2010 Year-end Tax Planning 

Date:               December 1, 2010

As another year comes to a close, it is important to keep abreast of changes in the tax laws.  This memo provides an overview of the major tax changes for 2010 and future years as well as a discussion of traditional year-end tax planning considerations.  Please be aware that Congress will undoubtedly enact additional tax legislation prior to December 31, 2010.

 BACKGROUND 

In prior years, we have seen numerous pieces of legislation passed that have impacted both individuals and businesses.  In 2010, there have been two major pieces of legislation enacted.  They are as follows: 

In addition to the legislation above, 2010 is the final year that certain tax provisions will be available, and that tax rates will stay at their currently low rates.  These provisions are scheduled to sunset at December 31, 2010, unless steps are taken by Congress to extend or alter them. 

 INDIVIDUAL TAX PROVISIONS

 Capital gains tax rates 

For 2010 qualified dividend income and capital gains tax rates are zero percent for taxpayers in the 10 and 15 percent tax brackets, and 15 percent for taxpayers in higher brackets.  These rates are currently set to expire at December 31, 2010.  For tax years beginning after January 1, 2011, capital gains rates will increase to their former 20% rate (18% for property held more than five years).  Dividends will revert to being taxed at ordinary income rates, which may be as high as 39.6%. 

Mortgage debt and mortgage insurance premiums 

In 2008 legislation was passed that allows for an exclusion from income of up to $2 million of discharge of indebtedness secured by a principal residence and incurred in the acquisition, construction, or substantial improvement of the residence. This legislation was extended through 2012.  Without this legislation, taxpayers who lost their homes, or sold their homes “short”, would be taxed on the amount of mortgage relief offered by their lender.

In addition, the deduction for mortgage insurance premiums paid or accrued is available only through 2010.  

Retirement savings tax incentives 

In 2006 the Pension Protection Act made previous retirement incentives permanent, and guaranteed that the limits would continue to rise with inflation.  Following are the 2010 limits, as well as provisions that affect 2011: 

IRA contributions: $5,000 in 2010 and 2011 ($6,000 if 50 or older)

Qualified employer-sponsored defined contribution plans: $49,000 in 2010 and 2011

401(k) deferrals: $16,500 in 2010 and 2011 ($22,000 if 50 or older)

SIMPLE plan deferrals: $11,500 in 2010 and 2011 ($14,000 if 50 or older).

Direct rollovers are allowed from a qualified retirement plan, tax-sheltered annuity or government plan to a Roth IRA with treatment as a Roth conversion if all other qualifications are met. Beginning in 2010, the $100,000 income limit on Roth conversions is repealed, and taxpayers will be able to make Roth IRA conversions without regard to their AGI.  The income from the conversion may be spread ratably over a two year period (2011 and 2012). 

Energy efficiency tax breaks 

The alternative fuel vehicles credit: Taxpayers may receive a tax credit for the purchase of a hybrid vehicle, worth roughly $2,000, depending on the vehicle’s fuel efficiency.  The credit applies to vehicles first placed in service on or before December 31, 2010, and is reduced once a manufacturer sells more than 60,000 units.   

Taxpayers may also receive a credit for the purchase of plug-in electric vehicles (street legal golf carts) that meet certain qualifications and are certified by the manufacturer through an Internal Revenue Service process. 

The home improvement energy credit is available for the installation of certain energy saving improvements in your home. The credit amount is 30% of the cost of energy conservation property, such as energy-efficient residential exterior doors and windows, insulation, furnaces or hot water heaters placed in service after December 31, 2008 and prior to January 1, 2011.  The credit is limited to $1,500 over the 2009 and 2010 tax years. 

The residential energy efficient property credit for solar equipment and fuel cells has been extended through 2016, and expanded to include small wind investment property and geothermal heat pump expenditures.  Although the maximum credit for qualified fuel cell property remains unchanged ($500 for each half kilowatt of capacity), there is no longer a maximum credit for qualified property expenditures on solar electric, small wind energy, or geothermal heat pump.  These credits apply both to primary residences as well as vacation homes. 

