Earlier in the year, Congress passed the Hiring Incentives to Restore Employment (HIRE) Act of 2010, providing special tax breaks to employers. The HIRE Act was quickly followed by the massive new health care law. Although most provisions in the Patient Protection and Affordable Care Act of 2010 are prospective, this new legislation will likely affect long-term planning for many years. Another new law signed in September, the Small Business Jobs Act of 2010, also includes several key tax breaks for employers. And you may be able to take advantage of traditional year-end tax-planning strategies for yourself, your family and your business.
Finally, certain key income-tax breaks for individuals may expire after 2010, unless Congress modifies the rules. For instance, tax rates are scheduled to rise for some taxpayers while tax cuts for long-term capital gains and dividends are slated to disappear. Controversial changes in the estate-tax law enacted in 2001 also add to the uncertainty. Now, more than ever, you need professional guidance to maximize the tax benefits and minimize the risks.
Keeping these in mind, we have prepared the following 2010 Year-End Tax-Planning Letter. Throughout this letter, take note of various year-end tax tips that may be applicable. For your convenience, the letter has been divided into the following three sections:
- Individual Tax Planning
- Business Tax Planning
- Financial Tax Planning
Be aware that the year-end planning ideas discussed within this letter are general in nature and are intended only as an overview. We suggest that you review your situation with an experienced tax professional before you take any action.
INDIVIDUAL TAX PLANNING
Charitable Donations
In the usual situation, you may deduct the full amount of cash donations made to qualified charitable organizations. If you donate appreciated property held for more than one year, you can generally deduct the property’s current fair-market value.
Year-end tip: To increase your charitable deduction for 2010, make sure gifts are completed before January 1, 2011. If you use a credit card to pay for year-end donations, you can deduct the contribution on your 2010 return—even if you don’t pay off the credit card charge until 2011.
Be aware of the strict substantiation rules for monetary gifts. You must maintain a record of the contribution, such as a bank statement, receipt or written communication supplied by the charity. The written communication should show the charity’s name, the contribution date and the amount.
Note: If you expect to be in a higher tax bracket in 2011 than 2010, you might postpone charitable gifts to offset higher-taxed income next year.
Alternative Minimum Tax
The alternative minimum tax (AMT) is a special tax return calculation involving certain “tax preference” items, technical adjustments and an exemption amount based on your filing status. If the resulting AMT liability exceeds your regular income tax liability, you must pay the AMT. The AMT rate is 26% for the first $175,000 of AMT income; 28% on amounts above $175,000.
Year-end tip: Review your AMT liability for 2010. If warranted, it may be advisable to shift tax preference items to 2011 to avoid or reduce expected AMT liability for this year.
The AMT exemption amounts have been “patched” several times during the past decade. The exemption amounts dating back to 2000 are shown below.
|
Filing status
|
2000
|
2001–2002
|
2003–2005
|
2006
|
2007
|
2008
|
2009
|
2010*
|
|
Joint filers
|
$45,000
|
$49,000
|
$58,000
|
$62,550
|
$66,250
|
$69,950
|
$70,950
|
$45,000
|
|
Single
filers |
$33,750 |
$35,750 |
$40,250 |
$42,500 |
$44,350 |
$46,200
|
$46,700
|
$33,750
|
*Proposed legislation would increase these amounts.
Be aware, however, that the exemption amounts are reduced for high-income taxpayers. The reduction is equal to 25 cents for each dollar of AMT income above $150,000 ($112,500 for single filers). These thresholds have not been adjusted for inflation in recent years.
Note: If you are facing AMT liability this year and expect to be in a high regular income tax bracket next year, you might accelerate additional income into 2010. The extra income will be taxed at either the 26% or 28% AMT rate.
Higher Education Expenses
The tax law provides some relief to parents who pay higher education expenses for their children. However, be aware that the tax benefits are phased out for taxpayers with income above certain levels.
Year-end tip: Generally, you can claim a deduction or credit (but not both) in 2010 for amounts paid or incurred this year. For instance, if you pay the tuition bill for the spring 2011 semester in December, you may qualify for a deduction in 2010. Here’s a brief summary of the two key tax breaks.
- Tax credits: You may claim either one of two credits. Under the revamped American Opportunity credit (formerly the Hope credit), the maximum credit for 2010 is $2,500. The credit begins to phase out for joint filers with a modified adjusted gross income (MAGI) of $160,000; $80,000 for single filers. The maximum Lifetime Learning credit of $2,000 begins to phase out for joint filers with an MAGI of $100,000; $50,000 for single filers.
- Tuition deduction: The maximum deduction for 2010 is $4,000 of qualified tuition and related fees for joint filers with an MAGI of $130,000 or less; $65,000 for single filers. The maximum deduction is $2,000 for joint filers with an MAGI up to $160,000; $80,000 for single filers. Taxpayers with an MAGI above these limits do not qualify.
