2009 TAX PLANNING
What is on the horizon?
For 2010 and beyond, it is also crucial to to do year-end tax planning this year.
- In 2010, the opportunity to convert any IRA into a Roth IRA without the long-time $100,000 income restriction has many individuals already setting aside funds. Some individuals, however, may do better to convert to a Roth IRA before the end of 2009, when the value of their accounts, and the consequential income that must be recognized on conversion, are at historic lows. (see page 3 for details)
- Effective for 2011, the Obama administration has proposed to increase the income and capital gains tax rates on single individuals with incomes of more than $200,000 and married couples with incomes exceeding $250,000. For taxpayers in those groups, following the traditional year-end planning maxim of deferring income into next year may not work well this year. Deferring too much income into 2010 could result in overloading income next year if you are looking to accelerate income into 2010 to escape the expected higher rates in 2011.
- Also, taxing all S corporation distributions to shareholders as “wages” may become a reality in the next few years.
New rules provide tax savings now, benefits later
Whether you think the economy is on the road to recovery or stuck in neutral, one thing is clear: cutting taxes has never been more important.
Fortunately, there are special incentives this year to both save taxes and help jump start the economy. Find out why the final months of 2009 may be your best opportunity in years to trim your tax bill and invest for the future.
* Look on the home front
It’s not too late to lower your 2009 taxes through energy-efficient home upgrades. Installing qualified windows and skylights can provide a tax credit, as can installing exterior doors, roofing, and insulation that meet energy-saving standards. What’s more, a tax credit is available for up to 30% of the cost of major energy-savers, such as a qualified solar water heater or geothermal heat pump.
Need a new car? The American Recovery and Reinvestment Act of 2009 provides a deduction for sales taxes paid on new cars, light trucks, motorcycles, and even motor homes. The deduction is limited to the tax on $49,500 of the purchase price. You don’t have to itemize to take the deduction, and if you live in a state without sales tax, you can still deduct other fees and taxes associated with the sale.
* Invest in your business
The Recovery Act restored the higher Section 179 equipment expensing limit, allowing small businesses to write off as much as $250,000 of new or used equipment purchased this year. In addition, brand new equipment, software, and leasehold improvements can qualify for a 50% first-year bonus depreciation deduction if purchased and placed in service before the end of 2009.
The Recovery Act also helps businesses invest in their most important asset – their employees. Employers can provide employees with a tax-free fringe benefit of up to $230 per month for qualified mass transit and van pooling expenses.
* Invest in yourself
Having thoughts about returning to school? Now may be the time. Up to $4,000 of higher education costs for yourself, your spouse, or a dependent can be deducted from taxable income in 2009 and 2010 if you meet the income limits ($65,000 or less for singles, $130,000 or less for joint filers). If income exceeds these amounts, the deduction drops to a $2,000 limit. Above income of $80,000 for singles and $160,000 for couples, no deduction is allowed.
Plan for next year’s Roth IRA change
On the Chinese calendar, 2010 is the Year of the Tiger. On the U.S. tax calendar, 2010 may be the Year of the Roth. Why? Because Roth IRAs become more accessible next year. That’s when the $100,000 income limit currently restricting the conversion from a traditional IRA to a Roth is repealed. Also, married taxpayers who file separate returns will be able to take advantage of the new rules too. Beginning January 1, 2010, you’ll be able to convert to a Roth no matter what your income is.
Though the revised rules provide a one-time incentive do a traditional to a ROTH IRA conversion in 2010, the time to start planning is now. One reason: Even if you’re ineligible for a Roth this year, it may be a smart move to make a 2009 contribution to a nondeductible traditional IRA, and then convert the account to a Roth next year.
• The first question to ask
Is converting a good idea? If it made sense before and you were unable to do so only because of the income limitation, the answer is probably yes. Switching gives you access to the benefits of Roth accounts. Those benefits include tax- and penalty-free distributions, both of which generally kick in once you’re 59½ and have met the five-year holding requirement.
In addition, Roths offer estate planning advantages. For example, unlike traditional IRAs, you’re not required to withdraw specified amounts from a Roth each year once you reach age 70½. The same is true when your spouse inherits the account as your designated beneficiary. Other heirs must take distributions, but the account balance can typically be withdrawn over a number of years.
The conversion to a Roth does have a cost. When you have no basis in your traditional IRA – for instance, you deducted your original contributions on prior tax returns – you’ll have to add the entire amount converted to your taxable income. That’s another reason to start planning now, since the increase in income could have tax and nontax implications, such as reducing itemized deductions or affecting college financial aid.
• The incentive works this way
If you want to do a conversion, here’s a reason to consider doing it in 2010. You do not have to include the taxable portion of the conversion in your 2010 income. Instead you are allowed to report half of the income on your 2011 tax return and the remaining half on your 2012 tax return.
The deferral gives you a multi-year period to plan for and pay the tax. Just be aware that taking distributions from converted funds may have tax consequences.
You can also choose to pay more quickly by making an election to report all of the conversion on your 2010 return. Remember that present federal tax rates are set to expire December 31, 2010. Postponing income into future years could mean a bigger tax bill.
• Your plans for retirement
There’s another way tax rates can affect your decision about converting. Say you intend to retire and relocate to a state with low or no income tax, and you expect the move to reduce your overall tax rate. In that case, you may decide to delay or forgo making a conversion.
Converting involves other variables too, and it’s important to weigh the pros and cons in your individual situation. Please give us a call if you would like to discuss the best strategy for you.
