Year-End Tax Planning for Individuals

November 2009

Year-End Tax Planning for Individuals

While the federal income tax environment is relatively favorable, that condition is not likely to continue much longer, and now is the time to take advantage of certain tax breaks before they disappear

Congress Modifies, Extends Homebuyer Credit

The Worker, Homeownership and Business Assistance Act of 2009, signed into law November 5, extended and modified the IRC § 36 homebuyer credit.

The credit – $8,000 or 10% of the purchase price, whichever is less – is extended to May 1, 2010, and is modified so that taxpayers who have entered into a binding contract to purchase an eligible principal residence by May 1 must close before July 1, 2010.

In another major change, the credit is no longer limited to first-time homebuyers. Taxpayers who have owned and lived in their former home for any five consecutive years within the preceding eight years will be treated for purposes of the credit as first-time homebuyers. (However, instead of receiving the full $8,000 credit, such long-term residents will be eligible for a credit of only $6,500 or 10% of the purchase price, whichever is less). This credit applies only to purchases that close after November 6 and that otherwise meet the deadlines mentioned above.

The credit has a phaseout range of $225,000-$245,000 ($125,000-$145,000 for single filers).

For purchases made after November 6, 2009, no credit is allowed if:

the home's purchase price exceeds $800,000,
the homebuyer (or his or her spouse) is related to the seller,
the homebuyer is under age 18 on the purchase date (unless his or her spouse is 18 or over), or
The homebuyer is a dependent of another taxpayer.

For a purchase that closes in 2009, the home buyer can claim the credit on either his 2008 or 2009 federal tax return; on 2010 closings, the credit can be taken on the 2009 or 2010 return.

As we approach year-end, it’s again time to focus on eleventh-hour moves you can make to save taxes – both on your 2009 return and in future years.

While the federal income tax environment is relatively favorable, that condition is not likely to continue much longer, and now is the time to take advantage of certain tax saving opportunities before they disappear.

Unusual Times. The goal of year-end tax planning is to identify strategies that will allow you to pay the lowest overall tax. Under normal circumstances, one means of accomplishing that is to (a) postpone when taxable income must be reported and (b) accelerate the time when expenses can be claimed as deductions. For many taxpayers, that is still a solid strategy. However, if your income puts you in the higher tax brackets, and if you believe that income tax rates are likely to climb in future years, one could envision a scenario in which you would be dollars ahead to accelerate income and pay your taxes now, at lower rates, and defer some of your deductions to a year when they will create greater savings. Do not try this at home. Extraordinary efforts to shift income and deductions can be risky business, and you should consult your Schmidt Westergard tax professional.

Regardless of the approach taken, however, it’s important to look at your tax situation for at least a two-year period, with the objective of reducing your tax liability for the two years combined rather than just for one particular year.

For this year, let’s take a look at some specific tax planning ideas that apply to the vast majority of taxpayers – that is, those in a regular tax situation.

Watch out for AMT. Individual taxpayers must compute their income taxes under two systems – the regular tax system and the AMT system – and pay the higher of the two amounts. Tax planning for AMT is often dramatically different than planning for regular tax. In fact, it’s sometimes backwards.

Many taxpayers can fall into AMT, but especially vulnerable are those who:

deduct a significant amount of state and local taxes;
claim miscellaneous itemized deductions (such as unreimbursed employee business expenses);
claim multiple dependents; or
recognize a large capital gain or exercise incentive stock options during the year.

If AMT might be an issue, please contact your Schmidt Westergard tax professional.

Ideas for Increasing Deductions

One way to reduce your 2009 tax liability is to look for additional deductions. Here’s a list of suggestions to get you started:

Make Charitable Gifts of Appreciated Stock. If you own appreciated stock that you’ve held more than a year and you plan to make significant charitable contributions before year-end, keep your cash and donate the stock (or mutual fund shares) instead. You’ll avoid paying tax on the appreciation and still be able to deduct the donated property’s full value. If you want to maintain a position in the donated securities, you can immediately buy back a like number of shares. (This idea works especially well with no-load mutual funds because there are no transaction fees involved.)

However, if the stock is now worth less than when you acquired it, sell the stock, take the loss, and then give the cash to the charity. If you give the stock to the charity, your charitable deduction will equal the stock’s current depressed value, and no capital loss will be available. Also, if you sell the stock at a loss, you can’t immediately buy it back, as this will trigger the “wash sale” rules. That means your loss won’t be deductible; rather, it will be added to the basis in the new shares.

