Year-end tax planning always makes sense, but recently enacted tax breaks and anticipated tax law changes in the near future make it especially vital this year. A host of current tax breaks won’t be around next year unless Congress acts to extend them. What’s more, recent convulsions in the markets and the economy may bring major tax changes next year as lawmakers confront the record deficit. Even if Congress takes no affirmative action to increase current tax rates in 2010, the top tax rates are scheduled to automatically increase in 2011. These tax developments and the scheduled future tax rate increases require careful analysis before implementing year-end planning strategies.
We’ve compiled a list of actions based on current tax rules that may help you save tax dollars if you act before year-end. Not all actions will apply in your particular situation, but you’ll likely benefit from many of them. You should not adopt any tax planning strategy offered in this letter without first considering its impact on your overall tax liability. Therefore, we suggest that you contact our firm before implementing any tax planning idea.
Click on the links below to expand on each strategy.
Time Your Income and Deductions
Generally, your objective is to defer income and accelerate deductions. This strategy may enable you to claim larger deductions, credits, and other tax breaks that are phased out over varying levels of income. If you’re self-employed and use the cash method of accounting, hold off on sending out invoices until very late in the year so that you don’t receive payment until next year. If you receive payment before year-end, deferring the deposit doesn’t defer the income. On the expenses side, wherever possible, try to accelerate deductions into this year by stocking up on supplies, paying employee bonuses, making charitable contributions, and prepaying January bills during December. Consider using a credit card to prepay expenses that can generate deductions for this year.
Save for Retirement
Contributing to a retirement plan is one of the best ways to reduce your taxable income and secure your financial future.
You can contribute up to $5,000 ($6,000 if you’re age 50 or older by year-end) to your IRA if certain conditions are met. For married couples, the combined contribution limits are $10,000 ($5,000 each) and $12,000 ($6,000 each if both are age 50 or older by year-end) when a joint return is filed provided one or both spouses had at least that much earned income. If you are an active participant in your employer’s retirement plan, your traditional IRA deduction is phased out ratably as your adjusted gross income (AGI) increases from $89,000 to $109,000 on a joint return ($55,000 to $65,000 on a single return). If your spouse is an active participant in his or her employer’s plan and you aren’t an active participant in a plan, you may contribute the full amount to a traditional IRA as long as the AGI on your joint return is $166,000 or less. The deduction for the non-active participant spouse begins to phase out when your AGI reaches $166,000 and is totally phased out once it reaches $176,000.
Every dollar you contribute to a deductible IRA reduces your allowable contribution to a nondeductible Roth IRA. Your ability to contribute to a Roth IRA is phased out ratably as your AGI increases from $166,000 to $176,000 on a joint return or from $105,000 to $120,000 on a single return.
If you are covered by your company’s 401(k) plan, you should consider putting as much of your compensation into the plan as allowable. The maximum amount is $16,500 ($22,000 if you’re age 50 or older by year-end).
If you’re self-employed, consider a small business retirement account such as a SEP IRA, SIMPLE IRA, Individual 401(k) or other qualified retirement plan. Contributing to a plan can enable you to reduce your current tax load while increasing your retirement savings. With a SEP IRA, you generally can contribute up to 20% of your net self-employment earnings, with a maximum contribution of $49,000. A SIMPLE IRA, on the other hand, allows you to set aside up to $11,500 plus an employer match. In addition, if you’re age 50 or older by year-end, you can contribute an additional $2,500 to a SIMPLE IRA. Generally, calendar-year taxpayers wishing to establish a qualified retirement plan for this year must adopt the plan by December 31. Exceptions to this general rule apply to SEP and SIMPLE plans. You have until the day you file next year, including extensions, to make this year’s employer contribution.
Contribute from Your IRA to Charities
If you’ve reached age 70 ½, you may have your IRA trustee contribute up to $100,000 from your IRA directly to a qualified charity and exclude the distribution from your income. Although you do not get a charitable contribution deduction, this distribution counts toward any required minimum distribution that you would otherwise be required to take during the year. Having your IRA make a charitable contribution may be beneficial if you don’t itemize your deductions or if your itemized deductions will be reduced because your income exceeds certain thresholds. You must have reached age 70 ½ before the date of the transfer. Married individuals filing jointly may each transfer up to $100,000 from each spouse’s own IRA if each has reached age 70 ½. The IRA check must be made payable directly to the charity (not to the beneficiary).
Charitable Contributions
If you are considering making a contribution to charity, it will generally save you taxes if you contribute appreciated long-term capital gain property, rather than selling the property and contributing the cash proceeds to charity. By contributing capital gain property held more than one year (e.g., appreciated stock), a deduction is generally allowed for the full value of the property, but no tax is due on the appreciation.
Sell Investments
Normally, the advice is to offset capital gains with capital losses. In other words, if you’ve sold profitable investments, find some losing investments you can sell to minimize or eliminate your capital gains tax. However, investors have significant losses in 2008 being carried over, and have additional losses in 2009. Capital losses will offset capital gains, and any excess losses are deductible up to $3,000 per year.
