Dictionary of Tax Deductions

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Edward A. Lyon, JD
TaxTuneup.com, Inc.
3416 Shaw Ave #5
Cincinnati OH 45208
513.321.2821
elyon@taxtuneup.com

Mattress

Deductible Medical Expense, subject to the 7.5% floor, if prescribed for treatment of a specific condition.

Magazines (See Subscriptions)

Maintenance and Repairs

Maintenance and repairs are generally deductible for business and investment property, but not for personal property:

• Maintenance and repairs on property and equipment for your trade or business are a deductible Business Expense on Schedule C, Form 1065, or your corporate return.
   

• Maintenance and repairs on rental property are a deductible rental expense on Schedule E.
   

• Maintenance and repairs to your home are partially deductible as a Home Office Expense.

Margin Interest (See Investment Interest)

Marijuana

Not deductible as a Medical Expense, even if prescribed by a doctor.

Marriage Penalty

The marriage penalty is a quirk in the tax code that causes many two-income couples to pay more tax than they would if they filed singly. Congress has eliminated the penalty for couples with taxable incomes up to $128,500. However, it still hits two-income couples whose combined incomes are split more evenly than 70/30. The "marriage bonus," on the other hand, rewards couples with just one income, or one income much higher than the other.

There are two reasons for the remaining marriage penalty:

• When you both work, your first income eats up your combined Itemized Deductions and Personal Exemptions, plus the benefit of moving up through tax brackets. Your second income piles on top, and you pay more at your highest rates.
   

• The standard deduction for married couples isn't twice the standard deduction for individuals.
   

• Once tax brackets top 25%, they don't rise at precisely twice the rate for joint filers as they do for singles.

If you're planning a year-end wedding, it might pay to wait a few weeks or months to avoid a marriage penalty (or marry early to claim a marriage bonus). If you can, take a "dry run" at estimating your taxes both ways, married and single, to see which costs least. Then, if it's not too disruptive, choose a date that forces the IRS to help pay for your honeymoon.

If you're planning a divorce, particularly near year-end, consider timing your divorce to eliminate the final year's marriage penalty (or take advantage of one last marriage bonus).

File a new Form W-4 with your employer (or start adjusting your quarterly estimates) as soon as possible in the year you marry or divorce. If your joint tax bill will rise, you'll avoid penalties for underwithholding. If your bill will fall, you'll see savings in your pocket as soon as the new form takes effect, rather than having to wait for next year's refund.

Meals and Entertainment

Meals and entertainment you host are deductible if they're directly related to the active conduct of your business or directly before or after substantial, bona fide discussion directly related to the active conduct of your business.

At the same time, Congress knows you're going to eat -- even if you can't do it on your company dime. So the law meets you halfway and lets you deduct 50% of most meal and entertainment costs. This includes "goodwill" meals and entertainment, entertainment at home, and the cost of including your spouse. Specific deductions include meals and drinks, taxes and tips, and the face value of tickets to sporting and theatrical events.

• Meals and entertainment related to your trade or business are a deductible Business Expense on Schedule C, Form 1065, or your corporate return. You have to have a "bona fide" business discussion; you can't just sip martinis with prospective clients.
   

• Meals and entertainment on behalf of your employer are a deductible Employee Business Expense subject to the 2% floor on Miscellaneous Itemized Deductions.
   

• Meals and entertainment related to your investments are a deductible Investment Expense, up to net investment income, subject to the 2% floor on Miscellaneous Itemized Deductions. This includes lunch with your broker, meals you eat while traveling to manage investment property, and the like.
   

• Meals and entertainment related to your job search are a deductible Job-Hunting Expense subject to the 2% floor on Miscellaneous Itemized Deductions.
   

• Meals and entertainment away from home are 50% deductible for overnight trips. You can claim actual costs or a "per diem" allowance according to your destination. This per diem is $45 for most locations within the continental U.S., and ranges up to $57 for more expensive locations, such as big cities and resort towns. (For a list of rates, see IRS Publication 1542, "Per Diem Rates.") The per diem is divided into quarters for days you leave and arrive back home. If you leave between midnight and 6:00 A.M., you qualify for the entire allowance; if you leave between 6:00 A.M. and noon, you qualify for ¾ of the allowance, etc. You can claim the full allowance even if your actual costs are less.

