Three Year-End Tax Strategies for 2007

As 2007 draws to a close, it's a good time to take a look at which tax-saving ideas will expire on New Year's Eve, and how best to take advantage of them. Here are three strategies you may never be able to use again after 2007 is history.

Postpone Long-Term Gains if You'll Be in 10% or 15% Rate Bracket Next Year
Assuming our current federal income tax rate structure stays in place, individuals in the lowest two brackets (the 10% and 15% brackets) will pay 0% on any long-term capital gains that are triggered between the years 2008 and 2010. No, that's not a misprint. Therefore, if you postpone taking some long-term gains until next year, you might benefit from the upcoming 0% rate. Now, you might be thinking this one-time opportunity is only available to relatively poor folks, so who cares, right? Wrong. You may be surprised to learn that one need not be poor, or even close to poor, to be in the 15% rate bracket. Here are some examples:

A married joint filer with two dependent kids who claims the standard deduction could have up to $90,000 of adjusted gross income in 2008 and still be within the 15% rate bracket. (Your taxable income would be $65,100, which is the top of the 15% bracket for joint filers.)

An unmarried head of household with two dependent kids who claims the standard deduction could have up to $62,150 of adjusted gross income in 2008 and still be within the 15% bracket. (Your taxable income would be $43,650, which is the top of the 15% bracket for heads of households.)

A single individual who claims the standard deduction could have up to $41,500 of adjusted gross income in 2008 and still be within the 15% bracket. (Your taxable income would be $32,550, which is the top of the 15% bracket for singles.)

If you itemize deductions, your 2008 adjusted gross income could be even higher, and you could still be within the 15% bracket.

Warning: As we explain below, postponing a child's long-term capital gains until 2008 in order to take advantage of the 0% rate may not work if he will be subject to the dreaded Kiddie Tax next year. In fact, if your child will be 18 or older as of Dec. 31, 2007, it may pay to take the opposite approach and accelerate some investment income into this year.

Beat the Kiddie Tax in 2007 (Next Year It May Be Impossible)
If the Kiddie Tax applies to your child, some of her investment income, including long-term capital gains, will be taxed at your higher marginal federal income tax rates. Specifically, your marginal rate on 2007 ordinary income, such as interest and short-term capital gains, could be as high as 35%, while your child's rate will probably be only 10% or 15%. On long-term gains for 2007, your marginal rate is most likely 15%, while your child's rate is probably only 5%. Long story short: You want to avoid the Kiddie Tax whenever possible.

Here's the good news. For 2007, the Kiddie Tax can only apply if your child is under age 18 at year's end. So if your child will be 18 or older as of Dec. 31, the Kiddie Tax won't be an issue for this year. However, it could be a different story in 2008 and beyond. Starting next year, the Kiddie Tax can potentially apply to children until the year they turn 24. That's because the Kiddie Tax can apply if your child will be age 18 at year-end or between 19 and 23 and a student (children in the 19-23 age category who aren't students won't be hit by the tax).

In addition, the Kiddie Tax can only apply if your child has unearned income that exceeds the threshold for the year. The 2007 threshold is $1,700. If this threshold is not exceeded, the Kiddie Tax is a nonissue, and all of your child's investment income will be taxed at his low rates. If the threshold is exceeded, only unearned income in excess of the threshold gets taxed at your higher rates. When only a relatively small amount of your child's income gets hit with the Kiddie Tax, it's really no big deal and not worth obsessing about.

Example 1: Child Is Subject to Kiddie Tax in 2007
Say your unmarried daughter will be 17 on Dec. 31. She will be hit with the Kiddie Tax for 2007 if her unearned income exceeds $1,700.

Example 2: Child Is Kiddie-Tax-Exempt in 2007 Due to Age
Say your unmarried son will be 18 or older on Dec. 31. He's exempt from the Kiddie Tax for this year due to his age. That's great, but what about next year and beyond? He might not be exempt because stricter age rules apply starting in 2008.

Kiddie Tax Avoidance Strategy for 2007
As Example 2 shows, a child who is 18 or older at year-end cannot be hit by the Kiddie Tax for 2007. However the same child could be a Kiddie Tax victim next year.

If this is the scenario your child falls under, it may be smart to have her purposely trigger some additional taxable gains and income before year-end. She will be taxed at her lower federal rates, which will probably be just 5% for long-term capital gains and 10% or 15% for ordinary income, including short-term capital gains and interest. If your daughter gets hit with the Kiddie Tax in 2008, her long-term capital gains could be taxed at 15% and some of her ordinary income could be taxed at up to 35%. That's why accelerating some gains and income into 2007 could help reduce your child's exposure to higher tax rates in 2008 and beyond.

(For more on the Kiddie Tax, click here.)

Buy Your Honda Hybrid This Year to Collect Full Tax Credit
Back in 2005, our beloved Congress created tax credits for purchasing (not leasing) new (not used) qualified hybrid vehicles. Perversely enough, popularity has a negative impact on the hybrid credits. Once a manufacturer sells over 60,000 qualifying hybrids, the credits for all hybrids produced by that manufacturer are reduced by 50% for a six-month period and then by 75% for the following six-month period. After the end of the second six-month period, the credits simply disappear. Under this wacky phase-out rule, credits for Toyota and Lexus hybrids purchased after Sept. 30 of this year have already vanished.

Honda hybrids are next up on the phase-out schedule. If you purchase a Honda hybrid between Jan. 1 and June 30 of 2008, credits will be halved. For purchases in the second half of 2008, the Honda credits will only be a quarter of the current amount. Here's the deal.

No other hybrid vehicle credits will be reduced until the second quarter of 2008 at the earliest. So there's really no hurry to buy, for example, a Ford or GM hybrid.