You should also be advised that it is not uncommon for Congress to tinker with the tax law as the end of the year approaches. Obviously, this newsletter only represents the law as it exists today. If there are changes in the law that we feel or noteworthy, we typically make every effort to publish them in our blog.
Planning Caution. If you are selling a security to recognize a loss, be sure you do not run afoul of the wash-sale rules. A wash-sale occurs if you repurchase substantially identical assets within the 61-day period, generally beginning 30 days prior to your loss sale and ending 30 days after the sale (even if the sale and repurchase occur in different years). Wash sales should be avoided because they will defer any current loss you thought you had.
3. Dividends. Like long-term capital gains, qualifying dividends are generally taxed at a maximum rate of 15% in 2011 and 2012 (or 0% for dividends otherwise taxable for taxpayers in the lowest two ordinary tax brackets). Most dividend income received from domestic corporations and qualified foreign corporations can qualify for this favorable tax treatment as long as you hold the underlying stock for a minimum period of time.
4. Suspended Passive Activity Losses. If you own a passive activity with a suspended loss, and you do not expect sufficient passive income in 2011 to allow you to deduct the suspended loss, consider disposing of the activity before December 31, 2011. If you dispose of a passive activity with a suspended loss, you can claim the deduction in the year of disposal without the need for passive income.
5. Education Planning. If you are saving or paying for the education of a child or love one, consider the following:
a. Section 529 Plan. You can make a contribution to a Section 529 Plan to save for the education of a loved one and obtain a Missouri state income tax deduction of up to $8,000 ($16,000 for married couples). Contributions made to a 529 Plan grow income tax-free. Further, distributions from a 529 Plan that are used to pay qualified higher education expenses (such as college tuition, mandatory fees, books, equipment, supplies and generally, room and board) are also income tax free. 529 Plans also provide estate planning benefits - you can front-load five years' worth of annual gift tax exclusions and make a $65,000 contribution (or $130,000 if you split the gift with your spouse) without adverse gift tax consequences. A sizable front loaded contribution can be beneficial because the earnings build up tax free on a larger amount.
b. Education Savings Account. You can make a contribution to a Coverdell Education Savings Account (ESA) to pay for a loved one's elementary, secondary or college education. Unlike a 529 Plan, these contributions are not deductible, but they grow income tax free and distributions used to pay qualified education expenses are also income tax free. There are limitations on making contributions to an ESA. Generally, they can only be made for the benefit of a child under age 18. Further, the annual ESA contribution limit per beneficiary is $2,000 through 2012 and then it goes down to $500 for 2013 unless Congress elects to change the law. Finally, the ability to make an ESA contribution is phased out for higher income taxpayers and is not available for a taxpayer with income above $110,000 ($220,000 for married taxpayers filing jointly). Amounts left in a ESA when the beneficiary turns 30 generally must be distributed within 30 days, and any earnings may be subject to a tax and a 10% penalty.
c. American Opportunity Credit. If you are currently paying for a loved one's undergraduate education, the American Opportunity Credit provides a credit against tax equal to 100% of the first $2,000 of tuition and related expenses and 25% of the next $2,000. The maximum credit is $2,500 per year for the first four years of college. The credit is phased out for higher income taxpayers and is not available if a taxpayer has modified adjusted gross income above $90,000 ($180,000 for married taxpayers filing jointly).
d. Lifetime Learning Credit. If you are paying for a loved one's undergraduate or graduate education or a job training course, you may be eligible for the Lifetime Learning Credit which provides a tax credit of up to $2,000 per return. The credit is phased out based on income levels and is not available if a taxpayer has modified adjusted gross income above $61,000 ($122,000 for married taxpayers filing jointly).
e. Tuition and Fees Deduction. In lieu of the American Opportunity Credit and the Lifetime Learning Credit, you may be eligible to deduct qualified higher education tuition and fees. The maximum amount of the tuition and fees deduction you can claim is $4,000 per year, but this is limited based on income levels. You can claim the maximum deduction if your income is under $65,000 ($130,000 for married taxpayers filing jointly). If your income is over $65,000 but under $80,000 ($160,000 for married filing jointly), a $2,000 deduction is available. No deduction is allowed for income over $80,000 ($160,000 for married filing jointly).
Planning Caution. With all the credits and deductions available, planning for education benefits can be tricky and it is often difficult to determine what will provide the best overall tax benefit. In general, a taxpayer may claim more than one education benefit in a tax year if the same qualified expenses are not used to claim more than one benefit. Only one of the following can be claimed per student per year - American Opportunity Credit, Lifetime Learning Credit or Tuition and Fees Deduction. If the expenses are paid for more than one student, all three benefits can be claimed in the same year by the same taxpayer as long as the expenses for each student are used to claim only one benefit and the requirements for each benefit are met.