Hope Credit  

The American Opportunity Credit, formerly known as the Hope Credit, saw significant changes in 2009.  The maximum credit is now $2,500 for qualified tuition and fees paid on behalf of a student who is enrolled on at least a half time basis.  The credit is available for the first four years (as opposed to two in the past) of the student’s post secondary education.  Qualified tuition and related expenses has been expanded to include course materials such as books, supplies and equipment needed for a course of study.  For 2010, the credit phases out at modified AGI levels between $160,000 and $180,000 for joint filers, and between $80,000 and $90,000 for other taxpayers. 

In 2011, we will revert back to the Hope Credit, which will have a maximum amount of $1,800.  The credit phases out at modified AGI of $100,000 to $122,000 for joint filers, and between $51,000 and $61,000 for other taxpayers. 

Health Care Reform Legislation 

Health care reform will affect nearly all taxpayers, many employers, and many elements of the health care industry.  The tax changes will go into effect over a number of years. 

2010: 

The general exclusion for reimbursements for medical care expenses under an employer-provided accident or health plan is extended to any child of an employee who has not attained the age of 27 as of the end of the tax year effective March 30, 2010. 

The adoption credit for tax years after December 31, 2010 increases to $13,170 per eligible child, and is refundable.  The maximum exclusion for employer provided adoption assistance is the same. 

2011: 

Health Savings Accounts (HSA) distributions that are not used for qualified medical expenses are subject to an additional tax of 20% (previously 10%).  The additional tax for distributions from an Archer Medical Savings Accounts (MSA) account is 15% (previously 10%). 

The new law excludes the costs for over the counter drugs not prescribed by a doctor from being reimbursed through a Health Reimbursement Account (HRA) or a Flexible Spending Account (FSA), and from being reimbursed on a tax free basis through an HSA or an MSA. 

2013: 

Medicare tax will increase by .9% (from 1.45% to 2.35%) for single individuals earning greater than $200,000 and married couples earning greater than $250,000.  

A new 3.8% Medicare tax will be applied to net investment income of single taxpayers with AGI above $200,000 and joint filers with AGI above $250,000.  Net investment income includes interest, dividends, royalties, net rental income and income from a trade or business involving passive activities. 

Itemized medical expense deductions will be allowable only to the extent that they exceed 10% of AGI (currently 7.5% of AGI).  The AGI floor for individuals 65 and older (and their spouses) will remain unchanged at 7.5% through 2016.  

Allowable contributions to FSA accounts will be capped at $2,500 per year.  Currently, there is no limit on the amount of contributions that can be made to an FSA. 

2014: 

U.S. citizens and legal residents will be required to have qualifying health coverage, or be subject to a tax penalty of the greater of $2,085 per family or 2.5% of income in excess of $18,700.  Exemptions will be granted for a variety of conditions.  Tax credits will be available for low and middle income individuals.  

BUSINESS TAX PROVISIONS 

Equipment purchases 

The 2010 Small Business Jobs Act increases the Section 179 deduction for capital purchases.  The deduction will be $500,000 for 2010 and 2011, and the threshold for reducing the deduction increases to $2,000,000.  In addition, the law makes certain real property such as leasehold improvements and restaurant property eligible for expensing.  The deduction for this type of property is limited to $250,000 of the $500,000 maximum expensing. 

Bonus depreciation of 50% which was added for new property purchased and placed in service in 2008 and 2009 has been extended to include property placed in service in 2010.  The placed in service date is extended through 2011 for certain aircraft and long production period property. 

With bonus depreciation taken into account, the first year limit on “luxury” auto depreciation for 2010 increased by $8,000 for a total of no more than $11,160 dependant on the type of vehicle purchased and the percentage of business use. 

Payroll tax credits 

To help stimulate the hiring of workers by the private sector, the Hiring Incentives to Restore Employment Act of 2010 exempts any private-sector employer that hires a worker who had been unemployed, or employed for less than 40 hours for at least 60 days, from having to pay the employer's 6.2% share of Social Security.  This credit is available for wages paid from March 18, 2010 to December 31, 2010.  As an additional incentive, for any qualifying worker hired under this initiative that the employer keeps on payroll for a continuous 52 weeks, the employer is eligible for an additional non-refundable tax credit of up to $1,000 after the 52-week threshold is reached, to be taken on their 2011 tax return. In order to be eligible, the employee's pay in the second 26-week period must be at least 80% of the pay in the first 26-week period.  The employee must sign Form W-11 certifying they meet the qualification test during the 60 day period prior to employment. 

