Income Shifting I Reduce Adjusted Gross Income I Stock Transactions I Reminders for Seniors Age 70 ½ Plus I Home Energy Improvements I Payroll Considerations I Estate and Gift Planning I Retirement Plan Options I Pennsylvania Considerations

As we approach year-end, it’s time to focus on moves you can make to save taxes – both on your 2011 return and in future years. Before we get to specific suggestions, here are two important considerations to keep in mind.

First, remember that effective tax planning requires considering both this year and next year – at least.  Without a multiyear outlook, you can’t be sure maneuvers intended to save taxes on your 2011 return won’t backfire and cost additional money in the future. For example, postponing a stock sale gain until next year would reduce your 2011 adjusted gross income (good), but increase the 2012 figure (bad). Higher income next year could make you ineligible for the child tax credit; reduce or eliminate the credits or deduction for college expenses; limit deductible losses from your rental real estate investments; and so on.

Second, be on the alert for the Alternative Minimum Tax (AMT) this year. It’s an add-on tax over and above your “regular” tax. Although you may have never owed AMT in the past, your odds of being hit are higher now. Why? Because the tax brackets, standard deduction, and personal exemption allowances used in calculating your regular tax liability are all indexed annually for inflation; however,  most AMT parameters are not. The odds of owing the tax go up every year due to this factor alone. The risk goes up another notch or two if you deduct a significant amount of state and local taxes or miscellaneous itemized deductions (like unreimbursed employee business expenses).

As always, you can call on us at any of our offices to help you sort through the options and implement strategies that make sense for you.

Income Shifting
Individuals and businesses alike can benefit from the classic strategy of shifting taxable income and accelerating or deferring deductions between 2011 and 2012 by controlling the receipt of income and payment of expenses. Taxpayers expecting to be in the same or lower tax bracket in 2012 should consider deferring income until next year and accelerating deductible expenses in 2011. 

Alternatively, if a substantial increase in income is anticipated in 2012 (propelling the taxpayer into a higher tax bracket), income should be accelerated in 2011 and deductions deferred until next year.

Reduce Adjusted Gross Income
Maximize contributions to 401(k) or other retirement plans.  If you have a 401(k) plan at work, it’s just about time to tell your employer how much you want to set aside on a tax-free basis for 2012. There is also still time to adjust your retirement contributions for the remaining pay periods in 2011.

Contribute to a Health Savings Account (HSA). If you are covered under a high deductible health plan and not enrolled in Medicare, you may be eligible to contribute to a HSA. Contributions, subject to annual limits, are deductible in computing adjusted gross income.

Consider your 2012 Flexible Spending Account (FSA) contribution. If your company has a healthcare and/or dependent care FSA, before year-end, you must specify how much of your 2012 salary to convert into tax-free contributions to the plan. Withdrawals from FSAs can be used to reimburse yourself for out-of-pocket medical and dental expenses and qualifying dependent care costs. Be careful, though, as FSAs are “use-it-or-lose-it” accounts - plan for what you’ll likely have in qualifying expenses next year.

If you currently have a healthcare FSA, make sure you drain it by incurring eligible expenses before the deadline for this year. Otherwise, you’ll lose the remaining balance. New eye glasses or contacts, dental work or prescriptions that can be filled early would be reimbursed. Over-the-counter drugs (e.g., aspirin and antacids) no longer qualify for reimbursement by healthcare FSAs; however, bandages and medical equipment (e.g., thermometers and blood pressure monitoring devices) do qualify.

Stock Transactions
Long-term stocks receive capital gain rates. For 2011 and 2012 sales, you’ll generally owe only 15% on gains from investments held over one year (0% if the gains would otherwise fall into the 15% regular income tax bracket). Gains from investments held one year or less are taxed at your ordinary rates. When planning to unload some winners before year-end, try to sell only those you’ve owned over 12 months. Then, the resulting gains will be taxed at no more than 15%. Without legislation, the capital gains rate is set to expire at the end of 2012.

Harvest tax losses. Between now and year-end, you can sell enough losers to offset any capital gains recognized earlier this year. Plus, you can sell enough to generate another $3,000 in losses ($1,500 for married filing separately status), which then can be deducted against your income from all other sources.

Donate appreciated property to charity. To avoid capital gains tax, you may want to consider giving appreciated property to charity. By doing so, you will avoid tax while still being able to claim a charitable deduction for the fair market value of the property. However, if the stock is now worth less than when you acquired it, sell the stock, take the loss, and then give the cash to the charity.

Reminders for Seniors Age 70 ½ Plus
Be aware of Required Minimum Distributions. The law generally requires those who have reached age 70 ½ to make annual withdrawals based on the size of your account and your age. Failure to take a required withdrawal can result in a penalty of 50% of the amount not withdrawn. If you turned 70 ½ in 2011, you can delay your 2011 required distribution to 2012 if you choose. However, beware that doing so will result in two distributions in 2012 – the amount required for 2011 plus the amount required for 2012.

