Year-end tax planning

Year-end tax planning

The midterm elections have changed the Congressional landscape, with Republicans winning control of the House of Representatives and picking up seats in the Senate. Even so, it's still too early to know exactly how this will affect open tax issues for 2010 and 2011.

Specifically, when the “lame-duck” Congress returns this month, it must decide whether to “patch” the alternative minimum tax (AMT) for 2010 (increase exemption amounts, and allow personal credits to offset the AMT), as it has done in past years. It also must decide whether to retroactively extend a number of tax provisions that expired at the end of 2009. These include, for example, 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.

In addition, Congress must decide whether to extend the Bush tax cuts for some or all taxpayers. These and other Bush-era tax rules expire at the end of this year. Without Congressional action, individuals will face higher tax rates on their income, including capital gains. Also, unless Congress changes the rules, the estate tax, which isn't in effect this year, will return next year with a 55% top rate.

In short, year-end planning—which always involves some educated guesswork—is a bigger challenge this year than in past years.

That said, we have compiled a checklist of actions that can help you save tax dollars if you act before year-end. These moves may benefit you regardless of what the lame-duck Congress does on the major tax questions of the day. Not all actions will apply in your particular situation, but you will likely benefit from many of them. We can narrow down the specific actions that you can take once we meet with you to tailor a 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.

Year-End Moves for Individuals

• 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. Don't forget that 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).

• 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, and 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.

• Increase your withholding if you are facing a penalty for underpayment of federal estimated tax. Doing so may reduce or eliminate the penalty.

• Take an eligible rollover distribution from a qualified retirement plan before the end of 2010 if you are facing a penalty for underpayment of estimated tax and the increased withholding option is unavailable or won't sufficiently address the problem. Income tax will be withheld from the distribution and will be applied toward the taxes owed for 2010. You can then timely roll over the gross amount of the distribution, as increased by the amount of withheld tax, to a traditional IRA. No part of the distribution will be includible in income for 2010, but the withheld tax will be applied pro rata over the full 2010 tax year to reduce previous underpayments of estimated tax.

• Make energy saving improvements to your main home, such as putting in extra insulation or installing energy saving windows/doors or buying and installing an energy efficient furnace, and 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 won't be around after this year. Additionally, substantial tax credits are available for installing energy generating equipment (such as solar electric panels or solar hot water heaters) to your home. This break stays on the books through 2016.

• Convert 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 (1) pay the tax on the conversion when you file your 2010 return in 2011, or (2) 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.

• Purchase qualified small business stock (QSBS) before the end of this year. There is no tax on gain from the sale of such stock if it is (1) purchased after September 27, 2010 and before January 1, 2011, and (2) held for more than five years. In addition, such sales won't cause AMT preference problems. To qualify for these breaks, the stock must be issued by a regular (C) corporation with total gross assets of $50 million or less, and a number of other technical requirements must be met. Our office can fill you in on the details.

• Take required minimum distributions (RMDs) from your IRA or 401(k) plan (or other employer-sponsored retired plan) if you have reached age 70 1/2. Failure to take a required withdrawal 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 withdrawal rules apply in full force for 2010. So, individuals age 70 1/2 or older generally must take the required distribution amount out of their retirement account before the end of 2010 to avoid the penalty. If you turned age 70 1/2 in 2010, you can delay the required distribution 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 2010 distributions to 2011—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.

• Make annual exclusion gifts before year-end to save gift tax (and estate tax if it is reinstated). You can give $13,000 in 2010 or 2011 to an unlimited number of individuals free of gift tax. However, you can't carry over unused exclusions from one year to the next. The transfers also may 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.

• If you and your spouse file jointly, by contributing to a traditional IRA each of you might be able to deduct up to $5,000 if you’re under 50 by the end of the year — if you’re older by yearend, that deduction rises to $6,000. But please consult us to see if you qualify for those limits based on your other retirement investments and income levels. Some employer qualified plans may also allow large employee contributions prior to year’s end—if you can afford to make one, check with your plan administrator.

• If you have stock with a large unrealized capital gain that you’ve held longer than a year, you can give that stock to a qualified charity and claim a deduction for the current fair market value of the security. The deduction is limited however to 30% of adjusted gross income.  Any amounts over this can be carried forward 5 years.