Health Care Reform Legislation 

As for individuals, health care reform legislation will go into effect over a number of years.  

2011: 

Eligible Small Employers (ESE’s) will be entitled to a tax credit for making non-elective contributions to buy health insurance for its employees. 

Employers must disclose the value of the employee’s health insurance coverage sponsored by the employer on each employee’s annual Form W-2. 

2013: 

Certain employers will be required to offer and contribute to their workers’ health insurance coverage, or pay a penalty.  Subject to this law are “applicable large employers” which are defined as those who employ an average of at least 50 full time employees during the preceding calendar year.  In addition, the law applies only if any full-time employee is certified to the employer as having purchased health insurance through a state exchange with respect to which a tax credit or cost sharing reduction is allowed or paid to the employee. 

Employers offering minimum essential coverage through an eligible employer sponsored plan and paying a portion of that coverage will have to provide qualified employees with a voucher whose value could be applied to purchase of a health plan through the Insurance Exchange. 

2017: 

An excise tax will be due on high cost employer sponsored health coverage (“Cadillac” plans).  This is a 40% excise tax on insurance companies based on premiums that exceed a certain amount.  The tax is not on the employers. However, it is expected that the employers and workers will ultimately bear the tax in the form of higher premiums. 

Other key business changes 

Start up expenses for a trade or business increased to $10,000 for 2010, with a phase out threshold of $60,000.  This is an increase from $5,000 and a threshold of $50,000. 

Business owners are allowed to deduct the cost of health insurance incurred in 2010 for themselves and their family members in calculating their 2010 self-employment tax. 

General business credits of eligible small businesses for 2010 get five-year carryback.  Previously the carryback was allowed for only one year.  In addition, general business credits of eligible small businesses are not subject to AMT for 2010. 

C corporations converting to S corporations must hold onto any appreciated assets for 10 years or face a built in gains tax at the highest corporate rate of 35%.  New legislation temporarily shortens the holding period of assets subject to the built in gains tax to five years if the 5^th tax year in the holding period precedes the tax year beginning in 2011. 

Rental income recipients will be considered to be engaged in the trade or business of renting property.  Therefore, any payments made to a service provider in the course of earning rental income are required to be reported to both the IRS and the service provider, typically by issuance of Forms 1099-MISC.   This new rule is effective for the 2011 tax year which means all taxpayers with rental properties should be obtaining W-9s from their service providers immediately.  

For payments after December 31, 2011, businesses must file an information return for all payments aggregating $600 or more in a calendar year to a single payee, which will now include any corporation not exempt from tax. 

Cell phone usage is no longer subject to the strict substantiation requirements of other listed property. 

Expiring tax breaks  

There are a number of tax breaks and credits that have been in existence for a number of years, and that we take for granted.  However, they are not permanent changes to the tax code.  Following is a partial list of breaks that are set to expire on December 31, 2010. 

·         Itemized deduction for state and local sales tax in lieu of deducting state and local income taxes.

·         Above-the-line student loan interest deduction – the deduction will phase out over lower AGI ranges and applies only to interest paid over the first 60 months during which interest payments are required.

·         Credit for dependent care expenses drops from $3,000 to $2,400 (1 qualifying individual) and from $6,000 to $4,800 (2 or more).

·         Child credit drops from $1,000 to $500 and the credit is not allowed against AMT.  More restrictive rules apply to refundable child credit. 

TRADITIONAL CONSIDERATIONS 

Year's end signals your last chance to balance the timing of income and deductions for tax purposes between the current and the upcoming year to your maximum advantage.  Carefully timing capital gains to match capital losses and making last-minute contributions to tax-deferred accounts such as retirement savings and flexible spending accounts all play roles in a successful year-end tax strategy.  So should testing your current tax status for AMT liability.  If you have had a change in circumstances during the year, such as marriage or divorce, birth of a child, a death, promotion or job loss, inheritance, or property loss, year-end tax planning takes on extra importance.  