Note: Technically, the American Opportunity credit is scheduled to expire after 2010, but it is expected to be extended by new legislation.
Estimated Tax Penalty
The IRS may impose an underpayment penalty if you do not pay sufficient “estimated tax” during the year through quarterly installments or income tax withholding, or a combination of the two.
Year-end tip: Seek tax shelter under one of the safe harbor rules. Typically, you may qualify by adjusting payroll withholding at year-end. The safe harbor exceptions are as follows:
- Your annual payments equal at least 90% of your current liability.
- Your annual payments equal at least 100% of the prior year’s tax liability (110% if your AGI for the prior year exceeded $150,000).
- You make installments currently under an “annualized income” method. This method is only if you receive or accrue most of your annual income in a short span (e.g., from holiday sales).
Note: If you increase withholding after clearing the Social Security wage base ($106,800 for 2010), there will be little or no reduction in take-home pay.
Residential Energy Credit
Due to a recent tax-law change, you may be able to claim an enhanced “residential energy credit” for qualified energy-saving improvements.
Year-end tip: Make sure the improvements are completed before January 1, 2011. As the law stands now, the credit equals 30% of the cost of expenditures in 2009 and 2010, for a maximum credit of $1,500 covering the two years.
The list of qualified expenses may be more expansive than you think. It covers such items as insulation materials; exterior windows (including skylights); exterior doors; central air conditioners; natural gas, propane and oil water heaters or furnaces; hot water boilers; electric heat pump water heaters; certain metal roofs; stoves; and advanced main air-circulating fans.
Note: Prior to 2009, the credit was equal to only 10% of qualified expenses, with a $500 lifetime dollar cap. Proposed legislation may extend and/or modify the current credit.
Miscellaneous Tax Benefits
- When state law permits, you can consolidate outstanding personal debts into a home equity debt. Interest on personal debts is not tax deductible, but you may deduct mortgage interest paid on the first $100,000 of home-equity debt, no matter how the proceeds are used. Caution: The debt must be secured by your home, so use this technique judiciously.
- The tax law allows you to deduct your annual unreimbursed medical expenses exceeding 7.5% of your AGI for 2010 (scheduled to increase to 10% in 2013). If you are near the 7.5% mark or already over it, schedule nonemergency medical and dental visits before the end of the year.
- As a general rule, you may claim a dependency exemption of $3,650 in 2010 for a child under age 19 (or a full-time student under age 24) if you provide more than half of his or her annual support. It doesn’t matter how much taxable income the child receives. To secure an exemption for an older child, make sure you clear the half-support mark this year.
- Miscellaneous expenses are deductible to the extent that the annual total exceeds 2% of your AGI. When it is warranted, pay qualified expenses (e.g., tax assistance fees) before the end of the year to maximize your deduction for 2010.
- Under the “kiddie tax,” investment income received by your child under age 19 or full-time student under age 24 is generally taxed at your top tax rate to the extent it exceeds $1,900 in 2010. Try to minimize any kiddie tax impact through astute investment planning.
- If you are in the market to buy a new hybrid vehicle, make the purchase before 2011. The tax law provides a special credit for hybrid vehicles placed in service this year based on the vehicle’s fuel economy. Caveat: The credit has been phased out for some of the more popular models. Consult a tax professional.
BUSINESS TAX PLANNING
Section 179 Deductions
Under Section 179 of the tax code, your business may currently deduct (or “expense”) the cost of qualified assets placed in service during the year, within limits. The deduction has been extended and enhanced by new tax legislation.
Year-end tip: Acquire and begin using assets before year-end to maximize Section 179 deductions for 2010. Under the new small-business law, the maximum deduction has been increased from $250,000 to $500,000 for assets placed in service in tax years beginning in 2010 and 2011.
There are two key limits to watch out for. (1) The Section 179 deduction cannot exceed your taxable income from business activities. (2) The maximum deduction is reduced on a dollar-for-dollar basis for acquisitions over an annual threshold. The previous threshold of $800,000 is increased to $2 million for tax years beginning in 2010 and 2011. Limits for recent years are shown below.
|
Tax year
|
Maximum deduction
|
Phaseout threshold
|
|
2003
|
$100,000
|
$400,000
|
|
2004
|
$102,000
|
$410,000
|
|
2005
|
$105,000
|
$420,000
|
|
2006
|
$108,000
|
$430,000
|
|
2007
|
$125,000
|
$500,000
|
|
2008
|
$250,000
|
$800,000
|
|
2009
|
$250,000
|
$800,000
|
|
2010
|
$500,000
|
$2 million
|
|
2011
|
$500,000
|
$2 million
|
Note: If acquisitions do not qualify under Section 179 or are affected by these limits, your business may still claim regular depreciation deductions for year-end purchases (see below).
