2012 Personal Tax Guide - 2011 Tax Planning Goals
2012 Personal Tax Guide and Tax Tips for 2011
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In this first chapter of the 2012 Tax Guide, EisnerAmper provides tax tips for 2011 filers.
In addition to saving income taxes for the current and future years, tax planning can reduce eventual estate taxes, maximize the amount of funds you will have available for retirement, reduce the cost of educating your children, and assist you in managing your cash flow to help you meet your financial objectives. Tax planning strategies can defer some of your current year’s tax to a future year, thereby freeing up cash for investment, business or personal use. This can be accomplished by timing when you pay certain expenses, or controlling when your income is recognized. Tax planning can also help you gain advantage of tax rate differentials between years. However, if tax rates rise in a subsequent year, extra caution may be necessary. And tax planning can help you prevent, or minimize, the impact of the alternative minimum tax (“AMT”) by preserving the tax benefit of many of your deductions.
Tax Planning Goals
In addition to saving income taxes for the current and future years, tax planning can reduce eventual estate taxes, maximize the amount of funds you will have available for retirement, reduce the cost of educating your children, and assist you in managing your cash flow to help you meet your financial objectives.
Tax planning strategies can defer some of your current year’s tax to a future year, thereby freeing up cash for investment, business or personal use. This can be accomplished by timing when you pay certain expenses, or controlling when your income is recognized. Tax planning can also help you gain advantage of tax rate differentials between years. However, if tax rates rise in a subsequent year, extra caution may be necessary. And tax planning can help you prevent, or minimize, the impact of the alternative minimum tax (“AMT”) by preserving the tax benefit of many of your deductions.
The key things you need to understand as you look for ways to minimize your taxes are:
- Residents of states with high income and property taxes, such as New York, California, Connecticut, Pennsylvania and New Jersey, are highly likely to be subject to the AMT.
- Long-term capital gains generally are subject to a maximum tax rate of 15% (with rates as low as 0% for lower income taxpayers). However, short-term capital gains can be taxed as high as 35%. Pursuant to the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, these rates will remain in effect through December 31, 2012. Complex netting rules (discussed in the chapter on capital gains and losses) have the potential effect of making your long-term gains subject to short-term rates, so you must carefully time your security trades to ensure you receive the full benefit of the lowest capital gains tax rate.
Tax Tip 1 gives you a snapshot of key strategies that will help you achieve your goals. It includes planning ideas to help you reduce your current year’s tax as well as ideas to reduce your future taxes. While this chart is not all inclusive, it is a good starting point to help you identify planning ideas that might apply to your situation. However, implementation of many of these ideas requires a thorough knowledge of tax laws, thoughtful planning and timely action.
|TAX PLANNING GOALS|
Proper tax planning can achieve the following goals:
Year-end Tax Planning Tips
Timing when you pay deductible expenses and when you receive income (to the extent you have control) can permanently reduce your taxes — especially if you are subject to the AMT in one year but not another. Timing expenses and income can also defer some of your tax to next year (or even later years) giving you, rather than the government, use of your money.
To gain the maximum benefit, you need to project, as best you can, your tax situation for both 2011 and 2012 so that you can identify your tax bracket for each year and determine whether the AMT will likely affect you in either or both years. Included in your projections should be your year-to-date realized capital gains and losses. Be sure to consider prior year loss carryforwards (if any). Based on these results, you can decide what steps to take before year-end. Should you prepay deductions and defer income, or defer expenses and accelerate income, realize capital losses, or lock in capital gains?
Tax Tip 2 offers basic guidance for deciding when to prepay or defer deductible expenses and when to defer or collect income. Tax Tip 3 offers steps to follow when deciding whether to take capital gains and losses, and the type of gains and losses you should trigger. Tax Tip 4 offers other tax savings steps to take before year-end.
Steps to Take if the AMT Applies either This Year or Next
Since AMT planning strategies can be very complicated, an entire chapter in this guide is dedicated to AMT issues. But, the following is a quick discussion of year-end planning strategies if the AMT applies.
