Commentary: Wisdom on Wealth - Tax planning has no season

Most of us think about our taxes at two points during the year - April 15 and Dec. 31. However, planning for your taxes is something to consider all year long as the decisions you make now can affect how much you will owe Uncle Sam later.

Here are some tips and strategies you can discuss with your financial advisor to ensure you become a tax efficient investor all year long.

Tax-deferred accounts

Make sure that you fully fund and fully invest your tax-deferred retirement accounts. Tax-deferred accounts present opportunities for you to reduce your overall income and therefore, reduce your tax bill. Some strategies to consider include:

Make the maximum annual contribution of $12,000 ($14,000 if you're over 50) to your workplace savings plans such as a 401(k) or 403(b).

Contribute up to the annual maximum of $3,000 ($3,500 if you're over 50) to an IRA if you are eligible.

Business owners should continue to defer as much income as they can (up to $40,000) in profit-sharing plans and Simplified Employee Pension (SEP) programs.

Also contribute to Roth IRAs and Coverdell ESAs as funds in these accounts grow tax-deferred and qualified distributions from these accounts are generally tax-free.

Lastly, contribute to Section 529 college savings plans, which allow for an $11,000 annual maximum contribution for individuals ($22,000 for couples), and you may receive a deduction on your state income taxes.

Tax-deferral strategies

If you have control over how and when you receive income, you have a unique opportunity to generate tax savings.

By delaying income and accelerating deductions, you can defer taxes from one year to the next, allowing you to use that money in the interim. This will also give you tax-free use of your money during the deferral.

Right mix

There are several tax-efficient equity investments and tax-exempt securities available.

These include, but are not limited to, municipal bonds and exchange-traded funds.

It is important to identify the appropriate allocation and diversification of investments unique to you to minimize tax liabilities and to alleviate risk. Pay special attention to the quality of your investments, especially during volatile market conditions.

Make deductions count

If your income is high, it may be difficult for you to take deductions for items that have an initial threshold, such as medical or miscellaneous itemized expenses.

Therefore, it is important to maximize other deductions, such as those for interest paid, taxes paid and charitable contributions.

Unique planned giving strategies might help as well. For example, take advantage of preferential treatment for employer stock held in your retirement account and donate those shares to a charitable remainder trust.

If you roll over your company stock to an IRA, withdrawals from your IRA will be taxed at ordinary income tax rates.

Additionally, if you have children or grandchildren who will be attending college in the next few years, the tax law changes from 2003 make outright gifts of appreciated securities particularly attractive.

Capital gains and qualified dividend taxes for taxpayers in the lowest brackets (most minors) are 5 percent until 2008 - when they fall to 0 percent. Married couples may make gifts totaling $22,000 annually to whomever they please without any gift tax consequences.

These are just some of the steps you can take to reduce your tax liability throughout the year, but remember that over the long-term, a comprehensive financial plan that includes specific measures for tax efficiency can enhance your overall investment performance.

It is important to discuss these tax issues with your financial, tax and legal advisors so that you can determine if you should incorporate these tax strategies into your unique situation.

Together, you can determine which strategies are most appropriate to help you generate tax savings and reach your personal and financial goals.

John Rachlin is first vice president - Investments and Wealth Management advisor with Merrill Lynch's Private Client Group in Rockville. He can be reached at 301-468-3000 or John_rachlin@ml.com.

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