6. Retirement Tax Planning. Consider making pre-tax salary deferrals to your employer's retirement plan (like a 401(k), 403(b), 457(b) or SIMPLE) to trim your taxable income and help you save for retirement. If you are already making salary deferrals, consider increasing your contributions before year-end to increase your tax savings. The table on the attached link shows the deferral limits for 2011. Note that your plan may allow you to make additional catch-up contributions once you reach age 50. Your regular and catch-up contributions, as well as plan investment earnings, will be taxed deferred until you begin receiving funds from the plan.
If your employer does not provide a retirement plan, consider funding an IRA or Roth IRA before the end of the year. If you qualify, an IRA contribution may be tax deductible. Roth contributions are made after tax, so there is no immediate tax benefit. Both IRA and Roth IRA's earning build up tax-free. IRA earnings are taxed on withdrawal, but Roth IRA funds will not be taxed on withdrawal after you have met a five-year holding period and reached age 59 1/2 (or in certain other limited circumstances).
7. Paying Expenses With a Credit Card. Consider paying tax deductible expenditures, including charitable contributions, with a credit card. Paying by a credit card in 2011 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 in 2011 to get the deduction.
8. Charitable Contributions.
a. Charitable Contributions of Appreciated Assets. 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.
b. Charitable Contributions From IRA's. The provisions for making charitable contributions from an IRA are set to expire on December 31, 2011. Normally, when you make a charitable contribution from an IRA, it is treated as a distribution and included in your taxable income. You receive a charitable contribution deduction only if you itemize your deductions. If you are age 70 1/2 or older, you can have charitable contributions made directly to a charity from your IRA. There is no deduction for the contribution, but it also is not treated as a distribution and not included in your taxable income. The contribution is limited to $100,000.
9. Home Improvements Tax Credit. A tax credit for qualifying home improvements may be available for improvements placed in service during 2011, but not in 2012 (unless the law changes). Therefore, consider making energy saving improvements to your home, such as putting in extra insulation, installing energy saving windows, or installing an energy efficient furnace. You will need to complete your purchase before December 31, 2011 to qualify for the credit in 2011. The new energy efficiency tax credit is a 10% credit, up to a lifetime maximum of $500. The prior cap had been up to $1,500, so check to see whether you have claimed this credit in prior years. You may already have claimed the maximum credit allowable.
10. Tax Credit for Alternative Vehicles. Several tax credits are available to purchasers of various types of motor vehicles that use fuel-savings or alternative-fuel technologies. The credits vary in amount by the type of credit and type of vehicle. Check with the manufacturer to see what tax credits may be available if you are considering the purchase of a new vehicle.
11 Alternative Minimum Tax. Always be cautious of the alternative minimum tax (AMT). The 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), high personal exemptions and large capital gains, among other things, can trigger the AMT. New retirees can often run afoul of the AMT because they experience lower income while their itemized deductions remain high. Before implementing any year-end tax strategy, be sure to consider the impact of AMT.
12. 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.
13. Do Not Forget to Take Required Minimum Distributions. Take required minimum distributions (RMD) from your IRA or qualified 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. If you turned 70 1/2 in 2011, you can delay the RMD to 2012, but if you do, you will have to take a double distribution in 2012 - the amount required for 2011 plus the amount required for 2012. Think twice before delaying a 2011 distribution to 2012. Sometimes bunching income into 2012 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.
14. 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.
15. 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.
16. Other Deductions and Credits. In addition to the above, be advised of the following sometimes overlooked deductions and/or credits that may be available to you:
a. Volunteer Expenses. You may deduct various out-of-pocket expenses incurred in connection with any volunteer work you do for a qualified charity. For example, if you drive while performing volunteer services, you may deduct 14 cents per mile, plus tolls and parking (or your actual unreimbursed auto expenses, such as gas and oil).
b. Job Search Expenses. The unemployment rate is high and many people may have incurred expenses looking for a job. You generally may deduct the cost of resumes, job counseling, travel for interviews and other job search expenses even if you are not offered or do not accept a new job, provided your job search relates to a position in your present trade or business. These expenses are claimed as a miscellaneous itemized deduction and are subject to the 2% of adjusted gross income floor.
