Year-End Tax Tips
By Albertina D. Lombardi, Esquire & Marie K. Rudzinski
The end of 2010 is rapidly approaching and that means it is time for year-end tax planning. Take advantage of these simple tips now to reduce your tax liability:
Capital Gains. The capital gains tax rate impacts taxpayers who sell capital assets. Capital assets are certain assets (such as stocks, bonds, real estate or other property) held for investment purposes. A capital gain is a profit that results from the sale of a capital asset at a price that exceeds the taxpayer’s initial purchase price. This year, the capital gains tax rate is generally 15% but for some income brackets it is less. The rates are expected to increase next year. If you are thinking about selling a capital asset, consider disposing of it this year rather than next.
You may also want to consider accelerating installment sale capital gains. By default, gain is recognized on installment sale proceeds in the year in which the installment payment is received. However, in some instances you may elect to recognize all gain in the current tax year, thus avoiding the uncertainty of the future capital gains tax rate.
Losses. Your projected financial position for next year will determine whether it makes sense to take a loss for tax year 2010 or to defer it until next year. If you expect to have lower income in 2011, it may make sense to take the loss in 2010. You can offset current capital gains with capital losses on a dollar for dollar basis. Once you offset all capital gains you can use up to $3,000 in losses to offset ordinary income. Excess losses can be carried over into future tax years; do not forget to use loss carryovers from prior years. On the other hand, if you expect to have a higher income in 2011, it may make sense to defer the loss until 2011. You can use it to offset next year’s income, which may be taxable at higher rates.
Two other important tips: first, remember that if you sell qualifying small business stock at a loss, you can treat up to $50,000 (or $100,000 for a husband and wife filing jointly) as an ordinary, rather than capital, loss. There is no holding period requirement, but this tax benefit is subject to specific requirements. Second, passive activity losses are generally only deductible against other passive activities. To avoid treatment as a passive activity, consider increasing your involvement above the statutory participation level.
Mortgage Matters. If you itemize, make an extra payment on your mortgage this year. The extra interest you pay will be added to your 2010 mortgage interest by your lender and boost your itemized deductions to 13 months of deductible interest instead of only 12 months. Prepaying your property taxes may provide an additional deduction. Also, consider taking out a home equity loan. Interest on some home equity debt may be tax deductible, so consider using the loan to pay off credit card or other debt.
Federal Estate Taxes and Federal Gift Tax Exclusion. At press time, Congress had not yet addressed Federal Estate Tax rates and the amount of the applicable exclusion (unified credit) for 2011 and years thereafter.If Congress does not pass new Federal Estate Tax legislation, there will generally be no Federal Estate Tax on transfers of up to $1 million dollars, but the tax rate will revert to a top rate of 55% after the first $1 million of the estate’s value.
Although the status of the Federal Estate Tax creates planning uncertainty, do not forget that the Federal Gift Tax annual exclusion affords a significant tax-free gifting opportunity. The 2010 Federal Gift Tax annual exclusion is $13,000 per donor/donee. Secondly, a present interest gift of up to $13,000 per donor/donee will generally not result in Federal Gift Tax, does not require filing of a gift return, and will not impact the donor’s lifetime Federal Gift Tax exemption (currently $1 million). A husband and wife can each gift $13,000 to a single beneficiary. This means that a married couple with two children and two grandchildren can make present interest tax-free gifts to them totaling $104,000 this year.
401(k) Retirement Plan. If possible, contribute the maximum amount allowable to your 401(k) to reduce taxable income and permit your plan assets to grow tax-deferred. Some 401(k) plans allow for “catch-up” contributions if your contribution level is less than the maximum allowed or if you exceed a certain age.
Donate to Charity. Make a donation of cash or property to charity and take a tax deduction. You can even donate appreciated stock to a charity. This allows you to claim a deduction for the full fair market value at the time of donation and avoid any capital gains on the appreciation. Donations of property are limited to the item’s fair market value; however, you cannot take a deduction for the value of time or services when volunteering. Your charitable donation tax deduction for cash contributions to a public charity will generally be limited to 50% of your adjusted gross income and 30% of your adjusted gross income for property donations.
For donations under $250, you must maintain a cancelled check, credit card statement or a written acknowledgment from the organization containing its name, the date of the contribution and amount of the contribution. To claim a deduction for donations equaling $250 or more, you must have a written acknowledgment from the organization containing its name, the date of the contribution, the amount of the contribution and a description of any property contributed and whether the organization provided any goods or services in exchange for the gift.
Changes to Flexible Spending Arrangements. Use your flexible spending dollars before the close of 2010. Effective January 1, 2011, the cost of over-the-counter drugs cannot be reimbursed from Flexible Spending Arrangements or health reimbursement arrangements unless a prescription is obtained. The change does not affect insulin, eye glasses, contact lenses, co-pays and deductibles. The new standard applies only to purchases made on or after January 1, 2011, so claims for drugs purchased without a prescription in 2010 can still be reimbursed in 2011.
Health Coverage for Older Children. If you have not done so yet, add your uninsured child under 27 years of age to your insurance plan. Employees can immediately begin making pre-tax contributions to pay for the expanded benefit. This also allows you to decrease your taxable income. This benefit may apply to self-employed individuals who qualify for the self-employed health insurance deduction.
Home Office Deduction. If you use a portion of your home for business purposes, you may be able to take a home office deduction. Generally, in order to claim a business deduction for your home, you must use part of your home exclusively and regularly as your principal place of business, as a place to meet or deal with clients in the normal course of your business, or in connection with your business where the business portion of your home is a separate structure not attached to your home. The amount you can deduct depends on the percentage of your home used for business. Although the business portion of your home is ordinarily depreciated over 39 years, a cost segregation study may enable you to accelerate a portion of the depreciation.
Health Care Credit for Small Business Owners and Non-Profits. The Small Business Health Care Tax Credit is effective for the 2010 tax year and is generally available to small employers that make contributions towards buying health insurance for their employees. The credit is designed to encourage small businesses to offer health insurance coverage for the first time or maintain coverage they already offer. For tax year 2010, the maximum credit is 35% of premiums paid by eligible small business employers and 25% of premiums paid by eligible tax-exempt organization employers. In general, the credit is available to small employers that pay at least half the cost of single coverage for their employees.
Alternative Minimum Tax. A number of middle and high-income taxpayers are caught off guard by the Alternative Minimum Tax. Many deductions permitted in the calculation of regular income tax (such as state and local income tax deductions and real estate and property tax deductions) are not allowed under the AMT and may trigger AMT liability. Additionally, certain items of income (such as long term capital gains and exercises of certain incentive stock options) may increase potential AMT liability. Planning now may help you avoid or minimize AMT exposure.