Depreciation Deductions
The main method for deducting depreciation expenses is called the Modified Accelerated Cost Recovery System (MACRS). Under MACRS, the recovery period is linked to the type of property. Generally, deductions are based on a “half-year convention,” regardless of when the asset is actually placed in service.
Year-end tip: Beware of a potential tax trap. If the cost of business assets (other than real estate) placed in service during the last quarter of the year (i.e., October 1 through December 31) exceeds 40% of the cost of assets placed in service during the entire year, deductions are computed under a less-favorable “mid-quarter convention.” Therefore, if you would otherwise trigger this tax rule for MACRS deductions, your business might postpone purchases to 2011. But business assets expensed under Section 179 are exempt from this calculation.
Note: “Bonus depreciation” equal to 50% of the cost of qualified assets (after any Section 179 deduction) has been extended through 2010 (through 2011 for certain assets) by the new small-business law.
HIRE Act Tax Breaks
The new HIRE Act provides two other significant tax benefits for employers. But the tax breaks may be fleeting unless Congress extends them.
Year-end tip: Step up hiring efforts. Your business is eligible for the tax breaks only if it hires qualified workers after February 3, 2010, and before January 1, 2011. Therefore, the window on this unique tax opportunity may close soon.
The two tax breaks are as follows: (1) An employer is exempt from paying the usual 6.2% Social Security tax on wages of “previously unemployed workers.” (2) An employer can claim a maximum $1,000 tax credit for retaining a qualified worker for at least 52 consecutive weeks. For these purposes, a qualified worker cannot have been employed for more than 40 hours during the previous 60 days.
Note: The HIRE Act tax breaks are available for full-time and part-time workers such as seasonal workers. The credit must be coordinated with any Work Opportunity Tax Credit (WOTC) claimed for target-group workers.
Bad Debt Deductions
In the current economic climate, your business may have difficulty obtaining payments from certain clients or customers. At least you may be able to salvage some tax relief for “business bad debts.”
Year-end strategy: Increase your collection activities. For instance, you may issue a series of dunning letters before the end of the year. If you are still unable to collect, you may be able to write off an unpaid debt as a business bad debt.
As a general rule, business bad debts are deducted from taxable income in the year that they become worthless. To qualify as a business bad debt, a loan or advance must have been created or acquired in connection with your business operation and result in a loss to the business if it cannot be repaid.
Note: Keep detailed records of collection activities—including letters, telephone calls, e-mails and efforts of collection agencies—in your files. This documentation can help support your position based on the worthlessness of the debt if the IRS ever challenges the deduction.
Repairs and Improvements
From a tax perspective, there is a difference between “repairs” and “improvements.” As a general rule, if you repair a business asset, you may currently deduct the entire cost. In contrast, the cost of an improvement to business property must be capitalized.
Year-end tip: When appropriate, schedule minor repairs to be made before the end of the year. The deductions can offset taxable income for 2010.
Based on IRS guidelines, a repair keeps property in efficient operating condition while an improvement prolongs the life of the property, enhances its value or adapts it to a different use. For example, fixing a broken window is a repair, but installing a new roof on your business building is usually treated as an improvement.
Note: If you make repairs and improvements at the same time, the IRS may group the cost of the repairs with the improvements because it constitutes a general rehabilitation plan. Therefore, if you prefer a current deduction, it may be preferable to handle repairs at a different time.
Miscellaneous Tax Benefits
- Purchase routine business supplies before the end of the year. Your company can generally deduct the cost in 2010—even if the supplies will not be used until next year.
- Maximize the “manufacturing” deduction available under Section 199 of the tax code. This deduction is available to many types of business entities for domestic production activities. For 2010, the Section 199 deduction is equal to 9% (up from 6%) of the lesser of taxable income from qualified production activities or taxable income.
- Any loss claimed by an S corporation shareholder is limited to the basis in the stock plus outstanding debt. Thus, shareholders might make a capital contribution or lend money to the corporation before year-end to increase the basis for loss deduction purposes.
- Your company can deduct 100% of its business travel costs and 50% of its qualified entertainment and meal expenses. To increase deductions for 2010, you might accelerate trips planned for early next year into this year. Note that you can deduct 100% of the cost of a holiday party if the entire workforce is invited.
- Get a new business up and running before 2011. The small-business law increases the maximum deduction for start-up expenses from $5,000 to $10,000 for 2010 only.
