November 20, 2009
Dear clients and business associates,
It's that time of year again to take some action to reduce your taxes. Although we realize that many things are beyond your control, there are still a few things you can do:
Avoid capital gains taxes this year
Review your investment accounts to be sure you shelter all of your capital gains by selling additional (loss) security positions if necessary. If you sell a loss security, then you cannot purchase the same security within 30 days (before or after), otherwise the tax loss will not be allowed under the 'wash sale' rules. Note that you can sell a mutual fund (Fidelity S&P 500) and purchase a similar mutual fund (Schwab S&P 500) or ETF from another company to avoid the wash sale rules. Pay special attention to your mutual fund long-term capital gain (LTCG) distributions by reviewing your brokerage statements. These distributions are made in the form of additional mutual fund shares and usually catch investors by surprise come tax time. You may not be able to predict your December mutual fund capital gains distributions, so consider taking excess capital losses to offset current capital gains and the potentially huge mutual fund LTCG distributions. Excess losses will carryover to future tax years so they will not be wasted.
Investment decisions to buy or sell should always be considered when tax trading.
Retirement Plan Contributions
Take a look at your last pay stub to check your YTD 401(k) or 403(b) contributions. You can contribute up to $16,500 ($22,000 if you are 50 or older). If you are able, see HR or the payroll department to maximize your contribution by December 31st for a tax write-off.
Charity
Donations are deductible in the year you make the gift so we recommend you make your last minute contributions by December 31st. Always obtain a receipt for non-cash gifts. Non-cash donations valued at $5,000 or more require a qualified appraisal. Credit card donations are deductible in the year charged to your account.
The donation of appreciated securities held over 1 year allows you to deduct the fair market value of the stocks while avoiding the capital gains tax. Never donate (loss) securities. The donation of publicly traded securities does not require an appraisal.
Donor advised funds
Donor advised funds (DAF) are beneficial since: 1) you can contribute cash or stock by December 31st to obtain an immediate tax deduction even if you haven't decided on a specific charity; and 2) it is usually easier to donate appreciated stock to a DAF than directly to a charity since many aren't setup to accept stock donations. The DAF sells the stock and you "advise" where the money goes.
Prepay taxes (N/A if you are in AMT, see AMT section below)
Projecting and prepaying state income taxes allows you to accelerate this tax write-off by a year. If you have consulting income or substantial interest, dividends, capital gains, rental profits, or K-1 income, then you will likely owe additional state taxes beyond your paycheck withholding. In this instance, contact us if you would like assistance in calculating this amount. We also recommend you prepay your April 2010 real estate tax installment by December 31st to obtain a 2009 deduction on both your federal and California tax returns. State income and real estate taxes are not deductible if you are in AMT.
Medical and miscellaneous itemized deductions (see AMT section below)
Try to bunch “threshold” expenses such as medical expenses or miscellaneous itemized deductions. These expenses are deductible only to the extent they exceed a certain percentage of adjusted gross income. These expenses are more valuable in lower income years.
Income shifting (for business owners)
If you are able to control your income, then deferring revenue to January will result in delaying the associated taxes as well. Consider billing your clients in late December or January to avoid receiving the payment until 2010. If you’re able to prepay January expenses this year, then you should pay them now and get a deduction in 2009. If you use a “bank” credit card (Visa, MC, AMEX, Discover) then the expense is deductible this year even though you pay your credit card bill in 2010.
But don't prepay expenses if you think you'll be in a higher tax bracket next year!
If you think your income will be substantially higher next year (maybe you were unemployed for a portion of this year, or you are anticipating a large bonus next year), then you might consider doing the opposite of the planning suggested above. That is, you may want to accelerate income into this year and defer expenses to next year to shift income to a lower tax bracket.
Business assets (§179 and "bonus depreciation")
A trade or business can expense up to $250,000 of equipment and furniture placed in service in 2009 ($25,000 for heavy trucks and 6,000 lb. SUVs).
Incentive Stock Options
An exercise and hold strategy will most likely result in you paying AMT. You need to call us if you exercised and held ISOs this year or are contemplating such a strategy. If you did ex-and-hold ISOs earlier this year, then you may be able to reduce your tax bill by selling the stock by December 31st if it has lost value since the exercise.