Other traditional considerations include:   

·         Minimizing taxable income to reduce tax on social security benefits.

·         Timing gifts to family or others to take advantage of the $13,000 (2010 calendar year) annual gift tax exclusion ($26,000 for couples).

·         Bunching medical expenses and/or miscellaneous itemized deductions to maximize use in connection with adjusted gross income minimums.

·         Deferring or accelerating year-end bonuses.

·         Increasing S corp or partnership basis to enable deduction of losses.

·         Paying expenses using a credit card to accelerate deductions without the need for immediate cash. 

Managing the income that you recognize or defer in 2010 may be beneficial, but with tax reform on the horizon, balancing tax rates between 2010 and 2011 and beyond becomes more difficult.  Proposed increases in income and capital gains tax rates for 2011 make the traditional year-end strategy of deferring your 2010 income into 2011 less attractive.  

As you may have surmised the political nature of changes to our system of taxation causes our tax laws to become more complicated every year.   Current uncertainty regarding Congressional action between now and the end of the year makes short and long-term financial planning very difficult.  Please call our office with questions concerning how these new provisions will affect you.

___________________________________________________________________________

2009 Year-end Tax Planning 

Date: November 30, 2009

As another year comes to a close, it is important to keep abreast of changes in the tax laws.  This memo provides an overview of the major tax changes for 2009 and future years as well as discussion of traditional year-end tax planning considerations.  

BACKGROUND 

As in past years, tax year 2009 has seen several pieces of tax legislation enacted by Congress.  Following is a listing of the highlights: 

INDIVIDUAL TAX PROVISIONS

Kiddie tax

The “kiddie” tax is designed to prevent income shifting from parents to children to circumvent tax laws.  The age limit on this tax has been increasing since 2006 and is currently applicable to children under age 19, or under age 24 if a full time student.  The “kiddie” tax kicks in when the child has more than $1,900 in passive (unearned) income and other criteria are met.

Capital gains tax rates

For 2009 qualified dividend income and capital gains tax rates are zero percent for taxpayers in the 10 and 15 percent tax brackets, and 15 percent for taxpayers in higher brackets.  These rates are currently set to expire in 2010. 

Mortgage debt and mortgage insurance premiums

In 2008 legislation was passed that allows for an exclusion from income of up to $2 million of discharge of indebtedness secured by a principal residence and incurred in the acquisition, construction, or substantial improvement of the residence. This legislation was extended through 2012.  Without this legislation, taxpayers who lost their homes, or sold their homes “short”, would be taxed on the amount of mortgage relief offered by their lender.

 In addition, the deduction for mortgage insurance premiums paid or accrued is available through 2010.

First-time homebuyer credit

In 2009 changes were made to the first-time homebuyer credit.  Effective January 1, 2009 a taxpayer who is a first-time homebuyer of a principal residence may claim a refundable credit of 10% of the purchase price of the residence (not to exceed $8,000).  This credit has been extended to residences purchased on or before April 30, 2010, or July 1, 2010 in the case of taxpayers who have entered into a binding contract prior to May 1, 2010, to close on the purchase of a principal residence prior to July 1, 2010.

Under the 2009 Worker Act, the credit was also expanded to apply to “long-time homeowners” who are purchasing replacement property.  Individuals who have owned and used the same residence as their principal residence for any five consecutive year period during the eight year period ending on the date of purchase of a subsequent principal residence may be eligible for a reduced credit of $6,500.  This is applicable to purchases made after November 6, 2009.

Congress also made the credit available to more individuals by increasing phase out limitations for the credit.  For purchases after November 6, 2009 the credit begins to phase out for individuals with modified adjusted gross income (MAGI) between $125,000 and $145,000, and for married couples filing joint returns with MAGI between $225,000 and $245,000. 

It should be noted that the credit is not permitted for a residence with a purchase price in excess of $800,000.  Also, in order to prevent recapture of the credit, you must use the home as a principal residence for at lease 36 months after purchase. 

