There’s Still Time to Cut Down on Taxes

Year-end is only a week away, but it’s not too late to make some key moves to save taxes.

Four of the most important moves you can make involve minimizing your exposure to the controversial new Medicare surtax, taking losses on your mutual funds or securities, opening a Keogh plan and making gifts of appreciated assets to your children.

Here’s a look at those steps that can put major dents in your tax bills:

- Minimize your exposure to the new Medicare surtax. If you will be eligible for Medicare in 1989--generally, if you will be 65 or older and covered by Social Security--consider ways to reduce your taxable income for next year.

Why? Because starting next year, those eligible for Medicare will be subject to a Medicare surtax. For every $100 of federal income tax that you owe in 1989--for returns you must file in 1990--you’ll also owe $15 to help pay for increased Medicare coverage for catastrophic illness. (That rate will go up in future years).

The maximum surtax for 1989 will be $800 for singles and $1,600 for couples, notes Dick Poladian, tax partner at the accounting firm of Arthur Andersen & Co. in Los Angeles. You will still be under these maximums as long as your taxable income is under $27,334 for singles and $51,907 for couples, according to Poladian.

If you are under those mini mums, you can cut your surtax by cutting your taxable income in 1989. One way is to sell before year-end any stocks, bonds or mutual funds that have appreciated in value. That way you can report their capital gains on your 1988 returns and keep them off your 1989 returns. If you still like those assets, you can buy them right back anyway and establish a higher cost that can reduce your future capital gains taxes, Poladian says.

Another possible step: If you don’t need income right away, buy Series EE U.S. savings bonds, Poladian suggests. Their accrued interest is not taxable until maturity.

Or consider shifting money you now have in taxable investments, such as bank certificates of deposit or money market funds, into tax-free municipal bonds or mutual funds investing in munis. The earnings from those investments won’t count as taxable income. But do this only if you find yields on tax-free investments similar to after-tax yields on your taxable investments, Poladian argues. Doing this just to cut your Medicare surtax won’t make sense if you earn a lot less in after-tax profit on tax-free investments, he says.

- Open a Keogh plan. These tax-deferred retirement-savings plans are available to you if you are self-employed on a full- or part-time basis. Similar to individual retirement accounts, you can deduct from your taxable income any contributions you make to the plans, and earnings will accumulate tax-deferred until you withdraw them.

But unlike an IRA, the limits on your annual contributions are much higher, up to 13%, 20% or possibly more of your annual income, depending on the kind of plan you set up (in most cases not to exceed $30,000), Poladian says. To qualify for a 1988 writeoff, open your Keogh before year-end. You don’t have to fund it until you file your 1988 return next year.

- Make a Christmas gift of cash or securities to your kids. You can give up to $10,000 per year per person ($20,000 with your spouse) free of federal gift taxes. This is a good way to reduce the size of your estate, and thus potentially lower your estate tax when you die.

There is an added advantage in giving stocks or other assets that have appreciated in value. If you give them to a child aged 14 or older and he or she sells the assets, the capital gains will be taxed at his or her lower rate rather than your higher rate, says Sidney Kess, tax partner at the accounting firm of Peat Marwick Main & Co. in New York. That could save your family a lot in taxes.

- Take losses on your mutual funds, stocks and bonds. Any losses that you realize before year-end could be used to reduce your taxable income. That could cut your tax bill by hundreds of dollars.

Capital losses can offset capital gains dollar for dollar. And if you have any losses left over, you may use $3,000 of them to offset ordinary income from wages, salaries or dividends. If you still have losses left over, you can carry them forward into future years to offset capital gains or income.

So say, for example, that you have a capital gain of $5,000. Taking a capital loss of $10,000 would offset that $5,000 gain entirely (meaning you won’t pay tax on it). You then can use another $3,000 to reduce your ordinary income and carry $2,000 forward into next year.

A further incentive to act now: Capital gains this year will be taxed the same as ordinary income, which means that if you are in the top 33% bracket, your capital gains will be taxed at 33%. But many believe that President-elect George Bush will push hard to cut capital gains taxes next year. So if you have already taken some capital gains--perhaps from selling stocks involved in takeover battles--try to take some losses to offset them.

Selling also provides you a chance to upgrade your portfolio, to get out of losers and into winners. Or you can sell low-yielding bonds and get into higher-yielding ones, such as two-year Treasury notes, which are yielding more than 9%.

What if you want to keep your losers because you think they might rebound? Sell them anyway to realize losses. The Internal Revenue Service’s so-called wash-sale rules allow you to buy back those securities after 30 days. Or you can buy something similar but not identical right away.

But remember, don’t buy or sell anything just for tax purposes alone. It should also make economic sense to do so, since commissions and other transaction costs can eat you alive. Says Edward Rosenson, director of the personal finance practice at the accounting firm of Arthur Young & Co. in Los Angeles: “Don’t let the tax tail wag the dog.”

Bill Sing welcomes readers’ comments and suggestions for columns but regrets that he cannot respond individually to letters. Write to Bill Sing, Personal Finance, Los Angeles Times, Times Mirror Square, Los Angeles, Calif. 90053.