As year-end approaches you should take some time to think about
your tax situation. Look closely at how much you are earning,
spending, and how that effects your tax situation.
Year-end tax planning is about timing. Conventional wisdom holds
that taxpayers should accelerate deductions into the current year
while deferring income into the next year. The premise here is
that a dollar saved today is worth more than a dollar saved
tomorrow, so lowering this year's taxes is better than lowering
next year's taxes.
Note: Virtually all tax planning this year depends on whether
or not the "Bush Tax Cuts" are extended. At this
writing, December 1, 2010, there is a lot of speculation in
the press, but it is unclear whether Congress and President Obama
will agree on an extension. If they do not the "Bush Tax
Cuts" will expire on December 31, 2010. As of January
1, 2011 the marginal federal income tax rates will revert to
their pre-2003 levels, with a maximum tax rate of 38.6%, up from
35%. Effective year-end tax planning is virtually impossible until
it is known whether or not the "Bush Tax Cuts" will be
extended. The discussion below assumes that the "Bush Tax
Cuts" ARE extended, keeping the federal income tax
rates the same in 2011 as they are in 2010.]
Did you work a full year in 2010? Your best strategy this year might be doing nothing at all.
Depending on how your year went your adjusted gross income might
be low enough to reverse the traditional strategy. The only way to
tell is to estimate your 2010 and 2011 incomes. If it looks like
you may have a lot more income next year you might want to reverse
the tax strategies explained below and maximize income this year while
deferring tax deductions until next year.
Itís been a crazy year for the
economy and as a result Congress created many tax incentives and
credits that may possibly reduce your 2010 taxes. Next year may
bring major tax changes as lawmakers confront the record federal
deficit. Unless you believe that next year you will be in a higher
personal income tax bracket, you may want to defer income until
after the first of the year. If you believe that your tax bracket
will be higher this year than next, you may want to accelerate
deductions. Bottom line: review your taxes before it's too late.
Here are some tax planning
strategies to consider implementing before year-end to keep your
income tax bill as low as possible. Chances are at least some of
them will apply to you.
You may be able to cut your tax bill by making alimony payments
before yearís end. You should probably check with your ex-spouse
first, as he or she will have to claim the payments as taxable
Bunch Your Itemized
If your total itemized deductions are close to the standard
deduction amount each tax year, consider bunching together
expenses for itemized deductions every other year. Itemize in
those years to deduct more than the standard deduction amount.
Then claim the standard deduction in the other years. Over time,
this technique can save thousands of dollars in taxes by
significantly increasing your cumulative write-offs.
For 2010, the standard deduction
is $11,400 for taxpayers married filing jointly and $5,700 for single
taxpayers. Both remain unchanged from last year. The standard deduction
is $8,400 for heads of households, up $50 from last
Under the cash method of accounting you claim income and deduct
expenses in the year they are received or paid. Under the accrual
method of accounting you claim income and deduct expenses in the
year they accrue. The discussion immediately below pertains to
cash method of accounting business owners.
You might consider invoicing
customers in late December or January so you donít have to
include that income on your 2010 tax return. Keep in mind that it
may only make sense to defer income if you think you will be in
the same or a lower tax bracket next year. For every dollar
deferred until January 2011, you will not owe taxes on that income
until April 2012.
Now may be the time to stock-up.
Purchase items your business will require in the immediate future
to maximize deductions for this year. You can accelerate your
expenses for this year by buying office supplies and any other tax deductible items before December 31st.
And be sure to save your receipts for tax time!
Pay your bills for telephone,
cell phone, subscriptions, rent, insurance, and utilities early to
take the deduction this year.
If you will be buying new office
equipment in the near future, consider purchasing now. Your
equipment will have to be in your office, "placed in
service" by year-end.
You can deduct donated household goods, clothing, and other items
so long as they are in good or better condition. You will need a
written receipt for all charitable donations. You can also deduct
the cost of driving for charity at 14 cents per mile. However, you
cannot take a charitable deduction for the value of your time when
Delay Mutual Fund Purchases
The later it gets in the year, the more likely you receive the
capital gains distributions on a mutual fund you didnít even own
except for a short time during the year. If you buy shares just
before the ex-dividend date, you'll get back part of the money you
just invested and owe taxes on it. Check the mutual funds
distribution schedule (ex-dividend date) and if it's late in the
year, wait until January to buy into the fund.
