Year-end tax planning......what should we do?

Congress adjourned in late September without a bi-partisan agreement to extend the tax cuts before the election; apparently many members of Congress were more concerned about saving their own jobs than they were about coming to an agreement on these important tax laws. And important they are: according to the Wall Street Journal, if the existing tax cuts are not continued, taxes will increase for more than 150 million Americans. This issue is now left to the lame-duck session of Congress.

The Bush tax cuts aside, here’s a look at what is clear at this point.

Energy Tax Credit (IRC Section 25C)

This popular industry tax credit expires on December 31, 2010. It allows a taxpayer a 30% tax credit on the installed cost of qualifying equipment (high efficiency furnaces, boilers, water heaters, air conditioners, heat pumps, and wood stoves and main air circulating fan). This credit applies to existing principal residences only. The maximum allowable credit is $1,500 so the credit is maxed out at installation costs of $5,000 and above. This is not an annual credit. If you took any credit in 2009, that amount must be subtracted from the $1,500 limit to see what, if any, credit amount is available for 2010. This provision is not expected to be extended even if the Bush tax cuts are.

Businesses Taxes

Typically, an asset purchased must be depreciated (written off) over a number of years. Section 179 of the Internal Revenue CodeThis deduction allows a business to immediately expense qualified property in the year it is bought.

The Section 179 deduction limits have been increased for 2010 and 2011. The maximum deduction is now $500,000 and the maximum investment limit is now $2,000,000. Any asset purchases in excess of $2,000,000 will reduce the allowable Section 179 deduction dollar-for-dollar from the $500,000 limit. The allowable Section 179 deduction is limited to the taxable income of the business. Any amounts not deductible in the current year may be carried forward. The allowable deduction for luxury autos (i.e. SUVs) is $25,000. The remaining cost is depreciated over five years.

The 50% bonus depreciation provision that expired at the end of 2009 was re-instated for 2010 only by the Small Business Jobs Act passed by Congress in late September. This allows a taxpayer to write off an additional 50% of the adjusted basis of the property placed in service during the year. Again, this revived provision expires December 31, 2010. First year depreciation limits for luxury autos are capped at $10,96011,060 (including the bonus depreciation). First year depreciation limits for light trucks and vans are capped at $11,06011,160 (including the bonus depreciation).

The Work Opportunity Tax Credit allows a business to claim a credit equal to 40% of the first $6,000 of wages paid to employees in a targeted group. The employee must work over 400 hours during the year. Otherwise, the credit is reduced to 25% for those who work at least 120 hours during the year. The 12 targeted groups include qualified veterans of service in the U.S. Armed Forces, vocational rehab individuals, ex-convicts and disconnected youth. For the complete list of targeted groups, go to the U.S. Department of Labor website (www.doleta.gov). This program is administered at the state level. This credit expires on December 31, 2010 as well.

If you are an “S” corporation that previously was a “C” corporation, the built-in gains (BIG) tax holding period for 2010 is seven years. That means any conversions before 2003 can now sell appreciated assets and avoid the BIG tax (35%). Recent legislation has decreased the holding period to five years in 2011.

If you are considering selling your business, you may avoid higher tax rates by closing the sale in 2010. You may also consider electing out of the installment method and recognizing the entire gain in 2010. It’s important that you do the calculations to make sure it makes sense in your situation. You should also consider selling and recognizing the gain on any other appreciated property.

You also may consider paying out “C” corporation dividends prior to the end of the year. The current dividend rate (maximum 15%) is much more favorable than the dividend rate would be in 2011 if the rates are allowed to increase. In that case, dividends would be taxed at ordinary income rates, which would be as high as 39.6%.

Individual Taxes

In this environment, it is extremely difficult to offer year-end tax planning guidance. Traditional general tax planning strategy is to defer (postpone) taxable income and capital losses and accelerate (pull into 2010) deductions. If the Bush tax cuts are allowed to expire, then the strategy would be reversed: you would accelerate taxable income into 2010 and defer above-the-line deductions into 2011. Above-the-line deductions include: IRA contributions, health savings account, self-employed health insurance, self-employment taxes and alimony, among others. Whether itemized deductions (medical expenses, real estate taxes, mortgage interest, charitable contributions, etc.) should be deferred into 2011 would be determined on a case-by-case basis. This is especially true if the itemized deduction phase-out provision returns for higher-income taxpayers.

The following chart shows the ordinary income tax rates for this year and 2011 if the Bush tax cuts are not extended.

Tax Rates
2010 2011
10.00% 15.00%
15.00% 28.00%
25.00% 31.00%
28.00% 36.00%
33.00% 39.60%
35.00%


The dividend tax rate (currently 0% for those in the 10 & 15% brackets and 15% for all others) would go to ordinary income rates (which could be as high as 39.6% for some taxpayers)! The long-term capital gain tax rate (currently 0% for those in the 10 & 15% tax brackets and 15% for all others;) would go to 10% for the 15% bracket and 20% for all others (different rates for qualified five-year gain property).

Estate Taxes

There currently is no estate tax for 2010. The estate tax returns for 2011 with the exclusion amount (amount exempt from estate taxes) scheduled to be $1 million and a top tax rate of 55%. In 2009, the exclusion amount was $3.5 million and the top tax rate was 45%. I expect that the estate tax issue will be addressed very quickly by Congress, as five billionaires have died so far in 2010, including New York Yankees owner George Steinbrenner. The government has lost over $8 billion in estate taxes from these five families alone because of this.

As you can see, with all this uncertainty surrounding the tax laws, it is difficult for businesses and individuals to do their year-end tax planning. While I expect that many of the Bush tax cuts will be extended, it may be well into 2011 before this gets resolved. At this point, my best advice is to pay close attention to news reports coming out of Washington, D.C. and stay in close touch with your CPA or tax preparer.

