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Seven Tax Treats for the Holiday Season

With the end of the year fast approaching, this is prime time for holiday shopping. It is also the optimal time to “shop around” for tax breaks. Although everyone's situation is different, here are seven items that could be on your shopping list this year.

1. Income-splitting: You can reduce the overall family tax bill by shifting taxable income from your high tax bracket to other family members in lower tax brackets. For instance, you might transfer income-producing property to custodial accounts for your minor children.

Caution: Be aware of the “kiddie tax.” To the extent that the unearned income of a child under age 18 exceeds an annual limit ($1,700 for 2006), the excess is taxed at the top marginal tax rate of the child's parents. Prior to this year, the age limit was 14, but the 2006 tax act changed it to age 18.

2. Charitable donations: As a general rule, the full amount of a cash donation is deductible on the donor's personal tax return. If a donation is made by credit card at year-end, you can deduct the gift on your 2006 return, even if the charge is not actually paid until next year. For donations of property, the full fair-market value is deductible if the property has been held for more than one year.

3. Alternative Minimum Tax (AMT) liability: The AMT applies if a special calculation, including an exemption based on your filing status, exceeds your regular tax liability. Individual taxpayers should have their AMT liability calculated before year-end. Depending on the result, it may be advisable to shift certain “tax preference items” to next year to avoid or reduce AMT liability. The new Tax Increase Prevention and Reconciliation Act (TIPRA) provides some modest tax relief by bumping up the exemptions for the 2006 tax year.

4. Section 179 allowance: Under Section 179 of the tax code, you can elect to currently deduct some or all of the cost of business assets placed in service anytime this year. For 2006, the maximum Section 179 allowance has been increased to $108,000. Note: TIPRA extends increased Section 179 allowances through 2009. After that, it is scheduled to revert to $25,000.

5. Estimated tax penalties: Even if you do not have enough federal income tax withheld during the year, you can avoid an estimated tax penalty by meeting one of two “safe harbor” exceptions. No penalty is imposed if annual tax payments for 2006 equal 90% of the current year's liability or 100% of the prior year's tax liability. The percentage is increased to 110% of the prior year's tax liability if your adjusted gross income for the prior year exceeded $150,000.

6. Dependency exemptions: Although the tax rules have been tweaked in recent years, the parents of a full-time student under age 24 can still claim a dependency exemption for the child by providing more than 50% of the child's support. Depending on the situation, it may make sense to add to the support total at year-end in order to clear the 50% mark. Each dependency exemption for 2006 is $3,300.

7. Hobby losses: If you operate a sideline business, you can claim a tax loss for the year, but be careful. If the activity is characterized as a hobby, not a business, your loss is deductible only up to the amount of your income from the activity. Because the IRS generally presumes the activity is not a hobby if you have shown a profit in three out of five consecutive years, you might accelerate income into this year and defer deductions to next year.

These seven strategies are available to a wide range of taxpayers, but your situation may differ. It is recommended that you have a year-end plan tailored to your personal circumstances.

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	[ return to list ] Seven Tax Treats for the Holiday Season With the end of the year fast approaching, this is prime time for holiday shopping. It is also the optimal time to “shop around” for tax breaks. Although everyone's situation is different, here are seven items that could be on your shopping list this year. 1. Income-splitting: You can reduce the overall family tax bill by shifting taxable income from your high tax bracket to other family members in lower tax brackets. For instance, you might transfer income-producing property to custodial accounts for your minor children. Caution: Be aware of the “kiddie tax.” To the extent that the unearned income of a child under age 18 exceeds an annual limit ($1,700 for 2006), the excess is taxed at the top marginal tax rate of the child's parents. Prior to this year, the age limit was 14, but the 2006 tax act changed it to age 18. 2. Charitable donations: As a general rule, the full amount of a cash donation is deductible on the donor's personal tax return. If a donation is made by credit card at year-end, you can deduct the gift on your 2006 return, even if the charge is not actually paid until next year. For donations of property, the full fair-market value is deductible if the property has been held for more than one year. 3. Alternative Minimum Tax (AMT) liability: The AMT applies if a special calculation, including an exemption based on your filing status, exceeds your regular tax liability. Individual taxpayers should have their AMT liability calculated before year-end. Depending on the result, it may be advisable to shift certain “tax preference items” to next year to avoid or reduce AMT liability. The new Tax Increase Prevention and Reconciliation Act (TIPRA) provides some modest tax relief by bumping up the exemptions for the 2006 tax year. 4. Section 179 allowance: Under Section 179 of the tax code, you can elect to currently deduct some or all of the cost of business assets placed in service anytime this year. For 2006, the maximum Section 179 allowance has been increased to $108,000. Note: TIPRA extends increased Section 179 allowances through 2009. After that, it is scheduled to revert to $25,000. 5. Estimated tax penalties: Even if you do not have enough federal income tax withheld during the year, you can avoid an estimated tax penalty by meeting one of two “safe harbor” exceptions. No penalty is imposed if annual tax payments for 2006 equal 90% of the current year's liability or 100% of the prior year's tax liability. The percentage is increased to 110% of the prior year's tax liability if your adjusted gross income for the prior year exceeded $150,000. 6. Dependency exemptions: Although the tax rules have been tweaked in recent years, the parents of a full-time student under age 24 can still claim a dependency exemption for the child by providing more than 50% of the child's support. Depending on the situation, it may make sense to add to the support total at year-end in order to clear the 50% mark. Each dependency exemption for 2006 is $3,300. 7. Hobby losses: If you operate a sideline business, you can claim a tax loss for the year, but be careful. If the activity is characterized as a hobby, not a business, your loss is deductible only up to the amount of your income from the activity. Because the IRS generally presumes the activity is not a hobby if you have shown a profit in three out of five consecutive years, you might accelerate income into this year and defer deductions to next year. These seven strategies are available to a wide range of taxpayers, but your situation may differ. It is recommended that you have a year-end plan tailored to your personal circumstances. [ return to list ]
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