by Cynthia Harrington

With the year-end flurry of activity over and a new year beginning, advisors have already started planning for the future.

There are new tax brackets to consider, and portfolios to adjust to the new capital gains and dividend tax rates, as well as cash from asset sales to invest or distribute. The earlier the start, the more time there is to pull all the pieces of the plan together.

By all accounts, tax planning in 2004 will be a cakewalk compared to the upheaval of 2003. The tax cut package passed mid-year is the third largest in U.S. history, and includes both retroactive treatments and sunset provisions. “We’re trying to take advantage of a few things from the Bush tax act,” said Irvin F. Diamond, CPA/PFS, CFP, of REDW Business and Financial Resources LLC, in Albuquerque, N.M. “There’s nothing razzle-dazzle in the act, but there are lots of little things we are reviewing for each clients’ use.”

The Jobs and Growth Tax Relief Reconciliation Act of 2003 updates the two previous years’ acts to attempt to juice the economic recovery.

Last year’s effort accelerated tax rate reductions and added cuts on capital gains and dividends. The result is a jumble of changes with varied phase-in and phase-out dates. “We’re reviewing all the regular issues to make sure we have the right kind of taxable event in the year that we want,” says Diamond. “We want to consider the timing on all transactions, and January is the time to set that up for the upcoming year.”

Early in the year is the time to review projected income and expenses. The new lower tax brackets open up opportunities for multi-year planning for some clients. For example, clients needing to take distributions from retirement plans might wish to accelerate their withdrawals before the current tax rates expire in 2010.

“We’re taking a look at each client’s overall plan as their tax returns are completed,” said Marsha G. LePhew, CPA/PFS, CFP, ChFC, with LePhew Financial Services Inc., in Rock Hill, S.C. “We’re looking to see which clients have breathing room in their marginal brackets and might be able to take advantage of the declining income tax rates by taking larger withdrawals now,” she said.

The new tax rates affect how planners view the fresh cash available from year-end tax strategies, as well as new savings. The reduced capital gains and dividend rates put a new twist on the question of where to put what kinds of assets.

“One obvious thing to review this year is the location of assets,” said LePhew. “We’re taking these renewed opportunities to look over all accounts to make sure that stocks are in personal accounts to take advantage of the 15 percent rate on capital gains and dividends, and that the income generators are in tax-favored accounts.”

All clients get regular budget reviews early in each year at KDA Financial, in Columbus, Ohio. Refined plans established each year project incomes and expenses, and the amounts available to add to savings. “Financial planning makes sense when we work backwards,” said Ken A. Dodson, CPA/PFS, of KDA Financial. “We project the cash needs over the next five years, and those needs determine the client’s investment policy for the year. We know how much to leave in cash, how much in intermediate bonds, and how much is reasonably set aside for longer-term investments.”

While the reduced rates on capital gains and dividends force a closer look at asset placement, advisors don’t need to adjust plans to balance out big capital gains. “We think this is a great period in the market to get clients back in who have been scared out for the past few years,” said Dodson. “Since mutual funds have capital gains and losses balanced, we are able to invest without considering the threat of built up-gains.”

Advisors with clients who own smaller businesses can use the dividend rate cut to lower their overall tax liability. Diamond is working with business owners to time equipment purchases to take advantage of the new Section 179 expensing limits, increased from $25,000 to $100,000. Since the corporate tax rates exceed both the dividend rates and personal income tax brackets, Diamond’s clients seek to get the cash out of the company and into their personal coffers. “We have a number of small business clients looking for ways to cut down on the built-in gains when they shifted from a C to an S corporation,” said Diamond. “These clients are bailing earnings out of companies at the lower dividend rates to maximize the tax advantages.”

Early in the year is a good time to take stock of the entire slate of possible events affecting investors. The upcoming election adds some uncertainty.

CPAs need to be much more aware of risk management in the face of uncertainty, according to Dodson. He addressed the topic at the American Institute of CPAs’ PFP Technical Conference early this month.

“Planning for disability, death and long-term care really needs to be understood in the overall process of financial planning,” said Dodson. “Advisors need to analyze which risks the client should shift to an insurance company, and also know how much they should be willing to pay for it.”


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