To verify your deductions, you'll need a diary, day planner, or similar log to record your business appointments. Include the time and place of the meeting, the names of guests, the business purpose of the meeting, and the business relationship between you and your guests. You'll also need receipts or bills for expenses over $75. Credit card statements are fine if you record the business purpose of the expense. 

Meals and lodging that you receive from your employer are tax-free if they meet three conditions:

• they're provided at your employer's place of business,
   

• they're provided for your employer's convenience, and
   

• in the case of lodging, you're required to accept it as a condition of employment.

For more information, see IRS Publication 463, "Travel, Entertainment, Gift, and Car Expenses." 

Medical Expenses

Medical expenses are generally deductible to the extent they exceed 7.5% of adjusted gross income (10% if you're subject to Alternative Minimum Tax). Deductible medical expenses generally include any cost of diagnosis, cure, mitigation, treatment, or prevention of disease. These expenses are reduced by any reimbursement you receive from insurance, Medicare, or Medicaid. Expenses must relate to a specific disease or condition; you can't deduct the cost of weight loss treatments taken simply to improve general health. Cosmetic surgery isn't deductible except for disfigurements related to a congenital abnormality, disfiguring diseases, or accidental injuries.

The 7.5% floor is a high hurdle for most taxpayers. Here are several ways to make the most of medical deductions:

• If you're self-employed, you can deduct 100% of your Health Insurance up to your net income from the business as an adjustment to income rather than an itemized deduction. This bypasses the 7.5 floor on adjusted gross income.
   

• If you undergo a medical examination for your business or your employer (such as to qualify for life insurance you buy to secure financing), you can deduct the cost as a Business Expense or Employee Business Expense. These deductions also bypass the 7.5% floor on adjusted gross income, although the Employee Business Expense is subject to the 2% floor on Miscellaneous Itemized Deductions.
   

• Long-term Care Insurance premiums may be deductible up to certain limits based on your age and the amount of coverage. Nursing home costs are deductible if you're is confined for medical treatment.
   

• Medical expenses provided by a nursing home are deductible even if you're not confined for medical treatment.
   

• Private nursing expenses are deductible. These include a nurse's salary, any employment taxes paid on behalf of the nurse, extra rent to make room for a nurse or attendant, and a nurse's travel costs if the nurse is required on the trip.
   

• Home improvements you make for medical reasons, such as swimming pools and elevators, are deductible to the extent the cost exceeds the increased value for the home.

Example: Your doctor recommends that you install a lap pool for exercise. The pool costs $10,000 and adds $6,000 to your home's value. You can deduct $4,000. You can also deduct the cost of maintaining such improvements so long as the medical need persists.

• Travel costs for medical care are deductible medical expenses. These include your transportation (actual costs or 19 cents per mile, plus parking and tolls), plus lodging on trips to receive medical treatment.
   

• If one spouse has particularly heavy medical expenses in a single year, it may pay to file separately to cut that spouse's 7.5% floor on adjusted gross income. However, this will subject more of your combined income to higher rates. It might also wipe out other tax breaks, such as the Low-Income Housing Tax Credit. The best way to see if this works is simply to figure your tax both ways.
   

• There's no deduction for over-the-counter drugs. There's no deduction for medical marijuana, even if prescribed by a doctor.

For more information, see IRS Publication 502, "Medical and Dental Expenses."

Medical Expense Reimbursement Plan

A medical expense reimbursement plan, or "Section 105" plan, lets you reimburse your employees, their spouses, and their dependents for uninsured medical costs. Plan benefits are deductible by the business, and nontaxable to the employee. Here’s how they work:

• You have to establish the plan for "employees." If you run your business as a proprietorship, partnership, Limited Liability Company or S Corporation, you're considered “self-employed,” and not eligible. If you’re single, you can establish a C Corporation and pay benefits to yourself as an employee. If you’re married, you can hire your spouse and pay the benefits through him or her. If you operate as an S corporation, you and your spouse are both considered self-employed. (In that case, segregate part of your income through a proprietorship or C Corporation and pay benefits through that entity.)
   