If you have a stock with an unrealized capital loss, you can do the opposite – sell the stock, claim the capital loss, then donate the resulting cash proceeds to charity. This is actually better than just donating cash, because you get the same deduction and never have to pay the capital gains taxes from the appreciated security, or you can take a current deduction if you have a loss. A similar donation to a donor-advised fund can provide the same current benefit while allowing you to take your time in appointing the specific charity to ultimately receive the gift.

• No matter the amount, you need a receipt or a canceled check to back up any contribution. You can’t simply give away the old stuff in your closet and give a “like new” value for it.  If you are audited and don’t have written records to back up your claims, the IRS will disallow the write-off if the lack of proper record keeping.

• If you moved due to a change in your job or business location, you may be able to deduct certain moving expenses. There are two tests. The distance test requires that the new job be at least 50 miles farther from your old home than your old job location was from your old home.

The second is the time test, which means you must work for at least 39 weeks during the first 12 months right after you arrive in the general location of your new job. Self-employed people have to work full-time for at least 39 weeks during the first 12 months for a total 78 weeks during the first 24 months after they arrive in the qualified location.

Tax Tid-Bits

· Hybrid vehicle tax credit expires for all models.

· Guaranteed 15% maximum rate for long-term capital gains. For 2011, the top rate might go back to 20% for long-term gains. Qualified dividends lose their preferred tax rate and revert back to being taxed at ordinary income tax rates.

· Child and dependent care tax credit will be reduced starting in 2011. For 2010, the child care credit is available for the first $3,000 of day care expenses for one child and the first $6,000 of day care expenses for two children, with the maximum tax credit set at 35% of expenses. For 2011, the credit will be limited to the first $2,400 of expenses for one child and $4,800 of expenses for two children, with the maximum credit being 30% of expenses.

· Child tax credit at $1,000 per child. For 2011, the child tax credit will revert to $500 per child.

· Computer technology purchases qualify as a nontaxable distribution if paid from your 529 college savings plan but this will expire at the end of 2010.

· Earned income credit for third child ends in 2010. For 2011, the EIC will be based on at most two children.

· Student loan interest deduction is scheduled to change. Beginning in 2011, interest paid on a student loan will be deductible only for the first 60 months of repayment, and the phase out range will start at $40,000 (or $60,000 for married couples filing jointly).

· American Opportunity tax credit for undergraduate education expires at the end of 2010. It will revert back to being the Hope credit for the first two years of undergraduate education.

· Making Work Pay tax credit expires at the end of 2010.

Income Acceleration Strategies

· Ask your employer to pay out bonuses in 2010 instead of next year.

· Sell off stocks and other investments with taxable gains in 2010 instead of next year.

· Take IRA distributions in 2010 instead of 2011.

· Convert some or all of your pre-tax IRAs and 401k(k) contributions to a Roth account,         and opt to report the income in 2010.

Deduction Acceleration Strategies

· Pay tax deductible expenses in 2010 instead of 2011, such as medical bills, charity     donations and property tax.

· Sell off stocks and other investments that have lost value so you can take the losses          on your    2010 return.

· Increase your 401(k) or IRA contributions.

Deduction Deferral Strategies

· Defer paying medical bills, charity donations, property tax and other deductions until next year.

· Hold off on selling losing investments until 2011 when presumably the capital gains    tax rate will be higher, and thus losses will have more tax value.

Year-End Moves for Business Owners

• Put new business equipment and machinery in service before year-end to qualify for the 50% bonus first-year depreciation allowance. Unless Congress acts, this bonus depreciation allowance generally won't be available for property placed in service after 2010. (Certain specialized assets may, however, be placed in service in 2011.)

• Make expenses qualifying for the $500,000 business property expensing option. The maximum amount you can expense for a tax year beginning in 2010 is $500,000 of the cost of qualifying property placed in service for that tax year. The $500,000 amount is reduced by the amount by which the cost of qualifying property placed in service during 2010 exceeds $2 million. Also, 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). Note that at tax return time, you can choose not to use expensing (or bonus depreciation) for 2010 assets. This is something to consider if tax rates go up for 2011 and future years, and you'd rather have more deductions after 2010 than for 2010.

