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Tax Newsletter
November - December 2006

The end of the year is fast approaching, together with the chance to do income tax planning. Our year-end newsletter reviews various concepts and rules with regard to managing your portfolio and the potential tax ramifications, as well as other year-end opportunities.

Low capital gains rates. The federal capital gain rate remains a historically low 15%. The combined federal and California tax rate for long term capital gains is approximately 25%. Although low by historical rates, the capital gains tax is still significant when disposing of low basis securities. Accordingly, the use of charitable remainder trusts remains a viable planning alternative to avoid or defer the capital gains tax, where the gains will be significant, and there is also a desire to leave money to charity.

Wash sales. Do you have a large amount of capital gains this year? Do you hold securities that would create a capital loss if you sold them by year-end? Would these losses come from investments you want to continue to hold because you believe the upside potential is great?

There are techniques that allow you to take advantage of the loss to reduce current year capital gains, and continue to include the loss investment in your portfolio. However, in order to take advantage of such techniques you must take into account the "wash sale" rules.

A "wash sale" is a transaction where you sell the loss security and, within a short time after or before the sale, you reacquire the same security. A deduction is not allowed for the loss generated if you acquire substantially identical securities within a 61-day period beginning 30 days before the sale and ending 30 days after it. The following techniques will help you to avoid the "wash sale" rules:

  1. Wait at least 31 days before repurchasing the loss securities. The risk to this approach is the potential loss of any gain on the stock that occurs during the "waiting" period.
  2. "Double up", buy a second lot that is equal to the original holding, wait 31 days, and then sell the original lot, thereby recognizing the loss. While this allows you to maintain a continuous interest in the stock, you do have to tie up additional funds for at least 31 days, thereby doubling your downside risk.
  3. Sell the loss stock and reinvest in the stock of another company in the same industry that has historically performed in a similar way as the loss stock. After 31 days, you can reverse the process to restore your original holding. This technique minimizes your risk during the waiting period.
  4. Consider investing in exchange-traded funds (ETFs). ETFs give investors the opportunity to buy or sell an entire portfolio of stocks in a single security. By owning an ETF containing the stocks in an entire industry sector or market index, an investor owns a large, diversified number of companies which gives a degree of protection in case the price of one company in the index goes lower. Wash sale rules do not apply if the ETF you purchase includes the stock you sold at a loss within 30 days of the ETF purchase, since an industry ETF is not substantially identical to any individual company.

Investment expenses. Investment expenses are deductible as miscellaneous itemized deductions, subject to the 2%-of-adjusted-gross-income limit. The following types of expenses qualify as investment expenses, providing there is a credible relationship between the expense and the investment activity of the individual:

  • Fees for financial and investment advice;
  • Servicing fees from banks, custodians, or brokers;
  • Subscriptions to professional and investment periodicals and books;
  • Travel to and from a broker’s office to transact business ($0.445/mile);
  • Rental of office space or payment for secretarial and other clerical expenses; and
  • Depreciation on property used to manage investments, such as a computer (investment use portion only)

Other year-end planning considerations for individuals:

The impact of AMT. The Alternative Minimum Tax (“AMT”) system was put in place to ensure that all taxpayers pay a minimum level of tax. Unfortunately, for California residents, the current AMT system often results in higher taxes due. This is because deductions are not allowed for California income tax paid and real property taxes in the AMT calculation.

While the alternative tax is a burden, it also may present a planning opportunity, particularly for taxpayers who are subject to the AMT in one year but not in the next (or vice versa). In order to determine whether AMT is a factor in the current year, and to assess year-end planning opportunities, a projection of taxable income for the year is generally required.

Prepayment of expenses. As the year-end approaches, evaluate if you are subject to AMT, and consider prepaying tax deductible expenses, such as state taxes, real estate taxes and home mortgage interest, to the extent you get a current year tax benefit.

