November and December are key months for individuals to focus on minimizing their income and capital gain tax liabilities. While we don’t hold ourselves out as tax advisors, one of our goals is to maximize the after-tax investment returns for our clients, so we thought it would be helpful to share some tax planning techniques to consider. Since each person’s tax situation is different, we recommend that you consult with your tax advisor before taking any action.

Charitable Donor-Advised Funds

Consider maximizing the tax benefit of your charitable gifts through the use of a Charitable Donor-Advised Fund. Donor-advised funds allow you to donate cash, or more ideally appreciated securities that you have held for a year or more, to a charitable account that you control. You receive a tax deduction in the year of transfer for the fair market value of the cash or securities transferred to the fund (and no capital gain is then realized by you, the donor). Assets transferred to a donor-advised fund are liquidated by the sponsoring organization and placed into an account, for which most donor-advised funds offer 5-10 investment options. At the instruction of the donor, assets can be transferred from this fund to qualified charities within the current year, or over several years.

Section 529 Plan for College Savings

Many people are now considering shifting assets they have reserved for college education expenses to accounts for your children or grandchildren through a College Savings Plan (a.k.a. Section 529 Plan). The benefit of these plans is that the investment earnings and the assets placed in these plans accounts are generally exempt from federal and state income taxes, provided that the withdrawals are used for qualified college expenses. This tax-free withdrawal feature can make 529 Plan accounts more attractive than other types of college savings strategies.

Roth IRA Conversion

If you have an IRA, it may be worthwhile to determine if you would experience long-term tax benefits from a Roth-IRA conversion.

With a Roth-IRA, withdrawals of your contributions or earnings are typically never taxed. Therefore, the long-term tax benefit of a Roth-IRA conversion (for people who find themselves in a low tax bracket) is that a small upfront tax payment, on the amount converted, can be a small price to pay for income tax savings on thousands and possibly hundreds of thousands of dollars of future earnings.

For 2009, to be eligible for a conversion your current year’s adjusted gross income (AGI) will need to be less than $100,000, but starting next tax year, 2010, that income limitation will be eliminated. You may not fall into this “under $100,000 of adjusted gross income” category this year, but a one-time event (e.g., business losses, rental losses or capital losses) may reduce income to unusually low levels and make it a prime year for a Roth-IRA conversion. And, starting next tax year, 2010, with the income limitation lifted, people at any level of AGI will be eligible to make a Roth IRA conversion.

Operationally, some or all of an individual’s traditional IRA is transferred to a Roth-IRA in a conversion. Taxes are due at ordinary income tax rates on the amount that is transferred, or converted. Ideally, conversions are done where the tax payer’s federal tax rate remains low, between 0% and 15%, so the upfront income tax cost are minimal. A relatively small (percentage-wise) upfront tax payment can be a small price to pay for the benefit of future tax-free withdrawals of both contributions and earnings that could extend for decades.

~Adam