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Tax strategies for 2002
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January 15, 2002: 10:21 a.m. ET
A few tips for taking advantage of the new tax laws in 2002.
By Gary Klott
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CHICAGO (Tribune Media) - The start of the New Year is an opportune time to consider what you might do in the months ahead to make your financial life less taxing. Early planning is always essential to achieve sizable tax savings. But it's especially important this year because of the sweeping tax law changes that took effect Jan. 1.
Most of the major new benefits from the Tax Relief Act of 2001 start to phase in this year. Here are some strategies to help make the most of the new law benefits and otherwise save on taxes in 2002 and beyond.
Keep close tabs on your income levels
The key to qualifying for many of the new law's breaks is to find ways to hold down your "adjusted gross income." Most of the new or expanded benefits are phased out for individuals with adjusted gross incomes above certain levels. Included are the child tax credit, retirement savings credit, the new college tax deduction, Coverdell Education Savings Account, adoption credit, student loan deduction, IRAs and the earned income credit.
Careful timing of investment sales may prove critical if you're bordering on the income limits for a valuable benefit you hope to claim. In some cases, you'll want to try to avoid realizing large investment gains in years in which you expect to reap substantial benefit from some income-contingent breaks. Employees can reduce their adjusted gross income by taking advantage of their employer's 401(k) plans and "flexible spending arrangements" for health-care and dependent-care expenses.
Shelter more
The new law gives most individuals the opportunity to shelter much more of their income in retirement and education savings accounts, where your money can grow and compound faster than if part of the earnings were taxed away each year. The contribution limits for IRAs, self-employed retirement accounts, employer-sponsored plans and education savings accounts have been sharply increased.
Defer income
Deferring income through the use of retirement accounts and deferred-compensation plans will not only postpone the tax liability for years, but also may make the income eligible to be taxed at a lower rate in the future. Tax rates above the 15 percent tax bracket are scheduled to drop in 2004 and again in 2006.
Think taxes in daily financial life
Whenever you make a financial move, consider the tax aspects. In some cases, how you arrange the financial transaction can greatly affect your tax bill. Charitable contributions are a prime example. How much of a tax benefit you'll receive for your charitable donation will depend not only on the amount of your contribution, but also on the type of gift you make.
While cash may be the most common form of charitable gift, you'll save more in taxes if you donate stocks or other investments that have increased in value. So long as you've owned the shares more than one year, you'll be eligible to claim a charitable deduction for the current market value of your donated shares. In addition, you'll escape capital gains tax on the appreciation.
Securities sales
If you plan to sell off part of your holding in a particular stock or mutual fund, the form of your "sell order" can have a significant impact on your tax bill. If you acquired the shares at different times and prices, you may be able to minimize the capital gains tax bite by designating in your sell order which specific shares to sell.
For instance, you could minimize your taxable gain by instructing your broker or mutual fund to sell the shares you acquired at the highest prices. If you don't identify which specific shares are to be sold when you place your sell order, the IRS will make you use on your tax return a much less favorable method for determining which shares were deemed sold.
Consider non-tax implications
Before making any tax move, be sure to consider all the ramifications. Not every tax benefit is worth pursuing. For example, parents who plan to take advantage of the expanded education savings account to save for their child's college education need to consider the potential impact on their child's eligibility for financial aid in college.
Middle-income families could lose more in financial aid than they'd save in taxes from setting up an education savings account in their child's name. In determining how much a family can afford to contribute to the cost of college, financial aid formulas count assets held in a child's name much more heavily than assets in the parent's name.
Alternative minimum tax
Higher-income individuals should pay close attention to their vulnerability to the alternative minimum tax (AMT), which inflates the tax bills of people who are able to make use of various tax breaks to slash their regular tax liability below certain levels. The number of taxpayers affected by the AMT is projected to double this year and continue to grow at a rapid rate in the years ahead, partly because of the new law's reduction in the top tax rates. Knowing whether you're likely to be hit by the AMT is important because strategies to minimize or avoid the AMT are much different than you'd normally employ. 
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