Individual Year-End Tax Planning
Individual Year-End Tax Planning
Tax Planning is Critical for your Household This Year
Year-End Tax Planning Part II: Individuals
Smith, Kunz likes to take advantage of this time of year, after the tax extension deadlines and before the holiday season, to do some year-end tax planning. Both individuals and businesses can take actions to reduce their taxes. As always, don’t let the tax tail wag the family budget dog. Any tax planning action must make economic sense.
Current Tax Environment
There seems to be a louder call for tax reform than in previous years. Much of this has to do with the U.S. budget crisis. Last year’s Simpson-Bowles Deficit Commission recommended tax reform as a way to reduce the deficit. President Obama has proposed changes to the tax code.; A trio of Republican congressman has come up with another tax reform plan. Everyone has heard of presidential candidate Herman Cain’s 9-9-9 plan. The congressional “Super Committee” that’s been charged with finding $1.2 trillion in savings over the next 10 years by around Thanksgiving is also considering tax law changes. No one is satisfied with the current law. Tax reform is a great possibility.
Although the long-term tax situation remains in flux after 2012, there is some degree of certainty for the next 14 months. We currently don’t expect major revisions to the tax code at the eleventh hour for 2011 and 2012. As always, tax planning is a moving target, but the following recommendations could suit your specific situation. Please contact us with any questions.
Certain individual provisions are slated to expire after 2011, with no guarantee at this time that they will be extended into 2012. For this reason, it is important to take advantage of these tax breaks while they are available. They include, but are not limited to, the following benefits:
- State and local sales tax itemized deduction in lieu of the state income tax deduction;
- Mortgage insurance premiums itemized deduction as mortgage interest;
- Higher education expenses above the line deduction, which can be as high as $4,000;
- Teacher’s $250 classroom expense above-the-line deduction;
- Exclusion from income of distributions of up to $100,000 from an IRA if made directly to charity;
- Non-business energy credit for qualified energy efficiency improvements and residential energy property expenditures, which used to be $1,500 but is $500 for 2011;
- Credit for certain plug-in electric vehicles;
- Use of nonrefundable personal tax credits against alternative minimum tax (AMT) liability; and
- Higher limits for charitable contributions of appreciated property for conservation purposes.
All wage earners and self-employed individuals will experience a tax increase in 2012 unless Congress extends the current employee-side payroll tax cut. For calendar year 2011, the employee’s share of OASDI taxes is reduced from 6.2% to 4.2% up to the Social Security wage base of $106,800 (self-employed individuals receive a comparable benefit). President Obama has proposed to extend and enhance the payroll tax cut. The fate of the payroll tax cut will likely be decided by Congress late in 2011.
Income and Deduction Shifting
The Bush-era tax cuts remain in effect through the end of 2012, so there is no difference in the income tax rates that generally apply in 2011 and 2012. Individual tax rates are not scheduled to rise until 2013, if at all. The 15% maximum rate for net long-term capital gains and qualified dividend income also will not rise until 2013.
Although tax rates aren’t predicted to change from 2011 to 2012, your income may not be so constant. There is always potential for year-end planning that involves shifting income to a later year, by accelerating deductions and deferring income. For example, an individual taxpayer would time his income and deductions so that taxable income is about even for 2011 and 2012. If a taxpayer anticipates a higher tax bracket for 2012, he may want to accelerate income into 2011 and defer deductions into 2012. If the taxpayer anticipates a leaner 2012, income might be delayed through deferred compensation arrangements, postponing year-end bonuses, maximizing deductions, and delaying year-end billings as appropriate for the taxpayer’s circumstances.
The twist for year-end tax planning for 2011 is the uncertain future for tax rates after 2012. Many political observers forecast that higher-income taxpayers will be asked to pay more, either through higher tax rates or more limited deductions. That may suggest a strategy in which income is not deferred but is recognized now at lower tax rates still available in 2011 and 2012.
Gains and Losses
Consideration should also be given to a taxpayer's capital assets, so that recognition of capital gains and losses at year-end are timed to minimize net gains and maximize deductible losses. Many investors have excess capital losses from recent stock market declines that they may now carry over to offset capital gains in the future that would otherwise be taxable.
Also of concern is whether the maximum tax rate for capital gains will rise from 15% to 20% or higher after year-end 2012 because of the scheduled expiration of the Bush-era tax cuts. Since long-term capital gains are only available on stocks and other capital assets held for more than one year, a capital asset must be bought on or before December 30, 2011, in order to be sold in 2012 and guarantee qualifying under the lower capital gains rates.
