The end of the year is a great time to help clients lower their tax bills or get a larger refund check for next year.
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1. Get Organized
Remind clients to gather their tax data as soon as possible. They should round up all receipts and canceled checks, such as those from charities; check their latest brokerage statements for year-to-date gains or losses; make a checklist of accounts to keep track of the 1099s, if any, when they arrive; and get medical receipts and insurance reimbursement forms in order. If they start organizing their files now, it will be easier to avoid a last-minute rush to your office. It is much easier to have the originals or to request replacements when they have time, instead of discovering at the last minute that they are missing some item that prevents you from finishing their tax return.
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2. Be Aware of the Alternative Minimum Tax
As you develop a year-end planning strategy for your clients, be sure to assess their AMT exposure. Taxpayers who are or might be affected by the AMT have additional factors to consider when attempting to reduce their overall tax bill. The AMT eliminates or reduces the federal tax savings of many common tax planning techniques. A decision to accelerate an expense or defer an item of income to reduce income for regular tax purposes may not always save federal taxes (although it could affect state taxes) because it may subject the taxpayer to the AMT. For example, the deduction for property taxes on a residence, state income taxes (or state sales tax if you elect this deduction option), miscellaneous itemized deductions, and personal exemption deductions are not allowed when calculating the AMT. Certain items of income can also trigger an AMT liability such as the exercise of incentive stock options, interest from certain municipal bonds and large, long-term capital gains and/or qualified dividends.
3. Prepare a Tax Projection
Before the end of the year, tax advisors should prepare a tax projection for their clients based on all of their known income and deductions for the year. By laying everything out in one spot, you can often identify planning opportunities, many of which must be done before the tax year ends. One example is that it may make sense to prepay any state income tax due during the year in order to get a current year federal tax deduction. If a client is in the AMT category, the opposite may be true: it may be more beneficial to make such a payment in the following calendar year.
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4. Review Income and Deductions
The most fundamental year-end tax saver is to adjust the timing of income and deductions. If you anticipate income tax rates to increase in 2013, it may be beneficial for your clients to take income earlier, if possible, in 2012 and defer deductions into 2013 in order to save the taxes on income and have the deferred deductions save on taxes in 2013 when the rates are expected to be higher. In using this strategy, it should be noted that different itemized deductions are subject to different phase-out limits for regular tax purposes as it relates to the AMT.
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5. Postpone Income
If clients are in line for a bonus, they may want to see if their employer will hold off writing the check until January. If they own a cash-basis business, they can time the receipt of income (by deferring receipt until January) by waiting until the end of the year to send their December billings to their own clients and customers. Taxpayers cannot simply defer taxes by not depositing checks received in the bank. (As a caveat, If you expect a client to be subject to the AMT, they should consider accelerating income to the current year in an effort to mitigate the negative aspects of this tax.)
6. Encourage Clients to Fund Their Retirement
Clients should consider converting a traditional IRA to a Roth IRA. Beginning with the 2010 tax year, the income limitations on converting a traditional IRA to a Roth IRA were removed, opening up this planning opportunity to many more taxpayers. Balances in a Roth IRA grow tax free and distributions from Roth accounts are generally not taxable after a five-year holding period. Unlike traditional IRAs, there is no minimum distribution requirement for Roth IRAs. That means that for those who do not need the entire IRA to live on during their retirement years, they can pass on a much larger balance to their heirs and the money continues to grow tax free. Two words of caution: conversion comes with a current-year tax bill and must be paid from money outside of the IRA account for the transaction to make sense. Roth conversions can be a very powerful planning tool, but they are not for everyone. A good tax advisor can help clients understand all of the relevant factors before choosing a Roth conversion.
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7. Are Your Clients Eligible to Claim Casualty Losses?
Affected taxpayers in a federally declared disaster area have the option of claiming disaster-related losses on their federal income tax return for either this year or last year. Claiming the loss on an original or amended return for last year will get the taxpayer an earlier refund, but waiting to claim the loss on this years return could result in a greater tax saving depending on other income factors.