Additional housing related deductions

Taxpayers who claim the standard deduction will be allowed an additional deduction of up to $500 ($1,000 for joint filers) for state and local property taxes.  This deduction is set to expire at the end of 2009.

Gain from the sale of a personal residence will no longer be excluded from gross income for the period that the home was not used as a principal residence.  This new rule applies to home sales after 12/31/08, and applies only to nonqualified use periods that begin after 1/1/09.   It reduces the exclusion available to those who move into their rental or vacation home for two years prior to sale.

Retirement savings tax incentives 

In 2006 the Pension Protection Act made previous retirement incentives permanent, and guaranteed that the limits would continue to rise with inflation.  Following are the 2009 limits, as well as provisions that affect 2010:

 IRA contributions: $5,000 in 2009 ($6,000 if 50 or older)

Qualified employer-sponsored defined contribution plans: $49,000 in 2009 and 2010

401(k) deferrals: $16,500 in 2009 and 2010 ($22,000 if 50 or older)

SIMPLE plan deferrals: $11,500 in 2009 and 2010 ($14,000 if 50 or older)

Required minimum distributions: In 2009 taxpayers may waive taking their required minimum distribution from IRA’s or defined contribution plans.

Direct rollovers are allowed from a qualified retirement plan, tax-sheltered annuity or government plan to a Roth IRA with treatment as a Roth conversion if all other qualifications are met. Beginning in 2010, the $100,000 income limit on Roth conversions is repealed, and taxpayers will be able to make Roth IRA conversions without regard to their AGI.  The income from the conversion may be spread ratably over a two year period (2011 and 2012).

Energy efficiency tax breaks 

The alternative fuel vehicles credit: Taxpayers may receive a tax credit for the purchase of a hybrid vehicle, worth roughly $2,000, depending on the vehicle’s fuel efficiency.  The credit applies to vehicles first placed in service on or before December 31, 2010, and is reduced once a manufacturer sells more than 60,000 units. 

Taxpayers may also receive a credit for the purchase of plug-in electric vehicles (street legal golf carts) that meet certain qualifications and are certified by the manufacturer through an Internal Revenue Service process.

The home improvement energy credit has been reinstated for the installation of certain energy saving improvements in your home. The credit amount is 30% of the cost of energy conservation property, such as energy-efficient residential exterior doors and windows, insulation, furnaces or hot water heaters placed in service after December 31, 2008 and prior to January 1, 2011.  The credit is limited to $1,500 over the 2009 and 2010 tax years. 

The residential energy efficient property credit for solar equipment and fuel cells has been extended through 2016, and expanded to include small wind investment property and geothermal heat pump expenditures.  Although the maximum credit for qualified fuel cell property remains unchanged ($500 for each half kilowatt of capacity), there is no longer a maximum credit for qualified property expenditures on solar electric, small wind energy, or geothermal heat pump.  These credits apply both to primary residences as well as vacation homes. 

Sales tax on new vehicles 

There is a new deduction for sales and excise taxes paid on the purchase of new cars, light trucks, motor homes and motorcycles after February 16, 2009 and before January 1, 2010.   This deduction is available even if you do not itemize your deductions on Schedule A, but is phased out for income above $125,000 for single taxpayers and $250,000 for joint filers. 

Hope Credit  

The American Opportunity Credit, formerly known as the Hope Credit, has seen significant changes in 2009.  The maximum credit is now $2,500 for qualified tuition and fees paid on behalf of a student who is enrolled on at least a half time basis.  The credit is available for the first four years (as opposed to two in the past) of the student’s post secondary education.  Qualified tuition and related expenses has been expanded to include course materials such as books, supplies and equipment needed for a course of study.  For 2009, the credit phases out at modified AGI levels between $160,000 and $180,000 for joint filers, and between $80,000 and $90,000 for other taxpayers. 

Unemployment compensation 

Unemployment compensation benefits ordinarily are fully taxable.  However, under the

Recovery Act, an individual does not have to pay tax on up to $2,400 in unemployment benefits received in 2009. 

