By Mark Buescher, C.P.A.
I have always felt that income tax planning can be challenging, but extremely beneficial, especially in these difficult economic times. Everyone can benefit to some degree. It doesn’t matter if you are a farmer in Pinetta, a small business owner in downtown Madison, or a member of the management team at the Nestlé’s plant.
However, year-end tax planning is especially challenging this year because of uncertainty over whether Congress will enact sweeping tax reform that could have a major impact in 2012 and beyond. And even if there’s no major tax legislation in the immediate future, Congress next year still will have to grapple with a host of thorny issues, such as what to do about the post-2012 expiration of the Bush-era income tax cuts (including the current rate schedules, and low tax rates for long-term capital gains and qualified dividends).
Regardless of what Congress does late this year or early the next, there are solid tax savings to be realized by taking advantage of tax breaks that are on the books for 2011 but may be gone next year unless they are extended by Congress. These include, for individuals: the option to deduct state and local sales and use taxes instead of state and local income taxes; the above-the-line deduction for qualified higher education expense; residential energy credits; and tax-free distributions by those age 70 ½ or older from IRAs for charitable purposes.
Here is a list of key year-end tax planning moves for individuals:
It may be advantageous to try to arrange with your employer to defer a bonus that may be coming your way until 2012.
Consider using a credit card to prepay expenses that can generate deductions for this year. The expenses are deductible when charged, not when paid.
Increase the amount you set aside for next year in your employer’s health flexible spending account (FSA) if you set aside too little for this year.
If you become eligible to make health savings account (HSA) contributions in December of this year, you can make a full year’s worth of deductible HSA contributions for 2011.
Realize losses on stock while substantially preserving your investment position. For example, you can sell the original holding, then buy back the same securities at least 31 days later.
Postpone income until 2012 and accelerate deductions into 2011 to lower your 2011 tax bill. This strategy may enable you to claim larger deductions, credits, and other tax breaks for 2011 that are phased out over varying levels of adjusted gross income (AGI). These include child tax credits, higher education tax credits, the above-the-line deduction for higher-education expenses, and deductions for student loan interest.
If you believe a Roth IRA is better than a traditional IRA, and want to remain in the market for the long term, consider converting traditional-IRA money invested in beaten-down stocks (or mutual funds) into a Roth IRA if eligible to do so.
Accelerate big ticket purchases into 2011 in order to assure a deduction for sales tax on the purchases. Unless Congress acts, this election won’t be available after 2011.
You may be able to save taxes this year and next by applying a bunching strategy to “miscellaneous” itemized deductions, medical expenses and other itemized deductions due to income percentage restrictions.
If you are a homeowner, make energy saving improvements to the residence, such as putting in extra insulation or installing energy saving windows, or an energy efficient heater or air conditioner. You may qualify for a tax credit up to $500 if the assets are installed in your home before 2012.
The up-to-$4,000 above-the-line deduction for qualified higher education expenses will not be available after 2011. Thus, consider prepaying eligible expenses if doing so will increase your deduction for qualified higher education expenses.
Purchase qualified small business stock (QSBS) before the end of this year. There is no tax on gain from the sale of such stock if it is (1) purchased after September 27, 2010 and before January 1, 2012, and (2) held for more than five years.
If you are age 70-1/2 or older, own IRAs and are thinking of making a charitable gift, consider arranging for the gift to be made directly by the IRA trustee. Such a transfer, if made before year-end, can achieve important tax savings.
Take required minimum distributions (RMDs) from your IRA or 401(k) plan (or other employer-sponsored retired plan) if you have reached age 70-1/2. Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn.
Mark Buescher, CPA is owner and principal of Buescher and Ruff, LLC, a local full service accounting firm in Madison, specializing in tax preparation, business consulting and tax planning. Tax laws contain varying effective dates and numerous limitations and exemptions that cannot be summarized easily. For details and guidance for your specific situation, contact your tax advisor.