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8. Pay Deductible Expenses Before December 31
Encouraging clients to pay their state income tax estimate before December 31 accelerates their federal deduction. They can also pay property taxes early, make an extra mortgage payment (the interest portion is deductible), pay you for their year-end tax-planning meetings or opt to have dental work or elective (deductible) surgery before the end of the year. Using a credit card is the same as using cashthe deduction is taken in the year the charge is incurred, not the year the credit card balance is paid off.
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9. Plan the Timing of Charitable Giving:
Clients should plan the timing of charitable contributions, and the type of property contributed, to maximize the tax savings. Charitable contributions, along with other deductions, should be timed so as to occur in a year in which clients will be in a higher marginal tax bracket. Only contributions actually made prior to year end are deductible. Clients should consider using a credit card to make year-end gifts and hold onto all receipts. To the extent possible, they should make contributions of appreciated publicly traded stock and other securities held for more than one year rather than cash. In most cases, the contribution of long-term, capital-gain property allows for a deduction equal to the fair-market value of the property contributed and avoids taxation of the appreciation. The exclusion of up to $100,000 from gross income for IRA distributions made directly to qualified charitable organizations is set to expire Dec. 31, 2011. The exclusion is available to taxpayers age 70 ½ or over and counts toward satisfying the donors annual Required Minimum Distribution. Qualified charitable distributions are not subject to the charitable deduction percentage limits, and because the distributions are not included in gross income, they do not increase AGI (Adjusted Gross Income, ones total federal income less certain specified items allowed to be subtracted on the face of IRS Form 1040) for purposes of phaseouts and limitations of deductions, exclusions and tax credits. Donors whose state itemized deductions are limited, as well as those who do not itemize, may find this method of charitable giving especially valuable.
If your clients intend to make gifts to children (or other relatives), they should do it well before December 31 so that the checks clear. Gifts up to $13,000 per person need not be reported. However, if they have not made any gifts in 2011, they should consider making a gift of $13,000 at the end of 2011, and follow it up with another gift in January 2012. Such planning will permit the donor to benefit by investing both amounts at the beginning of 2012 and earn income on the principal for the entire year. Keep in mind that the lifetime exception for 2011 is a generous $5,000,000 and should be considered in your overall tax planning. In 2011, the exemption for Generation Skipping Transfer (GST) tax is $5 million. Therefore, gifts to skip persons (such as grandchildren) that exceed the $13,000 annual exclusion amount per person, will be excluded from GST tax if the total is under $5 million dollars. This is an effective way to transfer wealth and exclude such amounts from estate tax. Review prior Forms 709 (U.S. Gift and Generation-Skipping Transfer Tax Return) first to determine if any GST exemption has been used in prior years. Even if GST gifts were excluded in 2011, these gifts may still be subject to gift tax. A tax advisor should be consulted before GST gifts are made.
11. Offset Capital Gains:
Clients should review their investment portfolio to determine whether they should sell some "losers" before year end in order to offset capital gains you have already realized. Capital losses are first netted with capital gains, and are deductible against ordinary income (the deductible loss is limited to $3,000 a year). Taxpayers should consider recognizing gains that might not be taxed because there is a loss that can offset it. In that way, they can immediately buy back the stock (there is no 30-day waiting period for stocks sold at a gain). If you expect capital gains rates to increase in 2011, your clients may want to consider taking the gain in this year in order to save on the potential income tax increase in the rate. When selling, your clients may wish to consider specifically identifying the shares to be sold. This strategy will help maximize any gains or losses, whether they are short term or long term.
12. Plans to Marry?
If any of your clients are considering getting married, they should consider the tax effects of getting married in December as opposed to January. Taxpayers are considered married for the entire year even if they get married on December 31. (On June 24, 2011, the Marriage Equality Act was signed into New York State law. This permits same-sex married couples to file NYS returns jointly; however, the filing status for same-sex married couples for federal purposes remains single.
For further tax and personal finance tips, visit the Sound Advice section of the Societys Web site at http://www.nysscpa.org.