Midyear 2011 Tax Planning Ideas
Thanks to the extension of the
so-called Bush tax cuts through 2012, the current federal income tax
environment remains favorable. Now is the time to take advantage because we
don’t know what tax rates will be in 2013 and beyond. While 2013 may seem a
long way out, it will be here before you know it. This article presents some
tax planning ideas to consider this summer while you have time to think. Some
of the ideas may apply to you, some to family members, and others to your
business.
Leverage Standard Deduction by
Bunching Deductible Expenditures
Are your 2011 itemized deductions
likely to wind being just under, or just over, the standard deduction amount?
If so, consider the strategy of bunching together expenditures for itemized
deduction items every other year, while claiming the standard deduction in the
intervening years. The 2011 standard deduction for married joint filers is
$11,600; the magic number for single filers is $5,800; it’s $8,500 for heads of
households.
For example, say you’re a joint
filer whose only itemized deductions are about $4,000 of annual property taxes
and about $8,000 of home mortgage interest. If you prepay your 2012 property
taxes by December 31 of this year, you could claim $16,000 of itemized
deductions on your 2011 return ($4,000 of 2011 property taxes, plus another
$4,000 for the 2012 bill, plus the $8,000 of mortgage interest). Next year, you
would only have the $8,000 of interest, but you could claim the standard
deduction (probably around $12,000). Following this strategy will cut your
taxable income by a meaningful amount over the two-year period (this year and
next). You can probably repeat the drill all over again in future years.
Examples of other deductible items
that can be bunched together every other year to lower your federal income
taxes include charitable donations and state income tax payments.
Consider Deferring Income
It may also pay to defer some
taxable income from this year into next year, especially if you expect to be in
a lower tax bracket in 2012. For example, if you’re in business for yourself
and a cash-method taxpayer, you can postpone taxable income by waiting until
late in the year to send out some client invoices. That way, you won’t receive
payment for them until early 2012. You can also postpone taxable income by
accelerating some deductible business expenditures into this year. Both moves
will defer taxable income from this year until next year. Deferring income may
also be helpful if you’re affected by unfavorable phase-out rules that reduce
or eliminate various tax breaks (child tax credit, education tax credits, and
so forth). By deferring income every other year, you may be able to take more
advantage of these breaks every other year.
Note: For
higher-income taxpayers, it may not be advisable to repeat the income deferral
drill in 2012 because pushing income from 2012 into 2013 could expose them to
higher marginal tax rates in 2013. For
2013, the top two federal income tax rates will increase to 36% and
39.6% (up from the current 33% and 35%) unless Congress takes action.
Take
Advantage of 0% Rate on Investment Income
For 2011, 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 $69,000 if you are married and file
jointly ($34,500 if you are single). While your income may be too high to
benefit from the 0% rate, you may have children, grandchildren, or other loved
ones who will be in one of the bottom two brackets. If so, consider giving them
some appreciated stock or mutual fund shares that they can then sell and pay 0%
tax on the resulting long-term gains. Gains will be long-term, as long as your
ownership period plus the gift recipient’s ownership period (before he or she
sells) equals at least a year and a day.
Giving away stocks that pay dividends is another tax-smart idea.
As long as the dividends fall within the gift recipient’s 10% or 15% rate
bracket, they will be federal-income-tax-free. The 0% rate is scheduled to be
available through 2012, but things could change after that depending on how the
2012 elections turn out and other factors. So, consider doing what you need to
do to take advantage of the 0% rate for this year and next year. In 2013, it
could be history.
Warning No. 1: If you
give securities to someone who is under age 24, the Kiddie Tax rules could potentially
cause some of the resulting capital gains and dividends to be taxed at the
parent’s higher rates instead of at the gift recipient’s lower rates. That
would defeat the purpose. Please contact us if you have questions about the
Kiddie Tax.
