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How To Significantly Reduce Your Earlier Quarterly Estimates
Certain types of income, such as capital gains and bonuses, typically are not related or earned evenly throughout the year. If you earn such income, you likely can reduce your earlier quarterly estimates by preparing actual quarterly tax projections.
By computing your year-to-date tax, after withholding, you can pay the net amount without incurring a penalyty – even if this amount is significantly lower than the amount due based on on your prior year's tax. Later in the year you can catch up by increasing your estimates as you earn income.
How To Catch Tax Savings With the Netting Rule
Let's say you determine that your year-to-date net capital gain is $40,000, resulting from an $80,000 short-term capital loss and $120,000 of long-term capital gains. If you take no year-end action, you will pay a tax of $8,000 ($40,000 at 20%). To eliminate this tax, first try to sell securities at a loss that you have held long-term rather than short-term. Why? Because securities held either long- or short-term sold at a loss of $40,000 will have the same effect as eliminating the tax.
If the year-to-date position were reversed, with net short-tern gains of $120,000 and net long-term capital lossses of $80,000, a year-end long-term capital loss of $40,000 would save you $15,440, since the 38.6% rate applies because you reduced your net long-term gains.
The result in both situations is the opposite of what you might initially think, because a short-term loss in the first situation would give you only a 20% benefit and the long term-loss in the reversed situation gives you a benefit of 38.6%.
Be Your Buyer's Lender and Defer Your Gain
You sell a building you own by agreeing the buyer a 10-year mortgage for 75% of the net selling price of $1.2 million. The first payment on the mortgage is due in January of 2003/ You initially paid $600,000 for the building but the accumulated depreciation has reduced your tax basis to $360,000, resulting in a capital gain of $840,000.
If the buyer took a mortgage from a bank instead, you would report the full $840,000 gain this year at a federal tax cost of $168,000 (before applying the %25 percent rate on the portion of the gain attributable to depreciation recapture). However, because the buyer gave you a note, you are eligible to elect installment sale reporting. As a result, your tax for 2002 is $42,000 based on a taxable gain of $210,000 ($300,000 down payment at the gross ratio of 70% based on the total gain of $840,000 compared to the selling price of $1.2 million).
The remaining tax of $126,000 gets deferred, payable only as additional principal payments are received.
Save More By Donating Stock Instead of Cash
Instead of donating cash, use appreciated securities to make a contribution of $75,000 before year-end. You bought the stock years ago for $25,000 and were planning to sell it because its growth had peaked. By using stock rather than cash, you save $10,000 in federal taxes that you would have saved on the appreciation of $50,000 when you sold the stock.
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Cash Contribution
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Stock Contribution
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Tax savings on contribution (at 38.6%)
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$28,950
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$28,950
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Capital gains tax if stock was sold (at 20%)
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($10,000)
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0
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Net tax savings
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$18,950
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$28,950
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AGI Too High To Claim a Credit? Have Your Child Take It
If you pay qualified expenses for your children , but income limitations prevent you from taking the Hope or Lifetime Learning credit, have your children claim the credit instead. You must forgo the dependency exemption that you are entitled to, but you would probably lose it anyway because of a phase-out for high income taxpayers.
Your child can use the tax credit to reduce his or her own tax liability, but won't be able to claim the expemption.
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