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 these events will affect important tax issues for 2010 and 2011.
Specifically, the “lame-duck” Congress 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. Congress 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 cuts 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 how the lame-duck Congress answers the major tax questions of the day. Not all actions will apply in your particular situation, but you may be able to benefit from many of them.
Year End Moves for Individuals
Roth IRA Conversion: 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.
RMD: 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. Additionally, if you think your tax rate will increase in 2011, you may prefer to pay tax on the RMD in 2010 at your current, lower rate.
Retirement Plan Funding: To qualify for a deduction in 2010, most retirement plans must be established before December 31. The exceptions are Individual Retirement Accounts (IRAs) and a Simplified Employee Pension (SEP) which can be created and funded by April 15, 2011 in the case of IRAs and the extended due date of your return in the case of a SEP.
Stock Losses: Realize losses on stocks 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. Or, if you think capital gains tax rates will increase next year, you may want to realize gains before year-end. Unlike with losses, you may immediately repurchase securities that you have sold for a gain without negating the gain recognition for tax purposes.
Flexible Spending Accounts: 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 (2010 is the last year that FSAs can be used for nonprescription drugs).
Income Tax Withholding: 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 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. Please contact Kristen Colston at email@example.com if you need further information.
Energy Tax Credits: Make energy saving improvements to your main U.S. home, such as putting in extra insulation or installing energy saving windows 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 tax break stays on the books through 2016).
Gifts: 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 would like more information on any of the above tax-saving moves, or if you would like to schedule a year-end tax planning meeting, please contact Grant Miller at firstname.lastname@example.org.
This newsletter is for informational purposes only. It should not be constituted as tax, legal, or investment advice. Information has been gathered from sources believed to be reliable, but individual situations can vary and you should consult with your investment, accounting and/or tax professional.
ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE WOLF GROUP TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.