The American Recovery and Reinvestment Act provides tax incentives
for energy efficient investments for your home. You can get a tax
credit on 30% of the cost of qualified home energy improvements up
to $1,500 for improvements placed in service in 2010.
Qualified improvements include insulation, replacement windows and
doors, energy-efficient air conditioning and heating systems,
water pumps, furnaces and water heaters. Improvements must be installed
by year's end.
Renewable energy devices also
get the 30% tax credit without the $1,500 cap. These include solar
panels, solar water heaters and geothermal heat pumps.
First-Time Homebuyer Tax
First-time homebuyers had until September 30, 2010 to close
on their home purchase (provided there was a binding sales
contract signed by April 30, 2010) in order to qualify for the $8,000 tax
credit provided by the American Recovery and Reinvestment Act
(ARRA). The credit was available to those who have not owned a
home during the past three years.
The credit is a
dollar-for-dollar tax credit of up to $8,000 for 10% of the cost
of a home. The credit is also refundable, meaning that even if you
donít owe $8,000 of tax, you can claim the full tax benefit and
receive a refund check. Those buying homes for more than $800,000
get no tax credit at all.
There is also a similar $6,500
credit for buyers who already own a home. It is also a refundable
credit for 10% of the purchase price of a house costing no more
than $800,000.To qualify the buyer has to have owned and lived in
the same home for five of the eight years preceding the new home
purchase, and the new home must become the buyer's principal
Two unmarried people buying a
house together may be able to allocate the credit as they wish.
Taxpayers who bought in 2010 can claim
the credit on either their 2009 or 2010 tax return.
Flexible Spending Accounts
If you have a Flexible Spending Account you have set aside
tax-free earnings to cover medical and dental expenses through a
plan offered by your employer. You should use up any funds in your
Flexible Spending Accounts. If you donít you risk losing that
money forever. Make doctor appointments now, and buy necessary
medical supplies that are covered in the plan Ė such as
eyeglasses and medications.
Give Appreciated Stock to
Charity Ė Sell the Losers
You have some appreciated stock that youíve owned for over a
year. Consider donating the shares to charity. You generally can
claim an itemized charitable contribution deduction for the full
market value of the stock at the time of the donation - and youíll
avoid any capital gains tax. On the other hand, donít donate
stocks with a loss. Sell them, take the capital loss, and give
away the cash proceeds. That way, youíll write off the full
amount of the cash donation while keeping the tax-saving capital
loss for yourself .
Make an Extra Mortgage
Make an additional mortgage payment on or before December 31st so
you can deduct the additional interest paid. Make sure that the
additional interest payment is included on you Form 1098-Mortgage
Interest Statement that you receive from your lender next month.
If not you may need to add the interest amount to the amount reported by
Consider prepaying your Miscellaneous Itemized Deductions.
Miscellaneous Itemized Deductions for investment expenses, fees for tax
preparation and advice, and un-reimbursed employee business
expenses count only to the extent they exceed 2% of Adjusted Gross
Income. If you can bunch these expenditures into a single tax
year, you may have a better chance of clearing the 2% and getting
some tax write-offs. This strategy wonít work for taxpayers
subject to Alternative Minimum Tax because Miscellaneous Itemized
Deductions are completely disallowed under the AMT rules.
Prepay Medical Expenses
Medical expenses are one of the least useful tax deductions
because you must spend more than 7.5% of your adjusted gross
income to claim any tax deduction. Pay doctor bills, insurance
premiums, buy eyeglasses, and stock up on prescription drugs now.
Medical expenses exceeding 7.5% of your adjusted gross income are
Prepay Property Taxes
If you're not affected by the Alternative Minimum Tax, and you
don't think your personal income tax bracket will be higher next
year, you might want to pay your property taxes and take the
deduction now. If you prepay any 2011 property taxes before January 1st,
you can deduct that amount on your 2010 income tax return.
However, donít do this if you
know youíll owe the Alternative Minimum Tax for 2010.
Write-offs for state and local income and property taxes are
completely disallowed under the Alternative Minimum Tax rules.
Contributions to a retirement plan reduce your taxable income.
Review your retirement plan options and decide on setting up a
retirement plan. Many retirement plans need to be established by
December 31st to make tax-deductible contributions for
Remember that ordinarily you can
contribute an entire year's retirement plan contribution each
year, even if you started your new job in the last quarter of the
year. Some taxpayers who begin a new job in the last quarter
arrange to have their entire paycheck go into the plan - which
eliminates their taxable income.