Warning No. 2: Be aware
that if you give away assets worth over $13,000 during 2011 to an individual
gift recipient, it will generally eat into your $5 million unified federal gift
and estate tax exemption. However, you and your spouse can together give away
up to $26,000 without any adverse effects on your respective exemptions.
Time Investment Gains and Losses and Consider Being Bold
about It
As you evaluate investments held in your taxable brokerage
firm accounts, consider the impact of selling appreciated securities this year.
The maximum federal income tax rate on long-term capital gains realized from
2011 sales of securities held over a year is only 15%. Therefore, it often
makes sense to hold appreciated securities for at least a year and a day before
selling.
Biting the bullet and selling some loser securities
(currently worth less than you paid for them) before year-end can also be a
good idea. The resulting capital losses will offset capital gains from other
sales this year, including short-term gains from securities owned for one year
or less, which would otherwise be taxed at higher ordinary income rates. You
may have significant short-term gains if you bought into the stock market
before this year’s uptick. The bottom line is that you don’t have to worry about
paying a higher tax rate on short-term gains if you have enough capital losses
to shelter those short-term gains.
If capital losses for this year exceed capital gains, you
will have a net capital loss for 2011. You can use that net capital loss to
shelter up to $3,000 of this year’s high-taxed ordinary income from salaries,
bonuses, self-employment, and so forth ($1,500 if you’re married and file
separately). Any excess net capital loss is carried forward to next year.
Important Point: Selling
enough loser securities to create a bigger net capital loss that exceeds what
you can use this year might make sense. You can carry forward the excess net
capital loss to 2012 and beyond and use it to shelter both short-term gains and
long-term gains recognized in those years. That will give you extra investing
flexibility in 2012 and beyond because you won’t have to hold appreciated
securities for over a year to get better tax results. Remember: the maximum
federal income tax rate on long-term capital gains is scheduled to increase to
20% for 2013 and beyond (up from the current 15%). Also, the top two federal
rates on ordinary income (including net short-term capital gains) are scheduled
to increase for 2013 and beyond to 36% and 39.6% (up from the current 33% and
35%). Contact us if you want help in identifying the best tax-smart options in
a world where future tax rates are uncertain.
For the Charitably Inclined: Sell Loser Shares and Give Away
Cash; Give Away Winner Shares
Say you want to make some gifts to favorite relatives (who
may be hurting financially) and/or favorite charities. You can make gifts in
conjunction with an overall revamping of your holdings of stocks and equity
mutual fund shares held in taxable brokerage firm accounts. Here’s how to get
the best tax results from your generosity.
Gifts to Relatives. Do not give away loser shares (currently
worth less than what you paid for them). Instead sell the shares, and take
advantage of the resulting capital loss. Then, give the cash sales proceeds to
the relative. Do give away winner
shares to relatives. Most likely, they will pay lower tax rates than you would
pay if you sold the same shares. In fact, relatives who are in the 10% or 15%
federal income tax brackets will generally pay a 0% federal tax rate on
long-term gains from shares that were held for over a year before being sold.
(For purposes of meeting the more-than-one-year rule for gifted shares, you get
to count your ownership period plus the recipient relative’s ownership period,
however brief.) Even if the shares are held for one year or less before being
sold, your relative will probably pay a lower tax rate than you would
(typically only 10% or 15%). However, beware of one thing before employing this
give-away-winner-shares strategy. Gains recognized by a relative who is under
age 24 may be taxed at his or her parent’s higher rates under the so-called
Kiddie Tax rules (contact us if you are concerned about this issue).
Gifts to Charities. The
strategies for gifts to relatives work equally well for gifts to IRS-approved
charities. So, sell loser shares and claim the resulting tax-saving capital
loss on your return. Then, give the cash sales proceeds to the charity and
claim the resulting charitable write-off (assuming you itemize deductions).
