Gifts from the IRS

By Daniel Kadlec

In the spirit of holiday shopping, let's consider some 11th-hour tax planning. It won't help you score a Furby for your toddler, but the right financial moves before the end of 1998 will have far more impact on Junior's well-being. The same basic year-end tips tend to get rehashed ad nauseam. So I won't spend a lot of time encouraging you to defer income into next year and accelerate deductions into this year. Ditto for making certain that you use, not lose, any money still in a flexible-spending account at work and for making charitable donations in the form of appreciated assets--stocks in most cases--to get a market-value deduction without anyone's paying tax on the capital gain. Let's skip to tips that are less well known or have special significance this year.

The big one is the Roth IRA--much talked about but mind-bogglingly underused. Put simply: you have just two more conversion weeks till Christmas. Don't blow it. Mutual-fund companies estimate that only 5% of people eligible to convert their old IRA to the Roth version have done so. There may be a crush of late activity, and paperwork received the last week of December may not get processed before the year-end deadline.

Should you convert? You'll have to pay income tax on the amount you shift. But the money can be withdrawn tax-free in retirement. Generally, if you meet the income limits (less than $100,000 household income), won't need the money for at least 10 years, and can pay the tax without dipping into IRA funds, you should convert. By doing so before year-end, you get to spread the resulting tax bill over four years. If you've already converted and find that your stocks or funds have fallen in value, reconvert to cut your tax bill.

The new Education IRA, which lets you set aside $500 per child each year, must be funded by year-end. Like the Roth, it allows your money to grow and be withdrawn for college free of tax, but it offers no deduction. You can take as much as a $1,500-per-student credit on 1998 taxes by using the Hope Scholarship and prepaying now for the college spring semester. You can take up to a $1,000 credit per family by using the lifetime learning credit. Each program has income limits and other restrictions.

Remember that gifting money to heirs is not the same as donating to charity. In the latter case, as long as you write the check this year, you can take the deduction. But gifts occur in the year that the check clears--a quirky distinction.

If you're in the midst of refinancing your mortgage a second time, get it done before year-end. Any points you paid on the earlier refinancing become immediately tax deductible. If you refinanced into a bigger mortgage and used the difference for a home improvement, you can take an immediate deduction for a prorated portion of the points on the new mortgage.

You still have time to sell losing or winning stocks in order to pair gains with losses, or to realize up to $3,000 of losses to set against ordinary income. Consider swapping a loser stock fund with a similar-style fund to stay invested but realize the loss. Finally, if you turned 70 before June 30, you must take an IRA or 401(k) distribution now--or pay a 50% surcharge. You can get relief, but the process is more painful than battling rabid shoppers on Christmas Eve.

See time.com/personal for more tips. E-mail Dan at kadlec@time.com And see him Tuesdays on CNNfn, 12:40 p.m. E.T.