As a general rule, if your 2011 year-end projection indicates that you will be in the AMT, or are highly likely to be in the AMT, it is very important that you do not pay any of the following expenses before the end of the year since they are not deductible in computing your AMT and you will receive no tax benefit from the deduction:
- State and local income taxes.
- Real estate taxes.
- Miscellaneous itemized deductions such as investment expenses and employee business expenses.
Conversely, if it looks like you will not be in the AMT in 2011, you should try to prepay as many of the above expenses as possible to receive the maximum tax benefit. Keep in mind, though, that the more you prepay, the more likely that you will end up in the AMT.
Expenses You can Prepay
Here are the most common deductible expenses you can easily prepay by December 31, 2011, if appropriate:
You can deduct cash charitable gifts totaling up to 50% of your adjusted gross income (“AGI”) and charitable gifts of appreciated capital gain property up to 30% of your AGI (30% and 20%, respectively, if given to a private nonoperating foundation). See the detailed discussion on this and other ideas in the chapter on charitable contributions.
State and local income taxes.
If you are not in the AMT this year, you can prepay your fourth quarter 2011 state estimated tax payment due on January 17, 2012, and even any state income tax you project will be due on April 16, 2012. You will gain the benefit of deferring part of your federal income tax liability and protect those deductions that could be lost if you fall into the AMT in 2012. Prepaying these taxes will probably outweigh any lost earnings on the use of the funds. However, be careful that the prepayment itself doesn’t put you into the AMT.
Real estate taxes.
Like state and local income taxes, prepaying 2012 taxes early can be an especially beneficial strategy should you end up subject to the AMT next year, but not this year.
Miscellaneous itemized deductions.
Miscellaneous itemized deductions are deductible for regular income tax purposes only if they exceed, in the aggregate, 2% of your AGI and you are not subject to the AMT. See the discussion later in this chapter for bunching these deductions to gain the most favorable tax result.
By prepaying your January 2012 mortgage payment in 2011, you can take the accrued mortgage interest portion as a deduction in 2011.
Be sure to pay any margin interest before December 31, 2011 since interest accrued at year-end is only deductible if actually paid.
You can accelerate purchases of business equipment before the end of the year to take advantage of expanded expensing allowances, subject to certain limitations. See the chapter on business owner issues and depreciation deductions for a more detailed discussion.
Income You can Accelerate or Defer
Timing income can be more difficult than timing deductions, but here are some types of income that you may be able to control the timing of receipt so that you can gain the advantage of having the income taxed in a year that you are in a lower tax bracket.
Cash salaries or bonuses.
You can defer salary or bonuses, but only if they are not constructively received in 2011 (i.e., made available to you this year). See the discussion in the chapter on deferred compensation for strict limitations on amounts that can be deferred and potential penalties.
Consulting or other self-employment income.
If you are a cash-basis business, you can delay billing until January 2012 for services already performed. See the chapter on business owner issues for a more detailed discussion.
Retirement plan distributions.
If you are over age 59 1/2 and your tax rate is unusually low this year, you can consider taking taxable distributions from your retirement plan even if they are not required.
The following ideas, discussed in much greater detail in the chapter on capital gains and losses, can lower your taxes this year:
- If you have unrealized net short-term capital gains, you can sell the positions and realize the gains in 2011 if you expect your 2012 tax rate to be higher: for example, if the gain will be taxed at the AMT rate of 28% this year but at the regular rate of 35% next year. But you would only consider this strategy if you do not otherwise intend to hold the position for more than 12 months, making it eligible for the long-term capital gain rate of 15%. However, there is a netting rule that may result in additional year-end short-term gains being taxed this year at the long-term rate of 15% rather than the short-term rate of 35%.
- Review your portfolio to determine if you have any securities that you may be able to claim as worthless, thereby giving you a capital loss before the end of the year. A similar rule applies to bad debts.
