October 2011
2011 YEAR-END TAX PLANNING NEWSLETTER
Dear Client:
This year, taxpayers are confronted with uncertainty in year-end tax planning as 2011 ends. Unless extended by Congress, a number of individual and business tax incentives are scheduled to expire after December 31, 2011. Other provisions, while not expiring, appear to be under-utilized. As 2011 draws to a close, it is a valuable time to review some of these tax incentives and how they may be able to help reduce your individual or business taxes.
Planning for Individuals
Income/deduction shifting
The traditional year-end strategy of income shifting applies to year-end 2011 but with an extra twist. Under traditional strategy, you time your income and deductions so that your taxable income is about even for 2011 and 2012 so your tax bracket does not spike in either 2011 or 2012. If you anticipate a higher tax bracket for 2012, you may want to accelerate income into 2011 and defer deductions into 2012. If you anticipate a leaner 2012, income might be delayed through deferred compensation arrangements, postponing year-end bonuses, maximizing deductible retirement contributions, and delaying year-end billings.
The twist for year-end 2011 is the uncertain future for tax rates after 2012. Many political observers forecast that higher-income taxpayers will be forced to pay more, either through higher tax rates or more limited deductions. That may suggest a strategy in which income is not deferred but is recognized now at lower tax rates still available in 2011 and 2012.
You should also consider prepaying deductible expenses, even with a credit card.
Roth conversions
If you converted an individual retirement account (IRA) to a Roth IRA in 2010, you were given an option: recognize all income in 2010 or defer that income, half into 2011 and half into 2012. If you elected to defer that income into 2011 and 2012, do not forget to figure that income into your year-end planning for 2011.
If you initiated a Roth conversion earlier in 2011 and that Roth account has declined in value since then, you should consider a "Roth reconversion." Reconverting your Roth IRA back to a regular IRA before year-end will allow you to avoid paying income tax on an account balance at its higher value.
Finally, if you have not yet made a Roth conversion, doing so at year-end 2011 might be an opportunity worth serious consideration. Variables include your present income tax bracket, how close you are to retirement, and your access to other funds both to pay the conversion tax and to delay distributions from your Roth account later. Our office can help you make the right decision.
Required Minimum Distributions (RMDs)
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. If you turned age 70- 1/2 in 2011, you can delay the first required distribution to 2012, but if you do, you will have to take a double distribution in 2012 - the amount required for 2011 plus the amount required for 2012. Think twice before delaying 2011 distributions to 2012 - bunching income into 2012 might push you into a higher tax bracket or have a detrimental impact on various income tax deductions that are reduced at higher income levels. However, it could be beneficial to take both distributions in 2012 if you will be in a substantially lower bracket that year, for example, because you plan to retire late this year.
Seniors age 70 1/2 and older should also consider making a charitable contribution directly from their IRAs up to $100,000 and paying no tax on the distribution. This tax break, especially advantageous to those who do not itemize deductions, is scheduled to end for distributions made in tax years beginning after December 31, 2011.
AMT
Because the AMT was not indexed for inflation, and for other reasons, the AMT today encroaches on many moderate-income taxpayers, especially two-income married couples. With most of your income and deductions for 2011 more predictable as year-end approaches, now is a good time to compute whether you will be subject to the AMT for 2011 or 2012. Our office can explore whether certain deductions should be more evenly divided between 2011 and 2012 and which deductions will qualify, or will not be as valuable, for AMT purposes.
Gains and losses
Our office can also help you time the recognition of capital gains and losses at year-end to minimize your net capital gains tax and maximize deductible capital losses. Many investors have excess capital losses from recent stock market declines that they may now "carry over" to offset capital gains that would otherwise be taxable.
Also of concern is whether the maximum tax rate for capital gains will rise from 15 percent to 20 percent or higher after year-end 2012 because of the scheduled expiration of the Bush-era tax cuts. Since long-term capital gains are only available on stocks and other capital assets held for more than one year, a capital asset must be bought on or before December 30, 2011 in order to be sold in 2012 and guarantee qualifying under the lower capital gains rates. We can help you coordinate your year-end trades with these tax variables in mind.
Payroll taxes
All wage earners and self-employed individuals will experience a tax increase in 2012 unless Congress extends the current employee-side payroll tax cut. For calendar year 2011, the employee-share of OASDI taxes is reduced from 6.2 percent to 4.2 percent up the Social Security wage base of $106,800 (self-employed individuals receive a comparable benefit). President Obama has proposed to extend and enhance the payroll tax cut. The fate of the payroll tax cut will likely be decided by Congress late in 2011.
Life changes
Marriage, divorce, the birth of a child, death, a change in job or loss of a job, and retirement are just some of the life events that trigger a special urgency for year-end tax planning. If you have had a life change, please contact our office so we can review how that change will impact your federal tax liability. After December 31, 2011, it will be too late to alter most of your bottom-line tax liability for 2011.