Perhaps we need to reverse the traditional advice and try to sell investments with gains to offset losses. One strategy might be to sell profitable investments and repurchase them immediately. This books a capital gain for tax purposes, uses up some losses, and gives you a new cost basis position in the investment. This tactic isn’t prohibited by the wash sale rule, which only applies when you sell an investment at a loss and repurchase the same investment within 30 days. If you’re selling an investment at a profit, the wash sale rule doesn’t apply.
Buy Necessary Equipment
If you’re thinking about upgrading your computer system, purchasing furniture, or buying machinery or other equipment for your business, purchasing it now will enable you to write off the costs against this year’s income. Code Section 179 permits you to “expense” or fully deduct up to $250,000 of qualified purchases. If you’re short of cash, you can finance the purchase. This deduction phases out, dollar-for-dollar, after eligible purchases reach $800,000.
Generally, sport utility vehicles (SUVs) weighing over 6,000 lbs. are entitled to a maximum first-year expensing deduction of $25,000. However, there’s no limit on the 50% bonus first-year depreciation allowance for SUVs weighing over 6,000 lbs.
Business vehicles with a gross vehicle weight of less than 6,000 lbs. are subject to certain depreciation limitations. However, if you acquire and place-in-service such a vehicle before year-end, you can receive up to an $8,000 additional first-year depreciation deduction. This deduction is scheduled to expire next year.
New Vehicle Purchases
Taxpayers who buy a new qualified motor vehicle before year-end may deduct sales or excise taxes on as much as $49,500 of the purchase price. A qualified vehicle is a new automobile with a gross vehicle weight of 8,500 lbs. or less, a new motorcycle, or a new motor home. This provision phases out between $250,000 and $260,000 of AGI for married couples and $125,000 and $135,000 for singles.
Pass-through Entity Losses
If you own an interest in a partnership or S-corporation, you may need to increase your basis in the entity so you can deduct a loss from it for this year. If you think this situation applies to you, please contact our office to discuss your specific situation since the basis and loan deduction rules are complex and beyond the scope here.
S-Corporation Health Insurance Premiums
If you’re a more than 2% S-corporation owner-employee, make sure the health insurance premiums paid for or reimbursed to you by the S-corporation are included in your W-2 in order to deduct the premiums as an “above-the-line” deduction on your personal return.
First-Time Home-Buyer Tax Credit
Congress extended and altered this benefit, making it more generous for many. The new rules took effect on November 6, 2009. The provision is a refundable tax credit up to $8,000 (not to exceed 10% of the cost of a home). The credit begins to phase out for single taxpayers with AGI of $125,000 and married couples with incomes of $225,000. It’s available for purchases through July 1, 2010 if the buyer has a contract in place before May 1, 2010.
The new law also authorizes a similar $6,500 credit for buyers who already own a home. It too is a refundable credit for 10% of the purchase price of a house costing no more than $800,000. To qualify the buyer has to have owned and lived in the same home for 5 of the 8 years preceding the new home purchase, and the new home must become the buyer’s principal residence.
Energy-Efficient Home Improvements
Make energy saving improvements to your principal residence, such as energy efficient insulation, doors, windows, roofs, and heating and cooling systems, and qualify for a 30% tax credit for qualified expenditures. The maximum total cumulative credit for 2009 and 2010 is $1,500. This credit isn’t phased out as AGI increases.
Avoid Underpayment Penalties
One way to avoid a penalty for failing to pay or withhold sufficient income taxes is to pay 100% of your prior year’s tax liability in quarterly estimated payments or through income tax withholding. If your prior year’s AGI was over $150,000, you must pay in 110% of your prior year’s tax liability to qualify for this safe harbor.
If certain conditions are met, however, you can avoid underestimated tax penalties by basing your 2009 estimated tax payments on 90% (rather than 100% or 110%) of your 2008 tax liability. To qualify: 1) you must have had AGI below $500,000 ($250,000 if married filing separately) for 2008, and 2) more than 50% of the gross income on your 2008 return must have come from a business that employed on average less than 500 employees during calendar year 2008.
Estimated tax payments can’t be “made up” at year-end. However, if you’ve not paid sufficient estimates to avoid an underpayment penalty, you may have additional amounts withheld from your wages, year-end bonuses, or retirement distributions. Any withholding is deemed paid equally on each quarterly installment date for estimated tax purposes, even if the withholding occurs in December.
Prepay Quarterly Estimated State Tax Payment
If you anticipate deducting your state income taxes and you aren’t vulnerable to the alternative minimum tax, consider paying your fourth-quarter estimated state income taxes by December 31 so you can take the deduction on this year’s return. The same idea applies to property taxes as well.
Please contact us with questions about tax saving strategies for yourself, your family, or your business. Tax laws constantly change due to new legislation, cases, regulations, and IRS rulings. Our firm closely monitors these changes and we’ll be glad to discuss any current tax developments and planning ideas with you.
Very truly yours,
Circular 230 Disclaimer: Any tax advice contained here was not intended or written to be used, and cannot be used, by the recipient for the purpose of 1) avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions, or 2) promoting, marketing, or recommending to another party any transaction or matter addressed herein.
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