This strategy results in a double tax benefit (tax-saving capital loss plus
tax-saving charitable contribution deduction). With winner shares, give them
away to charity instead of giving cash. Here’s why. For publicly traded shares
that you’ve owned over a year, your charitable deduction equals the full
current market value at the time of the gift. Plus, when you give winner shares
away, you walk away from the related capital gains tax. So, this idea is
another double tax-saver (you avoid capital gains tax on the winner shares, and
you get a tax-saving charitable contribution write-off). Because the charitable
organization is tax-exempt, it can sell your donated shares without owing
anything to the IRS.
Convert Traditional IRA into Roth IRA
Here’s the best scenario for this idea: Your traditional IRA
is (or was) loaded with equities and took a major beating during the 2008 stock
market meltdown. So, your account is still worth less than it once was.
Correspondingly, the tax hit from converting your traditional IRA into a Roth
IRA right now would also be less than it would have been at the market peak.
Why? Because a Roth conversion is treated as a taxable liquidation of your
traditional IRA followed by a nondeductible contribution to the new Roth IRA.
While even the reduced tax hit from converting is unwelcome, it may be a small
price to pay for future tax savings. After the conversion, all the income and
gains that accumulate in your Roth IRA, and all withdrawals, will be totally
free of any federal income taxes—assuming you meet the tax-free withdrawal
rules. In contrast, future withdrawals from a traditional IRA could be hit with
tax rates that are higher than today’s rates.
Of course conversion is not a no-brainer. You have to be
satisfied that paying the up-front conversion tax bill makes sense in your
circumstances. In particular, converting a big account all at once could push
you into higher 2011 tax brackets, which would not be good. You must also make
assumptions about future tax rates, how long you will leave the account
untouched, the rate of return earned on your Roth IRA investments, and so
forth. If the Roth conversion idea intrigues you, please contact us for a full
analysis of the relevant variables.
Make
Charitable Donations from Your IRA
IRA owners and beneficiaries who have reached age 70½ are
permitted to make cash donations totaling up to $100,000 to IRS-approved public
charities directly out of their IRAs. These so-called Qualified Charitable Distributions, or QCDs, are
federal-income-tax-free to you, but you get no itemized charitable write-off on
your Form 1040. That’s okay, because the tax-free treatment of QCDs equates to
an immediate 100% federal income tax deduction without having to worry about
restrictions that can delay itemized charitable write-offs. QCDs have other tax
advantages too. Contact us if you want to hear about them. If you’re interested
in taking advantage of the QCD strategy for 2011, you will need to arrange with
your IRA trustee for money to be paid out to one or more qualifying charities
before year-end.
Note: The QCD
privilege will expire at the end of this year unless Congress extends it.
Watch out for Alternative Minimum Tax
While many recent tax-law changes have been helpful in
reducing your regular federal income tax bill, they didn’t do much to reduce
the odds that you’ll owe the dreaded Alternative Minimum Tax (AMT). Therefore,
it’s critical to evaluate all tax planning strategies in light of the AMT rules
before actually making any moves. Because the AMT rules are complicated, you
may want our assistance. We stand ready to help!
Claim the Health Insurance Tax
Credit for Small Employers
Qualifying small
employers can claim a tax credit that can potentially cover up to 35% of the
cost of providing health insurance coverage to employees. A qualifying small employer
is one that: (1) has no more than 25 full-time-equivalent (FTE) workers, (2)
pays an average FTE wage of less than $50,000 and (3) has a qualifying
healthcare arrangement in place. The allowable credit is quickly reduced under
a complicated phase-out rule when the employer has more than 10 FTE employees
or an average FTE wage in excess of $25,000. Please contact us if you have
questions about this break.
Take Advantage of Generous But Temporary Business Tax Breaks
Several favorable business tax provisions have a limited
shelf life that may dictate taking action between now and year-end. They
include the following.
