Year End Tax Strategies for 2008

The decline of the stock market and early retirement has caused some changes in our year end tax strategies for 2008. In normal years, we try to delay income and accelerate deductions. This year we will be doing the opposite, accelerating income and delaying deductions, since this approach will give us a better overall tax benefit. Here are the income creating and deduction delaying year-end tax related activities we are doing:

1. Generate more stock sales gains, if possible. Although I would have benefited from a 0% long term capital gains rate this year, our stock market losses far exceed are current gains. Not selling losses at the end of a tax year was a investing mistake I made in 2001 which I don't plan to make again. Therefore, overall losses will cancel any gains, making any additional profits from individual stocks tax free for this year.



2. Convert my spouse's traditional IRA to a Roth IRA. Since we will be in a 15% tax bracket this year, it may be beneficial to convert funds from an IRA to a Roth IRA since I expect tax rates to be higher in the future. Since I am recharacterizing my 2008 Roth IRA conversion, I cannot do any more conversions for 2008. Therefore, we will do the conversion for funds in my spouse's IRA.
   
   Although we will need to pay taxes on the converted amount, future gains after the conversion will be tax free. This time the conversion will be done using CDs instead of stocks to avoid the possibility of a value decline in 2009.



3. Make 2008 IRA contribution in 2009. Although retired, I did have some part time wage income this year. Since our income situation may change in December, I am unable to determine whether a deductible IRA contribution or a Roth IRA contribution would be more beneficial from a tax perspective. Since 2008 contributions can be made before April 15, 2009, I will wait until next year to put funds in our IRAs.



4. Delay discretionary deductions to 2009. Usually, we try to accelerate deductions such as charitable contributions into the current tax year. However, I plan to defer these until next year since we may be in a higher tax bracket, which would make the tax deduction worth more.

In addition, I will be reversing my Roth IRA conversion from earlier this year to reduce taxes owed. Due to the bear market of 2008, the value of the transferred stocks in the Roth IRA have declined about 50%, but I am still required to pay taxes on 100% of the original converted amount.

Fortunately, the IRS allows recharacterizing (i.e. reversing) a Roth IRA conversion to eliminate taxes on the amount previously converted. The recharacterization rules are complex and I've consulted with a tax advisor and IRA specialist who are familiar with the process.

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This is not financial or tax advice. Please consult a professional advisor.

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