Maximize the Benefit of the Standard Deduction. For 2009, the standard deduction is $11,400 for married taxpayers filing joint returns. For single taxpayers, the amount is $5,700. Currently, it looks like these amounts will be about the same for 2010. If your total itemized deductions are normally close to these amounts, you may be able to leverage the benefit of your deductions by bunching deductions in every other year. This allows you to time your itemized deductions so that they are high in one year and low in the next. You claim actual expenses in the year they are bunched and take the standard deduction in the intervening years.

For instance, you might consider accelerating, to the end of 2009, charitable donations you normally would make in early 2010. If you’re temporarily short on cash, charge the contribution to a credit card; it is deductible in the year charged, not when payment is made on the card. You can also accelerate payments of your real estate taxes or state income taxes otherwise due in early 2010. But, watch out for the AMT, as these taxes are not deductible for AMT purposes.

Bunch Deductions Subject to an Adjusted Gross Income Limit. Miscellaneous itemized deductions (such as unreimbursed employee business expenses) are deductible to the extent they exceed 2% of your Adjusted Gross Income. (Your AGI is the number at the bottom of the first page of your return.) Medical expenses are deductible only to the extent they exceed 7.5% of AGI. To lessen the effect of these AGI limitations, try to bunch your miscellaneous and medical expense deductions into every other year.

Ideas for Employees

If you have a 401(k) plan at work, tell your company how much you want to set aside on a tax-free basis for next year. Contribute as much as you can, especially if your employer makes matching contributions. You give up “free money” when you fail to maximize your participation.

Take Advantage of Flexible Spending Accounts (FSAs). If your company has an FSA, before year-end you must specify how much of your 2010 salary to convert into tax-free contributions to the plan. You can then take tax-free withdrawals next year to reimburse yourself for out-of-pocket medical and dental expenses and qualifying child care costs. Watch out, though, as FSAs are “use it or lose it” accounts; you don’t want to set aside more than your likely qualifying expenses for the year.

Adjust Your Federal Income Tax Withholding. If it looks like you are going to owe income taxes for 2009, consider bumping up the federal income taxes withheld from your paychecks now through the end of the year. When you file your return, you will still have to pay any taxes due less the amount paid in; however, as long as your total tax payments (estimated payments plus withholdings) equal at least 90% of your estimated 2009 liability or, if smaller, 100% of your 2008 liability (110% if your 2008 adjusted gross income exceeded $150,000; $75,000 for married individuals who filed separate returns), interest and penalties will be minimized, if not eliminated.

Ideas for Investments

If you are sitting on investments that have dropped in value since you acquired them, now might be a good time to dump part or all of them to cut your tax bill. You can deduct capital losses up to the amount of any capital gains that you will have for the year (for example, from mutual fund distributions or sales of stocks or bonds). Also, you can claim up to an additional $3,000 of losses ($1,500 if you are married but filing a separate return) against your other income. Any losses in excess of these amounts carry over to next year.

If you’re selling less than your entire interest in an investment, you can maximize the amount of deductible loss that you realize by telling your broker or mutual fund company to sell the highest basis shares first (and then have them confirm your instructions in writing within a reasonable time after the sale). In addition, if you think your investments that are currently underwater are poised for a comeback, you can buy them back after taking a loss, as long as you don’t reacquire them within 30 days before or after the sale.

Don’t Miss Out on the 0% Capital Gains Rate. For 2009, the federal income tax rate on long-term capital gains and qualified dividends is 0% when they fall within the 10% or 15% regular federal income tax rate brackets. This will be the case to the extent your taxable income (including long-term capital gains and qualified dividends) does not exceed $67,900 if you’re married and file jointly ($33,950 if you’re single). This 0% rate will likely continue to apply in 2010 but is scheduled for repeal in 2011.

While your income may be too high to benefit from the 0% rate, you may have children, grandchildren or other loved ones who can. Consider giving them some appreciated stock or mutual fund shares that they can sell and pay 0% tax on the resulting long-term gains. Gains will be long-term as long as your ownership period and the gift recipient’s ownership period total more than one year.

Giving away stocks that pay dividends is another tax-smart idea. As long as the gift recipient is in the 0% or 15% regular tax rate bracket, the dividends will be free of federal income tax.