c. Mortgage Points. Many people refinanced their house this year. Points (prepaid interest) paid on a mortgage refinancing may generally be deducted over the loan term. If you sell your home before you have deducted the whole amount, you may deduct whatever amount remains in the year of the sale.
d. Casualty Losses. Missouri has been hit with tornados and other disasters that may have caused home damage. You may qualify for a casualty loss deduction if your property was totally or partially destroyed as the result of a sudden unexpected or unusual event such as a fire, storm, tornado or car crash. You must reduce the amount of the loss you claim on your tax return to the extent insurance covers the damage and certain other deduction limitations apply.
e. Medical Expenses. Subject to the 7.5% of adjusted gross income floor, you may deduct a variety of out-of-pocket medical expenses. The list of medical expenses that can qualify for the deduction is long and includes doctor's bills, tooth repairs, eye-glasses and contact lenses, hearing aids, laboratory fees, oxygen, psychiatric care and stop-smoking programs.
f. Child and Dependent Care Credit. If you pay child-care expenses so that you (and your spouse) can work, you may qualify for the child and dependent care credit. Up to $3,000 of expenses ($6,000 for two or more dependents) can qualify, and the minimum credit rate is 20%. Your child must be under age 13. This credit is available for household and other expenses of caring for a disabled spouse or other adult dependent while you work.
Year End Estate Planning Considerations
1. Review Your Estate Plan. The end of the year is always a good time to review your estate plan to ensure that it still accomplishes your goals and objectives. Many things can cause an estate plan to be outdated or in need of review, including:
- Children or Grandchildren May Have Been Born or Died;
- People You Selected as Trustees of Trusts May Need to be Changed;
- People You Selected as Guardians for Minor Children May Need to be Changed;
- People You Selected to Make Medical or Financial Decisions for You in the Event of a Disability May Need to be Changed;
- Remarriage, Divorce or Death of a Spouse;
- Revocable Living Trust May Not be Funded;
- Significant Change in Net Worth;
- Tax and Other Law Changes.
In addition, if you do not currently have an estate plan, the end of the year is always a good time to put one in place.
2. Estate Gift Tax Planning. The estate and gift tax exemption amount for 2011 is $5 million, or $10 for a married couple. This represents a significant increase from the prior exemption of $3.5 million for estate tax and $1 million for gift tax (not counting 2010 where the estate tax was temporarily repealed). As it has been in the recent past, there is uncertainty as to where the exemption amount will end up in the future. Under current law, the exemption will only stay at $5 million through 2012 unless Congress elects to change the law. If no change is made, beginning in 2013, the exemption is scheduled to decrease to $1 million. This means that now may be an excellent time to take advantage of the increased exemption through additional estate and gift tax planning. For example, making large gifts under the exemption amount not only removes the value of the gifted property from your estate, but also any appreciation on such property. For people who are concerned about estate tax, numerous planning opportunities are available, but going into those planning opportunities are beyond the scope of this newsletter.
3. Annual Exclusion Gifting. Consider making annual exclusion gifts before year-end to save gift and estate tax. You can give $13,000 in 2011 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.
Year End Income Tax Planning for Business Owners
Business owners may want to consider some of the following year-end tax planning strategies and/or suggestions:
1. Start-Up Costs. If you started a new business in 2011, you may have incurred expenses before the business actually began operating. For example, you may have had expenses for conducting market surveys, traveling to find customers or suppliers, advertising and training employees. You may elect to deduct up to $5,000 of these expenses in 2011 as long as the business is up and running before the end of 2011. The $5,000 deduction limit is reduced dollar for dollar once total start-up costs exceed $50,000. The excess of the start-up costs is generally deductible over a 180 month period.
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 has fewer than 25 employees and average annual wages are less than $50,000. If this is your case, you can be eligible for a credit of up to 35% of nonelective contributions you make on behalf of your employees for medical insurance premiums. The credit varies based on the numbers of employees and average compensation.
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 2011, 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).
4. Bonus Depreciation. You may be able to write off the cost of machinery, equipment and other fixed assets in 2011 using first year bonus depreciation. Generally, for business equipment and machinery placed in service after September 8, 2010 and before January 1, 2012, a deduction equal to 100% of the cost of the qualifying property may be available.
5. Retirement Plans. Consider setting up a retirement plan if you have not done so yet. A retirement plan has significant tax advantages. Employer contributions are deductible from the employer's income and employee contributions are not taxed until a distribution is made to the employee. In addition, investments in the retirement plan grow tax-free. Click on this link to compare various types of retirement plans an employer may offer.
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 pay dividends in 2011.
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.