Tax rules offer upside to stock market decline
Has last year’s stock market decline still got you down? While it may have given you plenty of headaches, the losses may have a tax upside. Consider the following strategies between now and the end of the year to restructure your portfolio in a tax-efficient manner.
Taxpayers are allowed to offset capital gains (such as from the sale of stocks) with capital losses. If capital losses exceed capital gains for the year, up to $3,000 of losses can be deducted from other income, such as wages. Any loss greater than that can be carried forward to future years. It’s important to remember that stocks you’ve owned for more than one year (called long-term) must be grouped together for purposes of calculating the capital gain or loss. The same is true for stocks held for one year or less (short-term).
Here’s the strategy. When you identify stocks in your portfolio that have lost value and are no longer worth holding, consider selling those securities and offset all but $3,000 of the loss by also selling stocks that have gained value. This is known as “tax loss harvesting,” and it can be an effective method for rebalancing your portfolio without paying capital gains taxes.
You can often manage the size of your gain or loss when you decide to sell some, but not all, of a particular stock or mutual fund. To do this, you must have kept good records of the date and the price for each share purchase. By selling the highest cost shares first, you’ll minimize your taxable gain or maximize your loss. You must specify the particular shares you are selling at the time you sell.
On the other hand, some investors see this market as a buying opportunity. If you are considering an investment in mutual funds, pay special attention to the fund’s proposed date for capital gains distributions. Mutual funds generally distribute all capital gains to investors toward the end of the year.
If you purchase a mutual fund just before a distribution date, you will receive the distribution and be required to include it in your taxable income. Since the price of the fund shares before and after a dividend distribution reflect the amount of the dividend, you are actually paying income tax on part of your own purchase price. To avoid this outcome, call the fund and ask for the ex-dividend date and the estimated payout and make your purchase after that date.
Retirees may also have investment decisions to make this year. If you have a retirement plan that is currently subject to the “required minimum distribution” (RMD) rules, you should note that RMDs for 2009 have been suspended. This means that instead of liquidating and withdrawing the funds, you can leave your investments intact to help recover from last year’s devastating losses. This is also true for those who inherited a retirement account subject to RMD rules.
Changes in your life this year?
Year-end tax planning is not only about what is happening in Congress and at the IRS. Addressing the changed circumstances in your life has always been a large part of year-end tax planning. What you planned for at the beginning of 2009 may not be what you are faced with now. Changes in your employment status, family, investments, or retirement plans raise new tax issues:
- Self-employment, severance pay, sign-on bonuses, stock options, moving expenses, and COBRA health benefits, to name a few employment-related events, all present unique challenges.
- In your personal life, marriage, divorce, a larger family, and child care or eldercare expenses arising in 2009 can impact your tax situation.
- Investments, too, generally benefit from year-end tax strategies. You can take steps to balance out gains and losses. You also should take a year-end tally of dividends and interest to make certain that are paying the correct estimated tax.
Working to rebuild a retirement nest egg through maximizing deductible 2009 contributions, and making certain that rollovers from former employers are done correctly, should also be a top priority at year end 2009.
Planning for deductions and credits at year-end can also get complex but can be equally as rewarding. Timing and qualification rules create traps and opportunities:
- Pre-paying certain expenses, such as real estate taxes or mortgage interest, do not necessarily translate into a larger deduction this year.
- Paying a spring college tuition bill in late December instead of early January, however, can impact whether you maximize the benefit of the new American Opportunity Tax Credit for both 2009 and 2010.
- Year-end charitable giving generally has always been a smart way to reduce current year taxes but strict timing rules and revised substantiation requirements for property donations cannot be overlooked.
- Homeowners should also not ignore taking advantage of the new residential energy property credit, which has a unique set of rules on qualifying expenses and deadlines for installations.
CALIFORNIA TAX PLANNING
LET’S CHECK YOUR WITHHOLDING:
Major changes in withholding and tax for both Federal and California may create a big tax bill next spring.
If you are in any of the following categories, you should come in for a withholding check-up to make sure you do not have to write a big check this spring.
Call for an appointment if you:
a. Have children or other dependents;
b. Have more than one job;
c. Received a COBRA subsidy;
d. Received a pension and you have taxes taken out of your pension;
e. Have or expect to have total income over $1 million;
f. Owed taxes when you filed your last year’s return and did not change your withholding;
g. Had a short sale or foreclosure;
h. Got married, divorced, or became widowed this year.
Especially during 2009 -- a year of tumultuous change for our economy and our tax laws – we consider a year-end tax checkup an essential service for our clients. If you would like more information on any of the planning strategies described in this letter, or if you would like to explore how year-end tax planning can be customized to your individual circumstances, please call us.
Sincerely,
Tim Powell EA CFP
I am required by IRS Circular 230 to inform you that, unless otherwise expressly indicated, any federal tax advice contained in this communication, including attachments and enclosures, is not intended or written to be used, and may not be used, for the purpose of (i) avoiding tax-related penalties under the Internal revenue Code or (ii) promoting, marketing, or recommending to another party any tax-related matters addressed herein.
For assistance with the year-end tax planning connected with your investments, give our office a call.
NOTE: This newsletter is issued annually to provide you with information about minimizing your taxes. Do not apply this general information to your specific situation without additional details. Be aware that the tax laws contain varying effective dates and numerous limitations and exceptions that cannot be summarized easily. For details and guidance in applying the tax rules to your individual circumstances, please contact us.
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