• If you have employees besides yourself and your spouse, you can't just pick and choose whom to include. However, you can exclude those under age 25; those who regularly work less than 35 hours per week; those who work less than nine months out of the year; and those who have worked for you for less than three years.
   

• You can deduct 100% of your employees’ Health Insurance. Deductible health insurance costs include major medical and supplemental premiums, Medicare premiums, qualified long-term care premiums, and Medicare supplemental ("Medigap") policies.
   

• Out-of-pocket medical costs include routine expenses such as copays, deductibles, and prescriptions; occasional expenses such as eyeglasses and dentistry; big-ticket items like orthodontics, fertility treatments, and schools for learning-disabled children. It also includes nonprescription medicines and health-care supplies.
   

• You can’t reimburse employees for costs they incur before the plan effective date.

Paying medical expenses through a Section 105 plan offers several advantages:

• You can reimburse employees or pay health-care providers directly.
   

• The plan lets you deduct 100% of your medical costs, bypassing the usual 7.5% floor for Itemized Deductions. You’ll also avoid any Self-Employment tax you would otherwise pay on amounts you deduct as plan benefits.

If you hire your spouse to qualify for a Section 105 plan, you can pay them in benefits only, rather than cash. This avoids managing payroll formalities and filing Form W-2. The key to making this work is to document your spouse’s bona fide employment. Consider executing a written employment contract. Track their hours, weekly or monthly, to substantiate your deduction. make sure you actually pay expenses or reimburse them out of your business account -- you can't just deduct expenses you pay out of personal funds.

You’ll need a written plan document and summary plan description to establish the plan. No special filings are required until the plan covers 100 or more employees. Report MERP benefits as “employee benefits” on Schedule C, Form 1065, or your corporate return.

Medicare Premiums

Deductible Medical Expense subject to the 7.5% floor (Part "B" and Part "D")

Medicare Supplemental Health Insurance

Deductible Medical Expense subject to the 7.5% floor.

Miscellaneous Itemized Deductions

Miscellaneous itemized deductions are a "catch-all" set of write-offs deductible on Schedule A. They include:

• Investment Expenses
   

• Job-Hunting Expenses
   

• Tax-Preparation Fees
   

• Employee Business Expenses.

Miscellaneous itemized deductions are deductible only to the extent that the total exceeds 2% of your adjusted gross income. Add up all your deductions before you subtract the floor. Don't apply the floor to each deduction, or even each category of deduction.

Example: Your 2008 income is $50,000. You contribute $5,000 to an Individual Retirement Account, so your adjusted gross income is $45,000. Your miscellaneous itemized deductions include $400 for tax preparation, $500 for a job-hunting seminar, and $175 to print and mail resumes. Total miscellaneous itemized deductions are $1,075. Two percent of your adjusted gross income is $900. Subtract $900 from your $1,075 total and deduct the remaining $175.

Miscellaneous itemized deductions are also a preference item for the Alternative Minimum Tax. The 2% floor and AMT make miscellaneous itemized deductions fragile.

For more information, see IRS Publication 529, "Miscellaneous Deductions."

Money Market Mutual Fund

Money market mutual funds invest in short-term commercial paper, Treasury bills, or municipal debt to generate current income with no principal fluctuation. This is terribly inefficient from a tax standpoint because all of your return comes from current income (taxed today at ordinary rates) and none comes from capital gains (taxed when you sell at preferential rates).

Money Purchase Plan (See Qualified Plans)

Mortgage Interest

Mortgage interest you pay to buy or substantially improve your primary residence and one more home is deductible within these limits.

• You can deduct interest on up to $1 million of "acquisition indebtedness" you use to buy your primary residence and one more home. Loans you use to substantially improve your home also qualify as acquisition indebtedness.

• You can deduct interest on up to $1 million of home construction loans for 24 months from the time construction begins. Interest before and after this period is nondeductible personal interest.

