The tax laws continue to provide opportunities for the wise and traps for the unwary. Often, tax savings can be achieved by taking action before the year-end. The information and strategies discussed herein may or may not be appropriate for your situation. Remember to consult with your tax professional before implementing them.
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Stay Tuned – Additional
Changes Coming?
More than ever, year-end tax planning for 2011 will be done in a highly uncertain legislative environment. The President and Congress are discussing numerous proposals designed to stimulate the economy. Also, before year-end, the Joint Select Committee on Deficit Reduction may recommend major tax reforms for 2012 designed to reduce the deficit.
Congress also must decide on whether to extend the alternative minimum tax patch and the post-2012 expiration of the Bush-era income tax cuts including tax rates for ordinary income and long-term capital gains and qualified dividends.
Finally, the US Supreme Court is probably going to rule on health care reform by June of 2012. This could have a major impact on future tax rules, because at least 42 of the 514 Affordable Care Act provisions add to or amend the Internal Revenue Code, and the Act contains $438 billion of revenue provisions in the form of new taxes and fees. Given this politically charged environment, anything is possible. Deficit spending has become a major political issue, and the days of automatically extending expiring tax breaks may be over.
Actions to Consider in 2011
As always, the general rule is to accelerate deductions into 2011 and defer income into 2012 to the extent that such actions are possible. This strategy may enable you to claim larger deductions, credits, and other tax breaks for 2011 that are phased out based on adjusted gross income. These items include child tax credits, higher education tax credits, the above-the-line deduction for higher-education expenses, and deductions for student loan interest.
Possible tax saving moves include; deferring a bonus until 2012 if possible or using a credit card to prepay expenses that can generate deductions for 2011. State and local income taxes may be prepaid through estimated payments or through increased employer withholding before year-end.
Consider investment loss harvesting, a strategy in which you realize losses on stock while substantially preserving your investment position. Capital losses may be used to offset capital gains and an additional $3,000 of ordinary income.
Capital losses in excess of these amounts are carried forward. If capital gains taxes increase in future years, these capital loss carryforwards will become more valuable. Losses can be harvested by selling a security at a loss and buying that same security back again, at least 31 days later. An alternative approach is to sell a type of security at a loss, and purchase a similar, but not identical security, immediately.
It is also a great time to consider converting traditional-IRA money invested in stocks or mutual funds that have declined in value into a Roth IRA. The converted value will have to be included in income for 2011. There is no special two-year income inclusion rule for conversions in 2011.
If you converted from a traditional IRA to a Roth IRA earlier in 2011, and the Roth IRA has declined in value, consider a recharacterization. Otherwise, you will have to include the converted amount in income in 2011, when the value of the account is actually lower. You can back out of the transaction by recharacterizing the conversion. To do this you need to transfer the converted amount, minus losses, from the Roth IRA back to a traditional IRA in a trustee-to-trustee transfer. You can later reconvert to a Roth IRA at the lower market value.
If you reached age 70½ in 2011, consider taking your first required minimum distribution (RMD) from your IRA or other employer-sponsored retirement plan in 2011 instead of waiting until 2012. If you turned age 70½ in 2011, you are allowed to delay the first required distribution to 2012, but if you do, you will have to take two distributions in 2012 – both the 2011 amount plus the 2012 amount. Taking two distributions in 2012 could push you into a higher tax bracket or reduce the benefit of various income tax deductions that are reduced at higher income levels. In some situations it may make sense to wait and take two distributions in the year after you turn 70 ½.
Note: As is the case with all tax provisions, these rules are applicable for Federal purposes. Not all states follow Federal rules for state tax purposes.
Individual Provisions Ending December 31, 2011
According to the staff of the Joint Committee on Taxation, there are over 50 provisions that will expire at the end of 2011. Following is a discussion of some of these expiring provisions.
Unless Congress acts, take-home pay will go down by 2% after December 31, 2011. The 2010 Tax Relief Act's reduction of the employee share of the OASDI portion of Social Security taxes from 6.2 percent to 4.2 percent on the first $106,800 ($110,100 in 2012) of wages is scheduled to end.
In 2011 individuals have the choice of claiming an itemized deduction for state and local sales and use taxes instead of state income taxes. Since this choice is no longer available in 2012, it may make sense to make major purchases which are subject to sales tax before December 31, 2011. This strategy only makes sense if you are going to elect to claim a state and local general sales tax deduction instead of a state and local income tax deduction.
Tax-free distributions by individuals age 70½ or older can be made from IRAs for charitable purposes in 2011. To qualify, the IRA distributions must be made directly to charities by the IRA trustee and may be made for up to $100,000. Such a distribution, if done properly, has no income tax consequences. This special rule increases the amount of funds available for contribution to the charity by reducing income taxes payable by the IRA owner. A charitable contribution deduction is not available for the donor when using this strategy. If contributions are contemplated for 2012, consider making them before December 31, 2011 to benefit from this strategy.
The classroom expense deduction of $250 ($500 if married filing joint and both spouses are educators, but not more than $250 each) for teachers ends in 2011. Eligible educators can deduct unreimbursed expenses paid for books, supplies, computer equipment (including related software and services), other equipment, and supplementary materials that are used in the classroom. Consider making additional purchases in 2011 in order to maximize the deduction.
