2011 Year End Tax Planning

Dear Clients and Friends,

As we get close to the end of the year, we wanted to provide to our clients a few possible strategies and some reminders on the current tax laws. The government has provided a variety of tax incentives to help weather the economic storm, and you are urged to take advantage of these special tax benefits as well as other strategies to keep your tax bite as low as possible.

• State & Local Estimated Tax Payments - Although the deadline to make the current year 4th quarter state and local estimated tax payments are January 15 of the next year for the most part, the payment will count as a tax deduction on the federal Schedule A for the current year if that payment is made before the end of December. A trap for the unwary, be aware of the AMT (Alternative Minimum Tax) position before finalizing this final 2011 tax payment.
• Required Minimum Distributions (RMDs) from Retirement Plans - If you are in a low or zero tax bracket this year, it may be to your benefit to take a withdrawal more than the minimum. RMDs generally apply to individuals age 70 ½ and older, but even younger retirees who are not yet required to take a distribution may find this strategy beneficial. If you receive Social Security benefits, IRA distributions can sometimes be planned to minimize the taxability of the Social Security income.
  • You may contribute up to $100,000 of IRA assets directly to one or more qualified charities (but not to a donor-advised fund) the assets must be transferred directly to the group by the IRA trustee. There is no deduction but the gift will be excluded from income, so it doesn’t swell income in a way that raises taxes on Social Security or Medicare premiums. The gift can count as part or all of the required minimum distribution.
• Tax Credit for First Four Years of College - The American Opportunity Credit (AOC) takes the place of the Hope education credit and provides a credit for tuition and certain other expenses of the first four years of college (Hope only applied to the first two years). So even if you used the Hope credit in prior years you may still qualify for the AOC. The credit is 100% of the first $2,000 of qualified expenses and 25% of the next $2,000. 40% of the credit is refundable which means that taxpayers with little or no tax liability can still benefit from the credit. This credit does begin to phase-out for single taxpayers with AGI above $80,000 ($160,000 for joint filers) and no credit is allowed for taxpayers filing married separate.
  • Important - The AOC is only applicable to tax years 2009 through 2012. Without Congressional action, 2012 is the final year for this more lucrative education credit.
• Energy-Efficient Home Improvements - Homeowners who have or will make certain energy-efficient improvements to their existing homes may qualify for energy credits up to 10% of the cost (credit limited to a lifetime maximum of $500 taking into account credit claimed in prior years). This credit applies to the following qualified energy efficient improvements: exterior windows and skylights, exterior doors, metal and asphalt roofs, heating systems, air-conditioning systems and insulation. With many contractors without work this could be an opportune time to negotiate reasonable prices and make those home modifications, but the work must be completed before year-end if you want the credit. Without Congressional action, this credit expires at the end of 2011.
• Roth IRA Conversions - If your taxable income is low or a negative amount for the year, it may be appropriate to convert some or all of your taxable traditional IRA to a Roth IRA for little or no tax cost. Taxpayers are able to convert funds in regular IRAs (as well as qualified retirement plans) to Roth IRAs regardless of their income level.
• Review Estimated Tax Payments and Withholding - Ensure they are sufficient to meet the "safe-harbor" payment amounts so as to avoid underpayment penalties. Please contact us if you would like us to look at this for you.
• IRA and Self-Employed Retirement Plan Contributions – The primary purpose of these plans is to provide for your future retirement and whenever you are eligible and financially able, you should always contribute as much as possible. Contributions also provide a tax deduction when they are made to Self-employed plans and to most traditional IRAs. The benefit derived from this tax deduction is based upon your tax bracket. (Some contributions to traditional IRAs may not be deductible if you also participate in another retirement plan, depending on your income level.) Those individuals who simply prefer the Roth option, but are barred from making Roth contributions because their income exceeds the AGI phase out limitations, might consider making a non-deductible traditional IRA contribution and then converting it to a Roth IRA since as of 2010 there are no income limitations on conversions.
• Establish a Retirement Plan – If you do not already have a retirement plan and you are considering one, there are several options. Some, such as Keogh or 401(k) plans, must be set up before the year’s end.
• Established Retirement Plans – Consider paying you and your spouse bonus amounts by the end of the year to maximize your 2011 elective deferral amounts through a 401(k) plan in effect. The maximum amount permitted to defer for those participants/taxpayers under the age of 50 is $16,500. For those over 50 years of age the total amount is $22,000 (a catch-up provision is allowed for another $5,500).
• Capital Loss Carryovers – If you have carryover capital losses remember you can only claim a maximum $3,000 net capital loss on your return and the remainder carries over to the subsequent year. However, you may have some gains you can take to offset the carryover. (If you sell at a gain but wish to repurchase stock in the same company, note that the wash sale rules don’t apply—they only apply to losses— so you will not need to wait 30 days to make the repurchase.) For long-term planning, it is important to keep in mind that the current lower capital gains rates of 0% and 15% are only available through 2012. After that, without Congressional intervention, the rates return to the pre-2003 levels of 10% and 20%.
• Fine Tuning Capital Gains and Losses - Year-end has historically been a good time to plan tax savings by carefully structuring capital gains and losses. Conventional wisdom has always been to minimize gains by selling "losers" to offset gains from "winners," and where possible, generate the maximum allowable $3,000 capital loss for the year.
  