• Your lender will report the interest you pay on Form 1098. This form also goes to the IRS. Check the amount your lender reports to make sure it's correct. If not, contact your lender and have them issue a revised form. If the amounts that you and your lender report don't agree, the IRS may question your return.
   

• You can deduct Points you pay to buy or improve your primary residence if charging points is an established practice in your geographical area, and the points charged don't exceed the points generally charged in the area. The amount has to be figured as a percentage of the loan amount and specifically itemized as points, loan origination fee, or loan discount fee. Finally, you have to pay the points directly to the lender. If your points don't meet these tests, you can still amortize them over the life of the loan. Your lender will report the amount of deductible points on Form 1098. If you miss a payment and pay a late fee, your late fee is tax-deductible. Prepayment penalties are also deductible.

Your mortgage interest might not give you the instant tax cut you expect. That's because your total itemized deductions, including interest income, don't actually cut your tax until they exceed your standard deduction. For 2008, single filers get a "free" $5,450; heads of households get $8,000; joint filers get $10,900; and married couples filing separately get $5,450. If you're married renters, filing jointly, and your state and local taxes, charitable contributions, and other deductions add up to just $2,000, you can still deduct the full $10,900. If you buy a house and pay $10,000 in interest, your total itemized deductions will be $12,000, just $1,100 more than the standard deduction. You don't get any benefit from the first $8,900 in interest. (If your first-year mortgage interest costs don't justify itemizing, then you won't get any tax break from itemizing Points you pay. If this is the case, consider amortizing points to get the tax break over the course of the mortgage.)

For more information, see IRS Publication 530, "Tax Information for First-Time Homeowners," and IRS Publication 936, "Home Mortgage Interest Deduction."

Motor Home (See Vacation Home)

Moving Expenses

Moving expenses related to relocating for work are deductible as an Adjustment to Income according to these rules:

• Your new job site has to be more than 50 miles from the old.
   

• You have work as a full-time employee in the area of your new job for at least 39 weeks during the 12-month period immediately following your move (78 weeks if you're self-employed or a partner in your own partnership following the move).

• You generally have to incur moving expenses within one year of starting work at the new location.

Specific deductible expenses include:

• the actual cost of packing and moving your belongings

• lodging costs for one night at the beginning of the move, all nights of the trip, and one night at arrival

• transportation costs, including gas, oil, and repairs (or 19 cents per mile) plus parking and tolls

• the cost of finding a new house at the new location.

Report moving expenses on Form 3903, then carry the balance to Form 1040. For more information, see IRS Publication 521, "Moving Expenses." 

MRI Scan

Deductible Medical Expense subject to the 7.5% floor.

Multiple Support Declaration

A multiple support declaration lets you claim someone, such as a parent, as a dependent even if you don't provide more than half of that person's support. This is a smart strategy when two or more siblings help support a parent. Here's how it works:

• You have to provide more than 10% of the person's support.
   

• You and the other contributors jointly have to provide more than half of the person's support.
   

• Each of the other contributors has to be eligible to claim the person as a dependent, except that they did not provide more than half of the support.

• Each of the other contributors has to sign the Multiple Support Declaration giving you the exemption.

File Form 2210 to make the declaration.

Municipal Bond

Municipal bonds, or munis, are issued by cities, counties, and their agencies, including universities, water and sewer districts, and even municipally-backed private activities such as stadiums and aquariums. Munis are a popular choice for tax-free income:

• Municipal bond interest is free from federal income tax.

• Most municipal bonds are free from state tax in the state of issue.

• Puerto Rico municipal bonds and bond funds are free from state tax in any state. These are a good alternative for investors in states that tax their own bonds.
   

• Interest income from "private activity" municipal bonds issued to finance stadiums and similar projects are subject to the Alternative Minimum Tax.

• Never buy a municipal bond or fund in an Individual Retirement Account, Roth IRA, or Qualified Plan account. You'll earn less interest. And you'll convert tax-free interest into ordinary income. This might seem like an obvious bonehead move. But custodians and plan sponsors report hundreds of tax-deferred accounts holding municipal bonds.