Sell Mutual Fund Shares Early
If you own appreciated mutual fund shares held over 12 months sell
them before the December dividend. This way your entire gain will
qualify for the lower 15% capital gains tax rate. If you wait, part of your dividend
will almost certainly consist of ordinary income on which youíll
pay 35% ordinary income tax.
Even though the stock market has gone up more than 70% from the lows of
March 2009, many investors still have long-term capital losses on
investments theyíve held longer than one year. If you have
capital gains you can take losses to offset some of the capital
gain income by selling losing investments. This will offset any
capital gains you made this year. Losses offset gains dollar for
dollar, and losses in excess of your gains can be deducted, up to
$3,000 per year against ordinary income. The excess losses are
carried forward to future years. Alternatively, if you already
have capital losses, you may want to take some gains if you do not
need the capital loss deduction this year.
This yearís top capital-gains
tax rate of 15% is the lowest in decades. Keep in mind that if you
are in the 10-15% income tax bracket, the current tax rate for
long-term capital gains is 0% percent. In that case you are best just claiming the capital
gain as it is tax free. The capital-gains tax rate is almost
certain to rise as the government scrambles to pay down the
What if you have both gains and
losses in your stock portfolio? Which ones should you sell? First,
sell the long-term winners - stock held for over 12 months. Youíll
benefit from the 15% maximum long-term capital gains rate.
Which stocks should you sell to
offset those gains? You will get the most tax savings with a
short- term loss because short-term losses first go to offset
short-term gains that would otherwise be taxed at your regular
income tax rate, which can be as high as 35%, and then to offset
long-term 15% gains.
You can further reduce taxes by
telling your broker to sell your highest-cost basis shares first.
Using this method requires you to identify the shares to be sold
by specifying their cost and purchase dates. You must also receive
a written confirmation of your instructions from the broker or
keep a record of your oral instructions in your tax file.
If you don't follow this
procedure, you must use the first-in, first-out (FIFO) method,
meaning the shares you bought first are considered sold first.
Those are the shares most likely to have the largest capital gains
Ė and tax hit.
Stocks and bonds that became completely worthless during the tax year are treated as though they were sold for zero dollars on the last day of the tax year. This affects whether
your capital loss is long-term or short-term Ė although most securities do not become worthless in the year they are purchased or otherwise acquired - so losses from worthless securities are almost always long-term losses.
Worthless means of absolutely no value. Just because a company is not doing very well financially, itís shares decline in price, itís shares were de-listed by the stock exchange or NASDAQ, or the company filed for bankruptcy protection, does not necessarily mean the securities are worthless. Be prepared to prove to the IRS that the securities are completely worthless.
If the security isnít completely worthless, but you desire to take a capital loss, then
you should sell the securities for whatever you can get no later than the last day of
2010. Thatís where year-end tax planning comes in.
Be careful to avoid a "wash
sale". If you buy the same security within 30 days before or
after you sell the original shares the tax rules disallow the
The American Opportunity Credit is a tax credit of up to $2,500
for paying tuition and other education expenses. This
credit is available for 2010.
Organize Your Financial
Good record-keeping pays off at tax time. It makes your tax
return preparation easier and faster, and we might uncover
additional tax deductions. Remember, the IRS requires receipts and
These year-end tax tips will apply differently to each
taxpayer. Changes to your adjusted gross income from one year to
the next can have a negative impact in certain circumstances. For
instance, postponing an IRA distribution will reduce your current
taxable income which is good, but it will increase your next
year's income, which may be bad. Higher income next year can
increase the taxable amount of your Social Security benefits;
reduce or eliminate your ability to make deductible IRA
contributions; "phase out" your itemized deductions and
personal exemptions; and reduce or eliminate your deductions for
medical expenses, casualty losses, charitable contributions and
rental real estate. Higher income could also reduce or eliminate
the tax credits for dependent children and college education
expenses, Roth IRA contributions, conversions of regular IRAs into
Roth IRAs and college education loan interest deductions. Weíll
need to consider the effects of potential year-end tax breaks for
both this year and next, and implement only those ideas that will
put you ahead over the two-year period. Take the time to review
the best strategy with us now and make the most of your year-end