Finally, capital gains taxes at a zero-percent rate apply to small business stock acquired by the taxpayer before the end of this year. The 2010 Tax Relief Act allows the exclusion of 100% of the gain from the sale or exchange of qualified small business stock acquired by an individual after September 27, 2010, and before January 1, 2012, and held for more than five years. The window of opportunity to invest in stock that will yield 100% tax-free gain closes on December 31, 2011.
AMT (Alternative Minimum Tax)
When the AMT was established, it was intended to apply to higher income taxpayers; however the exemption amounts were not indexed for inflation. In recent years, more and more taxpayers have become subject to the AMT. Congress has responded by raising the exemption amounts on a year-by-year basis as a temporary patch.
No one likes application of the AMT to middle-class taxpayers, but so far the loss of revenue from abolishing the tax or indexing the exemption amounts to inflation is considered too difficult to replace. Eliminating the AMT or indexing the exemption remains a target of comprehensive individual tax reform.
AMT relief has been provided through 2011 through an increase in the AMT exemption amount. Generally, the increase in the exemption amount is extended from year to year, but it is possible that Congress will not increase the exemption amount for 2012 and let it sink to prior levels. Thus, while dealing with the AMT may take additional planning, it could make sense as the year end gets closer to realize AMT income in 2011 (such as capital gain income), when the exemption is higher.
For 2011, the exemption amounts are $48,450 for individual taxpayers; $74,450 for married taxpayers filing jointly and surviving spouses; and $36,225 for married couples filing separately. Without the patch, the exemption amounts would drop, respectively, to $33,750, $45,000, and $22,500.
Contributions to an individual retirement account (IRA) are an important deduction that reduces taxable income. Individuals can also reduce their taxable wages by making a contribution to an employer-sponsored retirement plan such as a 401(k) plan.
The IRA contribution limits are $5,000 for individuals under 50 and $6,000 for individuals older than 50, who can make catch-up contributions. It is better to make a contribution each year if possible. For some taxpayers, the contribution is fully deductible; for other taxpayers (such as those in another retirement plan), the deduction is reduced or disallowed.
Converting an IRA to a Roth IRA was more important for 2010 because the income realized from the conversion in 2010 could be split between 2011 and 2012. This is not the case for a 2011 conversion; all income must be recognized in the year of the conversion.
Nevertheless, it is still important to consider whether to convert a traditional IRA to a Roth IRA, since distributions from a Roth IRA are nontaxable. Furthermore, those who converted in 2010 and elected not to recognize the income on their 2010 returns must remember to include half of that conversion income into estimates of 2011 income for tax planning purposes.
Effective January 1, 2011, over-the-counter medications and drugs can no longer be reimbursed from a health flexible spending arrangement (Health FSA) unless a prescription is obtained. The rule also applies to health reimbursement arrangements (HRAs), health savings accounts (HSAs), and Archer medical savings accounts (Archer MSAs). This is an important consideration for taxpayers who are required to make a decision by year-end 2011 on how much to fund their accounts in 2012.
Energy Tax Incentives
For taxpayers who are considering replacing their roof, HVAC system, or windows and doors, doing so using energy-efficient materials before January 1, 2012, may generate tax savings. Through the end of 2011, a number of residential energy-efficiency improvements qualify for a tax credit. These include qualified windows and doors, insulation products, HVAC systems, and roofing. The “lifetime” credit amount for 2011, however, is $500, and no more than $200 of the credit amount can be attributed to exterior windows and skylights.
The current estate tax through 2012 is set at a maximum 35% rate and a $5 million exemption amount. Many experts predict after 2012 that Congress will lower the exclusion to $3.5 million and raise the top rate to 45%. In light of this possibility, lifetime gift-giving, ideally on an annual basis, should continue to form part of a master estate plan. The annual gift tax exclusion per donee on which no gift tax is due is $13,000 for 2011 (and is predicted to remain the same for 2012), with $26,000 allowed to each donee by married couples. Making a gift at year-end 2011 to take advantage of this annual, per-donee exclusion should be considered by anyone with even modest wealth.
With the U.S. budget crisis defining most political debates and many different parties proposing tax reform, year-end tax planning has become more complex. Many significant credits and deductions are scheduled to expire at the end of 2011. Actions taken in 2011, while there is still a degree of certainty regarding the tax law, take on added importance. Please give us a call at (208) 356-8500 so we can discuss options available to you.