Toucan Talk
Year-End Investment Strategies to Reduce Taxes
Provided by Michael Oana mjo@teamoana.com 
Here are some things you can be doing today to help make tax time less taxing come April.

Michael Oana is the Chief Investment Officer with Team Oana Investment Advisors. Team Oana is a locally owned boutique investment firm specializing in helping conservative investors. Mr. Oana's Toucan Talk column appears bi- weekly in TheColumbiaStar.

Shifting income and controlling the timing of deductions and income between tax years. Certain deductions are available only above specified thresholds. For example, medical expenses are deductible only to the extent that they exceed 7.5% of Adjusted Gross Income (AGI). You may need to group these expenses into a single year - preferably the year of the lower income and lower threshold - in order to exceed the threshold and take a deduction. Similarly, arranging for a year-end bonus to be paid in the year of the lower tax rate can reduce the tax on the bonus. Other expenses, such as charitable contributions, have no threshold. You may want to group these expenses in higher-income years, when your tax rate may be higher and the tax savings from the deductions greater.

Timing purchases and sales of investments. Companies pay out capital gains and dividends at the end of the year. If you are planning to sell, be sure to do so before any upcoming dividend payment in order to recognize any resulting capital gain (or loss) instead of a taxable dividend, reducing the tax on the "income." If you are planning to buy, be sure to do so after the dividend is paid so as not to buy the dividend and the taxable income.

Capital gains and losses. Strategic asset allocation and rebalancing may provide opportunities to realize gains to offset losses. After offsetting capital gains, only $3,000 of capital losses can be used to offset ordinary income in a given year. Excess losses can be carried forward to future years until they are entirely used up.

Converting to a Roth IRA. With many Individual Retirement Accounts decimated by the bear market, taxpayers may find this a good time to convert their Traditional IRAs to Roth IRAs, whose eligible earnings are not taxable on withdrawal. Because you pay regular income taxes on the money you shift to a Roth, the idea is to convert the smaller pool of assets into a Roth before any rebound in your IRA's value.

Taxpayers who in the past couldn't qualify for a Roth conversion because their income was too high (over $100,000 for couples and singles) may qualify now if their income for the year is down. You must convert your Traditional IRA to a Roth by December 31. But be aware: it's better to pay for the conversion taxes with money outside of the IRA - potentially difficult in a bear market.

Diversifying low-cost-basis stocks. If you have been waiting to diversify a large holding of low-cost-basis stock, or want to "step up" your cost basis, consider offsetting losses by recognizing gains before the end of the year. If you believe the stock will rise in the coming months or years, you can establish a higher cost basis by selling and repurchasing. If the sale produces a loss, wait at least 31 days before repurchasing. Or you can do the two transactions in the opposite order: buy a second position in the same stock and then sell the original shares at least 31 days later. (The 31-day waiting period is required to avoid a wash sale: the IRS will disallow a tax loss resulting from a sale if a "substantially identical" security is bought within 31 days of the sale.)

If you plan to fund a child's or grandchild's college education, you may want to contribute to a 529 college savings plan. While you do not receive a federal incometax deduction, many states offer income-tax deductions. Funds grow tax-deferred; qualified withdrawals will be free of federal taxes, and (in many states) of state taxes also. (You will need to check the tax treatment for specific 529 plans in your state; many states offer tax advantages only to "in-state" plans.) You can also "front-load" a 529 plan, removing up to five years of gift-tax exclusions from your taxable estate. If you are using a Coverdell Education Savings Account, you now have until April 15, 2008 to make contributions for 2007.

Please consider the investment objectives, risk, charges and expenses carefully before investing in a Section 529 College Savings Plan. The official statement, which contains this and other information, can be obtained by calling your financial advisor. Read it carefully before you invest.

Charitable deductions. When you make a contribution by check, it's deductible in the year the check is mailed - not when it is cashed. If you make a contribution by credit card, it's deductible when you make the charge - not when you pay your creditcard bill.

Making charitable contributions with stock works best when you're using appreciated stock, since it allows you to deduct the full market value without incurring the capitalgains tax. Since many stocks are down this year, the potential capital gain available by keeping the stock might be worth more than the current deduction. You can only deduct the current market value if you contribute a "loss" stock - so you may want to keep the stock (or sell it for a capital loss) and give cash. If you are 70.5 or older, don't forget your required minimum distribution (RMD) from your IRA. While the deadline for IRA contributions is not until April 15, required distributions must be taken by December 31. If you don't have cash in your account, make sure you allow enough time for a sale to settle so that you can receive the proceeds by December 31 or take your distribution "in kind." An in-kind distribution will be valued on the date of the distribution.

Changing your distribution method under Revenue Ruling 2002-62. If you have been taking "a series of substantially equal periodic payments" from your IRA under Rule 72(t), how have those payments been calculated? If you've been using either the fixed amortization method or the fixed annuitization method, you haven't been able to change payments from year to year - so the decline in the stock market may have put you in danger of depleting your IRA. To address this problem, the IRS has recently published a ruling that allows you to switch to the required minimum distribution method for calculating the remainder of your payments.

Under this method, the required distribution is your year-end IRA balance divided by your remaining life expectancy. Switching to this method mayreduce your required distribution, leaving more money in your IRA for the future. Consult your Financial Advisor to see whether this strategy makes sense for you.

Creating tax savings from losses in Roth IRAs. Investors who have seen declines in their Roth IRAs may be able to harvest significant tax losses. Because these accounts are funded with after-tax contributions, they do have a cost basis that can be used to calculate a potentially tax-deductible loss. This strategy should be considered only if the losses are so large that you are willing to close those accounts entirely and start over. On your tax return, any loss in these closed accounts is considered a miscellaneous itemized deduction, not a capital loss. As a miscellaneous itemized deduction, the loss can be applied only if the total amount of these deductions exceeds 2% of adjusted gross income.

You must be wary, though. If you are under age 59.5, any funds withdrawn from the IRA to close out the account will carry a 10% penalty. Also, very large losses could lower your taxes enough to make you subject to the alternative minimum tax, which could nullify any benefit from the deduction. Remember, too, that investors must empty all of their Roth IRAs in order to qualify. You should consult with your tax advisor before initiating this strategy.

The accuracy and completeness of this article are not guaranteed. The opinions expressed are those of the author and are not necessarily those of Team Oana or its affiliates. The material is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy.

Team Oana Investment Advisors, Inc., is an independent company with securities offered through Summit BrokerageServices, Inc. Member FINRA & SIPC.

Please listen in on the "U Need 2 Know" radio show on WOIC 1230 AM. Mr. Oana will be a guest every third Wednesday of each month at 3:05 to 3:25 pm.