- Under the new health care law, a qualified “small business” may claim a tax credit of up to 35% of the cost of contributions to purchase health insurance for its employees. The credit begins to phase out for employers with more than ten employees with average annual wages above $25,000. Unlike most other provisions in the law, the credit is effective for contributions in 2010
FINANCIAL TAX PLANNING
Capital Gains and Losses
For tax purposes, capital gains and losses effectively cancel out each other. However, any excess capital loss can also offset up to $3,000 of high-taxed ordinary income in 2010. The remainder is carried over to next year. If a gain from a sale qualifies as long-term capital gain (i.e., you have owned the asset for more than a year), the maximum tax rate in 2010 is normally 15%.
Year-end tip: If it otherwise makes economic sense, you might time capital gains and losses to your tax advantage. For example, if you have already realized capital gains in 2010, you might “harvest” capital losses at year-end to absorb those gains. Similarly, if you have realized capital losses in 2010, you can realize gains at year-end to offset those losses.
For taxpayers in the regular 10% or 15% tax brackets, the maximum tax rate for long-term capital gains in 2010 is 0%. If warranted, you might have low-bracket children sell securities to realize long-term capital gain in 2010. But you must also consider any potential kiddie tax impact.
Note: The 15% and 0% maximum tax rates for capital gains are scheduled to increase to 20% and 10%, respectively, in 2011. However, Congress is weighing proposals to extend lower rates.
IRA Contributions
There are two main types of Individual Retirement Accounts (IRAs) designed to benefit retirement-savers: traditional IRAs and Roth IRAs.
- Traditional IRAs: Contributions are tax deductible unless you are an “active participant” in an employer-sponsored retirement plan and your AGI exceeds a certain level. For 2010, deductions are phased out for an AGI between $89,000 and $109,000 for joint filers; $56,000 and $66,000 for single filers. If your spouse is an active participant and you are not, the deduction is phased out for an AGI between $167,000 and $177,000.
The maximum IRA contribution for 2010 is $5,000. Furthermore, if you are 50 years of age or older, you can make an extra “catch-up” contribution of $1,000.
- Roth IRAs: Contributions are not tax deductible, but withdrawals to a Roth in existence five years may be completely tax-free. To qualify, distributions must be received after age 59½, upon death or disability, or to pay first-time home-buyer expenses (up to a lifetime limit of $10,000). The ability to contribute to a Roth IRA for 2010 is phased out for joint filers with an AGI between $167,000 and $177,000; $105,000 and $120,000 for single filers.
The contribution limits for Roth IRAs are the same as for traditional IRAs. If you choose, you may allocate contributions to both types of IRAs, up to the total annual limit.
Note: The deadline to make IRA contributions for the 2010 tax year is your tax return due date. Nevertheless, you can boost retirement savings by contributing sooner rather than later. This provides more time for contributions to grow on a tax-deferred basis.
Roth IRA Conversions
For the first time ever, many high-income taxpayers may convert a traditional IRA to a Roth IRA. Previously, this was not permitted in a year in which your MAGI exceeded $100,000. Due to a recent tax-law change, this limit has been removed, beginning in 2010.
Year-end tip: Weigh the pros and cons of a Roth conversion. Remember that a conversion results in tax liability based on the amount transferred to the Roth IRA. But future Roth distributions may be tax free and, unlike a traditional IRA, annual lifetime distributions are not required after age 70½.
As an added incentive, you can choose to have the taxable income from a Roth conversion occurring in 2010 split evenly between the following two years—2011 and 2012. Alternatively, if it suits your needs, you can choose to pay the full amount owed on your 2010 tax return.
Furthermore, be aware that you do not have to convert all of your traditional IRA funds. A partial conversion is allowed.
Note: The decision to convert or not is a complex one. You should take into account various factors, such as whether IRA funds are needed to pay the tax, your age and health status, your expected tax rates in future years and potential state income-tax liability. Consult a professional adviser to determine the best course of action.
401(k) Plans
A 401(k) plan allows you to allocate a portion of your salary to an account where the funds can grow on a tax-deferred basis. In addition, your company may provide matching contributions based on a percentage of your compensation (e.g., 3% of your salary).
Year-end tip: Increase 401(k) plan contributions at year-end to boost retirement savings. For instance, you might decide to defer more dollars to your 401(k) account after you clear the 2010 Social Security wage base of $106,800. This will not reduce your take-home pay if the payroll tax savings are allocated to the 401(k) deferrals.
As with other tax-qualified retirement plans, a 401(k) plan must meet strict nondiscrimination requirements to maintain its tax-favored status. Furthermore, there is an annual dollar cap on elective deferrals. For 2010, you can defer a maximum of $16,500 to your account.
Note: If you’re age 50 or older, you can add a “catch-up contribution” of $5,500. Thus, the total maximum deferral allowed in 2010 for 401(k) participants age 50 or older is $22,000.