Medical expenses. Within certain limits, medical expenses are deductible and may provide tax benefits. Medical care includes:

  • Doctors, nurses, hospitals and/or prescriptions;
  • Health insurance premiums;
  • Medically related expenses while living in a nursing home; and
  • Long term care insurance premiums (there are some limitations)

Charitable contributions. Because the timing of making contributions to charity is discretionary, charitable contributions continue to be one of the most flexible of the deductible expenses. As a general rule, gifts of appreciated property (e.g., stocks) have a significant tax advantage over cash contributions. You receive a charitable contribution deduction for the fully appreciated value of the property, while avoiding tax on the capital gain that would have been realized if you had sold the property and contributed the proceeds. Even with the reduced tax on capital gains, there is a benefit to avoiding the 25% combined federal and California tax cost associated with the sale of appreciated assets. As mentioned previously, charitable remainder trusts and private foundations are additional planning tools that may help you reduce income taxes while helping you achieve your charitable goals.

Other charitable considerations. Laws passed in 2006 may also affect your current year contribution decisions, as follows:

  • Taxpayers, age 70 ½ or older, will be able to make tax-free distributions from IRAs to charities. The distributions must be direct from the IRA to charity. The maximum amount per year is $100,000. While a charitable contribution deduction is not available, the withdrawal from the IRA will not generate taxable income, but will satisfy the Minimum Distribution Requirement for the year. This provision is available for tax years 2006 and 2007.
  • A deduction is not allowed for used clothing and household items unless the items are in “good” condition. At this time, there is no guidance on what constitutes “good condition”.
  • Charitable contribution of vehicles. An individual who wishes to claim a charitable deduction for a vehicle in an amount in excess of $500 must obtain a contemporaneous written acknowledgment from the charity. The acknowledgment must reflect the gross proceeds from the sale of the vehicle; the maximum deduction available to the taxpayer will be the gross proceeds from such sale.

Maximize retirement plan contributions. Contributions to tax deferred retirement plans remain a valuable financial planning tool. One of the easiest and least expensive ways to save for your retirement is to take advantage of your employer qualified plans and/or IRAs, by making annual pre-tax contributions to such plans. Increased contribution limitations and catch-up provisions allow older workers to increase their retirement savings. Parents with children that have earned income may want to consider making a gift to a child, which the child can contribute to an IRA up to the amount of his or her earned income.

Other year-end planning considerations for businesses:

SUV limit. The law limits to $25,000 the expense deduction for the cost of a sports utility vehicle (SUV) that is used in a trade or business. This limitation applies to an SUV that has a gross vehicle weight rating that exceeds 6,000 pounds.

Self employed health insurance deduction. For the year 2006 self-employed persons may deduct 100% of the cost of health insurance from gross income.

Gift and estate tax considerations:

Gifting. The current top marginal rate is 46% for estate and gift tax purposes. For larger estates, a gift-giving program may be an effective way to reduce transfer taxes and provide for beneficiaries:

  • The first $12,000 (per donee) of gifts made by a donor is not subject to gift tax.
  • The first $1,000,000 (excluding annual $12,000 gifts) of lifetime gifts is not subject to gift tax.
  • Gifts of appreciated property carry over the cost basis from the donor to the donee.
  • Direct payments of medical and/or educational expenses to the institutions on another person’s behalf, do not count against the $12,000 annual exclusion.
  • Gifts of appreciated stock to children is a good planning tool, but keep in mind that beginning in 2006, the "kiddie tax" applies to children under age 18

Estate tax

Although the lifetime gift tax exclusion (described above) continues to be limited to $1,000,000, the estate tax exclusion was increased to $2,000,000 in 2006.

California highlights.

  • California continues to charge a 1% surcharge on taxable income over $1 million dollars.
  • Registered domestic partners will be taxed as married couples for California purposes beginning in 2007.
  • Businesses no longer need a tax clearance from the FTB to dissolve.

Running the numbers. We recommend running tax projections for 2006 and 2007 before implementing year-end tax strategies. Please let us know if you would like our assistance in preparing a projection.

We often remind our clients that tax considerations should generally not drive financial decisions. However, once financial objectives are defined and understood, it becomes easier to determine the tax planning strategies that are consistent with overall objectives. Unfortunately, frequent changes in the income tax rules, coupled with the changes and uncertainty in the estate tax area, make both short and long-term planning more complex. With the year-end approaching, it may be a good time to review your financial objectives with a view toward assessing whether any of the recent tax incentives can be incorporated into the financial plan.


The information contained in this newsletter is general in nature and does not constitute tax advice or opinion. Applicability to specific situations should be determined through consultation with your tax advisor.

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