With the mid-term elections now over, one thing is clear - the Congressional landscape has changed. The Republicans have won control of the House of Representatives and they also picked up seats in the Senate, albeit not enough to obtain Senate control.
It is still too early to know exactly how this election will affect long-term tax policy. However, in the near term, when the "lame-duck" Congress returns to work in mid-November, we will hopefully get some closure on a number of tax questions that have been hanging around for some time.
For example, for 2010, Congress must decide whether to "patch" the alternative minimum tax (AMT) (increase exemption amounts, and allow personal credits to offset the AMT) as it has done in past years. The latest word on AMT came from a letter dated November 9, 2010, where Senate Finance Committee Chairman Max Baucus and House Ways and Means Committee Chairman Sander Levin, along with other ranking congressmen, wrote to the Commissioner of the IRS committing themselves to legislation that will set the AMT exemption amounts for 2010 at $47,450 for individuals and $72,450 for married taxpayers filing jointly. We will have to wait and see if this committment leads to a patch in the tax law.
Congress must also decide whether to retroactively extend a number of tax provisions that expired at the end of 2009. These include the research credit for businesses, the election to take an itemized deduction for State and local general sales taxes in lieu of the itemized deduction permitted for State and local income taxes, and the additional standard deduction for State and local real property taxes.
Congress must further decide whether to extend the Bush tax cuts for some or all taxpayers for 2011 and beyond. Without Congressional action, individuals will face higher tax rates on their income, including capital gains. President Obama wants the tax cuts extended (or made permanent) for taxpayers making under $250,000. Republicans want the tax cuts extended for all taxpayers. It appears that some type of compromise is in the works. Although I certainly have no crystal ball, if I were a betting man, I would bet that the Bush tax cuts will be extended for all taxpayers for at least a year, and maybe two.
Finally, Congress may take up the estate tax. Unless it changes the law, the estate tax, which is not in effect this year, will return in 2011 with a 55% top rate and a lower exemption or credit amount ($1,000,000 per person compared to $3,500,000 per person in 2009, the last year the estate tax was in effect).
For a list of the many tax provisions that either expired or are set to expire, click here for a prior blog we published on this topic.
Because of all of this uncertainty, year-end planning - which has always involved some educated guesswork - may present a bigger challenge than it has in prior years. You may want to wait until closer to year-end to implement certain of the strategies discussed in this newsletter. By delaying, you may have more certainty based on Congressional actions that may take place later in the year.
The purpose of this Special Edition of e-Counsel is to provide you with year-end tax strategies you may want to consider to help you save tax dollars. Note that not all actions will apply to your particular situation. Therefore, and as always, this Special Edition of e-Counsel is only intended to be an overview of the topic under discussion and is not intended to give specific advice regarding any person's particular situation. If you have any questions regarding this e-newsletter, please do not hesitate to contact us.
Year End Tax Planning for Individuals to Consider
Individual may want to consider some of the following year-end tax planning strategies and/or suggestions:
1. Deferral or Acceleration of Income or Deductions. No one likes to pay taxes any sooner than they have to. Therefore, year-end planning often focuses on deferring income from this year into future years and accelerating deductions from future years into earlier years. For 2010, it becomes a little more complicated. Since at the time this issue is being published, we do not know for certain what the tax rates will be next year, it is possible that the general rule of tax deferral could produce a higher overall tax for 2010 and 2011. This would be the case if the Bush tax cuts expire and higher rates come into affect in 2011. In this situation, deferring income until 2011 might mean that you are paying income tax at a higher rate. Hopefully, Congress will act before year-end so people will have more certainty. Nevertheless, what follows are some basic principles that can help guide your overall thinking:
- If you think your tax rate might be the same or lower next year, consider deferring income to next year and accelerating deductions into this year.
- If you think your tax rate might be higher next year, think about whether it makes sense to accelerate income into this year and defer deductions.
- If you think your deductions might be restricted next year (because of income limitations for example), consider whether you can accelerate some deductions into this year.
2. Capital Gains and Losses. Consider realizing losses on securities to offset any capital gain. Sales at a loss can reduce other capital gains, and a net loss of up to $3,000 can be used to offset other income. Before you make any sale, be mindful of your holding period (how long you owned the security). Long-term capital gain (owned over a year) are eligible for a significantly lower tax rate - generally no more than 15%. If certain tax cuts expire, this rate could move up to 20% in 2011. Therefore, it could make sense to accelerate a gain to 2010 and save up to 5% in tax.