• Set up a self-employed retirement plan if you are self-employed and haven't done so yet.

• Increase your basis in a partnership or S corporation if doing so will enable you to deduct a loss from it for this year. A partner's share of partnership losses is deductible only to the extent of his partnership basis as of the end of the partnership year in which the loss occurs. An S corporation shareholder can deduct his pro-rata share of an S corporation's losses only to the extent of the total of his basis in (a) his S corporation stock, and (b) debt owed to him by the S corporation.

• Consider whether to defer cancellation of debt (COD) income from the reacquisition of an applicable debt instrument in 2010. The business can elect to have the COD income included in gross income ratably over five tax years beginning with the fourth tax year following the tax year in which the repurchase occurs (i.e., beginning with 2014).

• Every year, businesses can take advantage of a traditional planning technique that involves alternatively deferring income and accelerating deductions. However, business taxpayers such as passthrough entities (limited liability companies, partnerships, S corporations, sole proprietorships) should consider accelerating business income into the current year and deferring deductions until 2011 (and perhaps beyond) in light of the scheduled 2011 tax rate increases (the top two income tax brackets are set to rise from 33 and 35 percent to 36 and 39.6 percent respectively). Since pass-through entities generally pay tax at the individual income tax rate level, and those levels are expected to rise, this may be a significant factor affecting this year’s planning.

For example, limited liability companies, partnerships, and S corporations can avoid or minimize the impact of the scheduled 2011 rate increases by accelerating certain business transactions and thus income into 2010 (and deferring deductions until next year). For instance, if your business is planning to sell certain property, you may want to close the sale in 2010 to avoid the higher 2011 rates. Not only are the ordinary income tax rates scheduled to rise, but too are the capital gains rates. Thus, this strategy can generally help regardless of the type of income generated since rates in both categories are going to rise next year.

The strategy of accelerating income and deferring deductions may apply to a number of transactions affecting your business, including leasing, inventory, compensation and bonus practices, depreciation and expensing. Pass-through entities need to be particularly sensitive to the scheduled 2011 income tax rate increases and therefore plan accordingly.

Cash basis businesses that expect to be in the same or a higher tax bracket in 2011 should consider moves to shift income into 2010 by accelerating cash collections this year, and deferring deductions until next year. Thus, delay payment of certain expenses until next year, where possible, since deductions are allowed when the expenses are actually paid. If you have outstanding accounts receivable, collect on those payments due to your business in 2010.

Accrual method businesses that anticipate being in higher rate brackets next year may want to accelerate the shipment of products or provision of services into 2010 so that your business’s right to the income arises this year.

• Employers that hire certain unemployed individuals after February 3, 2010, and before January 1, 2011 may qualify for a 6.2-percent payroll tax incentive. The incentive exempts businesses from paying the employer’s share of Social Security taxes on wages paid to qualified new hires after March 18, 2010 and before January 1, 2011. Some employers mistakenly believe that they cannot claim the incentive unless they had previously laid off employees. This is incorrect. The payroll tax exemption can apply to wages paid to any qualified employee.

Not every new hire may qualify for the incentive. Generally, a qualified employee is an individual who was unemployed or who was employed but worked 40 hours or less during the 60-day period ending on the date of new employment. The individual also must not have been hired to replace another employee of that employer, unless the other employee separated from employment voluntarily or was terminated for cause. Certain family members of the employer or employees who are related in other ways to the employer are not qualified employees for purposes of the payroll tax exemption.

• Related to the payroll tax exemption is a new but temporary worker retention credit. An eligible employer may claim the credit for each new hire who meets certain retention requirements. A retained worker is a qualified employee (as defined for purposes of the payroll tax exemption) who remains an employee for at least 52 consecutive weeks, and whose wages (as defined for income tax withholding purposes) for the last 26 weeks equal at least 80 percent of the wages for the first 26 weeks. The amount of the credit is the lesser of $1,000 or 6.2 percent of wages (as defined for income tax withholding purposes) paid by the employer to the retained worker during the 52 consecutive week period. The credit may be claimed for a retained worker for the first taxable year ending after March 18, 2010 for which the retained worker satisfies the 52 consecutive week requirement.

