 | Client Letter |
| Big changes make 2010 a watershed year for tax planning |
| Your 2010 Tax Reminders |
| Homebuyer credit extended and expanded in recent law |
| Your 2010 Tax Numbers |
New Year 2010
Big changes make 2010 a watershed year for tax planning
The dawn of the second decade of the 21st century will start off with sunsets, at least in the tax world. You may recall that many of the tax acts passed over the last nine years included "sunset" provisions, or built-in expiration dates. The result: 2010 might be the last year to take advantage of certain credits, deductions, and other federal tax breaks.
The biggest change involves tax rates. Current favorable capital gains and ordinary income tax rates are scheduled to expire at the end of 2010. On January 1, 2011, rates will revert to higher pre-2001 levels — unless Congress enacts new legislation. Either way, the potential for increased tax rates in 2011 and beyond calls for advance planning in several areas, including investments, income timing, and your business.
Here are suggestions to help you get started.
Your investments
For 2010, the maximum long-term capital gains tax rate for most investments and for qualified dividends is 15%. The rate falls to zero if you're in the 10% or 15% tax brackets for ordinary income. Those two brackets currently apply when you're married filing jointly and your taxable income is less than $68,000 ($34,000 if you're single).
After the temporary rules end on December 31, 2010, selling appreciated investments may cost you more in taxes. Yet making sales in the current year to take advantage of lower rates can put you in a higher bracket and affect income-limited deductions and credits.
As an alternative to selling, other forward-looking tax strategies might better suit your overall goals.
For instance, since after this year it's likely that dividends will once again be taxed at your ordinary income tax rate — which may also be higher than this year's rates — you could choose to invest in stocks with growth potential instead of those paying current income in the form of dividends.
If tax rates go higher, you might want to consider investing in tax-free municipal bonds. There is an easy way to compare the yield on tax-exempt municipal bonds with the after-tax yield from taxable investments. Subtract your top tax bracket from 100 and divide the tax-exempt interest rate by that number. The result is the equivalent taxable return. In making your investment decision, you'll want to choose the investment that provides the greater after-tax return.
As you rebalance your portfolio over the course of 2010, you might also consider increasing your investment in mutual funds with low turnover rates. Here again, you'll reduce taxable capital gains in future years.
Gifts of stock to certain family members in lower tax brackets and donations of appreciated assets to your favorite charity are other viable alternatives for reducing the amount of capital gains tax you'll pay now and in the future.
Timing your income
When tax rates are expected to increase in the near future, a basic tax planning move is to calculate the effect of shifting income into the current period. This year offers an excellent opportunity to do just that.
Are you aware that you'll be able to convert your traditional IRA to a Roth during 2010 no matter your income or filing status? The conversion creates taxable income this year, which you can pay in full prior to any tax rate increase.
The benefit to doing this is that later withdrawals will be tax-free. Converting to a Roth also eliminates the need to withdraw required amounts from the account, so you could reduce your income, and the related taxes, in future years.
Another income planning consideration is the effect of minimum distributions from your traditional IRA if you'll reach age 70½ this year. The rule requiring mandatory withdrawals is reinstated in 2010. However, for the first year in which you're required to take distributions, you have the option of deferring your initial withdrawal from December 31 until the following April.
Doing so means you'll have to take two distributions in 2011. Depending on your expected income next year, waiting may not be advantageous.
Your business
Does your business operate as a regular "C" corporation? Think about making dividend payments during 2010. In a typical tax planning year, dividend distributions are unappealing because they're not a deductible business expense and you have to report them on your personal return as income. But the expiration of preferential tax rates for dividends at the end of 2010 could make this a good time to pay dividends from your corporation.
An important recent rule change could affect your business if your company suffered a loss in 2008 or 2009.
Normally, a business can carry back a net operating loss (NOL) for only two years before carrying it forward for up to 20 years. The American Recovery and Reinvestment Act of 2009, signed in February 2009, allowed a carryback for three, four, or five years to qualified small businesses for NOLs in tax years beginning or ending in 2008. To qualify for the longer carryback period, the business had to have average gross receipts of $15 million or less.
A new law signed November 6, 2009, expanded the longer carryback period to include businesses of any size. The longer carryback is generally available for NOLs incurred in either 2008 or 2009. One important restriction: An NOL carried back to the fifth year is limited to 50% of the taxable income for the year.
Planning for future events is an ongoing process, made more important by the big changes coming. For suggestions and advice that will help you save tax dollars, please call for a tax planning review.