Since municipal bond buyers don't pay tax on their interest, issuers can pay lower rates. The key rate is taxable equivalent yield--the rate you'd have to get with a taxable bond to equal the muni's tax-free yield. Your taxable equivalent yield equals the muni bond rate divided by (100 minus your tax rate). If you're in the 28% tax bracket, a muni paying 5.00% equals a taxable bond paying 6.94% (5.00 divided by .72). If you're in the 35% bracket, the same muni equals a taxable bond paying 7.69% (5.00 divided by .65).

State and local taxes also affect your taxable equivalent yield:

• If you're comparing a municipal bond's yield against a Treasury Bond, use your combined rate only if your state taxes the muni bond interest. If you're comparing a municipal bond's yield against a fully taxable corporate or foreign bond, use your combined rate to calculate your taxable equivalent yield.
   

• Municipal bond interest is included in your "provisional income" for purposes of calculating tax on Social Security benefits. If you're collecting benefits, don't forget to include the effect of this tax.

Municipal bonds are even more valuable if your income is high enough to phase out for Itemized Deductions, Personal Exemptions, Tax Credits, and similar breaks. Muni bond interest doesn't increase your adjusted gross income, so your true tax break can be even higher.

Muni bond interest is tax-free. But Capital Gains and losses on sales are taxable. This makes muni bonds terrific candidates for Tax Swaps. If your bond's value falls, you can exchange it for another to realize a capital loss. You can increase your income, improve your credit quality, and lengthen or shorten your bond's maturity, all at the same time. To qualify, you'll need to change two of these features: maturity, issuer, and coupon.

If you buy a municipal bond at a "premium"--a price above its face value--you'll have to amortize the premium over the remaining term of the bond to determine gain or loss on any sale before maturity.

Example: In 2008, you pay $1,040 for a muni maturing in four years at $1,000. Each year you have to reduce your basis by $10. If you sell the bond after two years, your basis will be $1,020. So if you sell the bond for $1,030, you'll report a $10 gain, rather than a $10 loss. If you hold the bond to maturity, there's no deduction for the capital loss when you redeem the bond for $1,000.

Zero-coupon municipal bonds don't make semiannual interest payments like most bonds. Instead, you buy the bond at a deep discount to face value. The value of the bond increases steadily as it moves towards maturity, finally maturing at face value. Since muni bond interest is not taxed, you pay no tax on the gain if you hold to maturity. All of your gain will be considered interest. But if you sell the bond before maturity, you'll have to calculate how much of your gain consists of nontaxable interest and how much consists of taxable capital gain. The process works the same as with any other zero-coupon bond. For details, see IRS Publication 1212, "List of Original Issue Discount Instruments."

Mutual Funds

Mutual funds are investment companies that pool money from shareholders and invest in a diversified portfolio of assets. Funds offer professional management at a reasonable fee, instant diversification, and easy liquidity. Funds pay a wide variety of distributions taxed in different ways. These distributions play a big part in establishing how much tax you pay:

• "Income" dividends consist of income earned by the fund's portfolio investments, such as interest earned by bonds and dividends paid on stock. These are taxed as ordinary income whether you take the dividend in cash or reinvest it in additional shares.
   

• "Qualified dividends" consist of Qualified Corporate Dividends earned by the fund's stock holdings. Tax on these dividends is capped at not more than 15%.
   

• "Capital gains" distributions consist of profits from sales of securities within the fund's portfolio. These distributions are generally taxed as long-term Capital Gains, regardless of how long you own the shares. And, like income dividends, capital gains distributions are taxed when distributed whether you take the distribution in cash or reinvest in additional shares.
   

• "Return of capital" distributions are simply distributions of your own capital. These distributions generally aren't included in taxable income. Instead, they reduce your Basis in your shares when you finally sell. If your basis is already down to zero, then report these "return of capital" distributions as Capital Gains.
   

• Some funds may retain long-term capital gains and pay tax themselves, rather than distributing those gains to shareholders to pay individually. You still owe tax on the gain, but you can claim a credit for the tax the fund pays. The fund will report your share of the tax on Form 2439.

