Year-End Tax Planning

As mentioned above, year-end tax planning is especially difficult this year because of the uncertainty over whether/how Congress will enact sweeping tax reform that could have a major impact in 2012 and beyond.  And even if there's no major tax legislation in the immediate future, Congress next year will still have to grapple with a host of sticky issues, such as whether to once again "patch" the AMT, and what to do about the post-2012 expiration of the "Bush-era" tax cuts - which includes the current tax rate schedules, the low tax rates on long-term capital gains and qualified dividends), and the expiration of favorable estate and gift tax rules.

Here are some of the standard planning ideas to consider before year-end:

•  if you're trying to increase your charitable contributions and are thinking of selling appreciated stock to do so, keep your cash and consider donating the stock instead - you'll avoid paying tax on the capital gains and will get a deduction on the stock's full value
• if you're age 70 1/2 or older, this may be the last chance to arrange for a transfer of up to $100k of otherwise taxable IRA money to go directly to a charity.  This must be a DIRECT transfer from your IRA to the charity!  This keeps the distribution/contribution out of your AGI, thus potentially qualifying you for other tax deductions/credits that are based on AGI limits
• investments - many of us have been hit hard by the stock market, so keep in mind that you can sell some losers to help offset any gains you've recognized this year and then deduct an extra $3k of losses; however, we may want to consider selling some winners, too, depending on what we think Washington may do with long-term capital gains rates over the next couple of years, thus locking in these gains at a 15% tax rate rather than a potentially higher rate of 20%+
• if you believe you are going to owe a good chunk of taxes this year, and haven't been making required estimated payments, consider having your employer bump up your income taxes withheld from your paychecks now through the end of the year.  This may help minimize associated penalties
• if you just became eligible to make contributions to an HSA (health savings account), you can still make a full year's worth of deductible contributions for 2011
• if you have a 401(k) plan at work, it's that time of year that you'll be having to tell your company how much you want to set aside for next year, so consider contributing as much as you can stand, especially if your employer makes matching contributions
• the common approach of deferring income and accelerating expenses may still be a good approach for this year and next since it seems there will not be any significant changes in tax rates before the big election next year - so consider to arrange with your employer to defer a potential bonus until next year; use your credit card to prepay some expenses
• if 2011 has been a rough year and your income will be substantially lower, consider converting your traditional IRAs to Roth IRAs - this will of course increase your AGI this year, but if this will still keep you in relatively lower tax rates than you typically are, and a Roth IRA is a better long-term retirement vehicle for you, then this may be something to consider

Energy Credits

If you are considering making some energy-efficient home improvements, please consider the following as you may want to accelerate them before year-end. 

There are basically two different tax credits allowed for energy-saving home improvements.  The credit for what I typically refer to as the "smaller ticket" items is set to expire this year, and we really don't know if it will be extended.  Further, it's not nearly as attractive as it was the past few years, but it does still allow for a credit of up to $500 (used to be $1,500).  This credit is 10% of the expenditures for the following types of improvements - exterior windows, exterior doors, and insulating costs; and 100% of the expenditures for items such as high-efficiency air conditioners, furnaces, certain hot water boilers, etc.

The "bigger ticket" items still come with a more generous credit - this credit is 30% of the qualified expenditures to buy and install more "exotic" energy-saving equipment for their residence; such as solar panels and wind energy equipment.  This credit is NOT set to expire next year and is available through 2016, so there is no need to rush.

Business vs. Hobby?

One of the most mis-understood tax topics is whether and activity in which a taxpayer is engaged is to be considered a "trade or business" or if the IRS would consider it a "hobby".  Unfortunately there are no hard-and-fast rules that we can look to for the answer, and I've commonly heard folks worried about losses impacting this determination (in and of themselves not a determining factor), but typically it comes down to the facts and circumstances involved.  No single factor is determinative; instead, a final determination is made only after considering all facts and circumstances.  Some of the factors considered include:

• the manner in which the taxpayer carries on the activity (i.e. intent for profit?)
• the expertise of the taxpayer in the field
• the time and effort expended
• the taxpayer's history in carrying on similar activities
• the elements of personal pleasure or recreation

With many folks out of work, many are turning to self-employment.  It's very important that these folks understand how the IRS views taxpayers' various activities, so if you or someone you know may be exploring this area, please have them contact us for guidance.

Hiring Your Children 

Us small business owners are always looking for ways to reduce our taxable income, especially if we are self-employed and can also reduce our self-employment taxable income, and thus SE tax.  As parents with kids, we also want to teach our kids how to work hard and how they can earn money and hopefully save some of that money.  As business owners, we have a unique opportunity to accomplish these objectives by hiring our children to some work for the business.

For sole proprietors and partnerships (LLCs included), if you hire a child that's under 18 as an employee the child's wages will be exempt from Social Security and Medicare tax and there is also no federal unemployment tax on their wages (under 21 qualifies for this exemption)!  Further, the kids can shelter up to $5,800 of their wages (for 2011) from federal income tax by using their standard deduction, and any taxable income above and beyond their deduction will probably only be taxed at 10% or 15%.  Here are the tax savings delivered:

• the owner gets a deduction for the wages paid, which reduces their overall taxable income, but also reduces their income subject to SE tax
• this reduces the owner's AGI, thus potentially helping them qualify for other tax breaks that are subject to AGI-based phaseouts
• no FICA or FUTA taxes on these wages
• children typically pay little or no taxes on these wages 

You can also accomplish similar tax savings if you operate your business as a corporation, with the exception that the wages would be subject to FICA and FUTA taxes.

However, the only catch with all of this is that the child's wages MUST be reasonable and MUST be in relation to the actual work performed.