  Long-term capital losses offset long-term capital gains before they offset short-term capital gains. Similarly, short-term capital losses offset short-term capital gains before they offset long-term capital gains. ("Long-term" means that the stock or property has been held over one year.) Keep in mind that taxpayers may use up to $3,000 of total capital losses in excess of total capital gains as a deduction against ordinary income in computing adjusted gross income or AGI. Individuals are subject to federal income tax at a rate as high as 35% on short-term capital gains and ordinary income. But long-term capital gains are generally taxed at a maximum rate of 15%.
  
  All of this means that having long-term capital losses offset long-term capital gains should be avoided where possible, since those losses will be more valuable if they are used to offset short-term capital gains or ordinary income. Avoiding this requires making sure that the long-term capital losses are not taken in the same year as the long-term capital gains. However, this is not just a tax issue; investment factors also need to be considered. It would not be wise to defer recognizing gain until the following year if there is too much risk that the property’s value will decline before it can be sold. Similarly, one wouldn't want to risk increasing a loss on property that is expected to continue declining in value by deferring its sale until the following year. The first $69,000 of Long Term Capital Gain on a married filing jointly filing basis ($34,500 for singles) can be tax free if you plan it correctly for 2011
• Non-Cash Charitable Donations – If you itemize your deductions and your garage and closets contain never-used items, you might consider donating those items to charity before year-end to increase your deductions. To claim a deduction for donated clothing and household goods, they must be in good condition or better, and the donations must be substantiated by a written receipt that includes the name of the charity, dates and location of the donation and a reasonably detailed description of the property donated. A receipt is not required where the value is less than $250 and it is impractical to obtain one (for example, when items are left at an unattended drop site). If, instead, you decide to sell some of the property, the income is generally tax free provided you sell each item for less than your cost or basis in the property.
• Deduct IRA Losses – If a traditional IRA account that includes non-deductible contributions declines in value and the value of all of your IRA accounts combined is less than the sum of your non-deductible contributions, you can take a loss by withdrawing from (closing) all your IRA accounts. However, this loss is beneficial only if you itemize your deductions and the loss, along with your other miscellaneous deductions, exceeds 2% of your income (AGI) for the year.
• Business Owners – Consider paying your dependent children through payroll of your business. This income will be tax-free up to the standard deduction amount of $5,850. Any amounts paid above the standard deduction will be taxed at the 10% rate bracket, which should still be below that of parent’s effective tax rate bracket.
  
  Consider deferring some business income on a cash basis of accounting into 2012 and paying down any year end payables by December 31st to reduce this year’s income as much as possible.
  
  The foregoing are frequently encountered tax strategies that can be employed by most, but by no means all, taxpayers. Please call this office if have questions regarding these issue or others or would like to engage in some year-end tax planning. If you have a substantial increase or decrease in income this year it may be wise to schedule an appointment before the holidays to strategize.
• Raising Marginal Tax Rates – At least through 2012, we are assured of retaining the lower individual tax rates which are currently 10, 15, 25, 28, 33 and 35 percent. These rates apply to "ordinary" income. Without Congressional intervention, the rates are scheduled to return to their original levels of 15, 28, 31, 36 and 39.6 percent, beginning in 2013.

It may be in your best interest to review you current year tax strategy with an eye to the future to maximize your benefits from gains or losses associated with capital assets. Please call us if you should have any questions.

Warfield and Company CPAs, Ltd.