- Consider a bond swap to realize losses in your bond portfolio. This swap allows you to purchase similar bonds and avoid the wash sale rule while maintaining your overall bond positions.
Real estate and other nonpublicly traded property sales.
If you are selling real estate or other nonpublicly traded property at a gain, structure the terms so that most of the payments will be duel next year and you can use the installment sale method to report the income. This will allow you to recognize only a portion of the taxable gain in the current year to the extent of the payments you received, thereby allowing you to defer much of that tax to future years.
U.S. Treasury bill income.
If you have U.S. Treasury bills maturing early in 2012, you may want to sell these bills to recognize income in 2011 if you expect to be in a lower tax bracket this year than next year. You can also purchase bills with a maturity date after December 31, 2012 to give you the same flexibility to recognize the income in either 2012 or 2013.
Bunching miscellaneous itemized deductions from two different years into a single year may allow you to exceed the 2% of AGI limitation that applies to these deductions. If you have already exceeded the 2% floor, or will do so by prepaying some of next year’s expenses now, prepay the following expenses by December 31, 2011 (assuming you will not be in the AMT this year):
These include investment advisory fees, custody fees, and investment publications.
The most common of these fees are tax planning and tax return preparation, accounting, and legal fees (to the extent deductible).
Unreimbursed employee business expenses.
These include business travel, meals, entertainment, vehicle expenses and publications, all exclusive of personal use. You must reduce expenses for business entertainment and meals (including those while away from home overnight on business) by 50% before the 2% floor applies.
These expenses are only deductible if they exceed 7.5% of your AGI (10% for AMT purposes). Therefore, bunching unreimbursed medical expenses into a single year could result in a tax benefit. Medical expenses include health insurance and dental care. If you are paying private nursing or nursing home costs for a parent or other relative, you can take these expenses on your tax return if you do not claim the parent or relative as your dependent, assuming you meet certain eligibility requirements.
Adjust Year-end Withholding or Make Estimated Tax Payments
If you expect to be subject to an underpayment penalty for failure to pay your 2011 tax liability on a timely basis, increase your year-end withholding and/or make an estimated tax payment to eliminate or minimize the amount of the penalty. The chapter on estimated tax requirements discusses the situations that can result in an underpayment penalty and methods to avoid the penalty.
Utilize Business Losses or Take Tax-free Distributions
It may be possible to deduct losses that would otherwise be limited by your tax basis or the “at risk” rules. Or, you may be able to take tax-free distributions from a partnership, limited liability company or an S corporation if you have tax basis in the entity and have already been taxed on the income. See the discussion in the chapter on business owners.
If you have passive losses from a business that you do not materially participate in that are in excess of your income from these types of activities, consider disposing of the activity. The tax savings can be significant since all losses become deductible when you dispose of the activity. Even if there is a gain on the disposition, you can get the benefit of having the long-term capital gain taxed at 15% with all the previously suspended losses offsetting ordinary income at a potential tax benefit of 35%. See the chapter on passive and real estate activities.
Incentive Stock Options
Review your incentive stock option plans (“ISOs”) prior to year-end. A poorly timed exercise of ISOs can be very costly since the spread between the fair market value of the stock and your exercise price is a tax preference item for AMT purposes. Other issues, such as avoiding a cash flow problem on the exercise of options and funding taxes as a result of an exercise, are discussed in detail in the chapter on stock options.
If you have not already done so, make your annual exclusion gifts to your beneficiaries before the end of the year. You are allowed to make tax-free gifts up to $13,000 per year, per individual ($26,000 if you are married and use a gift-splitting election, or each spouse gives $13,000 from his or her separate funds). By making these gifts, you can transfer substantial amounts out of your estate without using any of your lifetime exemption. Also, try to make these gifts early in the year to transfer that year’s appreciation out of your estate. There are many other estate and gift planning ideas you should consider, as discussed in detail in the chapter on gift and estate taxes.