3. Credit Card Payments. Consider paying tax deductible expenditures, including charitable contributions, with a credit card. Paying by a credit card in 2010 will secure the deduction, even if you do not actually pay the credit card company until the following year. A pledge or a promise is not enough - you actually have to make the payment or charge it to your credit card.
4. Charitable Contributions. Consider contributing appreciated securities instead of cash to a charity. You can deduct the fair market value of long-term capital gain property contributed to charity, even though your basis in that security might be significantly less. Not only do you get a higher deduction, you also avoid tax on the gain that would have been recognized if you sold it and donated the proceeds. However, if you want to get rid of securities that have declined in value, you should sell them first to realize the loss and then gift the proceeds.
5. Home Improvements Tax Credit. Consider making energy saving improvements to your home, such as putting in extra insulation, installing energy saving windows, or installing an energy efficient furnace to qualify for a 30% tax credit. The total (aggregate) credit for energy efficient improvements to the home in 2009 and 2010 is $1,500. Unless Congress acts, this tax break will expire at the end of 2010.
6. Alternative Minimum Tax. The alternative minimum tax (AMT) is a separate tax system that shadows regular income tax. If you do not pay "enough" regular income tax, you might have to pay AMT. An increasing number of middle-income taxpayers are having to pay AMT. High itemized deductions (other than charitable contributions) often triggers AMT. Before implementing any year-end tax strategy, be sure to consider the impact of AMT.
7. Increased Withholding to Avoid Penalty. Consider increasing your withholding if you are facing a penalty for underpayment of federal tax. Doing so may reduce or eliminate the penalty.
8. Flexible Spending Account. Consider increasing the amount you set aside for next year in your employer's health flexible spending account (FSA) if you set aside too little for this year. You cannot set aside amounts to get tax-free reimbursements for over-the-counter drugs, such as aspirin and antacids (2010 is the last year that FSAs can be used for nonprescription drugs).
9. 529 Plan Contributions. Consider making a contribution to a Section 529 Plan to save for a child or other loved one's education and obtain a Missouri state income tax deduction of up to $8,000 on your Missouri state income tax return ($16,000 for married couples).
10. Fund an IRA or Roth IRA. Consider funding an IRA or Roth IRA before the end of the year. If you qualify, an IRA contribution may be tax deductible and the income and earnings for both an IRA and Roth IRA build up tax free.
11. Convert Traditional IRA to Roth IRA. Consider converting your traditional IRA into a Roth IRA if doing so is expected to produce better long-term tax results for you and your beneficiaries. Distributions from a Roth IRA can be tax-free but the conversion will increase your adjusted gross income for 2010. However, you will have the choice of when to pay the tax on the conversion. You can either pay the tax on the conversion when you file your 2010 return in 2011 or you can pay half the tax on the conversion when you file your 2011 return in 2012 and the other half when you file your 2012 return in 2013.
12. Do Not Forget to Take Required Minimum Distributions. Take required minimum distributions (RMD) from your IRA or 401 plan (or other employer-sponsored retirement plan) if you have reached age 70 1/2. Failure to take a RMD can result in a penalty of 50% of the amount not withdrawn. A temporary tax law change waived the RMD requirement for 2009 only, but the usual rules apply for 2010. If you turned 70 1/2 in 2010, you can delay the RMD to 2011, but if you do, you will have to take a double distribution in 2011 - the amount required for 2010 plus the amount required for 2011. Think twice before delaying a 2010 distribution to 2011. Sometimes bunching income into 2011 might push you into a higher tax bracket or have a detrimental impact on various income tax deductions that are reduced at higher income levels.
13. Health Savings Account. If you qualify for making a health savings account contribution, consider maximizing your contribution before year-end. The beauty of an HSA is that you do not have to use the funds for medical expenses this year, but the contributions are currently deductible.
14. State Income Taxes. Consider paying anticipated state income taxes before year-end if you would benefit from a deduction for state income taxes on your federal return. Remember that accelerating taxes will not do any good if you are subject to AMT.