• Often overlooked is the Code Sec. 199 domestic production activities deduction. The deduction is targeted to U.S. taxpayers engaged in manufacturing activities. The definition of manufacturing is broad for purposes of the deduction but its under-utilization may be due to the complexity surrounding the deduction. Generally, the maximum Code Sec. 199 deduction is equal to a percentage of the lesser of either the taxpayer’s qualified production activities income (QPAI) or taxable income. The maximum deduction for 2010 is, for most taxpayers, nine percent. The deduction is, however, limited to 50 percent of the W-2 wages actually paid to employees and reported by the employer. Additionally, certain businesses, such as oil producers, must reduce their Code Sec. 199 deduction.

• Small employers offering qualified health insurance coverage to their employees may be eligible for a new tax credit. The Code Sec. 45R credit is generally available to small employers that pay at least half the cost of qualified coverage. For the 2010 tax year, the maximum credit is 35 percent of premiums paid by eligible employers (nonprofit employers may be eligible for a reduced credit of 25 percent). The maximum credit goes to employers with 10 or fewer full-time equivalent (FTE) employees paying average annual wages of $25,000 or less. The credit is completely phased out for employers with more than 25 FTEs or with average annual wages of more than $50,000.

The Code Sec. 45R credit has many restrictions. For example, many small businesses may employ family members of the owner(s). Certain family members are excluded from the definition of employee for purposes of the Code Sec. 45R credit. A sole proprietor, a partner in a partnership, a shareholder owning more than two percent of an S corporation, and any owner of more than five percent of other businesses also are not considered employees for purposes of the credit.

• The 2010 Small Business Act made some taxpayer-friendly changes to the Code Sec. 38 general business credit. The eligible small business credits of an eligible small business (ESB) determined in the first tax year of the business that begins in 2010 may be carried back five years and forward for 20 years. An ESB is a corporation the stock of which is not publicly traded; a partnership; or a sole proprietorship (Code Sec. 38(c)(5)(C), as added by the 2010 Jobs Act). Additionally, the ESB must have average annual gross receipts for the three-tax-year period before the tax year of $50 million or less. The provision is intended to encourage ESBs to accelerate their business expenditures to 2010.

• A variety of tax incentives are available to encourage businesses to invest in energy conservation, energy efficiency and the production of alternative energy. Taxpayers generally have through December 31, 2013 to place in service biomass, marine and other types of renewable energy property to claim the renewable energy production tax credit (although the placed in service date for wind facilities is through December 31, 2012). Additionally, taxpayers that place in service qualified renewable energy property may elect to claim the investment tax credit in lieu of the production tax credit. Taxpayers may also be eligible to apply for a grant instead of claiming the investment tax credit or the renewable energy production tax credit for property placed in service in 2010.

• New businesses can take advantage of the increased deduction for start-up expenditures. For 2010, the start-up expense deduction limit has been raised from $5,000 to $10,000. The phase out threshold is also increased to $60,000 (up from $50,000). Thus, if you have incurred during 2010 costs relating to the creation of an active trade or business, or the investigation of the creation or acquisition of an active trade or business, you may be able to benefit from this increased deduction. Entrepreneurs can recover more small business start-up expenses up-front, thereby increasing cash flow and providing other benefits.

• Uncertain Tax Positions: Starting with the 2010 tax year, new Schedule UTP, Uncertain Tax Position Statement, will require certain corporate taxpayers to disclose their uncertain tax positions (UTPs) annually.  A corporation will need to file Schedule UTP with its income tax return if it: (1) files Form 1120, Form 1120-F, Form 1120-L or 1120-PC; (2) has asset of at least $100 million; (3) issued (or a related party issued) audited financial statements reporting all or a portion of the corporation’s operations for all or a portion of the corporation’s tax year, and (4) has one or more UTPs.  A UTP is a tax position that will result in an adjustment to a line item on a return if the position is not sustained, provided the corporation has taken the position for the current or a prior tax year and the corporation (or a related party) either recorded a reserve for the position or did not record a reserve because it expects to litigate the position.

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.