• Some funds also pay foreign tax on foreign income. See Foreign Taxes.

For more information, see IRS Publication 564, "Mutual Fund Distributions."

It's important to keep appropriate records to cut your tax when you sell. Mutual fund shares and, especially, reinvested dividends can be a nightmare when it comes time to sell. The rules themselves are fairly simple. It's recordkeeping that becomes a chore. Many funds, especially income-oriented funds, pay dividends every month that are reinvested at different prices. A fund account held for five years might include shares with 60 different prices, including ordinary income, capital gains, and even fractional shares. There are three ways to account for fund share costs. The method you choose can make a huge difference in your tax bill:

• With the "average cost" method, you divide the number of shares you own into your total basis in the fund "including reinvested dividends) to figure your basis for each share you sell. You can also divide your shares into two groups, those held a year or less and those held one year or longer, to figure separate average bases for short-term and long-term holdings.

• With the "first-in, first-out method," you'll be considered to sell your oldest shares first. In rising markets, these will generally be your least expensive shares, generating your highest taxable gains.
   

• Finally, with the "specific shares" method," you keep track of your purchase price for each share and designate which specific shares you wish to sell. If you've bought shares over a period of months or years at different prices, this method lets you report the lowest gain. By selling the highest-priced shares, you pay the lowest tax, since your gain will be less on the higher-priced shares. This recordkeeping will also keep you from paying tax on reinvested dividends.

As with any investment, it's what you keep that counts. And not all funds are created alike. Here are several strategies for choosing tax-efficient funds:

• Consider Index Funds, Exchange-Traded Funds, and Tax-Managed Funds.

• Use Morningstar tax analysis ratings to find tax-efficient funds. Morningstar reports three figures for investors seeking tax-efficient funds. "Tax-adjusted return percentage" is each fund's after-tax total return. "Percentage Pre-tax Return" tells you what percentage of a fund's return consists of taxable distributions. And "Potential Capital Gains Exposure" tells you what percentage of a fund's total assets represents undistributed capital appreciation. If the fund were liquidated today, this embedded capital gain would be taxable to shareholders. As a fund's assets grow, this percentage is diluted over a larger total pool of assets. 

• Avoid funds with high turnover. Turnover isn't a perfect measure of a fund's tax efficiency -- some studies suggest turnover's effect diminishes as it passes 30% or so (this may be because managers who trade so often rack up as many losers as winners). But turnover is a useful indicator of tax-efficiency once you've narrowed your fund choices down to a few finalists.

Once you've chosen which funds to buy (and sell), there are several strategies you can use to buy and sell efficiently. Several of these are the same as for individually traded stocks. Others take advantage of funds' particular operating structure:

• Limit turnover within your mutual fund portfolio. Frequent turnover whacks your profits with each sale, just as with individual securities. And frequent trading subjects more of your gains to punitive ordinary-income rates, rather than favorable long-term gains. However, there are two exceptions to this rule. First, don't be afraid to walk away from a loser. And second, Tax Swaps may be an appropriate strategy for converting paper losses into real tax savings. (Tax swaps are especially appropriate for "commodity" funds that differ little from one fund family to the next, such as index funds and Treasury funds.)
   

• Avoid buying funds late in the year before managers distribute capital gain dividends. All mutual funds force you to buy your neighbor's tax bill in the form of potential capital gains exposure. But buying a fund right before a capital gains distribution forces you to pay your neighbor's tax bill now. Funds accumulate capital gains throughout the year, then pay them out near the end of the year. If you own the fund on a designated date, called the ex-dividend date, you pay tax on the accumulated gains whether you actually profit from it or not. You owe the tax even if the value of the shares is less than what you paid. Where's the fun in that?