Qualified Higher Education Deduction
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. Generally, the deduction is allowed for qualified education expenses paid in 2011 in connection with enrollment at an institution of higher education during 2011 or for an academic period beginning in 2011 or in the first 3 months of 2012.
Medical expenses
Effective January 1, 2011, the Patient Protection and Affordable Care Act (PPACA) provides that over-the-counter medications and drugs can no longer be reimbursed from a health flexible spending arrangement (health FSA) unless a prescription is obtained. The rule also applies to health reimbursement arrangements (HRAs), health savings accounts (HSAs), and Archer medical savings accounts (Archer MSAs), an important consideration for employees who are required to make a decision by year-end 2011 on how much to fund their accounts in 2012.
Casualty losses
Taxpayers in many states experienced natural disasters in 2011. A casualty loss can result from the damage, destruction or loss to your property from any sudden, unexpected or unusual event, such as a hurricane, earthquake, wildfire, or flood. Casualty losses are generally deductible in the year the casualty occurred, less ten percent of your adjusted gross income and a $100 per casualty deductible.
However, if you have a casualty loss from a federally declared disaster, you can elect to treat the loss as having occurred in the year immediately preceding the tax year in which the disaster happened, and you can deduct the loss on your return or amended return for that preceding tax year. The election gives taxpayers the opportunity to maximize their tax savings in the year in which the savings will be greatest.
Energy tax incentives
If you are considering replacing your roof, HVAC system, or windows and doors, doing so using energy-efficient materials before January 1, 2012 may generate tax savings. Through the end of 2011, a number of residential energy-efficiency improvements qualify for a tax credit. These include qualified windows and doors, insulation products, HVAC systems, and roofing. The "lifetime" credit amount for 2011, however, is $500 and no more than $200 of the credit amount can be attributed to exterior windows and skylights.
Gift/estate tax
The current federal estate tax through 2012 is set at a maximum 35 percent rate and a $5 million exemption amount. (Tennessee is $1,000,000). Many experts predict after 2012 that Congress will lower the exclusion to $3.5 million and raise the top rate to 45 percent. In light of this possibility, lifetime gift-giving, ideally on an annual basis, should continue to form part of a master estate plan. The annual gift tax exclusion per donee on which no gift tax is due is $13,000 for 2011 (and, again, for 2012), with $26,000 allowed to each donee by married couples. Making a gift at year-end 2011 to take advantage of this annual, per-donee exclusion should be considered by anyone with even modest wealth.
Additional Items to Consider
A number of tax extenders are scheduled to expire after December 31, 2011. They include:
- the state and local sales tax deduction (you may want to accelerate big ticket purchases),
- the higher education tuition deduction, and
- the teacher's classroom expense deduction.
Planning for Businesses
Bonus depreciation
An additional first-year depreciation deduction equal to 100 percent of the adjusted basis of the property is available for qualified property acquired after September 8, 2010 and before January 1, 2012, and placed in service before January 1, 2012. This additional depreciation deduction, known as "100 percent bonus depreciation" is temporary. As a result, 2011 year-end tax planning should take into account 100 percent bonus depreciation as well as its scheduled drop to 50 percent for qualified property acquired after December 31, 2011 and before January 1, 2013.
These dates are important in year-end planning. Let's look at an example. ABC Co. acquires a qualified asset on November 1, 2011 and places it in service on December 1, 2011. The 100 percent rate of bonus depreciation applies. However, if ABC Co. acquires a qualified asset on November 1, 2011 and places it in service on January 1, 2012, the 50 percent rate of bonus depreciation applies. The rules for determining the acquisition date of an asset are different for the 100 percent and 50 percent rates. Special rules apply to self-constructed property.
Taxpayers may elect out of bonus depreciation. An election out of 100 percent bonus depreciation in 2011 will spread the depreciation deductions for the cost of an asset into future years measured by the asset's depreciation period. Electing out of 100 percent bonus depreciation may be a valuable strategy for certain taxpayers. Our office can help you determine the best strategy for applying bonus depreciation.
Business vehicles
Special consideration should be paid to the interaction of 100 percent bonus depreciation and the so-called "luxury vehicle" caps. In Rev. Proc. 2011-26, the IRS set out a safe harbor method of accounting for businesses nominally entitled to 100 percent bonus depreciation but still limited by the maximum luxury vehicle depreciation caps ($11,060 for passenger autos for 2011 and $11,160 for light trucks in 2011). The effect of the safe harbor is generally to allow the taxpayer under the 100 percent bonus depreciation regime to claim exactly the same amount of depreciation during each year of the vehicle's recovery period as would have been allowed if a 50 percent bonus depreciation rate had originally applied. The safe harbor method may be used for qualifying new vehicles placed in service after September 8, 2010 and before January 1, 2012 for which a 100 percent bonus depreciation rate applies.
