Five smart tax moves

May 1, 1998
The 1997 Tax Act has changed the rules for future tax strategies, some for the better. Here are five important moves for your consideration now.

Hugh F. Doherty, DDS, CFP

The 1997 Tax Act has changed the rules for future tax strategies, some for the better. Here are five important moves for your consideration now.

1. Capitalize on the new capital-gains tax rates.

The new tax law presents a dizzying array of new rules regarding holding periods, purchase and sale dates, and tax brackets. But offsetting all this data is the benefit of sharply lower tax rates (specifically, the drop in the maximum long-term capital-gains rate from 28 to 20 percent). Even here there is a twist. The maximum tax rate on long-term capital gains from the sale of art, antiques or other collectibles still remains a steep 28 percent.

If you invest in mutual funds, you must divide the payouts from your fund, separating gains that qualify for the new lower rate from those that still will be taxed at 28 percent. A few fund companies like Vanguard and American Century have mailed new 1099 forms that include a separate column showing the dollar amount of your so-called 28 percent gain.

2. Find your way to a Roth IRA.

One of the most powerful investment vehicles that the government has created is a Roth IRA. You can sock away up to $2,000 a year if you are married and have a combined AGI below $150,000. Your children (whom you should employ in the practice for pretax income to fund their college education) who have earned income are eligible to open Roth IRAs.

As with a traditional nondeductible IRA, contributions to a Roth IRA are not tax-deductible, but your investment in the account grows tax-free. That`s where the resemblance ends. You will pay taxes on the earnings you eventually withdraw from the traditional IRA. Withdrawals from a Roth IRA are tax-free, if you make them after age 591/2 and after you have held your account at least five years. You also can withdraw up to $10,000 tax-free at any age after the five-year holding period - which must be used for expenses relating to the purchase of a first home. Another very attractive feature is, you can keep contributing to a Roth IRA after age 701/2, unlike traditional IRAs. In addition, you don`t have to make withdrawals from a Roth IRA during your lifetime. That makes the Roth an excellent estate-planning tool. You can bequeath your Roth IRA to your children or your grandchildren and pass a tax-free lifetime annuity to a second generation.

3. Move on the new $500,000 tax break.

The old tax law encouraged home sellers to continually trade up to more expensive homes. Under that law, you could defer the gain on the sale of a principal residence if you spent the sale proceeds on a replacement house within two years. There also was a once-in-a-lifetime $125,000 exclusion on the sale of a principal residence, but only taxpayers age 55 and older could take it. Now, married taxpayers jointly can shield up to $500,000. You can use this new exclusion once every two years if you have owned and occupied a home as your principal residence for at least two of the five years prior to its sale. How best to cash in on this generous cash break? If your kids have grown up and left home, this is probably a good time to consider trading down to a house that`s more in line with your current lifestyle.

4. Cash in on the new tax break for education.

Starting this year, you can contribute up to $500 annually to an education IRA for a child or grandchild under age 18. Contributions to education IRAs are not tax-deductible, but they do grow tax-free. If you invested $500 at 8 percent for 18 years (child age 1), the total amount will be in the area of $22,000 to $25,000. Putting away a relatively paltry $500 a year per child really doesn`t get your blood rushing. It`s not going to pay for college, but look at the bright side: Anytime you can save on a tax-deferred basis, you should do it.

5. Clarify new home-office rules.

The new tax law clarifies who can deduct operating and appreciating expenses associated with home offices. Starting in 1998, a home office will qualify as a principal place of business if it is used regularly and exclusively to administer or manage your practice. So, if you run your practice from one location, but administer it from your den, that room qualifies as your home office. To avoid trouble with the IRS, take your kids` Nintendo off the den TV and put it on another set in some other room.

Hugh F. Doherty, DDS, CFP, is a national lecturer, financial advisor to the health-care profession and CEO of Doctor`s Financial Network. For personal financial consultations or to have Dr. Doherty speak to your study club or dental society, call (800) 544-9653.