BUSINESS TAX PROVISIONS 

Equipment purchases 

Increases in Section 179 deduction for capital purchases originally enacted in 2008 were extended for 2009 equipment purchases.  The deduction remains at $250,000 for 2009, and the threshold for reducing the deduction remains at $800,000.  In 2010 these amounts drop back to $134,000 and $530,000 respectively. 

Bonus depreciation of 50% which was added for new property purchased and placed in service in 2008 has been extended to include property placed in service in 2009.  The placed in service date is extended through 2010 for property with a recovery period of 10 years or more, for transportation property, and for certain aircraft. 

With bonus depreciation taken into account, the first year limit on “luxury” auto depreciation for 2008 increased by $8,000; this increase is extended to property placed in service in 2009 as well for a total of no more than $11,060 dependant on the type of vehicle purchased and the percentage of business use. 

Net Operating Loss (NOL) Carrybacks 

Stimulus legislation passed early in 2009 allowed eligible small businesses to elect to carry back NOLs from 2008 for 3, 4, or 5 years rather than the standard 2 years.  The 2009 Worker Act provides an election for most taxpayers (not just small businesses) to increase the carryback period for an applicable NOL to 3, 4, or 5 years from 2 years.  An applicable NOL means the taxpayer’s NOL for any tax year ending after December 31, 2007 and beginning before January 31, 2010.  

Generally, an extended carryback period election may be made for only one tax year.  However, small businesses that have already elected an extended carryback for a 2008 NOL may also elect to extend the carryback for NOLs from 2009. 

Tax breaks  

There are a number of tax breaks and credits that have been in existence for a number of years, and that we take for granted.  However, they are not permanent changes to the tax code.  Following is a list of breaks that are set to expire on December 31, 2009. 

·        State and local tax deduction

·        Above-the-line higher education tuition deduction

·        Above-the-line deduction for teacher’s out-of-pocket classroom expenses

·        Tax-free distributions from IRAs for charitable purposes.  Allowable only for taxpayers who are at least 70½ by year end.

·        Research tax credit for amounts paid or incurred for qualifying research expenses, including wages

·        15 year cost recovery for qualifying restaurant and leasehold improvements, as well as certain improvements to retail space

·        Enhanced deductions for donations of food to charitable organizations and books and computers to schools 

TRADITIONAL CONSIDERATIONS 

Year's end signals your last chance to balance the timing of income and deductions for tax purposes between the current and the upcoming year to your maximum advantage.  Accelerating payment of expenses to generate deductions, deferring receipt of income to defer payment of tax on it up to a full year, carefully timing capital gains to match capital losses, and making last-minute contributions to tax-deferred accounts, such as retirement savings and flexible spending accounts, all play roles in a successful year-end tax strategy.  So should testing your current tax status for AMT liability.  If you have had a change in circumstances during the year - such as marriage or divorce, birth of a child, a death, promotion or job loss, inheritance, or property loss - year-end tax planning takes on extra importance.  

Other traditional considerations include:   

·        Minimizing taxable income to reduce tax on social security benefits.

·        Timing gifts to family or others to take advantage of the $13,000 (2009 calendar year) annual gift tax exclusion ($26,000 for couples).

·        Bunching medical expenses and/or miscellaneous itemized deductions to maximize use in connection with adjusted gross income minimums.

·        Deferring or accelerating year-end bonuses.

·        Increasing S corp or partnership basis to enable deduction of losses.

·        Paying expenses using a credit card to accelerate deductions without the need for immediate cash. 

Managing the income that you recognize or defer in 2009 may be beneficial, but with tax reform on the horizon, balancing tax rates between 2009 and 2010 and beyond becomes more difficult.  Proposed increases in income and capital gains tax rates for 2011 make the traditional year-end strategy of deferring your 2009 income into 2010 less attractive.  Deferring too much income could result in excessive income in 2010, especially if you also accelerate 2011 income into 2010 to escape higher rates.

As you may have surmised the political nature of changes to our system of taxation causes our tax laws to become more complicated every year.   Through the end of 2010, the number of temporary tax rate and other changes, with their various phase-in and phase-out dates, makes mid- and long-term financial planning more tax driven than ever before.  Please call our office with questions concerning how these new provisions will affect you.