says. "Do youwant to give cash or would you prefer togive actual securities? If you have securitiesthat are selling at a gain that youwould have sold anyway or were thinkingof selling, give them away. You createthe tax deduction and don't eat intoyour normal cash flow."

It's also important to make sure youtake maximum advantage of availablevehicles that defer taxes, such as 401(k)plans. With this plan, if you're aged 50 orolder, there are catch-up provisions thatapply. For 2004, you can put up to$13,000 into a 401(k). But if you're aged50 or older, you can contribute an additional$3000 to the retirement plan.

Bressler also recommends that physiciansconsider setting up a defined-bene-fit plan. "If set up properly—dependingon the physician's income, age, andplanned retirement date—the contributionto a defined-benefit plan can be asmuch as $150,000,"he points out. "In aregular retirement plan or a simplifiedemployee pension, you're limited to$41,000. But if you can put away$150,000, that makes a big difference."

The most important thing for physiciansto do this time of year is to schedulean appointment with their accountant oradvisor. "Every fall when you changeyour clocks and change the batteries inyour smoke detectors, think of your year-endtax planning and use that as a triggerto call your accountant,"Bressler suggests."It's a good way to determine whatshould happen between now and the endof the year."