It’s hard to believe, but 2006 is rapidly coming to a close and, by all accounts, it has been a dramatic year. Between events in the middle and far east, oil and gas prices and just the normal pressures of day-to-day life, it’s probably safe to say that this year has put a great deal of stress on all of us.

In this short space, you won’t find any solutions to geopolitical and economic events that are too complex for even the most sophisticated world governments, but perhaps a little reminder of how to minimize your 2006 tax bill will help you deal with the inevitable stress of tax time in 2007.

What’s New?

This year has seen its share of tax law changes; some that will affect future years and some that will take effect in 2006. Additionally, some new laws enacted in prior years will take effect in 2006. Let’s first look at what’s new for 2006:

Electric and Clean-fuel Vehicles: The list of vehicles that qualify for the credit for electric or clean-fuel vehicles has expanded. As of July 11, 2006 there were approximately 32 vehicles the IRS had certified as eligible for a credit of anywhere from $250 to $2,600. Key points to remember are: 1.) the vehicle must be placed in service after December 31, 2005 and before December 31, 2010 and 2.) only the original purchaser of a new vehicle will qualify for the credit.

A word of caution - don’t buy a vehicle just to get a tax credit. Compare the qualifying vehicle’s purchase price with a similar one that does not qualify for the credit. Sometimes, simple economics will tell you to buy the car that doesn’t qualify for a credit. For example, the national base price of one popular automobile that comes in both a qualifying and non-qualifying model is $25,900 for the hybrid and $19,320 for the standard version, according to Edmunds. The allowable credit for the vehicle is $1,300, which means the hybrid costs an extra $5,280. At a savings in gasoline cost per mile of approximately 4.2 cents ($2.50 average per gallon of gas), you would have to drive approximately 126,000 miles to recoup the cost difference.

On the other hand, if you are interested in minimizing your car’s negative impact on the environment, a hybrid vehicle may be a good alternative.

Other energy savings incentives: The Energy Policy Act of 2005 created various credits for those who pay to increase the energy efficiency of existing or new home construction, as well as business property. For a more detailed discussion, see our December 2005 Tax and Financial News article.

Other 2006 news: each year, the IRS adjusts various deductions and exemptions, along with tax rates, based on the requirements of tax law. This year is no different, so be sure to use the proper numbers in calculating your expected tax for year-end planning.

Domestic Production Activities Deduction: If your business involves activities that qualify as "manufacturing" for purposes of Internal Revenue Code Section 199, you may owe less in tax than you think. This deduction allows you to reduce taxable income by a percentage of what is known as Domestic Production Activities Income. For 2006, the percentage is 3%, subject to certain limitations. While the deduction has been available since 2005, it’s easy to overlook, especially if you are not directly involved in manufacturing products. Construction contractors and many other businesses may also qualify for the deduction.

Expense limit for capital expenditures: This year you can expense up to $108,000 in qualifying fixed asset purchases. If you haven’t met that threshold and still plan on acquiring new equipment (or off-the-shelf software), make sure you purchase what you need and place it in service before December 31, 2006.

Tried and True Strategies

One of the most powerful games you can play in tax savings is the "rate game." Simply put, our taxation system is a progressive one, where the percentage of income taxed increases as your income increases. Tax planning often involves accelerating deductions or decreasing income if you are in a higher tax bracket this year, but expect to be in a lower bracket in the future. You may also want to increase income and decrease deductions if this year’s bracket will be low and next year’s will be higher. Here are a few ideas to take advantage of these concepts:

• If you are in a cash basis business, hold off on billing until you are comfortable your customer will not pay you until 2007.
• Don’t purchase mutual funds or other investments that will throw off year-end dividends.
• Cash basis taxpayers should pay all of their deductible expenses by December 31, 2006 to take the deduction in the current year. If you don’t have the cash, consider paying by credit card.
• If you already have capital gains income, consider selling investments at a loss to offset the gains.
• Numerous other techniques are available to minimize your tax burden, but what’s right for you depends on your individual situation.

Even if you expect this year’s and next year’s tax rate to be the same, you can still benefit by putting off taxable income until 2007. Simply put, it’s better to pay a dollar of tax tomorrow than to pay it today. If you are currently near or below the floor where itemizing deductions would be advantageous to you, consider holding off on paying such items until early 2007. By "bunching" deductions, you may be able to get a larger tax deduction over the 2006 and 2007 period than you otherwise would have.

What Have We Forgotten?

This article has touched on a few tax changes and planning strategies that may be available to you. Nobody can adequately advise you how best to paint your tax picture, and make the 2007 tax season less stressful, without a detailed knowledge of your finances. Give us a call if you have questions or need help in planning the rest of 2006. Helping you keep your money is what we are all about.