The mortgage insurance premium deduction for premiums paid for qualified mortgage insurance expires at the end of 2011. The deduction is phased out starting at adjusted gross incomes greater than $100,000 ($50,000 if your filing status is married filing separately). Special pro-ration rules prevent a taxpayer from benefiting from prepaying these premiums.
The above-the-line deduction for up to $4,000 of qualified higher education expenses is also scheduled to end December 31, 2011. If you are eligible for the deduction, consider prepaying eligible education expenses. The deduction is allowed for qualified education expenses paid in 2011 in connection with enrollment during 2011 or for an academic period beginning in 2011 or in the first 3 months of 2012.
The tax credit for energy saving non-business home improvements or for purchasing energy efficient property is ending after 2011. The credit is available for property placed in service in 2011, with a lifetime limit of $500, of which only $200 may be used for windows. Subject to the lifetime limits, the residential energy property costs are limited to $300 for energy efficient building property, $150 for any qualified natural gas, propane, or oil furnace or hot water boiler, and $50 for any advanced main air circulating fan. Exterior windows, doors, and skylights must now just meet or exceed the Energy Star program requirements. Unfortunately, a simple list of all qualified property does not exist. However, you can check with the manufacturer and ask them for a Manufacturer Certification Statement certifying that the product or component qualifies for the tax credit.
Individuals who buy qualified small business stock before January 1, 2012 will be able to exclude 100% of the gain on the sale if they hold the stock for more than five years. There is no tax on gain from the sale of such stock if it is (1) purchased after September 27, 2010 and before January 1, 2012, and (2) held for more than five years. The stock must be issued by a C corporation with gross assets of $50 million or less. Investments in qualifying ventures should be made before year end, if possible. After 2012, the normal exclusion rate will drop to 50 percent, although it has been 75 percent in recent years.
Without an extension of the AMT "patch," the Congressional Budget Office estimates that an additional 20 million middle-class taxpayers would suddenly become subject to AMT. The AMT exemption amount for individuals is scheduled to decrease from $74,450 for joint filers/surviving spouses and $48,450 for others to $45,000 and $33,750, respectively, in 2012. Consider realizing AMT income, such as capital gains, in 2011, rather than in 2012.
Standard Mileage Rate
Taxpayers can use the standard mileage rate (in lieu of actual expenses) in computing the deductible costs of operating automobiles owned or leased by them (including vans, pickups or panel trucks) for business purposes. This rate is also used as a benchmark by the federal government and many businesses to reimburse their employees for business travel. Due to higher fuel costs, the IRS increased the standard mileage rate for the second half of this year. The following rates are applicable for the 2011 tax year:
1/1/11 – 6/30/11 7/1/11 – 12/31/11
Business $.51 $.555
Medical .19 .235
Moving .19 .235
Charitable .14 .14
If you are an employee you may deduct an amount computed using the standard mileage rate only as an itemized deduction, subject to the 2 percent floor on miscellaneous itemized deductions.
Looking Ahead
At present, there is no tax legislation effective January 1, 2012. However, tax increases are already set for 2013. When planning during 2012, keep this in mind. It may make sense to recognize income in 2012 instead of 2013. Tax rates should remain the same for 2011 and 2012, with ordinary income tax rates for individuals at 10, 15, 25, 28, 33 and 35 percent; capital gains rates are zero and 15 percent.
Social Security announced a 3.6% benefit increase for 2012. This cost-of-living adjustment is the first since 2009. Monthly Social Security and Supplemental Security Income (SSI) benefits for more than 60 million Americans will increase 3.6 percent in 2012. Also, the maximum amount of earnings subject to the Social Security tax (taxable maximum) will increase to $110,100 from $106,800.
Estate and Gift
For an estate of any decedent dying during calendar year 2012, the basic exclusion from the estate tax amount is $5,120,000, up from $5,000,000 for calendar year 2011.
The annual exclusion for gifts remains at $13,000.
Retirement Planning
The elective deferral (contribution) limit for employees who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan is increased from $16,500 to $17,000. The catch-up contribution limit for those aged 50 and over remains unchanged at $5,500.
The contribution limitation for SIMPLE retirement accounts remains unchanged at $11,500.
The traditional IRA deduction is phased-out for singles and heads of household who are covered by a workplace retirement plan and have modified adjusted gross incomes (AGI) between $58,000 and $68,000, up from $56,000 and $66,000 in 2011.
For married couples filing jointly, in which the spouse who makes the IRA contribution is covered by a workplace retirement plan, the income phase-out range is $92,000 to $112,000, up from $90,000 to $110,000.
For an IRA contributor who is not covered by a workplace retirement plan and is married to someone who is covered, the deduction is phased out if the couple’s income is between $173,000 and $183,000, up from $169,000 and $179,000.
The AGI phase-out range for taxpayers making contributions to a Roth IRA is $173,000 to $183,000 for married couples filing jointly, up from $169,000 to $179,000 in 2011.
For singles and heads of household, the income phase-out range is $110,000 to $125,000, up from $107,000 to $122,000.
For a married individual filing a separate return who is covered by a retirement plan at work, the phase-out range remains $0 to $10,000.
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This publication contains contributions from tax professionals who are subject to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury. Any U.S. federal tax advice that is contained in such contributions is not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service and it cannot be used by any taxpayer for such purpose.
