Year-End Tax Planning Moves for 2003

A few strategic moves today could save you a bundle come April 15.

IT'S NOT TOO LATE! Between now and Dec. 31, you can still take steps to cut your 2003 income-tax bill. Even better, the Jobs and Growth Tax Relief Reconciliation Act of 2003 has created some new opportunities that are simply too good to ignore. So read on -- and save.

Harvest Tax Losses in the Year That Works Best
Now's the time of year to think about dumping loser stock and mutual-fund investments (thankfully, you probably have far fewer than last year). You can use the resulting capital losses to shelter capital gains earned earlier this year, as well as any additional gains racked up between now and year-end. Once you've offset all your capital gains, you can deduct any remaining capital losses against up to $3,000 of highly taxed ordinary income from salary, interest, retirement-plan distributions, alimony and so forth ($1,500 if you use married-filing-separate status). After all that, if you still have some excess capital losses, they carry over to next year and become subject to the same rules all over again. (For more on the basics of capital gains, click here.)

But you probably know all this. This year, however, there's a one-time twist to consider.

If You Have Long-Term Losses to Harvest
Thanks to the 2003 Act, your long-term capital gains and losses for this year must be segregated into those from sales before May 6, 2003, and those from sales after May 5. Therefore, if you follow the time-honored strategy of harvesting some long-term capital losses before year-end, they will go first to offset any long-term gains from sales after May 5. Because those gains would be taxed at no more than 15%, your tax savings from harvesting long-term losses will be no more than 15%. That's better than nothing, but waiting could be the tax-smart move here.

Specifically, if you expect to have only short-term gains in 2004 (or no gains at all), you might be better off postponing at least part of your long-term loss harvesting until next year. That way, you could use the postponed losses to offset next year's short-term gains plus up to $3,000 (or $1,500) of next year's ordinary income. Since these amounts would be taxed at your regular rate of up to 35%, the wait-until-next-year approach could result in tax savings as high as 35%. (All you Cubs and Red Sox fans will easily understand any wait-until-next-year concept.)

On the other hand, if harvesting long-term losses before year-end would allow you to offset pre-May 6 long-term gains, your tax savings will generally be 20%. Better! And if harvesting losses before year-end would allow you to offset short-term gains and up to $3,000 (or $1,500) of ordinary income, the tax savings will be at your regular rate of up to 35%. Much better! In either of these latter scenarios, harvesting your losses this year rather than next year could be the tax-smart way to go.

If You Have Short-Term Losses to Harvest
If you harvest short-term losses before year-end, they'll go first to offset short-term gains earned anytime this year. These gains would be taxed at your regular rate of up to 35%. So your tax savings can be as high as 35%.

If you don't have any short-term gains, short-term losses harvested before year-end will go first to offset post-May 5 long-term gains that would be taxed at no more than 15%. So your tax savings would be at that low rate, which is OK but not great. Once your post-May 5 long-term gains are wiped out, any remaining short-term losses will go to offset pre-May 6 long-term gains that would generally be taxed at 20%. So your tax savings would be 20%. Better! And if harvesting short-term losses would allow you to offset up to $3,000 (or $1,500) of ordinary income, the tax savings will be at your regular rate of up to 35%. Much better!

Get Out the Calculator
As you can see, the exact impact of harvesting losses between now and year-end depends on your exact circumstances. So I recommend hauling out your records, your calculator and the 2003 version of Schedule D of Form 1040 to figure out where you stand before doing any serious harvesting. (You can print out a draft copy of Schedule D here.) Once you know where you stand, here's my advice, again in shorthand: