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Tax Tidbit 11/10: Year-End Tax Planning

As 2010 draws to a close, there is still time to reduce your 2010 Federal income tax bill and plan ahead for 2011. Here are highlights of several potential tax-saving opportunities for you to consider.

Basic Numbers You Need To Know
Because many tax benefits are tied to or limited by adjusted gross income (AGI), a key aspect of tax planning is to estimate both your 2010 and 2011 AGI. Also, when considering whether to accelerate or defer income or deductions, you should be aware of the impact this action may have on your AGI and your ability to maximize itemized deductions that are tied to AGI. Your 2009 tax return and your 2010 pay stubs and other income- and deduction-related materials are a good starting point for estimating your AGI.

Another important number is your “tax bracket,” i.e., the rate at which your last dollar of income is taxed. The tax rates for 2010 are 10%, 15%, 25%, 28%, 31%, and 35%. The President's proposals would only raise the highest two brackets for those earning more than $250,000 ($200,000 for single taxpayers). Given the real possibility of higher income tax brackets in 2011, tax planning takes on a great importance before the 2010 tax year ends.

Deferring Income to 2011 - If you expect your AGI to be higher in 2010 than in 2011, or if you anticipate being in the same or a higher tax bracket in 2010, you may benefit by deferring income into 2011. Deferring income will be advantageous so long as the deferral does not bump your income to the next bracket.

Accelerating Income into 2010
In certain circumstances, you may benefit by accelerating income into 2010. For example, you may anticipate being in a higher tax bracket in 2011, or perhaps you will need additional income in order to take advantage of an offsetting deduction or credit that will not be available to you in future tax years. Note, however, that accelerating income into 2010 will be disadvantageous if you expect to be in the same or lower tax bracket for 2011. In any event, before you decide to implement this strategy, you should “crunch the numbers.”

Deduction Planning
Deduction timing is also an important element of year-end tax planning. If you are a cash-method taxpayer, remember to keep the following in mind:

• Deduction in Year Paid:  An expense is only deductible in the year in which it is actually paid. Under this rule, if your tax rate is going to increase in 2011, it is a smart strategy to postpone deductions until 2011.
• Payment by Check: Date checks before the end of the year and mail them before January 1, 2011.
• Medical Expenses: Medical expenses, including amounts paid as health insurance premiums, are deductible only to the extent that they exceed 7.5% of AGI. Consider bunching medical expenses into years when your AGI is lower.
• State Taxes:  If you anticipate a state income tax liability for 2010 and plan to make an estimated payment, consider making the payment before the end of 2010. Note that in 2009, taxpayers were able to elect to deduct as an itemized deduction state and local sales taxes, instead of state and local income taxes. Unless extended by Congress into 2010, this extra deduction does not apply.
• Continued next pagCharitable Contributions: Consider making your charitable contributions by the end of the year.  You can use a credit card to charge donations in 2010 even though you will not pay the bill until 2011. A mere pledge to make a donation is not deductible, however, unless it is paid by the end of the year. To avoid capital gains, you may want to consider giving appreciated property to charity.

Energy Incentives
Nonbusiness Energy Property Credit: After expiring in 2007, the nonbusiness energy property credit was re-enacted for 2009 and 2010 only. Property qualifying for the credit includes windows (including skylights), exterior doors, insulation, metal roof, advanced main air circulating fans, natural gas, propane, or oil furnace or hot water boilers, and other energy efficient building property that meets certain energy standards. The credit is 30% of the cost of the improvement(s) up to a maximum credit of $1,500 (therefore, if you took any credit in 2009, your total for both years cannot exceed $1,500). The property must be installed by the end of the year to qualify.

Investment Planning
The following rules apply for most capital assets in 2010:

• Capital gains on property held one year or less are taxed at an individual's ordinary income tax rate.
• Capital gains on property held for more than one year are taxed at a maximum rate of 15% (0% if an individual is in the 10% or 15% marginal tax bracket.

Note that if Congress does not act to extend the reduced capital gains rates, beginning in 2011, the rates will revert back to pre-2001 levels, or up to a maximum of 20% for all taxpayers.

Dividends: Qualifying dividends received in 2010 are taxed at a maximum rate of 15%. Qualifying dividends include dividends received from domestic and certain foreign corporations. Note that if Congress does not act to extend the reduced dividend rates, beginning in 2011, the rates will revert back to pre-2001 levels, that is taxed at a taxpayer's ordinary income rate, up to a maximum of 39.6%. The President has proposed to keep qualifying dividend income taxed at the same rate as capital gains, which could increase to 20% in 2011.

Some of the standard year-end planning ideas will not reduce tax liability if you are subject to the alternative minimum tax (AMT) because different rules apply. Because of the complexity of the AMT, it would be wise for your tax advisor to analyze your AMT exposure.

There is still time to implement these strategies to minimize your 2010 tax liability. If you have any questions, please contact Andrew D. Ross, CPA of Bedard, Kurowicki & Co., CPA's, PC (908) 782-7900 x 113, adr@bkc-cpa.com, or visit www.bkc-cpa.com.