CHARITABLE CONTRIBUTIONS
As a general rule, you may deduct the full amount of monetary donations made to qualified charitable organizations. If you donate appreciated property held for more than one year, you can generally deduct the fair-market value of the property.
Year-end strategy: Step up charitable gift-giving at the end of the year. If you use a credit card to pay for donations before January 1, 2010, you can deduct the full amount on your 2009 return—even if you don’t actually pay off the credit card charge until 2010. Congress recently tightened the substantiation rules for monetary gifts. For instance, no deduction is allowed unless you maintain a record of the contribution, such as a bank statement, receipt or written communication from the charity. The written communication must show the charity’s name, the date of the contribution and the amount of the donation.
Tip: Deductions for charitable gifts of clothing and household goods are generally limited to items in “good condition.” However, if you obtain an appraisal of more than $500 for a single item, the amount may be deducted, regardless of its condition.
Higher Education
If you are sending a child to college or grad school, the tax law provides some tax relief through credits and deductions. However, be aware that these tax benefits are phased out for high-income taxpayers.
Year-end strategy: Generally, you’re entitled to the tax benefits on your 2009 return for amounts paid or incurred this year. For instance, if you pay the tuition bill for the spring 2010 semester in December, you may qualify for a credit or deduction in 2009. Here’s a brief summary of the two main tax breaks for higher education:
Tax credits: You may qualify for either one of two credits. Under the revamped American Opportunity Tax Credit (formerly called the Hope credit), the maximum credit for 2009 is $2,500 (up from $1,800 for 2008). The credit begins to phase out for joint filers with a Modified Adjusted Gross Income (MAGI) of $160,000; $80,000 for single filers.
The maximum Lifetime Learning credit of $2,000 begins to phase for joint filers with an MAGI of $100,000; $50,000 for single filers.
Tuition deduction: The maximum deduction for 2009 is $4,000 of qualified tuition and related fees for joint filers with an MAGI of $130,000 or less; $65,000 for single filers. The maximum deduction is $2,000 for joint filers with an MAGI up to $160,000; $80,000 for single filers.
Tip: The tax law also allows you to deduct up to $2,500 of annual interest paid on student loans. For 2009, the deduction begins to phase out for joint filers with an MAGI of $120,000; $60,000 for single filers.
ALTERNATIVE MINIMUM TAX
The Alternative Minimum Tax (AMT) is a special tax return calculation involving certain “tax preference” items, technical adjustments and an exemption amount based on your filing status. However, the exemption amounts are phased out for high-income taxpayers.
In effect, if the resulting AMT liability exceeds your regular income tax liability, you must pay the higher of the two. The AMT rate is 26% for the first $175,000 of AMT income; 28% on amounts above $175,000.
Year-end strategy: Have a tax professional calculate your potential AMT liability for 2009. Note that Congress has “patched” the AMT several times in recent years by slightly increasing the exemption amounts. The exemption amounts are shown below.
|
Filing State |
2007 |
2008 |
2009 |
|
Joint filers |
$66,250 |
$69,950 |
$70,950 |
|
Unmarried filers |
$44,350 |
$46,200 |
$46,700 |
Tip: If you are facing AMT liability for 2009 and expect to be in a high regular income tax bracket next year, you might accelerate additional income into 2009. The extra income will be taxed at either the 26% or 28% AMT rate.
New-vehicle Deduction
The new economic stimulus law includes a special tax provision designed to generate sales of motor vehicles. It applies to qualified vehicles purchased after February 16, 2009.
Year-end strategy: If you purchase the vehicle before 2010, you may currently deduct the sales and excise taxes attributable to the first $49,500 of the vehicle’s price. But the deduction begins to phase out if your MAGI exceeds $250,000 for joint filers; $125,000 for single filers.
For this purpose, a “qualified vehicle” includes passenger cars, light trucks, motorcycles and sport utility vehicles (SUVs) weighing no more than 8,500 gross pounds. Motor homes are also eligible for this tax break. The deduction can be claimed only by the initial purchaser of the vehicle. In addition, it is not available for used vehicles, only new ones.
Tip: The new-vehicle deduction must be coordinated with the existing optional deduction for sales tax. Essentially, you can claim one of these tax breaks, but not the other
Kiddie Tax
Under the “kiddie tax,” unearned income of a child who has not reached a specified age is taxed at the top marginal tax rate of the child’s parents to the extent it exceeds an annual threshold. The threshold for 2009 is $1,900 (up from $1,800 for 2008).
Due to a recent tax law change, the kiddie tax currently applies to a child under age 19 (age 24 for children who are full-time students) if the child does not have earned income equal to half of his or her annual support. Thus, this tax affects a wide range of families.
