With a brief three months remaining in 2011 and a high degree of uncertainty surrounding any major tax changes, practitioners have begun stepping up the annual rite of year-end planning strategies for both their individual and business clients.
Though strategies and client situations may differ, tax experts strive to reduce client tax liabilities both for the current and following year, and therefore avoid unpleasant - and often expensive - surprises via tax underpayments.
We asked a number of veteran tax practitioners to weigh in with their top year-end planning strategies, as well as to highlight what they felt were among the most overlooked tax planning techniques.
"The fundamentals of effective tax planning are to defer taxable income and to accelerate deductible expenses and losses," explained George Farrah, executive editor, Tax and Accounting, at BNA. "This includes measures such as making your January mortgage payment in December or selling stocks for which you'll recognize a loss."
Farrah also emphasized maximizing the 2011 payroll holiday. "For 2011, individuals who have wages or self-employment income subject to the Social Security tax that can be accelerated, should do so to take advantage of the reduced payroll tax holiday rate," he said. "In 2011 only, employees and self-employed individuals pay just 4.2 percent Social Security taxes on wages and self-employment income up to $106,800, which is reduced by 2 percent. This is an incentive to accelerate such income to 2011, rather than recognizing it in the following year."
Farrah further suggested making lifetime gifts in excess of the annual exclusion amount, as the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 increased the gift tax exemption to $5 million for 2011 and 2012, providing a window of opportunity for large estates to make significant gifts without the imposition of tax.
"Lifetime transfers can be used to reduce the size of the donor's taxable estate and to shift income-producing assets to beneficiaries in lower income tax brackets," he said. "Due to the equivalent increase in the GST exemption to $5 million, even greater tax savings may be achieved by transfers to trusts in which all the beneficiaries are skip persons, with a corresponding allocation of GST exemption. If the GST exemption is sufficient to cover the entire trust, future distributions from the trust will not be subject to transfer tax."
STOCK AND SALES TAX DEDUCTIONS
Meanwhile, new business owners should consider the advantages of structuring as a C corporation that issues qualifying small-business stock.
Shareholders who acquired qualifying small-business stock after Sept. 27, 2010, and before Jan. 1, 2012, may exclude 100 percent of the gain on the stock, provided that the five-year holding period and certain other requirements are satisfied.
"Given that the current 15 percent highest capital gains rate is set to increase in 2013, the potential exclusion of 100 percent of the gain from qualifying small-business stock several years out, when the capital gains rate likely will be higher, is an important consideration in structuring an investment in a business entity," Farrah declared.
At UHY LLP, principal LeighAnn Costley pointed to sales tax deductions as one of the provisions set to expire in 2011 that taxpayers should take advantage of. "Individuals who itemize deductions can deduct state income tax payments on their federal returns, but for those who live in areas without individual income taxes - Florida, Texas, Nevada, Washington, South Dakota, Wyoming and Alaska - there's a statute whereby they can deduct state and local sales taxes paid on their federal returns," she noted. "There's a sliding scale based on income and jurisdiction for the deductible amount of sales taxes, but those affected can additionally benefit by making any qualifying large purchases, such as a car, before December 31, as the sales tax on such purchases is deductible in addition to the sliding scale amount specified in IRS tables."
Another year-end strategy for taxpayers would be to avail themselves of tax-free distributions from IRAs to charities. Costley said that taxpayers who are required to take a minimum distribution from their IRA (those over age 70-1/2) currently may take advantage of a tax-free distribution up to $100,000 when they distribute it directly to a charity of their choice. "The distribution is not includible in adjusted gross income, nor is the charitable contribution deductible on Schedule A, yet it satisfies the minimum distribution requirements," she said. "For taxpayers that have sufficient sources of income other than their IRAs, this provides a unique opportunity, and expires at the end of 2011."
For small businesses, she explained that the expanded provisions of Section 179 (passed as part of the Small Business Act of 2010) will expire at the end of the year. "This allows businesses to fully expense up to $500,000 of qualifying property, instead of capitalizing and depreciating it over time," she said. "In order to expense this property, business income cannot exceed $2 million dollars."
THE POWER OF THE 401(K)
Jude Coard, a tax partner at New York-based Berdon, urged those who are self-employed to establish a 401(k): "If your goal is to maximize your contributions, this may be a more powerful alternative to a Simplified Employee Pension plan if you act before year-end. Even though you can establish and contribute to SEP plans all the way up to the extended due date of your tax return, the deduction may be less than the 401(k)."
Also, he said that business owners should accelerate deductions. "Project your capital outlay for the business. If you expect to purchase items early next year that qualify for bonus or Section 179 expenses - technology, manufacturing equipment - it may be to your benefit to accelerate the purchase before year-end - even if you have to borrow."
For individuals, Coard urged taxpayers to use up the maximum $13,000 of the annual gift exemption. "It's a simple, no-cost way of doing a little estate planning," he advised.
Wonsun Willey, a tax partner at California-based Sensiba San Filippo, instructs clients to sell highly appreciated capital assets if capital losses are available from prior year, as the prior capital loss carryover will absorb the current-year gain and therefore have no tax impact.
Also, Willey said that taxpayers should consider prepaying or deferring state income tax and real estate tax payments, but only in the case where a client is not subject to the Alternative Minimum Tax.
In the scramble to implement effective tax-planning strategies, many practitioners overlook a number of potential money-savers.
Farrah of BNA said that while most taxpayers focus on federal tax planning, many forget about state planning. He suggested finding out whether your state offers credits or incentives for energy-efficient home improvements that expire at the end of the year, and if so, consider making improvements by year-end. Also he advised residents to inquire whether their state offers deductions for 529 college savings plans, and if it does, to set one up.
UHY's Costley opined that one of the most missed opportunities is the failure to time income and deductions. She said that each person or business should assess their situation and strategically think about when deductions are made, which can significantly impact their tax situation.
Coard of Berdon said that high-net-worth individuals often bypass the gifting of depreciated assets - particularly with values of closely held businesses and real property still depressed and low interest rates. "There are a number of estate planning techniques using such vehicles as GRATs and intentionally defective trusts to transfer these assets to the next generation and let them recover in value and grow outside your estate," he said.
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