U.S. Treasury Department Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that, unless expressly stated otherwise, any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. This article is not intended to be comprehensive in nature and competent professional tax advice should be sought in determining the issues that impact your specific situation.

Year End Tax Planning for Individuals

As the holidays & end of the year fast approach, I’m going to ask you to take a few minutes to review your tax situation for 2009 to see if some of the following ideas may save you some money on your taxes come next spring. As with everything else, you need to consult your own CPA or tax advisor for advice specific to your situation. This post only covers a portion of possible opportunities that may be available to you and there are also some hurdles (like the Alternative Minimum Tax) that may trip you up & keep you from being able to use some of these suggestions. Also, the clock is ticking REALLY fast as some of these opportunities expire on December 31, 2009.

Traditionally, the typical year end tax strategy is to defer income into next year and accelerate deductible expenses into this year. This is done to defer paying income taxes. Think of it as kicking the “tax” can further down the street. This holds true in years where you expect to be in the same or lower tax bracket the following year. If you expect the opposite to be true (higher tax bracket), then accelerate income and postpone deductible expenses. This way more income is taxed at a lower rate. Currently, tax rates for 2011 will be going up for the high-end tax brackets as the Bush tax cuts are allowed to expire. With the programs that the current administration has on its’ agenda to implement, I do not see how they can keep from raising the tax rates on the middle class in 2011 as well.
Here are a few year-end tax planning ideas for your individual returns:

American Opportunity Education (AOE) Tax Credit – This used to be called the “HOPE” scholarship credit. The Stimulus Bill has increased and expanded the educational tax credit. For 2009 and 2010, the credit is 100% of the first $2,000 of qualified educational expenses plus 25% of the next $2,000 of qualified expenses. The maximum credit amount is $2,500 per student per year. Additionally, the credit now applies to the first 4 years of post-secondary education. It was only 2 years under prior law. Qualified expenses include tuition, fees and course materials including books. The old law did not include books. The credit starts phasing out for taxpayers with an adjusted gross income (AGI) of $80,000 (single)/$160,000 (married.)
Tuition Deduction – For taxpayers who don’t qualify for the AOE Tax Credit, there is a deduction allowed for up to $4,000 of tuition and fees paid to an accredited post-secondary school. The deduction is not available to those with an AGI over $80,000 (single)/$160,000 (married).
Estimated Tax Payments-Small Business Owners – For 2009, the “safe harbor” provision for taxpayers in order to avoid underpayment penalties has been expanded. Taxpayers can avoid the penalty if the taxpayer has withheld or makes estimated tax payments totaling 90% of the previous year’s tax return. It was 100% under the old law. The taxpayer’s AGI must have been less than $500,000 and more than 50% of the gross income on the previous year’s return must have come from the small business. NOTE: This provision doesn’t apply to “C” corporations.
Sales vs. Income Tax Deduction – You are allowed to deduct the state & local sales taxes paid instead of the state & local income taxes if you choose. This provision would be most beneficial to those of you in states with no income taxes.
Sales Tax Deduction on Vehicles – For vehicles purchased from February 18th through December 31st, 2009, you can deduct state and local sales taxes on the purchase. The vehicle purchase price cannot exceed $49,500. Vehicles with a gross vehicle weight (GVW) that qualify include: passenger autos, light trucks and motorcycles. Motor homes also qualify with no GVW restrictions. You can take this deduction whether you itemize your deductions or not. The deduction phases out for those whose modified AGI is over $125,000 (single)/$250,000 (married.)
Additional Standard Deduction – For 2009, an additional standard deduction amount is available to those who pay real estate taxes and who do not itemize. The amount is the lesser of the state & local real estate taxes paid during the year or $500 (single)/$1,000 (married.) This expires 12/31/09.
First-Time Homebuyer’s Credit – This credit was expected to end on November 30, 2009. However, it was extended to April 30, 2010 in early November by the bill passed that extended unemployment benefits. This law allows those who haven’t owned a home in the U.S. during the previous 3-year period prior to buying the home a tax credit equal to 10% of the purchase price up to $8,000. The home has to be purchased with a signed contract by April 30, 2010 and it must close by June 30, 2010. The credit is equal to 10% of the purchase price of the home up to a maximum credit of $8,000. The purchase price of the home cannot exceed $800,000 to be eligible for the credit. The credit is a refundable credit meaning you may receive a check from the IRS if you have a zero tax liability. The credit phases out at the following income levels: Single - $125,000 - $145,000. Married filing Joint - $225,000 - $245,000. The taxpayer must be at least 18 years old and not a dependent. Related party transactions (sales between family members) are not eligible for the credit.
The law has also been expanded to include current homeowners who do not qualify for the 1st Time Homebuyer’s Credit. Current homeowners are eligible for a credit up to $6,500 for buying a new house as long as they’ve lived in their current home as their principal residence for 5 consecutive years out of the 8 years prior to the sale of the house.
These are just some of the deductions and credits available. You have until December 31, 2009. Talk to your CPA or tax advisor to discuss your specific situation.
U.S. Treasury Department Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that, unless expressly stated otherwise, any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. This article is not intended to be comprehensive in nature and competent professional tax advice should be sought in determining the issues that impact your specific situation.
Michael A. Bohinc is a certified public accountant in Cleveland, OH. He is also a licensed HVAC and plumbing contractor in the State of Ohio. He is a Consult & Coach Partner for the Service Roundtable. He has over 20 years’ experience working on business management issues in the HVAC and plumbing industries. He can be reached at: 440/ 708-2583, e-mail mbohinc@keepingscorecpa.com.