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New U.S. millionaires need to learn new tax strategies
Prosperity can bring with it unexpected financial pains

WASHINGTON -- There are twice as many millionaires in America today as there were five years ago, but the booming economy and rising number of stock market investors can mean a lot more headaches when tax time rolls around.

The number of U.S. households with a total net worth over $1 million -- not including their primary home -- has reached 7.1 million, compared with 3.45 million in 1994, according to the Spectrem Group research firm. And the number of federal income tax returns with adjusted gross income of $1 million or more topped 144,000 in 1997, compared with about 70,000 in 1994, the IRS says."When you get into a cab and the driver is telling you what he's buying and selling, you know times have changed," said Joanne E. Johnson, an attorney and wealth strategist at J.P. Morgan in New York. "The unwary can get caught at this tax filing time."

This unprecedented wealth can push people into much higher income tax brackets and force some to pay capital gains or alternative minimum taxes for the first time. Others with over $150,000 in adjusted gross income may have to begin making estimated quarterly payments to the Internal Revenue Service.

And even if they are young, wealthy taxpayers should start making estate plans to avoid a much bigger tax bite later -- as much as 55 percent under current law.

"Our new millionaires don't realize they are going to be hit with estate taxes they didn't anticipate initially," Johnson said. "Everything you own is taxable in your estate."

Unfortunately, taxpayers have a limited number of ways to reduce their income tax bill from 1999, which is due on April 17. They should maximize deductions, as always, and they still can contribute up to $2,000 in an individual retirement account.

But there are many moves taxpayers can make in 2000 to improve the picture for next tax season. Here are some recommendations from J.P. Morgan and the Deloitte & Touche and KPMG accounting firms:

Transfer stock options into a trust when they have a relatively low value. When the trust exercises the options at a higher value, the taxpayer has to pay income taxes but only at the original value and the trust keeps 100 percent of the proceeds. Taxpayers should get an independent appraisal of the stock's original value to back up their claim.

Maximize tax-deferred contributions to retirement plans -- one way is to contribute corporate directors' fees and claim self-employed status -- and contribute to any accounts an employer may allow for pre-tax dollars used for medical and child care expenses.

Make the most of any stock losses. Taxpayers can write off capital losses to offset capital gains, but mutual fund distributions are considered dividends and don't count. Beware of the "wash-sale" rule, which prohibits taxpayers from selling a security to create a paper loss and then purchasing it right back.

Consider purchasing municipal bonds. Coupon payments from these bonds are exempt from federal income tax, and the interest is also exempt from tax in the state in which the bond was issued.

Make more charitable contributions, including stock. The charity gets the value of the stock, while the taxpayer making the donation gets a deduction based on its fair market value subject to some income limits.

Be careful about cashing in stock to pay for needs such as home remodeling, children's education or a vacation. The value of the stock may eventually grow much higher if left alone and it could be more advantageous to simply borrow the money.

On the estate tax front, J.P. Morgan's Johnson said taxpayers should consider making money transfers now, to take advantage of an annual $10,000 exclusion if the money is given to a child, directly to a school or health facility, or is used for medical bills or a child's tuition.

In addition, a living person can transfer up to $675,000 this year -- or $1.35 million if the spouse joins in -- without triggering the estate tax that would occur on those same assets after death. This "unified credit" will eventually rise to $1 million for an individual in 2006, and $2 million for a couple.

This move would save estate taxes not only on assets given away but also on the future appreciated value of those assets. The same is true of individual retirement accounts: If they are withdrawn early and some funds given away, it will save in both estate taxes and income taxes that apply after death.