Tax credits for hybrid autos and light trucks (2008-2010)
You may receive a tax credit when you purchase a qualified hybrid passenger car, SUV, or light truck placed in service before 2011. Your local dealership will have specific information related to the tax credit for a particular vehicle. This credit is not available for Hondas, Toyotas, and Lexus and you will not receive a tax credit if you are subject to AMT.
Tax Credits for solar and fuel-cell equipment (for purchases through December 31, 2016)
Tax credits for energy efficient improvements (purchases in 2009)
You will be able to claim a tax credit for buying an assortment of energy saving improvements (insulation materials, exterior windows, including skylights and exterior doors) and installing them in your primary residence. The credit equals 30% of the cost plus installation with a maximum credit of $1,500. The various manufacturers / retail outlets will have information regarding the applicability of the tax credits to the materials you purchase.
Solo 401(k)
A solo 401(k) plan may be established by self-employed individuals or small business owners. You can contribute up to $16,500 ($22,000 if you are 50 or over). This plan is better than a SEP-IRA in lower income years since it enables you to contribute a larger % of your net profit. Note that these plans usually have related adminstrative costs that SEP-IRAs don't.
Health Savings Accounts
Health Savings Accounts resemble IRAs for medical costs since:
- The HSA is a financial account,
- Contributions to the account are tax deductible, and
- The account grows tax free
The funds in the account are used to pay your qualified medical expenses and you are not taxed on HSA distributions to pay these costs. HSA health plans are more tax-efficient than regular insurance plans due to the ability to deduct the contributions to the account. Without an HSA, payments for medical expenses are usually not deductible due to AGI limitations. You’ll need to comparison shop to see if it makes sense to switch from your current insurance plan to an HSA plan since HSA premiums tend to be higher due to the tax benefits.
* The insurance premium for an HSA insurance plan is deductible but subject to the AGI limits L
An 'extra' IRA
The HSA functions much like an IRA for amounts withdrawn at age 65 or later and not used for medical bills. Consider maximizing your HSA contributions, build up the account, and whatever is left over after medical expenses can be used as additional "taxable" retirement funds. Taxable distributions before age 65 are subject to additional penalty taxes.
* Alternative Minimum Tax (AMT) - be careful when tax planning
The following tax deductions are not deductible for AMT purposes:
- State income tax
- Real estate taxes
- Sales taxes
- Miscellaneous itemized deductions
If you are in AMT, then we recommend that you do not prepay state and real estate taxes. The AMT significantly complicates tax planning and the proper timing for certain tax deductions. We will be able to determine if you are in AMT by preparing a tax projection.
Gift Planning
Each person is entitled to give $13,000/year to an unlimited number of persons without incurring a gift tax. You can contribute $65,000 ($130,000 with your spouse) to a §529 college savings plan in a single year and avoid gift taxes if a gift tax return is filed with the proper tax elections. The direct payment (to the provider) of education or medical expenses for another are considered tax-free gifts without limitation. Contact us for details.
If income is down this year
If you're income is down due to a business loss or unemployment, yet you still have significant deductions such as mortgage interest, real estate taxes, charitable contributions and dependent exemptions, then this presents an opportunity to convert your taxable IRA accounts to tax-free Roth-IRA accounts, with potentially little to zero tax cost. Contact us to assist you in calculating the amount you should convert.
Other reasons to convert a Traditional/SEP IRA to a Roth IRA
Now may be a good time to convert your traditional IRA to a Roth-IRA since the portfolio may have taken a beating. If your modified adjusted gross income (AGI) does not exceed $100,000, you may convert an amount held in a traditional or SEP-IRA to a Roth IRA. The conversion is subject to tax as if the funds in the traditional IRA were distributed and recontributed to the Roth IRA, but the conversion isn’t subject to the 10% premature distribution tax. All taxpayers may participate regardless of AGI beginning in 2010.
Spread out the tax on a Roth Conversion
If you plan to convert an IRA to a Roth, you may want to wait until 2010 since the tax on 2010 conversions can be deferred and spread out over 2 years. You can have 50% of the conversion taxed in 2011 and 50% taxed in 2012. This may not be a good strategy if you expect to be in a higher tax bracket during those years.
1st Time Home Buyer Credit has been extended!
