YEAR END TAX PLANNING

Year-end tax planning for 2011 presents many opportunities for individual taxpayers like you to reduce or defer your federal income tax liability. You may benefit from an "income shifting" strategy, which equalizes income over a two-year period by properly timing income and deductions. Although the tax cuts enacted in 2001 (EGTRRA) and 2003 (JGTRRA) were extended by the Tax Relief Act of 2010, many of the extended provisions are due to expire at the end of the 2011 or 2012 tax year. This uncertainty over the fate of the expiring tax provisions makes 2011 year-end tax planning a challenge.

Twenty-five years ago, Congress overhauled the Tax Code in the Tax Reform Act of 1986. At that time, the 1986 Tax Reform Act was lauded for simplifying a Tax Code that had grown too complex. Since 1986, complexity has return to the Tax Code, largely because Congress has enacted a host of temporary tax incentives with a variety of expiration dates. Today, many taxpayers are trying to navigate all of this complexity as they draft their 2011 year-end tax plans. Presented are highlights of some of the more widely-utilized 2011 year-end tax strategies for individuals and businesses. Every taxpayer’s situation is different. Please contact our office so we can schedule a time to discuss your year-end tax planning in detail.

Few tax laws have complicated tax planning as much as the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and its progeny. EGTRRA was enacted as a temporary tax law. Its supporters predicted that a future Congress would make EGTRRA permanent. Indeed, some of EGTRRA’s retirement savings provisions were made permanent in 2004. Other provisions, however, have been extended one or two years at a time. Many of the extended tax provisions are scheduled to expire at the end of 2011 or the end of 2012.

Uncertainty over the fate of the expiring tax provisions makes year-end 2011 tax planning a challenge for many individuals and businesses. Fortunately, we know that certain tax incentives will be available through the end of 2011 and others through the end of 2012. Additionally, some traditional year-end tax planning strategies are valuable even with all the uncertainty.

Income/deduction shifting. Income and deduction shifting is a traditional year-end tax strategy that is worth a look at year-end 2011. However, one key complication is uncertainty over the individual income tax rates after 2012. We know that the individual income tax rates will be 10, 15, 25, 28, 33, and 35 percent for 2012. Under current law, the 10 percent rate is scheduled to expire after December 31, 2012 and the remaining rates are scheduled to revert to 15, 28, 31, 36, and 39.6 percent after December 31, 2012 (unless extended by Congress). As a result, some taxpayers may want to abandon the traditional strategy of shifting income into a future year and recognize income in 2011 or 2012 when the lower rates are available.

Capital gains/dividends. Reduced tax rates on qualified dividends and capital gains are scheduled to expire after December 31, 2012 (unless extended by Congress). Taxpayers need to carefully review when to recognize income from qualified capital gains and dividends to maximize their tax savings in 2011 or 2012.

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. For many individuals, year-end tax planning requires “running the numbers” for regular federal tax liability and alternative minimum tax (AMT) liability and this year is no exception. Taxpayers may want to explore if certain deductions should be more evenly divided between 2011 and 2012 and which deductions may qualify, or will not be as valuable, for AMT purposes.

Gift tax exclusion. Many individuals overlook gift-making as a year-end tax strategy. Under current law, the annual gift tax exclusion per recipient on which no gift tax is due is $13,000 for 2011. Married couples may make combined tax-free gifts of $26,000 to each recipient. Use of a “lifetime” estate and gift tax exclusion should also be considered for larger gifts. (The current exclusion is $5 million through 2012. Estate tax is set at a maximum 35 percent rate above the $5 million exemption amount.)

Big ticket purchases. Taxpayers planning a big ticket purchase in 2012 may want to accelerate that purchase into 2011 to take advantage of the deduction for state and local general sales taxes. The deduction for state and local general sales taxes is scheduled to expire after December 31, 2011 (unless extended by Congress). Taxpayers may take the deduction for state and local general sales taxes in lieu of the deduction for state and local income taxes.

Energy improvements. In recent years, Congress has enacted a number of tax incentives to encourage homeowners to make energy efficient improvements to their primary residences. The Code Sec. 25C tax credit for certain nonbusiness energy property is scheduled to expire after December 31, 2011 (unless extended by Congress). The credit is complex; if you are considering installing energy efficient improvements such as windows, doors, heat pumps, and other items, please contact our office to determine if your purchase qualifies for the credit.

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.

Bonus depreciation. Business taxpayers have a limited window in which to take advantage of 100 percent bonus depreciation (unless extended by Congress). One hundred percent bonus depreciation applies to qualified property acquired after September 8, 2010 and before January 1, 2012, and placed in service before January 1, 2012 (or before January 1, 2013 for certain longer-lived and transportation property).

Code Sec. 179 expensing. Business taxpayers also have a limited window in which to take advantage of enhanced Code Sec. 179 expensing (unless extended by Congress). 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 for 2012 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). 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. After 2011, special expensing rules for qualified real property are scheduled to expire (unless extended by Congress). 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 under Code Sec. 179 up to $250,000 of the cost of the property.

WOTC. The Work Opportunity Tax Credit (WOTC) is scheduled to expire after December 31, 2011 (unless extended by Congress). The WOTC rewards employers that hire individuals from one of nine groups of targeted job seekers. Under current law, the WOTC applies to wages paid to qualified individuals who begin work for the employer before January 1, 2012.

Differential wage payments. Employers may qualify for a tax credit for differential wage payments made to employees called up for military duty. Under current law, the credit applies to wage payments made through December 31, 2011 (unless extended by Congress).

FUTA surtax. The 0.2 percent FUTA surtax expired after June 30, 2011. As a result, the FUTA tax rate falls to 6.0 percent for the remaining six months of 2011 before any state unemployment tax credits are taken into account. The IRS has indicated it will provide guidance for employers. Our office will keep you posted of developments.

Energy tax incentives. A number of tax credits for alcohol fuels and biodiesel/renewable diesel will expire after December 31, 2011 (unless extended by Congress). Tax credit for construction of new energy efficient homes and manufacture of energy efficient appliances will also expire after December 31, 2011 (unless extended by Congress).

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.

· The recognition period for the S corporation built-in gains tax has been reduced through 2012. The relief provided by this provision should be valuable to small family or privately-owned businesses that are forced to downsize and sell assets to raise cash.

Retirement plan contributions. If you make a contribution to your retirement plan before year-end, you can generally deduct at least a portion of the contribution amount to reduce your taxable income. An additional “catch-up” contribution is allowed for an individual who is over age 50 by the end of the tax year. Although Roth IRA contributions are not deductible because they are made after-tax, their earnings are tax-free.

Beginning in 2010, Roth IRAs were made available to all individuals, regardless of income amount or filing status. This enhancement enables you to make nondeductible IRA contributions, and periodically convert them into a Roth IRA. Remember, if you made a Roth IRA conversion in 2010 and chose to recognize the income ratably over two years, you must report half of the total amount in 2012.

With the year drawing to a close, now is an ideal time to review your tax situation and evaluate strategies that may help minimize your tax bill. Hopefully, the information here provides some alternatives that you would like to discuss in greater detail. Please call our office at your earliest convenience to arrange an appointment.