As the end of the year approaches, we often suggest methods that can help lower your tax bill this year and possibly next. The process is very challenging this year. As we all are too well aware, the Bush tax cuts that were enacted in 2001 and 2003 are scheduled to expire in 2011. Such expiration would result in increased tax rates next year for virtually all taxpayers. Accordingly, the standard planning practice of deferring all taxable revenues and accelerating all deductions and credits may serve to actually increase the total income tax liabilities for the years in question.
Until as recently as the first week in December 2010, it appeared that Congress was not going to extend the Bush tax cuts prior to this year end, thus prolonging the suspense associated with the current year end tax planning. If such Bush tax cuts were not extended for a taxpayer, then the reverse of the customary tax strategies would be appropriate. We would be recommending that taxpayers accelerate taxable income and defer deductions and credits through a variety of available techniques.
Last week, however, the White House and certain Congressional leaders announced a compromise bill entitled, "Tax Relief, Unemployment Insurance Authorization and Job Creation Act of 2010," which among other things, would extend for a two-year period the Bush tax cuts for all taxpayers. The compromise bill was met with considerable opposition by certain Congresspersons, but, as we go to press with this missive, most commentators believe that the compromise bill will be enacted in substantially the proposed form. Consequently, it appears that we can proceed with year end income tax planning utilizing many of the conventional tactics that have been implemented in past years. If the compromise bill is derailed, however, these issues must be revisited.
We have compiled a checklist of actions that may help you save tax dollars if you act before year-end. Not all actions will apply in your particular situation, but you will likely benefit from many of them. Our tax attorneys can narrow down the specific actions that you can take when we meet with you to tailor your particular plan. In the meantime, please review the following list and contact us at your earliest convenience so that we can advise you on which tax-saving moves to make:
- Increase 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.
- If you become eligible to make health savings account (HSA) contributions in December of this year, you can make a full year's worth of deductible HSA contributions for 2010.
- Realize losses on stock while substantially preserving your investment position. There are several ways this can be done. For example, you can sell the original holding then buy back the same securities at least 31 days later. It may be advisable for us to meet to discuss year-end trades you should consider making.
- Subject to the foregoing caveats, postpone income until 2011 and accelerate deductions into 2010 to lower your 2010 tax bill. This strategy may enable you to claim larger deductions, credits, and other tax breaks for 2010 that for future years may be phased out over varying levels of adjusted gross income (AGI). These include IRA and Roth IRA contributions, conversions of regular IRAs to Roth IRAs, child credits, higher education tax credits, the above-the-line deduction for higher-education expenses, and deductions for student loan interest. Postponing income also is desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. Note, however, that in some cases, it may pay to actually accelerate income into 2010. For example, this may be the case where a person's marginal tax rate is much lower this year than it will be next year, or if the tax rates for next year are increased, as discussed above.
- If you believe a Roth IRA is better than a traditional IRA, and want to remain in the market for the long term, consider converting traditional IRA money invested in beaten-down stocks (or mutual funds) into Roth IRA's if eligible to do so. For 2010, even taxpayers with higher income are eligible for the Roth conversion. Keep in mind, however, that such a conversion will increase your adjusted gross income for 2010. Remember also to take your required minimum distributions from your IRA, 401(k) Plan, or other qualified plan.
- It may be advantageous to try to arrange with your employer to defer a bonus that may be coming your way until 2011.
- If you own an interest in a partnership or S corporation, you may need to increase your basis in the entity so that you can deduct a loss from it for this year.
- Consider using a credit card to prepay expenses that can generate deductions for this year.
- If you expect to owe state and local income taxes when you file your return next year, ask your employer to increase withholding of state and local taxes (or pay estimated tax payments of state and local taxes) before year-end to pull the deduction of those taxes into 2010.
- Those facing a penalty for underpayment of federal estimated tax may be able to eliminate or reduce it by increasing their withholding prior to year-end.
- Estimate the effect of any year-end planning moves on the AMT for 2010, keeping in mind that many tax breaks allowed for purposes of calculating regular taxes are disallowed for AMT purposes. This includes the deduction for state property taxes on your residence, state income taxes (or state sales tax if you elect this deduction option), miscellaneous itemized deductions, and personal exemption deductions. Other deductions, such as for medical expenses, are calculated in a more restrictive way for AMT purposes than for regular tax purposes. As a result, in some cases, deductions should be deferred rather than accelerated to keep them from being lost because of the AMT.
- Businesses should consider making expenditures that qualify for the business property expensing option (under IRC §179) for assets bought and placed in service this year, assuming the compromise bill is enacted.
- You may want to settle an insurance or damage claim in order to maximize your casualty loss deduction this year.
- If you are self-employed and have not done so yet, set up a self-employed retirement plan.
- If you are thinking of donating a used auto to charity, you may want to inquire whether the charity plans to sell the car or use it in its charitable activities, the latter may yield a bigger deduction for you.
- If you are age 70½ or older, own IRAs (or Roth IRAs), and are thinking of making a charitable gift before year-end, consider arranging for the gift to be made directly by the IRA trustee. Such a transfer can achieve important tax savings.
- Consider extending your subscriptions to professional journals, paying union or professional dues, enrolling in (and paying tuition for) job-related courses, etc., to bunch into 2010 miscellaneous itemized deductions subject to the 2%-of-AGI floor.
- Depending on your particular situation, you may also want to consider triggering a debt-cancellation event in 2010, electing to deduct investment interest against capital gains, and disposing of a passive activity to allow you to deduct suspended losses.
- If you have losses from businesses that might otherwise be suspended under the passive loss rules, consider increasing the time that you devote to such business to satisfy the minimum hourly requirements for classification as an active business, thus freeing up such loss deductions.
These are just some of the year-end steps that can be taken to save taxes. Again, by contacting us, we can tailor a particular plan that will work best for you.