Make a direct charitable contribution from your IRA. If you are age 70 ½ or older, you can arrange to transfer up to $100,000 of otherwise taxable IRA money to a charity. The amount transferred is federal-income-tax-free to you and it counts toward your minimum required distribution for the year.  The law prohibits a charitable deduction for these payments. The funds must be transferred directly from your IRA to the charity. Be sure to obtain a receipt and statement from the charity that no consideration was received to satisfy the charitable donation substantiation requirements. This favorable provision will expire at the end of 2011 unless Congress extends it; so this may be your last chance.

Home Energy Improvements
It’s the Last Chance for the Tax Credit on Home Energy Improvements. This popular tax credit is set to expire at the end of 2011 without further legislation. You may be eligible to claim a credit for home energy-efficient improvements (insulation, exterior windows, augmented metal roofs, heat pumps, air conditioners, furnaces, and boilers) that you place in service before the end of 2011, provided you did not claim credits of over $500 for such property in 2006 through 2010. The “lifetime” limit for the 2011 credit is $500, of which only $200 may be used for windows, and there are separate $300, $150 and $50 limits for specified improvements. Subject to the limits, a credit for qualified property purchased by the end of the year must actually be installed by the end of the year to meet the pre-2012 “placed in service” requirement.

Payroll Considerations
Increase Federal income taxes withheld. If it looks like you are going to owe income taxes for 2011, consider bumping up the Federal income taxes withheld from your paychecks now through the end of the year. When you file your return, you will still have to pay any taxes due less the amount paid in.  However, as long as the total tax payments (estimated payments plus withholdings) equal the lesser of 90% of your 2011 liability or 100% of your 2010 liability (110% if your 2010 adjusted gross income exceeded $150,000 for married filing jointly), penalties will be minimized, if not eliminated.

Payroll tax reduction expires. All employees and self-employed taxpayers benefit in 2011 from the 2% reduction in the rate on the employee share of Social Security taxes, from 6.2% to 4.2%, which applies to the maximum 2011 tax base of $106,800. Unless Congress acts to extend the 4.2% rate, the employee rate (as well as the employer rate) will go back to 6.2% for 2012 on a maximum tax base of $110,100

Estate and Gift Planning
Utilize the annual gift tax exclusion. A taxpayer can give $13,000 for 2011 per person (i.e., $26,000 per married couple) to any number of recipients in a calendar year without paying federal estate and gift tax.

Make gifts of income producing property to donees in lower tax brackets. Gifting dividend-yielding stock or other income producing property to donees in lower tax brackets is another income shifting technique. Be sure to consider the full impact of such gifts. Gifting to children that are subject to kiddie tax provisions would be taxed at the parents’ rate; and the donor’s basis of the stock would be transferred to the done (while inherited stock would yield a step-up in basis for the date of death value).

Don’t overlook estate planning. For 2011 and 2012, the unified federal gift and estate tax exemption is a relatively generous $5 million. However, the exemption will drop back to only $1 million in 2013 unless Congress takes action. In addition, the maximum federal estate tax rate for 2011 and 2012 is 35%. For 2013 and beyond, it is scheduled to rise from the current 35% to a painfully high 55%.  Therefore, planning to avoid or minimize the federal estate tax should still be part of your overall financial game plan. Even if you already have a good plan, it may need updating to reflect the current $5 million exemption.

Retirement Plan Options
Contribute to an IRA. The basic contribution limit for traditional and Roth IRAs is remaining at $5,000 for 2012. The additional catch-up contribution limit for those who will be age 50 or older by the end of 2012 is $1,000. For Traditional IRAs, the $5,000 or $6,000 (age 50 or older) contribution limit is also the deductible limit, subject to phase-out limits based on modified adjusted gross income (MAGI) for active participants in employer retirement plans. For Roth IRAs, the $5,000 or $6,000 contribution limit is phased out for married persons filing jointly and qualifying widows or widowers with 2012 MAGI exceeding $173,000, up from $169,000, and the phase-out will be complete if MAGI is $183,000 or more. For single taxpayers and heads of households, the phaseout threshold is increasing to $110,000 from $107,000; the phaseout will be complete if 2012 MAGI is $125,000 or more.

Consider Roth Conversions. Before 2010, Roth conversions were available only to individuals whose modified AGI was $100,000 or less. Now that account values are down from the market downturn, you may want to consider converting your eligible retirement plan or traditional IRA to a Roth IRA. 

Pennsylvania Considerations
Contribute to a 529 Plan. Contributions to 529 Plans are one of the few deductions available on the Pennsylvania income tax return.

New requirement added to report Use Tax in 2011. Pennsylvania residents are now required to complete information on their use tax liability with their 2011 individual tax returns. This would primarily occur when an item is purchased through a mail order catalog or online when the seller is not required to be registered and collecting Pennsylvania sales tax. To make is simpler, Pennsylvania has provided a chart that calculates the estimated use tax based on the taxpayer’s Pennsylvania taxable income.

Through careful planning, it’s possible your 2011 tax liability can still be significantly reduced, but don’t delay. The longer you wait, the less likely it is that you’ll be able to achieve a meaningful reduction. The ideas we have shared are a good way to get you started with year-end planning, but they’re no substitute for personalized professional assistance. If you have any questions, please do not hesitate to call our offices.