Act now to cut taxes
New IRS rules affecting year-end strategies
Russ Wiles
The Arizona Republic
Dec. 20, 2004 12:00 AM
If you're looking to buy a car, or get rid of one, changes to the nation's tax code can make it wise to act before Jan. 1.
Two new tax rules relate to autos, trucks, boats and other vehicles. One reduces the deductible value of vehicles that individuals give to charity starting Jan. 1, thus making it smart to donate before year-end if you're so inclined.
The other, more significant rule lets taxpayers deduct either their state and local income taxes or their state and local sales taxes - the first time since the mid-1980s that Uncle Sam has allowed a sales-tax break. advertisement
"It will save some people taxes to have the choice, even in Arizona," said Ellen Campbell, an enrolled-agent tax specialist in Phoenix. "But the obvious winners are people in Florida, Texas and other places with no state income taxes."
While the sales-tax rule isn't geared to vehicles per se, they're the highest-dollar items on which most people pay sales taxes.
Both rules spice up the usual array of year-end tax-planning tips, such as:
• Taking as many deductions as you can before year-end while deferring the receipt of income, if possible, until 2005. This assumes you'll be in the same or a higher tax bracket next year.
As a general rule, all medical expenses can be deducted in Arizona. That differs from federal law, for which medical costs can be written off only to the extent they exceed 7.5 percent of adjusted gross income.
• Donating money or personal property like clothes to charitable groups - one of the easiest ways to compile deductions before year-end.
"Go through your closet and go through your garage," suggests James Darling, a certified public accountant in Tempe. "If you're thinking of giving money to charities, do it before year-end."
• Donating to help Arizona students. The state allows a tax credit of up to $200 for singles or $250 for married couples for donations in support of extracurricular activities at public schools. There's also a credit worth up to $500 for singles and $625 for married couples on donations to organizations that provide scholarships for private-school students. Any credit taken can't exceed the amount of your donation.
• Selling stocks, mutual funds or other investments before year-end. If your losses exceed your gains, you can deduct up to $3,000 in losses each year from ordinary income.
Just be aware that you first must net any losses against gains in calculating year-end tax liabilities, Darling said.
So if you've already locked in long-term gains that will be taxed at a modest 15 percent rate, you might want to delay taking losses until 2005.
"You don't necessarily want to realize losses if it means wiping out your 15 percent gains," he said.
• Avoiding the purchase of mutual funds until after they pay capital-gains distributions. This way, you avoid "buying the dividend" - normally a poor move but a timely caveat since most funds make capital-gains payments in December. This tip doesn't apply if you invest within 401(k) or other sheltered accounts.
As a footnote, some of those year-end tips shouldn't be pursued by people subject to the alternative minimum tax. Items that can trigger the AMT include deductions for state income tax, sales tax and real estate taxes. So can unusually large capital gains.
The vehicle-donation issue carries the most urgency, since the rules will change Jan. 1. Starting then, donors will be able to deduct only the price at which the charity sells their vehicle, rather than the fair market value. Most charities sell donated cars at auctions, at low wholesale prices.
"It's best for donors to do it now," said Jamie Craig Dove, development director for the Arizona Kidney Foundation, which operates one of the biggest and oldest donation programs in the state.
The new provision, which applies to donations above $500, threatens to cut into future vehicle gifting, which some charities rely on as a key source of revenue.
"We're not pretending this will be a non-issue," Dove said. "But the people who are committed to the Arizona Kidney Foundation will continue to donate cars anyway."
The charity generates about $600,000, roughly one-fifth its annual budget, from vehicle donations. Proceeds pay for dialysis, transplants and other assistance for needy patients.
The sales-tax break is perhaps the main new provision affecting individuals this year. It applies in both 2004 and 2005, yet it's available only to taxpayers who itemize, or separately list, deductions. About 45 percent of Arizonans itemize.
If you choose to deduct sales taxes, you can rely on IRS tables that estimate tax outlays for people in various states, income ranges and exemption categories. The tables are listed in Publication 600, which can be viewed at www.irs.gov. The IRS will send the brochure early next year to taxpayers who normally receive a Form 1040 package.
If you buy a car or other big-ticket item, you can still add the taxes from those purchases to your table amounts to calculate the overall sales-tax deduction.
Arizonans paid $1,013 in state income taxes on average in 2002, reports the Department of Revenue. That provides a rough comparison for anyone considering the sales-tax option.
Reach the reporter at russ.wiles@arizonarepublic.com or (602) 444-8616.
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