Year-end strategy: Try to minimize your child’s unearned income in 2009. For instance, you might have the child shift investments into growth stock or U.S. government obligations where taxable income is deferred. Another possible option is to invest in tax-free municipal bonds or municipal bond funds. Naturally, you should consider all the relevant economic factors, not just taxes.
Tip: The kiddie tax may also dilute the benefit of the zero percent capital gains rate available to taxpayers in the lower income tax brackets (more on this later).
Medical Expenses
Typically, you may not qualify for medical deductions on your tax return. Reason: You’re entitled to a deduction only to the extent your unreimbursed medical and dental expenses for the year exceed 7.5% of your AGI.
Year-end strategy: If you are near the 7.5% mark—or already over it—schedule nonemergency medical and dental visits before year-end. For instance, you might have an eye examination and end up ordering new glasses. The additional expenses can help you qualify for a medical deduction in 2009 or increase your existing deduction. You may be closer to qualifying for a medical expense deduction than you think. If you’re like most employees, you must contribute an ever-escalating amount to the company health insurance and/or dental plan. When you add in the other expenses, co-payments and deductibles, you might qualify for a deduction in 2009, especially if your family has incurred other sizeable expenses this year.
Tip: Conversely, if you definitely will not exceed the 7.5% mark for 2009, you may as well postpone nonemergency expenses to 2010. The basic idea is to bunch together medical and dental expenses in the year they will benefit you the most.
Dependency Exemptions
As a general rule, you can claim a dependency exemption for a child under age 19, or a full-time student under age 24, if you provide more than half the child’s annual support. For 2009, each dependency exemption is $3,650 (up from $3,500 for 2008).
Year-end strategy: Give your child extra funds if it will push you over the half-support mark for 2009. For example, you might pay the child’s rent bill or car insurance for one month. The exemption will generally be worth more to you than it will to a child in a low tax bracket. However, the tax benefit of personal exemptions (including dependency exemptions) is phased out for high-income taxpayers. The phase-out for 2009 begins at $250,200 of AGI for joint filers; $166,800 for single filers.
Tip: Similarly, you may claim a dependency exemption for an elderly relative you support, but only if the relative has earned less than $3,650 in taxable income in 2009. The half-support test also applies.
Residential Energy Credits
The new economic stimulus law enhances the tax incentives available for installing energy-saving improvements in the home.
Year-end strategy: Don’t delay qualified expenditures. The changes generally apply to installations made in 2009 and 2010. Therefore, expenses you incur this year may count toward your 2009 credit. The new law triples the residential energy credit from 10% to 30%. The list of qualified expenses ranges from skylights to energy-efficient furnaces to simple insulation. In addition, the lifetime $500 dollar cap is eliminated. Instead, the new law imposes a limit of $1,500 over both tax years.
Tip: The dollar caps for solar hot water property, geothermal heat pumps and wind energy property installed by homeowners are also removed. However, a $500 cap remains for qualified fuel cell property costs.
Homebuyer Credit
As part of the 2008 bailout law, Congress created a new tax break for qualified first-time homebuyers. Now the new economic stimulus law has sweetened the deal.
Year-end strategy: Complete a home purchase before December 1. This will entitle you to a credit equal to the lesser of $8,000 (up from $7,500) or 10% of the price of the home. For this purpose, a “first-time homebuyer” is defined as someone who has not owned a principal residence for the three years prior to the purchase. So this tax break is not necessarily limited to young taxpayers. However, the credit begins to phase out for an MAGI of $150,000 for joint filers; $75,000 for single filers.
Tip: Unlike the earlier version of the credit, you do not have to repay the 2009 credit as long as you continue to live in the home for at least three years following the purchase. But the credit is recaptured if you stop using the home as your principal residence during this three-year period.
Capital Gains and Losses
For tax purposes, capital gains and losses are used to offset each other. However, any excess capital loss can also offset up to $3,000 of high-taxed ordinary income in 2009. The remainder is carried over to next year. If a gain qualifies as long-term capital gain (i.e., you have owned the asset for more than a year), the maximum tax rate on the gain is normally 15% (5% for low-income taxpayers).
Year-end strategy: When it makes economic sense, “time” capital gains and losses. For example, if you have already realized capital gains in 2009, you might realize capital losses at year-end to absorb those gains. Similarly, if you have realized capital losses in 2009, gains realized at year-end can offset those losses. For taxpayers in the regular 10% or 15% tax brackets, the maximum tax rate for long-term capital gains of 5% is reduced to 0%. Even taxpayers in higher tax brackets may benefit from the 0% rate on a portion of their long-term capital gain.