Tax Tip 1 — Key Tax Planning Strategies
|Your regular tax rate will be the same or lower next year and the AMT will not apply in either year.||• Prepay deductions.
• Defer income.
|Your regular tax rate will increase next year and the AMT will not apply in either year.||• Defer deductions.
• Accelerate income.
But only if the tax rate increase warrants accelerating tax payment.
|The regular tax rate applies this year and is higher than the AMT rate that you expect will apply next year.||• Prepay deductions, especially if they are not deductible against the AMT and would therefore be lost next year. These deductions include state and local income taxes, real estate taxes, and miscellaneous itemized deductions such as investment fees.
• Defer income.
|This year you are in the AMT and next year you will be subject to a higher regular tax rate.||• Defer deductions, especially those not allowed against the AMT that would be lost this year.
• Accelerate income.
|You have net realized capital losses this year or loss carryforwards from last year.||• Consider recognizing gains by selling appreciated securities to offset realized losses.|
|You have net realized capital gains this year.||• Sell securities with unrealized losses to offset the gains — if market conditions justify it.
• Use a bond swap to realize losses.
• Consider tax implicaations of netting rules.
• Avoid wash sale rules.
|You are contemplating purchasing new business equipment.||• Accelerate the purchases into 2011 to take advantage of bonus depreciation available this year.|
|Your miscellaneous deductions will be reduced due to the limitation based on 2% of your adjusted gross income.||• Bunch these deductions into a single year, thereby increasing the deductible amount.
Make sure you avoid the AMT.
|A penalty for underpayment of estimated taxes will apply.||• Withhold additional amounts of tax from your wages
before December 31.
• Prepay fourth quarter estimates due January 17 and increase the payment amount, if necessary.
|You want to diversify a concentrated low-basis stock position and avoid paying taxes currently.||• Consider using a charitable remainder trust that will allow you to sell the stock in exchange for an annuity. This will allow you to defer the tax while benefiting a charity of your choice.|
|You have incentive stock options that you can exercise.||• Consider exercising your options to start the long-term holding period, but only if the spread between the market price of the stock and the exercise price will not put you into the AMT.|
|Your passive activity losses exceed your passive income.
||• Dispose of an activity that is generating passive losses in order to deduct the suspended loss on that activity.
|You would like to make significant charitable contributions.||• Donate appreciated securities you have held for more than one year.
• Consider establishing a charitable trust or a private foundation, or take advantage of a donor-advised fund.
• Consider directing charitable contributions directly from your IRA(2011 is the last year eligible barring further legislation)
|You need funds for personal use, such as improvements to your home in excess of the mortgage limitations, or to pay tax liabilities.||• Sell marketable securities with little or no appreciation to fund your needs, and then use margin debt to purchase replacement securities. The interest on the debt will be deductible, subject to investment interest limitations.
• Take distributions, if available, from partnerships, limited liability companies, or S corporations on income that you have already paid taxes on. Just make sure you have sufficient tax basis and are at risk in the entity.
|You want to take advantage of the
tax-deferred nature of retirement accounts.
|• Maximize your contributions to your retirement accounts
and take advantage of the best plans available to you.
|You expect the value of your IRA to appreciate over time, and you want to position your IRA now so that there will be little or no tax impact when you or your beneficiaries take distributions later.||• Consider converting your traditional IRA into a Roth IRA in 2011. However, this will cause a current tax liability.
|You have a sizeable estate and want to protect your assets from estate tax.
You want to transfer assets to your designated beneficiaries during your lifetime.
|• Make gifts of $13,000 to each individual.
• Pay beneficiaries’ tuition and medical expenses directly.
• Use your lifetime gift tax exemption of $5 million (effective for 2011 and 2012 only).
• Create a grantor retained annuity trust (“GRAT”).
• Set up a family limited partnership (“FLP”) or family limited liability company (“FLLC”).
• Make loans to your beneficiaries at minimum required interest rates.
|You want to provide for your children’s and/or grandchildren’s college costs.||• Establish a 529 plan that can grow tax-free as long as you use the funds to pay qualified education expenses.