Example: You buy 1,000 shares of the Gambino Growth & Income Fund for $10 apiece. The next week, the manager declares a capital gains distribution of $2 per share. You'll now own 1,000 shares worth $8,000, plus a taxable check for $2,000. This turns your pre-tax principal into taxable income. The process works the same if you direct the fund to reinvest your dividends. Now, instead of owning 1,000 shares at $8.00 each, plus a $2,000 taxable dividend check, you'll own 1,250 shares at $8 each, and you'll still owe tax on your 250 "new" shares.

• Take advantage of ex-dividend days to convert income dividends into Capital Gains. This strategy lets you avoid tax on shares you plan to sell. This strategy also takes advantage of the ex-dividend date to convert ordinary income into capital gains. It's actually the reverse of avoiding purchases near year-end. When a mutual fund distributes a dividend, the price of each share falls by the amount distributed as a dividend. That dividend is then taxed as ordinary income or capital gain. If you're ready to sell shares you've held for more than a year, and you sell when the shares are fat right before a dividend, you'll pay capital gains tax on the portion of the value that might otherwise soon be distributed as an income dividend. This strategy makes little difference with capital gains dividends that are taxed as long-term capital gains already. But you can squeeze out some extra tax savings by selling future income dividends as capital gains. (This can also help with year-end planning. If you buy shares in a high-tax year, use this strategy to cut that year's income.)
   

• Write off front-end sales loads for funds you buy through brokers. Once you've paid your load, you're free to switch funds within the family at no extra charge. If you buy into a family, then immediately switch into another fund, you'll show a short-term capital loss equal to the load. You can use the loss to offset capital gains or up to $3,000 of ordinary income. For example, if your broker recommends the Gambino Emerging Markets Fund, first buy shares in the Gambino Equity Fund (or any fund with the same sales load), then immediately transfer your funds into the emerging markets fund. (This strategy works only in taxable accounts, not IRAs.)

When you finally sell your shares, your basis for figuring gain or loss will be lower than if you hadn't used this strategy. Still, the extra gain you delay until your sale will be taxed at lower long-term gain rates (assuming you keep the shares longer than a year), while your up-front loss will offset ordinary income and short-term gains. Your savings up front are greater than the extra tax at the end. The net result of the strategy is to convert an amount equal to your load from ordinary income into capital gains.

• Beware checkwriting with short-term bond funds. Many of these funds come with a checkbook that lets you redeem shares merely by writing a check. The fund company then pays the recipient of the check directly. This is a wonderful convenience. But, each time you write a check, you're selling shares, with different holding periods and cost bases. And you can't specify which shares to sell. Your fund's prospectus will tell you which shares you can expect to be liquidated. (This isn't a problem with Money Market Mutual Funds, which don't generate capital gains when you redeem shares.) This doesn't mean you should throw away the checkbook. Just be aware of the bookkeeping hassles it creates.
   

• Avoid systematic withdrawal plans from taxable accounts. These plans pay you a specified dollar amount from your fund at a specified period -- generally, monthly or quarterly. The fund pays out accumulated income first, then sells shares if accumulated income isn't enough to pay the entire distribution. They're an excellent alternative to annuitization if you need steady, predictable income from their holdings. And they let you manage your portfolio for total return and still draw a regular income.

The problem, of course, is that, like checkwriting, systematic withdrawal plans force you to sell shares at different times and different prices. This can make bookkeeping hard. If you confine your systematic withdrawals to tax-deferred accounts, you'll avoid a lot of paperwork.

• Finally, use caution rebalancing your portfolio in taxable accounts. Portfolio rebalancing simply means maintaining your target asset allocation. Let's say you choose to keep $50,000 in stocks and $50,000 in bonds. At the end of your first year, your stocks may be worth $55,000 and your bonds $53,000. Rebalancing would require you to sell $1,000 of stocks and invest the proceeds in bonds to maintain your 50-50 split. If you don't rebalance, your asset allocation drifts away from your target. The problem, as you've already guessed, is that rebalancing forces you to recognize capital gains. This generates tax bills -- and possible transaction costs, too.

There are two solutions to this problem. First, replenish your laggards with new money, rather than from selling your winners. Second, confine rebalancing to your tax-deferred accounts. Many retirement plan and variable annuities offer automatic rebalancing services, perhaps quarterly or annually.