Watch out, though, if during 2009 you give assets worth over $13,000 to an individual recipient. The portion that exceeds $13,000 will generally eat into your $1 million lifetime federal gift tax exemption and your $3.5 million federal estate tax exemption. However, you and your spouse can, together, give away up to $26,000 per recipient without any adverse effects on your respective gift and estate tax exemptions.

Also, if you give securities to someone under age 24, the Kiddie Tax rules could cause some of the investment income to be taxed at the parent’s higher rate instead of at the gift recipient’s lower rate. That would defeat the purpose.

Take a Deduction for Nearly Worthless Securities. If you own securities that are all but worthless with little hope of recovery, you might consider selling them before the end of the year so you can capitalize on the loss this year. You can deduct a loss on worthless securities only if you can prove the investment is completely worthless.

Total worthlessness can be very difficult to establish with certainty. To avoid the issue, it may be easier to just sell the security if it has any marketable value. As long as the sale is not to a close family member, this allows you to claim a loss for the difference between your tax basis and the proceeds, subject to the normal rules for capital losses and the wash sale rules the restrict the recognition of loss if the security is repurchased within 30 days before or after the sale.

Ideas for Your Estate

The federal estate tax exemption for 2009 is $3.5 million. For 2010, the federal estate tax is supposed to be repealed – but just for that one year. It now seems clear that if the promised repeal happens at all, it will just be for 2010. The more likely scenario is that we will continue to have a federal estate tax for 2010 and beyond, with a $3.5 million or somewhat larger exemption. Therefore, planning to avoid or minimize the federal estate tax should remain part of your financial game plan.

Make Annual Gifts to Reduce Your Estate. Whittling your estate down by making annual gifts continues to be a tax-smart strategy. If you have some favorite relatives or unrelated persons, both you and your spouse can give each of them up to $13,000 this year. These gifts will reduce your estate tax exposure without any adverse gift tax effects. Making multiple gifts over multiple years can dramatically reduce your estate tax exposure.

Capitalize on Depressed Values. The weak economy has produced estate planning opportunities like never before. Real estate values have not yet rebounded, interest rates are still very low, and the government continues to allow the discounting of minority ownership interests. This gives major opportunities to reduce estate taxes and transfer assets to family members at significantly reduced values. Both simple and complex strategies can provide substantial benefits to taxpayers who take advantage of these unique circumstances.

The current depressed security values may mean that more assets can be transferred within the limits of the gift tax annual exclusion amount ($13,000 for 2009) and the lifetime applicable exclusion amount ($1 million). Thus, if a security’s value is expected to participate in the inevitable economic recovery (and especially if the security is expected to significantly appreciate), this may be the perfect time to give the security to the intended recipients. However, do not give away loser shares (currently worth less than the purchase price or basis). Instead, sell the shares, take advantage of the resulting capital loss, and then give away the cash.

Ideas for Seniors

If you’ve reached age 70½, you can arrange to transfer up to $100,000 of otherwise taxable IRA money to the public charity of your choice (such as your church or other favorite charity). The distribution is free of federal income tax. While you can’t claim it as an itemized deduction on your Form 1040, the tax-free treatment equates to a 100% write-off, and you don’t have to itemize your deductions to get it. Additionally, since it is tax-free, it may reduce your Social Security benefits subject to tax.

Be careful, though – to qualify for this special tax break, the funds must be transferred directly from your IRA to the charity (you can’t receive cash and then donate it). Also, this provision expires at the end of 2009 unless Congress extends it, so this could be your last chance.

Environmentally Friendly Ideas

A great way to cut energy costs and save up to $1,500 in federal income taxes this year is to make energy-efficient improvements to your principal residence. Basically, if you install energy-efficient insulation, windows, doors, roofs, heat pumps, hot water heaters or advanced main air circulating fans to your home during 2009 or 2010, you may be entitled to a tax credit of 30% of the purchase price, up to a maximum credit of $1,500. For 2009, the credit is allowed against the AMT; however, unless Congress changes the rules, this will not be the case for 2010. If there is any possibility that you will be subject to AMT next year, you may want to make these improvements this year.

Conclusion

With a little effort and some careful planning, it is possible to significantly reduce your 2009 tax liability. Please contact your Schmidt Westergard tax professional with questions or ideas on minimizing your tax bill.

Based in Mesa, Arizona, and serving closely held businesses in the East Valley, the Phoenix area and throughout Arizona, Schmidt Westergard & Company, PLLC, is an independent full-service tax, audit, accounting and business advisory firm focusing on the middle market.