Typically people rely on a standard set of year-end tax planning techniques such as deferring income to the following year and accelerating deductions into the current year. Examples of these types of tactics are holding off on selling investments with gains until later or paying tax deductions such as property tax or charity donations.
For the year 2010 there’s an extra twist on these traditional tax planning techniques. For one thing, we know with certainty what the 2010 tax rates are. But the exact tax rates that will be in effect for 2011 is somewhat uncertain. As the law is currently written, all the tax rates will change for 2011. There’s been various proposals to keep the tax rates the same or increase only the top two tax brackets. But so far those proposals have not passed into law. Accordingly, people may want to plan out their 2010 taxes with an eye towards the presumably higher tax rates that might go into effect in 2011. And this means that several traditional tax planning techniques need to be reversed. For example people may want to accelerate income into 2010 to lock in a known tax rate now instead of an uncertain or possibly higher tax rate next year. Similarly people may want to defer any tax deductions until 2011 so those deductions will offset next year’s income at presumably higher rates.
Income Deferral Strategies
• Ask your employer to pay out any bonuses in January 2011 instead of in 2010.
• Hold off on selling stocks and other investments with taxable gains until next year.
• Hold off on taking distributions from an IRA or other retirement account until January.
• Convert pre-tax retirement savings to a Roth account, and opt to report the income in 2011 and 2012.
Income Acceleration Strategies
• Ask your employer to pay out bonuses in 2010 instead of next year.
• Sell off stocks and other investments with taxable gains in 2010 instead of next year.
• Take IRA distributions in 2010 instead of 2011.
• Convert some or all of your pre-tax IRAs and 401k(k) contributions to a Roth account, and opt to report the income in 2010.
Deduction Acceleration Strategies
• Pay tax deductible expenses in 2010 instead of 2011, such as medical bills, charity donations and proeprty tax.
• Sell off stocks and other investments that have lost value so you can take the losses on your 2010 return.
• Increase your 401(k) or IRA contributions.
Deduction Deferral Strategies
• Defer paying medical bills, charity donations, property tax and other deductions until next year.
• Hold off on selling losing investments until 2011 when presumably the capital gains tax rate will be higher, and thus losses will have more tax value.
AMT Tax Planning
People who are or might be impacted by the alternative minimum tax have additional considerations to think about. The AMT eliminates or reduces the federal tax savings for medical expenses, state and local taxes, and miscellaneous itemized deductions. The suggestion here is to pay those expenses when they are due instead of trying to accelerate or defer them. For example, instead of prepaying the next installment of your property tax, wait until the actual due date to pay that since property tax is an adjustment for the AMT calculations. Similarly, anyone impacted by the AMT should sell any incentive stock options that they exercised during the 2010 calendar year since the value of an exercised but unsold ISO is added to your income for calculating the AMT.
Planning for the AMT does have uncertainty. As the law currently stands, the AMT will be affecting many more taxpayers in 2010 than in 2009 and people will have higher AMT tax liabilities in 2010 compared to 2009 as a result of a lower AMT exemption amount. However, Congress often adjusts the AMT at the end of the year or the early part of next year to minimize this tax increase. So part of the planning process is figuring out how much AMT you might have to pay, and then figuring out what steps, if any, can be done to mitigate the tax impact.
Tax Planning Tips Specific
to 2010 Only
There are several tax breaks that expire at the end of 2010. The advice here is to take the tax break while you can.
• Energy efficient home improvement credit expires at end of 2010. Certain types of energy-efficient home repairs can result in a federal tax credit. Replacing windows, doors, and replacing HVAC system and installing new insulation all count towards this tax credit.
• Hybrid vehicle tax credit expires for all models.
• Guaranteed 15% maximum rate for long-term capital gains. For 2011, the top rate might go back to 20% for long-term gains. Qualified dividends lose their preferred tax rate and revert back to being taxed at ordinary income tax rates.
• Child and dependent care tax credit will be reduced starting in 2011. For 2010, the child care credit is available for the first $3,000 of day care expenses for one child and the first $6,000 of day care expenses for two children, with the maximum tax credit set at 35% of expenses. For 2011, the credit will be limited to the first $2,400 of expenses for one child and $4,800 of expenses for two children, with the maximum credit being 30% of expenses.
• Child tax credit at $1,000 per child. For 2011, the child tax credit will revert to $500 per child.
• Computers as a qualified expense for section 529 college savings plans expires at the end of 2010.
• Earned income credit for third child ends in 2010. For 2011, the EIC will be based on at most two children.
• Student loan interest deduction is scheduled to change. Beginning in 2011, interest paid on a student loan will be deductible only for the first 60 months of repayment, and the phase out range will start at $40,000 (or $60,000 for married couples filing jointly).
• American Opportunity tax credit for undergraduate education expires at the end of 2010. It will revert back to being the Hope credit for the first two years of undergraduate education.
• Making Work Pay tax credit expires at the end of 2010.