Tip: Depending on your situation, you might have children in low tax brackets sell securities to realize long-term capital gain in 2009. This tax break is scheduled to expire after 2010.
401(k) Plans
A 401(k) plan allows you to allocate a portion of your salary to an account where the funds can grow on a tax-deferred basis. In addition, your company may provide matching contributions based on a percentage of your salary.
Year-end strategy: Adjust your 401(k) plan contributions to increase your retirement nest egg. For instance, you might defer more dollars to your 401(k) account after you clear the 2009 Social Security wage base of $106,800. This will result in little or no reduction in your take-home pay. As with other tax-qualified retirement plans, a 401(k) plan must meet strict nondiscrimination requirements to maintain its tax-favored status. There is also an annual dollar cap on elective deferrals. For 2009, you can defer a maximum of $16,500 to your account.
Tip: If you’re age 50 or over, you can add a “catch-up contribution” of $5,500. Thus, the total maximum annual deferral for taxpayers age 50 or over is $22,000.
IRA Contributions
There are two main types of Individual Retirement Accounts (IRAs) designed for retirement savings: traditional IRAs and Roth IRAs.
Traditional IRAs: Contributions are tax deductible unless you are an “active participant” in an employer-sponsored retirement plan and your MAGI exceeds a certain level. For 2009, deductions are phased out for an MAGI between $89,000 and $109,000 for joint filers; $55,000 and $65,000 for single filers. If your spouse is an active participant and you are not, the deduction is phased out for an MAGI between $166,000 and $176,000.
The maximum IRA contribution for 2009 is $5,000. Plus, if you are 50 years of age or older, you can make an extra “catch-up” contribution of $1,000.
Roth IRAs: Contributions are not tax deductible, but withdrawals after five years may be tax-free. To qualify, distributions must be received after age 59½, upon death or disability or to pay first-time home-buyer expenses (up to a lifetime limit of $10,000). The ability to contribute to a Roth IRA for 2009 is phased out for joint filers with an MAGI between $166,000 and $176,000; $105,000 and $120,000 for single filers. The contribution limits for Roth IRAs are the same as for traditional IRAs. If you choose, you may allocate contributions to both types of IRAs, up to the total annual limit.
Tip: The deadline to make IRA contributions for 2009 is your tax return due date. Nevertheless, you can boost retirement savings by contributing sooner. This provides more time for contributions to grow on a tax-deferred basis.
Roth IRA Conversions
If it suits your purposes, you may be able to convert a traditional IRA into a Roth IRA. For instance, you might convert to a Roth to secure future tax-free distributions. However, you can convert in 2009 only if your AGI is $100,000 or less. The tax on a conversion is based on your account balance on the last day of the previous tax year.
Year-end strategy: Wait until 2010 to convert. Due to a recent tax law change, the $100,000-of-AGI barrier will be removed next year. This will provide a new opportunity for high-income taxpayers.
If you convert to a Roth in 2010, the resulting tax liability may be spread out over the following two years—2011 and 2012.
Tip: When it is appropriate, you might undo a Roth IRA conversion by recharacterizing the Roth into a traditional IRA. The deadline for undoing a 2009 Roth IRA conversion is April 15, 2010 (October 15, 2010, if you file an extension for your 2009 return).
Required Minimum Distributions
Normally, you must take Required Minimum Distributions (RMDs) from traditional IRAs and qualified retirement plans after you turn age 70½. If you turn 70½ in the current year, you have until April 1 of the following year to take the RMD. Otherwise, distributions must be made by December 31.
Year-end strategy: Skip the RMD this year if you don’t need the cash. Under a recent tax law change, this requirement has been suspended for the 2009 tax year for IRAs and defined-contribution plans like 401(k) plans. In other words, if you turned age 70½ this year, you do not have to take an RMD by April 1, 2010. However, you still must arrange a distribution for the 2010 tax year by December 31, 2010.
Tip: The tax-law waiver for 2009 does not apply to defined-benefit plans like traditional pension plans. Participants in these plans still must take an RMD before January 1, 2010.
Estate-tax Planning
Culminating a decade of change, the top federal estate-tax rate has been reduced to 45% for 2009, with an effective estate-tax exemption of $3.5 million. Significantly, the estate tax is scheduled to be completely repealed in 2010. However, the tax will be revived in 2011 with a top 55% rate and only a $1 million effective exemption, unless new legislation is enacted. See the chart below for the progression after the law was changed in 2001.
|
Year |
Estate-Tax Rate |
Exemption Amount |
|
2002 |
50% |
$1.0 million |
|
2003 |
49% |
$1.0 million |
|
2004 |
48% |
$1.5 million |
|
2005 |
47% |
$1.5 million |
|
2006 |
46% |
$2.0 million |
|
2007 |
45% |
$2.0 million |
|
2008 |
45% |
$2.0 million |
|
2009 |
45% |
$3.5 million |
|
2010 |
Repealed |
Not applicable |
Year-end strategy: You may reduce the size of your taxable estate through a series of lifetime gifts. Under the annual gift-tax exclusion, you can give each recipient up to $13,000 (up from $12,000 for 2008), without paying any gift tax. For example, if you have three children and five grandchildren, you and your spouse can give each one $26,000 in December 2009 and $26,000 in January 2010. This reduces your estate by a total of $416,000 (8 recipients × $26,000 × 2 years).