Tax Tip 2 — Year-end Tax Tips
|You will not be in the AMT this year or next year and your 2011 tax rate||You are in the AMT*|
|Nature of deduction or income||will be the same or decrease||will increase||only this year||this year and next year||only next year|
|Charitable contributions, mortgage interest, investment interest and self-employed expenses||Prepay||Defer||Defer||Prepay||Prepay|
|State and local income taxes, real estate taxes, and miscellaneous deductions that are not deductible if you are in the AMT||Prepay||Defer||Defer||Defer||Prepay|
|Income such as bonuses, self-employed consulting fees, retirement plan distributions, and net short-term capital gains (unless you have long-term losses offsetting the gains)||Defer||Collect||Collect||Defer||Defer|
|Miscellaneous itemized deductions bunched (not deductible for the AMT) into a single year will exceed the 2% adjusted gross income floor||Prepay||Defer||Defer||Defer||Prepay|
|(Legend = Prepay before Dec. 31, 2011 / Defer into 2012 or later / Collect before Dec. 31, 2011 )
*The chart assumes your regular tax rate on ordinary income is higher than the maximum AMT tax rate of 28%.
Tax Tip 3 — Year-end Capital Gains and Losses
|If you have||Consider taking these steps|
|Both short-term and long-term losses||Sell securities to recognize unrealized gains, preferably if held short-term, up to the amount of your losses less $3,000.|
|Long-term gains in excess of short-term losses||Take losses equal to the net gain, plus $3,000. Use long-term loss positions first, then short-term loss positions. But consider holding the short-term losses until next year if you anticipate net short-term gains in 2012.|
|Both short-term and long-term gains, or short-term gains in excess of long-term losses||Take losses equal to the net gain, plus $3,000. Use long-term loss positions first to gain the benefit of offsetting short-term gains (taxed at a rate as high as 35%). If the long-term loss positions are held until next year and then sold, you may receive only a 15% tax benefit if they offset long-term gains.|
|Worthless securities and bad debts||Identify these securities and debts and take the necessary steps to ensure that the losses are deductible in the current year, including having the proper substantiation, as discussed in the chapter on capital gains.|
|Note: If you are married, filing separately, substitute $1,500 for $3,000 in the above tip.|
Tax Tip 4 — Save Taxes by Using Year-end Planning Strategies
|Take the following steps before December 31, 2011 (if you are not in the AMT) so you can defer some of your tax liability to 2012.*|
|Prepay your January 2012 monthly mortgage payment up to the amount of accrued mortgage interest||$5,000|
|Prepay the first half of your 2012 real estate tax||15,000|
|Accelerate charitable contributions into this year that were intended for next year||25,000|
|Prepay your fourth-quarter 2011 state estimated tax payment which is otherwise due January 17, 2012||35,000|
|Wait until after January 1, 2012 to bill consulting fees earned in 2011||20,000|
|Reduction of taxable income||$100,000|
|Federal tax rate||35%|
|Federal tax deferred until next year||$35,000|
|*Reverse the above strategies if you will be in the AMT in 2011 (see below)|
If you are subject to the AMT in 2011 (but will not be in 2012), do not implement the above year-end strategies, since if you do it will cost you $21,000 in additional taxes, assuming you will be subject to the maximum regular tax rate in 2012. This is because:
- Deferring your consulting fees will result in the loss of the lower AMT rate of 28% in 2011, at a tax cost of $1,400.
- Prepaying your real estate taxes and the fourth quarter 2011 state estimated tax payment will give you no tax benefit in 2011 since these expenses are not deductible for AMT purposes. By waiting until January 2012, you would get the benefit of the combined $50,000 deduction and save $17,500 in taxes.
- Charitable contributions and the interest portion of your mortgage payment will generate a smaller tax benefit at the AMT rate of 28% – resulting in a lost tax benefit of $2,100.