Tax Planning Tips for 2010 Year-End
There are a number of year-end actions and new tax developments that may help individuals and businesses reduce their tax bills for 2010.
Roth conversions in 2010
In the past, only those with taxable income under $100,000 could convert an individual retirement account (IRA) or other qualified retirement plan to Roth status. But beginning in 2010, that income limit is gone. To convert a deductible retirement plan to Roth status, you must report income on the amount converted. After the funds are within the Roth, they accumulate tax-free and eventually can be withdrawn tax-free. Further, the Roth has no minimum distribution requirement for those age 70½ and over; the taxpayer decides when the dollars are withdrawn.
“A Roth can be a powerful wealth accumulation tool, and we believe that this law change presents a significant opportunity for many clients,” says Andy Biebl, tax principal with LarsonAllen. “Further, conversions that occur by December 31, 2010, are permitted to defer the income equally to 2011 and 2012.”
For information on the differences between a Roth IRA and a traditional IRA, read “New Rules for Roth IRAs May Prompt Conversions.”
Residential energy credits
Through December 31, 2010, a tax credit remains available for homeowners who make energy-saving improvements to their principal residence, such as insulation, doors, windows, furnaces, water heaters, and air conditioners. The credit is 30 percent of the expenditure, capped at a $1,500 cumulative credit limit for 2009 and 2010. In other words, the first $5,000 of eligible expenditures maximizes the credit. And unlike most other tax credits, there is no high-income phaseout. Visit the Energy Star website for details.
Whither 2011 income tax rates?
We still don’t have an answer from Congress regarding the upcoming 2011 income tax rates. With the recession lingering and unemployment high, there is a likelihood Congress will extend the present 2010 tax rates for two years. A failure by Congress to address the rates for 2011 causes a default to the old 2001 rates, and effectively raises income taxes on every filer from top to bottom—an unlikely political outcome. This issue should be decided in Congress in December’s lame duck session; however, it is possible it won’t be resolved until February or March, in the next Congressional session.
“For those with pending capital gain transactions or other income events, it still makes sense to aim for tax recognition in 2010 when the rates are a certainty,” Biebl advises. “But stay tuned—if Congress extends the present rates for several years, the pressure to accelerate income and gains will dissipate.”
Retirement plan distributions
For 2009 only, Congress waived the requirement that those over 70½ must take a taxable distribution from their IRA or other retirement plan. But for 2010, that requirement is back in the law. For those who have not yet addressed this, be sure the required minimum amount is taken in 2010. High net worth persons should consider waiting until the results of the lame duck Congressional session are known. Pending legislation would extend the rule that allows up to $100,000 of IRA funds to be transferred as charitable contributions to the 2010 tax year.
Economic recession provisions
To assist those impacted by the economic downturn, the tax code contains a number of provisions. For those who have debt relief in connection with their principal residence, there is a tax-free exclusion. And business debt relief, in addition to existing exclusions, can electively be deferred under a mechanism that postpones reporting of the income until 2014 and the following four years.
Timing of itemized deductions
Consider prepaying expenses that generate deductions, such as state income taxes, real estate taxes, charitable contributions, and other itemized deductions. Some of these prepayments, such as income and certain real estate taxes, are ineffective if the alternative minimum tax (AMT) is in play.
Solidify your charitable contribution documentation
Several recent court cases have emphasized the importance of carefully adhering to charitable documentation rules. In the 2008 case of Gomez v. Comm’r, a donor had over $6,000 in canceled checks to his church, but lacked a receipt that was dated before his tax return filing date. The result was entire disallowance of the deduction, because each check exceeded $250 and was not supported by a receipt, as the tax law requires. Cash donations (i.e., greenbacks) are no longer permitted as charitable contributions unless supported by a receipt. Also, be cautious of large donations of personal goods and other assets to charity; if the total exceeds $5,000, an independent appraisal is required.
Business losses
If you own an interest in a partnership or S corporation, you may need to increase your basis/investment in the entity so you can deduct a loss for 2010. Also, if your personal participation in this business is less than 500 hours per year, you should determine strategies for dealing with the passive loss restrictions.
Businesses: bonus depreciation
Under temporary economic stimulus provisions, Congress improved the Section 179 first-year depreciation deduction to $500,000 and also extended a front-end 50 percent bonus depreciation deduction. These are designed to encourage businesses to accelerate purchases of new equipment, vehicles, and other depreciable property. The 50 percent bonus ends for all taxpayers as of December 31, 2010, but the $500,000 expanded Section 179 deduction is applicable to the tax years beginning in 2010 and 2011. Also there is new opportunity to claim up to $250,000 of the $500,000 Section 179 allowance for some leasehold improvements, restaurant buildings, and retail building improvements.
For more information, read “Significant Tax Incentives in Jobs Act; Not Limited to Small Business” and “Construction Companies Should Think Strategically About New Tax Incentives.”
Small business health insurance tax credit
Smaller employers with fewer than 25 full-time equivalent employees and less than $50,000 of average per person payroll may be able to claim a new tax credit for employee health insurance coverage. The business must pay at least 50 percent of employee premiums for 2010. The tax credit can be as large as 35 percent of the employer’s costs. In assessing eligibility, owner compensation is ignored, as well as compensation to family members of owners.
Gift and estate taxes
By using the annual gift tax exclusion before year-end, you may give $13,000 to an unlimited number of individuals to reduce the costs of a future federal estate tax to your heirs. This annual exclusion remains at $13,000 for 2010 as well. We anticipate that Congress will soon restore the estate tax system for 2011, increasing the per-person exemption to $5 million. For those with a net worth over this exemption amount, gift planning and other estate reduction strategies remain very important.
Lock in low IRS interest rates
For those looking to reduce a potentially taxable estate, or simply attempting to transfer a business or other assets to heirs, today’s low IRS interest rates present an opportunity. Seller-financed sales can be set in place using the low rates (under 4 percent on long-term financing). And there are strategies that can mix gift and charitable transactions to leverage your ability to pass assets to the next generation.
How we can help
These are only a few of the year-end steps that can be taken to save taxes. LarsonAllen has developed tools and calculators that can assist in developing a plan specific to your situation.
View our tax principals.