Bigger Section 179 Deduction. Your
business may be able to take advantage of the temporarily increased Section 179
deduction. Under the Section 179 deduction privilege, an eligible business can
often claim first-year depreciation write-offs for the entire cost of new and
used equipment and software additions. For tax years beginning in 2011, the
maximum Section 179 deduction is $500,000 (same as for tax years beginning in
2010). For tax years beginning in 2012, however, the maximum deduction is
scheduled to drop back to $125,000.
Note: Watch out
if your business is already expected to have a tax loss for the year (or close)
before considering any Section 179 deduction, as you cannot claim a Section 179
write-off that would create or increase an overall business tax loss. Please
contact us if you think this might be an issue for your operation.
Section 179 Deduction for
Real Estate. Real property improvement costs are generally ineligible
for the Section 179 deduction privilege. However, an exception applies to tax
years beginning in 2011 (and 2010). Under the exception, your business can
immediately deduct up to $250,000 of qualified improvement costs for the
following types of real property under the Section 179 deduction privilege:
·
Interiors
of leased nonresidential buildings.
·
Restaurant
buildings.
·
Interiors
of retail buildings.
The $250,000 Section 179 allowance for real estate
improvements is part of the overall $500,000 allowance. This temporary real
estate break will not be available for tax years beginning after 2011 unless
Congress extends it.
Note: Once
again, watch out if your business is already expected to have a tax loss for
the year (or close) before considering any Section 179 deduction. You can’t
claim a Section 179 write-off that would create or increase an overall business
tax loss.
100% First-year Bonus
Depreciation. Above and beyond the bumped-up Section 179 deduction, your
business can also claim first-year bonus depreciation equal to 100% of the cost
of most new (not used) equipment and software placed in service by December 31
of this year. For a new passenger auto or light truck that’s used for business
and is subject to the luxury auto depreciation limitations, the 100% bonus
depreciation break increases the maximum first-year depreciation deduction by
$8,000 for vehicles placed in service this year. The 100% bonus depreciation
break will expire at year-end unless Congress extends it. Contact us if you
want more details about this generous, but temporary, tax break.
Note: 100% bonus depreciation deductions can create or increase a net operating
loss (NOL) for your business’s 2011 tax year. You can then carry back a 2011
NOL to 2009 and 2010 and collect a refund of taxes paid in those years. Please
contact us for details on the interaction between asset additions and NOLs.
S Corporation Built-in
Gains Tax Break. When a C corporation converts to S corporation
status, the corporate-level built-in gains tax generally applies when built-in
gain assets (including receivables and inventories) are turned into cash or
sold within the recognition period. The recognition period is normally the
10-year period that begins on the conversion date. For tax years beginning in
2011, however, there is an exemption from the built-in gains tax if the fifth
year of the recognition period had gone by before the start of the 2011 tax
year. Therefore, making asset sales that would trigger built-in gains this year
(instead of in future years) is something to consider if those gains would be
exempt from the built-in gains tax. Please contact us if you have questions
about this issue.
100% Gain Exclusion for
Qualified Small Business Stock. Legislation enacted in 2010
created a temporary 100% gain exclusion (within limits) for sales of Qualified
Small Business Corporation (QSBC) stock that is issued in calendar-year 2011.
QSBC shares must be held for more than five years to be eligible for the 100%
gain exclusion break, so we are talking about sales that will occur well down
the road here (in 2016 and beyond). Nevertheless, there’s a short fuse on the
100% gain exclusion deal.
Don’t Overlook Estate Planning
For 2011 and 2012, the unified federal gift and estate tax
exemption is a relatively generous $5 million. However, the exemption will drop
back to only $1 million in 2013 unless Congress takes action. In addition, the
maximum federal estate tax rate for 2011 and 2012 is 35%. For 2013 and beyond,
it is scheduled to rise from the current 35% to a painfully high 55%.
Therefore, planning to avoid or minimize the federal estate tax should still be
part of your overall financial game plan. Even if you already have a good plan,
it may need updating to reflect the current $5 million exemption. Contact us
for more information on the best ways to minimize estate taxes for someone in
your situation.