Code Sec. 179 expensing
Business taxpayers are allowed to expense up to a certain dollar amount in annual investment expenditures for qualified property. The maximum amount that can be expensed is reduced by the amount by which the taxpayer's cost of qualified property exceeds a certain investment limit. For tax years beginning in 2010 and 2011, the Code Sec. 179 dollar limit is $500,000 and the investment limit is $2 million. The dollar limit is scheduled to fall to $125,000 (indexed for inflation at $139,000) and the investment limit is scheduled to fall to $500,000 ($560,000 indexed for inflation) after 2011. As a result, business taxpayers contemplating qualified purchases should weigh the benefits of accelerating those purchases into 2011. Keep in mind that Code Sec. 179 expensing is also allowed for off-the-shelf computer software placed in service in tax years beginning before 2012.
Real property expensing
Real property generally is excluded from Code Sec. 179 expensing. However, tax legislation in 2010 provided that qualified leasehold property, qualified restaurant property, and qualified retail improvement property placed in service before January 1, 2012 are eligible for special expensing rules. However, the special expensing provision is temporary and is scheduled to expire after 2011.
A taxpayer that places qualified leasehold improvement property, qualified restaurant property or qualified retail improvement property in service in a tax year that begins in 2010 or 2011 may elect to treat the property as Code Sec. 179 property and expense up to $250,000 of the cost of the property. There are some important limitations. While qualified leasehold improvement property is eligible for bonus depreciation, qualified restaurant property and qualified retail improvement property are generally ineligible for bonus depreciation unless they meet the definition of qualified leasehold improvement property. Additionally, current law does not provide for a carryover of an unused real property expensing election for qualified property placed in service in 2011. If you are considering a real property improvement, please contact our office before the window of opportunity for this special expensing rule closes.
Work Opportunity Tax Credit (WOTC)
Employers that have taken advantage of the popular Work Opportunity Tax Credit (WOTC) in past years may be surprised to learn the credit is scheduled to expire after December 31, 2011. The WOTC is designed as an incentive to encourage employers to hire individuals from nine targeted groups, which have historically, experienced higher than average unemployment rates and other barriers to employment. The WOTC generally is 40 percent of the qualified worker's first-year wages up to $6,000 (with higher and lower amounts for certain groups). Under current law, the WOTC applies to wages paid to qualified individuals who begin work for the employer before January 1, 2012. Wages paid to qualified individuals who begin work for the employer after December 31, 2011 (under current law) are ineligible for the WOTC.
Payroll taxes
Employers should remind employees that effective January 1, 2012, the employee-share of OASDI taxes is scheduled to revert to 6.2 percent. Under the 2011 payroll tax holiday, employees paid OASDI taxes at a rate of 4.2 percent rather than 6.2 percent. A similar benefit was provided to self-employed individuals. The employer-share of OASDI taxes for 2011, however, remains at 6.2 percent.
Small business health insurance tax credit
According to the IRS, many small businesses are overlooking the Code Sec. 45R small employer health insurance tax credit. Small employers that provide health care coverage to their employees and that meet certain requirements ("qualified employers") generally are eligible for the Code Sec. 45R tax credit for health insurance premiums they pay for certain employees. The employer must have fewer than 25 full-time equivalent employees (FTEs) for the tax year; average annual wages of its employees for the year must be less than $50,000 per FTE; and the employer must pay the premiums under a qualifying arrangement. For tax years beginning in 2010 through 2013, the maximum credit is 35 percent of the employer's premium expenses that count towards the credit (25 percent for tax-exempt employers). If the number of FTEs exceeds 10 or if average annual wages exceed $25,000, the amount of the credit is reduced until it phases-out.
Code Sec. 199 deduction
Another under-used tax incentive, according to the IRS, is the Code Sec. 199 domestic production activities deduction. The Code Sec. 199 deduction generally allows taxpayers to receive a deduction based on qualified production activities income (QPAI) resulting from domestic production. The deduction effectively reduces the income tax rate on domestic production activities. Qualifying domestic production includes the manufacture of tangible personal property; the production of computer software, sound recordings and certain films; the production of electricity, natural gas, or water; and construction, engineering, and architectural services. One deterrent to greater use of the deduction is its complexity. Our office can help you navigate the deduction's rules and calculations.
Energy tax incentives
Energy tax incentives are a mixed bag for businesses. A number of tax credits for alcohol fuels and biodiesel/renewable diesel will expire after December 31, 2011. Tax credits for construction of new energy efficient homes and manufacture of energy efficient appliances will also expire after December 31, 2011. Other energy tax incentives, including the deduction for energy efficient commercial buildings, do expire until after 2013 or subsequent years.
If you have any questions about any of these topics for individuals or businesses we have discussed and year-end planning for 2011, please contact our office.