15. Annual Exclusion Gifts. Consider making annual exclusion gifts before year end to save gift tax (and estate tax if it is reinstated). You can give $13,000 in 2010 to an unlimited number of individuals free of gift tax (married couples can give $26,000). Note that you cannot carry over unused annual exclusions from one year to the next. Gifting may also save family income taxes where income-earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax.
For certain high net worth individuals, making gifts above a person's annual exclusion could make sense. For more information on taxable gifts, click here then select "Taxation" in the contents to read an article I wrote titled "To Gift or Not to Gift - That is the 2010 Tax Planning Question" which was published in "The Asset," a professional journal sponsored by the Missouri Society of Certified Public Accountants.
Year End Planning for Business Owners to Consider
Business owners may want to consider some of the following year-end tax planning strategies and/or suggestions:
1. Payroll Tax Holiday for New Hires. Consider hiring a worker who has been unemployed for at least 60 days before year end if you will be otherwise adding to your workforce soon. Your business will be exempt from paying the employer's 6.2% share of the Social Security payroll tax on the formerly unemployed new hire for the remainder of 2010. Plus, if you keep that formerly unemployed new hire on the payroll for a continuous 52 week period, your business will be eligible for a nonrefundable tax credit of up to $1,000 after the 52 week threshold is reached.
2. Health Insurance Tax Credit. A tax credit is available for an eligible small employer (ESE) to purchase health insurance for its employees. An ESE is one that pays for at least 50% of the premium cost for employees and generally has no more than 25 full-time equivalent employees employed during the year and whose employees have annual full-time equivalent wages that average no more than $50,000.
3. Section 179 Deduction. Instead of depreciating an asset over several years, consider expensing all or a portion of certain qualifying assets in the year placed in service. There are limitations, the most significant of which is the nature of the asset - it must be used in an active trade or business and generally must be personal as opposed to real property. For 2010, the Section 179 expensing amount is $500,000. For total investments of qualifying property exceeding $2,000,000, there is a dollar-for-dollar reduction of the $500,000 expense available. Note that within the overall $500,000 expensing limit, you can expense up to $250,000 of qualified real property (certain qualifying leasehold improvements, restaurant property, and retail improvements). At the time you file your tax return you can choose not to use expensing (or bonus depreciation discussed below) for 2010 assets. This is something to consider if tax rates go up for 2011 and future years, and you would rather have more deductions after 2010 than for 2010.
4. Bonus Depreciation. Property that does not qualify for an immediate tax write-off under Section 179 may qualify for first-year bonus depreciation. For business equipment and machinery placed in service before year-end, a deduction equal to 50% of the cost of the qualifying property may be available. Unless Congress acts, this bonus depreciation allowance will not be available for property placed in service after 2010.
5. Retirement Plans. Consider setting up a self-employed retirement plan if you are self-employed and have not done so yet.
6. Pay Corporate Dividends. Traditional C corporations face a double tax - a tax on profits at the corporate level and another tax on dividends paid out to shareholders. Given the maximum 15% tax rate for qualified dividends, many have seen this as an opportunity to pay out accumulated earnings at a relatively low tax cost. With the possibility that the tax rate on dividends may increase, it may be worth looking at whether it makes sense to accelerate any dividends to 2010.
We trust you have found this issue of e-Counsel to be interesting and informative. If you have any questions regarding anything contained in this issue or if you have any ideas as to how we can improve our newsletter, please do not hesitate to contact us.
Circular 230 Disclosure
Under U.S. Treasury Department guidelines, we are required to inform you that (1) any tax advice contained in this communication is not intended or written to be used, and cannot be used by you, for the purpose of avoiding penalties that may be imposed on you by the Internal Revenue Service, or by any party to market or promote any transaction or matter addressed herein without the express and written consent of the Richard C. Petrofsky Law Office and Helfrey, Neiers & Jones, P.C., (2) the Richard C. Petrofsky Law Office and Helfrey, Neiers & Jones, P.C. imposes no limitation on any recipient of this tax advice on the disclosure of the tax treatment or tax strategies or tax structuring described herein, and (3) any fees otherwise payable to the Richard C. Petrofsky Law Office or Helfrey, Neiers & Jones, P.C. in connection with this written tax advice are not refundable or contingent on your realization of federal tax benefits from the advice contained herein.