Where did 2011 go?
The close of another tax year is almost upon us, which means it is time to once again talk about year-end tax planning. Individuals and businesses generally want to defer income and accelerate deductionswhen implementing year-end tax strategies. However, that general strategy may not prove beneficial if tax rates increase next year or you are experiencing alternative minimum tax.
This time last year we were wondering if the Bush-era tax cuts would be expiring to result in tax increases to most Americans. Then, President Obamaon Dec. 17, 2010, signed into legislation the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the “2010 Tax Act”).The 2010 Tax Act extended the Bush-era tax cuts until Dec. 31, 2012, at which time they would expire. Thus, Congress gave us two more years of the cuts and more uncertainty as to what the future will hold.
The year 2011 saw only one piece of tax legislation – the Comprehensive 1099 Taxpayer Protection and Repayment of Exchange Subsidy Overpayments Act of 2011. The highlights from this legislation was the repeal of the requirement to issue Form 1099s to corporations, abolishment of patents on tax strategies, and increased rates on large corporations’ estimated tax obligations. Tax legislation in 2011 was quiet due to the dysfunction in Congress and huge deficits and debts. There was no legislation to deal with the Bush-era tax cuts.
Currently, the only possible legislation in the works that could increase taxes would be the result of the Super Committee. By the time this is published, the Super Committee’s deadline will have passed and the legislation would have to be voted on by Dec. 23, 2011, to prevent extensive cuts to budget in 2013. That is, if they come up with any solutions or agreements.
The skeptic in me says an agreement will not be reached, so I do not see any tax rate legislation coming that will affect our tax planning for year-end and we can employ normal year-end tax planning strategies.
While tax planning is a year-round process, year-end tax planning presents important tax saving opportunities. Year-end planning is an inexact process, yet a systematic analysis of planning options can produce benefits for the individual or business taxpayer by postponing or accelerating items of income and deduction. The tax planner may use the following strategies to assist both individual and business clients.
If your tax planning shows that you will be in the same or a lower tax bracket next year, you probably want to delay the receipt of year-end income until early next year, provided the delay does not jeopardize your prospect of collecting the income. Here are a few techniques you may be able to use to achieve that goal: 1) delay collections; 2) defer compensation; 3) take year-end bonus in the next tax year; 4) transfer funds to annuities instead of interest bearing accounts; 5) maximize retirement plan contributions; or 6) close capital transactions in the next tax year to gain the deferral of time to report the gain.
A rule of thumb says you should defer income if at all possible. But in the following situations, it may be advantageous to accelerate income: 1) change in income level or tax bracket; 2) liability for Alternative Minimum Tax (AMT);or 3) itemized deductions exceed taxable income.
The following are strategies for accelerating your income: 1) collect receivables; 2) take your year-end bonus in current tax year; 3) treat restricted stock as vested; 4) dispose of your incentive stock options; 5) take IRA or retirement plan distributions if over 59 ½; 6) dispose of installment notes; 7) take dividends; and 8) sell capital assets.
If you need to accelerate deductions, the following techniques may be employed to accomplish that goal: 1) doubling up on charitable contributions, paying next year’s with this year’s; 2) realizing losses on investments; 3) taking bad debt deductions; 4) accelerating purchases of business equipment; 5) prepaying state and local income taxes, which will be allowable if the relevant authority accepts such as payment and not simply as a deposit; and 6) prepaying property taxes.
One of the greatest areas of year-end flexibility comes from your ability to time your investment transactions for maximum tax benefit. Often the change of a few days in the timing of sales or acquisitions of stocks or bonds can make a significant difference in the way a transaction is taxed. With the approach of year’s end, it is wise to add up all the gains and losses you have realized to date and compare them with the unrealized gains and losses in your portfolio. As with most planning decisions, economic factors in the market should take precedence over tax considerations. That is, you should not hold on to an asset just because you do not want to pay tax on the gain. Conversely, you should not sell an asset just to take a loss if you think that asset will rise in value. Capital losses can only be recognized to the extent of gains plus an additional $3,000. To the extent capital losses exceed gains plus $3,000, the unused portion can be carried forward until used up.
‘Wash sale’ rules
If you are considering selling losing positions to recognize the losses and plan on purchasing the same stocks, be careful of the “wash sale” rules. A “wash sale” is a sale or other disposition of stock or securities in which the seller, within a 61-day period – that begins 30 days before and ends 30 days after the date of such sale or disposition – replaces the stock or securities by acquiring or entering into a contract or option to acquire substantially the same stock or securities. The “wash sale” rules provide that any loss realized on the stock or securities sold may not be recognized for income tax purposes and, therefore, may not be used to offset capital gains or otherwise deducted.
Other losses strategies
Various year-end planning strategies for losses other than losses from securities transactions should also be considered. Specifically, there may be planning opportunities with regard to partnership losses, S Corporation losses, and net operating losses for individuals and corporations.
A partner can deduct his share of partnership losses only to the extent of basis in the partnership interest. Thus, if toward year-end you have losses that will be denied as a deduction because of the basis limitation, you can make a capital contribution to the partnership to increase basis and thereby deduct the loss.
An S shareholder’s losses are also limited to the sum of stock basis and basis in debt owed him by the company. If you foresee nondeductibility of a loss because of the basis limitation, you may be able to secure the deduction by making a capital contribution.
With the approaching year-end, it may be appropriate to review your current business structure to see if you could benefit from a change in such business structure. For example, if you are a sole proprietorship and you anticipate that you will have a net profit of at least $60,000 next year, it may be advantageous for you to incorporate your business and utilize the S corporation election to save money on your employment taxes resulting from social security taxes imposed on self-employed individuals. Under authority contained in the Social Security Act, the Social Security Administration announced on Oct. 19, 2011, that the contribution and benefit base for remuneration paid in 2012, and self-employment income earned in taxable years beginning in 2012, is $110,100. The social security tax is equal to 12.4 percent for self-employed individuals and 6.2 percent for employees, including owner-shareholders of an S corporation. However, distributions of profits of an S corporation not taken as wages are not subject to self-employment tax. Accordingly, social security taxes can be saved with proper planning involving the use of an S corporation.
The start of a new year is the perfect time to incorporate your business.
Tax benefits expiring
Getting ready for 2012, the following are some of the tax benefits that are expiring come Dec. 31: IRA to charity tax free transfers cease; deductions for tuition and related fees cease; deductions for state and local sales taxes cease; deductions for mortgage insurance premiums cease; and deductions for school teacher supplies ceases.
Some of the tax benefits slated to expire come Dec. 31, 2012 are: the marriage penalty equalization ends; dividends being taxed at capital gains rates cease; lower tax rates for capital gains expire; child care deduction reverts to $2,400 from $3,000; child credit reduces to $500 per child from $1,000; and the income tax exemption for debt forgiven on home foreclosures and repossessions will cease.
Of course, these items could be extended, but at this point they are slated to expire. Thus, timing to take advantage of these items that are set to expire will be critical next year.
In these uncertain times, stay tuned to the news and what Congress does in the next couple of weeks. Consult with your certified public accountant and tax attorney to properly advise and implement your year-end tax planning.