This credit has been extended to purchases before May 1, 2010 (including if you are in contract before May 1 and you close before July 1). Note the following limitations:
- $4,000 credit ($8,000 if married) for 1st time home buyers
- $3,250 credit ($6,500 if married) for existing homeowners who have lived in their current residence for 5 consecutive years of the 8 years ending on the date of close. You do not have to sell your existing residence to qualify.
- Not eligible if you are under 18 on date of purchase
- Not eligible if you can be claimed as a dependent by another taxpayer
- The credit phases out if your AGI exceeds $125,000 ($225,000 if married)
RMDs suspended this year
If you are over 70 1/2, you are not required to take an RMD this year. If you already took an RMD payout from an IRA or retirement plan in 2009, you can deposit the money back into the account by Nov 30th to avoid the taxes.
Retirement Planning for Kids
If your child or granchild had a summer job this summer, consider making a contribution to a Roth-IRA for him/her. The contribution is limited to the lower of their earned income or $5,000. This counts against your annual tax-free gift limit of $13,000 ($26,000 for couples). A 16 year old with $5,000 in a Roth IRA that earns 7% each year will have $193,000 of tax free money at age 70 (for a single $5,000 contribution), $319,000 at 8%.
Earning their Allowance
Hiring your children can save substantial taxes since your children are in a lower tax bracket, and there are no social security taxes when sole proprietors or husband-wife partnerships hire their under-age-18 kids.
More Tax-Free Interest
Interest earned on IOUs issued by the State of California are tax-free if the IOUs are redeemed within 1 year. The interest is considered muni interest.
Not all Long-term gains get 15% tax treatment
ETFs that invest in metals do not qualify for the federal 15% cap on long-term capital gains; these gains are taxed at 28% if long-term. On the bright side, IRAs are generally not allowed to invest in metals, but they are allowed to invest in 'metal' ETFs to give you a bit more diversification if desired.
Considering purchasing a new car?
You can deduct the sales tax paid on a new vehicle purchased by the end of the year in addition to your normal deduction of state income taxes. If you're considering purchasing a car soon, consider purchasing this year versus next.
2008 Tax Filing Statistics
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Income Group
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Income
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Taxpayer's in this group paid ___% of all U.S. income taxes
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Top 1%
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$410,000 and up
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40.4%
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Top 5%
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$160,000
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60.6%
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Top 10%
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$113,000
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71.2%
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Bottom 50% of all filers
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Not available
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2.9%
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FYI - Pending Legislation
Estate tax
On November 17th, the Senate reintroduced a Bill to permanently extend the estate tax with a $3.5 million exemption (indexed annually) per person and a 45% tax on estates exceeding that amount. Congress is expected to pass a 1 year extension of the estate tax after the Thanksgiving Day break (exemption likely to remain at $3.5 million). Under current law, the estate tax is set to expire at the end of this year with no estate tax for decedent's dying in 2010. It is unlikely the estate tax will expire.
Health Care Reform
The House bill contains the following proposals to pay for this:
- 5.4% surcharge on AGI over $500,000 ($1 million if joint return) beginning in 2011
- 2.5% excise tax manufacturers on the sale of medical devices
- 1099s will now be issued to corporations (previously exempted)
The Senate bill contains the following proposals to pay for health care reform:
- Additional 0.5% hospital insurance tax on wages exceeding $200,000 ($250,000 if married) beginning in 2013
- 40% excise tax on employee insurance coverage in excess of $8,500 (singles) or $23,000 (families). The tax is levied on insurance companies.
- Employees would be taxed on the value of their health insurance benefits beginning in 2011.
- Contributions to health FSAs would be capped at $2,500 beginning in 2011.
- 5% excise tax on cosmetic surgery beginning in 2010.
- Annual fees levied on manufacturers and importers of various drugs and medical devices.
Identity Theft Scams
Do not respond to emails purportedly from the IRS requesting your social security number, credit card data,bank account data, PINS, donations for wildfire victims, or other personal information as it is likely a scam. Feel free to call us if you receive correspondence from the IRS or CA Franchise Tax Board and you are not sure what to do.
We’re here to help you
These strategies apply to most of our clients but every situation is unique. If you think your particular situation warrants a closer look, then call or e-mail us as soon as possible for a year end tax projection. The taxes saved with proper planning may be substantial.
