While lawmakers have pledged to patch the Alternative Minimum Tax this year, there remains plenty of uncertainty in the current tax landscape.
However, there are a number of actions that advisors can recommend to their clients to save taxes, according to Leigh Mutert, a CPA with tax preparation chain H&R Block. "We tell advisors there are three areas that taxpayers can invest in and save money at the end of the year," she said. "They can invest in themselves, in their home, and in their future retirement."
"To invest in themselves, for example, they can take advantage of education credits by prepaying their spring tuition," she said. "They can do it now, but we don't know yet if it can be done next year."
"Further, they can invest in a hybrid vehicle, and save several hundred to several thousand dollars in tax credits," she said. "And if their overall stock portfolio shows gains, those can be offset with losses. This might be a good year to sell out of a loss position and save in taxes by using them against any gains. Also, it's likely that the capital gains rate will be higher next year, so this might be a good year to take out a pure gain."
Taxpayers can invest in their home by using the Energy Efficiency Credit, which is in effect for 2009 and 2010 returns, she explained. "These expire at the end of this year. There's a $1,500 limit for the two years. If they used up $800 in 2009, they have $700 left to use this year."
Mutert advised preparers to be on the watch for the First-Time Homebuyer's Credit. "If they qualify in 2010, we advise people to amend their 2009 returns and get the refunds now, rather than wait," she said. "And for those who received the first credit, which was really a loan, this is the year they have to start paying it back over 15 years at $500 per year."
RETIREMENT AND ROTHS
Now is a good time to beef up contributions toward a company retirement plan, Mutert advised. "And check out Roth IRA conversions, which give the option of paying the tax in 2010, or divided between 2011 and 2012. Exercise caution here, because we don't know what the rates will be in 2011 and 2012".
Pauline Dana-Bashian, a tax attorney and chief compliance officer at Pension Parameters Financial Services, agreed. "If income is low this year, it may be the ideal time to start a Roth IRA, because you only have to pay the tax once," she said. "While you don't get a deduction, the earnings accumulate tax-free and there is no tax when you withdraw the funds as long as you are over age 59-1/2 and have had the money in the account for at least five years. This offers the same advantages as a 401(k) plan in that you accumulate more shares through re-investments of dividends and capital gains."
"One of the most important things is to consider setting up some form of pension or retirement plan," she added. "Not enough CPAs push this with their clients, and it's so important for small-business owners to have. If they're paying any taxes, they should be putting money into some form of plan and getting a deduction. Also, it aids the accountant because it enhances the bond with the client."
"For example, they can open a profit-sharing plan, put in $1,000 now and make contributions by the time they owe taxes, which can be as late as Oct. 15, 2011," she said. "In the meantime, they get a deduction for the money they want to shelter this year."
Traditional retirement accounts like 401(k)s and IRAs still offer some of the best tax savings, agreed Justin Ransome, a partner in Grant Thornton's Washington, D.C., National Tax Office. "The contribution limits for 2010 are $16,500 for a 401(k) and $5,000 for an IRA, not including catch-up contributions for those 50 and older. Regardless of whether tax rates go up, it almost always makes sense to put as much money into tax-favored retirement vehicles as you can."
CONTROLLING INCOME, EXPENSES
Year-end planning emphasizes deferral of income and acceleration of deductions. "However, if tax rates increase next year, it may be wise to reverse this strategy," Ransome explained. "There are plenty of income items and expenses you may be able to control. Consider accelerating bonuses, consulting income or self-employment income. On the deduction side, you may be able to defer state and local income taxes, interest payments and real estate taxes."
Since many expenses can be deducted only if they exceed a certain percent of adjusted gross income, Ransome suggested bunching itemized deductible expenses into one year to overcome these AGI floors. "Consider scheduling your non-urgent medical procedures all in one year to get over the 7.5 percent AGI floor for miscellaneous expenses," he said.
The "Kiddie Tax," which requires a portion of a child's unearned income to be taxed at the parents' marginal rate, has been expanded to apply to full-time students under the age of 24 whose earned income does not represent at least one half of their support, Ransome cautioned. "Be careful transferring income-producing assets to children," he said.
Tax expert Doug Van Der Aa, CPA, JD, advised preparers to bone up on depreciation changes and take advantage of the new IRC Section 179 deduction for nonresidential real estate. "The Small Business Jobs Act of 2010 increased the Section 179 deduction to $500,000 and also, for the first time, made certain kinds of real estate eligible for the deduction," he said. "You can take up to $250,000 of the Section 179 deduction on qualified leasehold improvements, qualified restaurant property and qualified retail improvement property."
"Double-check all your fixed asset and depreciation reports, because in a lot of firms fixed asset additions are done by junior accountants, often audit staff who are not even tax people," cautioned Van Der Aa. "Many of them don't know the depreciation rules, and haven't paid attention to recent tax changes."
Those who convert from a traditional IRA to a Roth should plan to extend their tax return, he advised. "You want to keep it open depending on what happens in Washington with regard to tax rates. When you convert to a Roth, the normal rule is to take the amount into income over two years on the 2011 and 2012 returns, but you have the election to include everything on your 2010 return. If you extend, you have until October 15 of next year to wait and decide whether to include everything in income this year, or spread it into 2011 and 2012."
"This is the first year that the $100,000 AGI limitation has disappeared, and it might be more attractive to pay the tax this year if there will be higher rates in future years," echoed CCH principal analyst Mark Luscombe.
"The way you opt out of spreading the tax due to 2011 and 2012 is simply to pay it for 2010," Luscombe said. "If you don't include it on your 2010 return, the IRS assumes you intended the default situation. And even if you convert in 2010, you have until October 15 to watch the market. If you decide you converted at a high point in the market, you can undo that conversion. And it's possible to do separate Roth conversions from different accounts, so you can pick which ones make sense to convert."
Watch out for foreign bank accounts and foreign trusts, Van Der Aa warned preparers. "There are extensive new reporting and compliance rules," he said. "Especially troublesome are foreign spouses with inherited assets. It's easy to be overlooked by an individual or a company controller or treasurer that has signatory authority."
Inherited assets generally can present a problem, according to Van Der Aa. "While there's no estate tax, there's also no more tax-free step-up in basis," he said. "We either have to worry about how much Aunt Sally paid for her AT&T stock when she was a switchboard operator for Ma Bell in the 1960s, or learn how to allocate and report the limited basis step-up we're allowed under the statute."
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