Tip: It is expected that Congress will modify these rules. Keep apprised of new developments that affect estate-tax planning.
Miscellaneous
§ When state law permits, you can consolidate outstanding personal debts into a home equity debt. Interest on personal debts is not deductible, but you may deduct mortgage interest paid on the first $100,000 of home equity debt, no matter how the proceeds are used. Caution: The debt must be secured by your home, so use this technique carefully.
§ Miscellaneous expenses are deductible to the extent that the annual total exceeds 2% of your AGI. If possible, pay these expenses at year-end to maximize your deduction for 2009.
§ You may claim a state sales tax deduction in lieu of deducting state income tax on your 2009 return. The sales tax deduction is based on a state-by-state table. Keep records of “big-ticket items,” such as cars and boats that can be added to the table amount.
§ From a tax perspective, it is generally beneficial to sell mutual fund shares before the fund declares dividends at year-end (the “ex-dividend date”) and to buy shares after the date the fund declares dividends.
§ Consider investments in dividend-paying stocks. As with long-term capital gains, the maximum income tax rate on qualified dividends received in 2009 is only 15% (0% for taxpayers in the 10% and 15% regular income tax brackets).
§ Under the “wash sale rule,” you cannot deduct a loss on securities sales if you acquire substantially identical securities within 30 days. To avoid this result, you can (1) wait at least 31 days to repurchase the securities, (2) acquire replacements and wait at least 31 days before selling the first shares or (3) buy similar (but not identical) securities.
§ Use up the funds in your flexible spending account (FSA). In general, if you do not use FSA funds by March 15, 2010, the remainder is forfeited.
§ When appropriate, minimize personal use of a vacation home. Deductions related to rental use are limited to the amount of rental income if your personal use exceeds greater of 14 days or 10% of the number of days the home is rented out.
§ Sell rental property on the installment-sale basis. The gain attributable to the sale may be spread out if payments are received over two or more years.
§ Defer tax on investment income from certificates of deposit (CDs) and Treasury securities by acquiring investments that mature after 2009. Generally, the income from these investments is taxable in the year it is received.
Conclusion
This year-end tax-planning letter is intended only to serve as a general guideline. Of course, your personal circumstances may require in-depth examination. We would be glad to schedule a meeting with you to provide assistance with your tax-planning needs.
This year-end planning letter is published for our clients, friends and professional associates. It is designed to provide accurate and authoritative information with respect to the subject matter covered.
IRS Circular 230 requires us to inform you that the information contained in this letter is not intended or written to be used for the purpose of avoiding any penalties that may be imposed under federal tax law and cannot be used by you or any other taxpayer for the purpose of avoiding such penalties. Before any action is taken based on this information, it is essential that competent, individual, professional advice be obtained.
YEAR END TAX & FINANCIAL PLANNING
We are living in a time of great economic turmoil and uncertainty. Aggressive financial behavior might produce greater profits – or it might increase exposure and cause further losses.
Please check off or list the areas of concern.
* ESTATE PLANNING. There are three bills now under consideration by Congress, with significantly different tax rates and exemptions. Something must be passed in order to address the 2010 One-Year Tax Repeal.
* INVESTMENT DIVERSIFICATION. This can be used to increase potential profit – but might add more risk. Or perhaps you want to consider an even more conservative approach – with different benefits and exposures.
* TANGIBLE INVESTMENTS. The prices of gold, silver, mining stocks, metal funds and futures have fluctuated significantly, but rising steadily due to international economic fears and opportunities.
* OIL AND MINERALS. Many factors affect the price of oil, gasoline and other raw materials used in manufacturing. What are the dangers and where are there some opportunities?
* CURRENCY CONCERN. What if the U.S. dollar continues its recent decline? Will this hurt you – or perhaps be of benefit? What are the options and what are the risks of action – or non-action?
* DEBT MANAGEMENT. Are there opportunities to re-finance debt to gain lower interest rates? Does the economic distress create attractive moves in residential or commercial real estate? Would it be best to accelerate debt repayment?
