Dealer Insights – May/June 2011 - Plan your individual income tax strategies for 2011
No sooner is your individual 2010 income tax return filed than it’s time to start thinking about your strategies for 2011. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 extends many breaks through 2012. What follows are some facts about key Tax Relief act changes affecting individuals, and tips for taking advantage of them.
Fact: Ordinary income tax rates are holding steady for a while. Rates were scheduled to return to 15%, 28%, 31%, 36% and 39.6% for 2011 per a “sunset” provision of 2001 tax legislation. But the Tax Relief act extends the lower ordinary tax rates of 10%, 15%, 25%, 28%, 33% and 35% through Dec. 31, 2012.
Planning tip: With the lower rates in effect for 2011, consider paying the tax up front on installment sales executed during the year. Because tax rates aren’t scheduled to go up until 2013, in 2011 you also can employ the traditional tax planning strategy of accelerating deductions into the current year and deferring income to the next year. But watch out for the alternative minimum tax — certain deductions and income items can trigger it, boosting your overall tax bill. Fact: The Tax Relief act extends the elimination of the itemized deduction and personal exemption phaseouts through 2012. The phaseouts reduced the benefit of these breaks for individuals with incomes exceeding certain levels.
Planning tip: This extension provides another reason to accelerate deductions. If, for example, you’re considering a sizable charitable contribution, making it in 2011 or 2012 will allow you to maximize your tax benefit.
Fact: The Tax Relief act extends the lower rate for most long-term capital gains. Through 2012 the rate is 15% (generally 0% for those in the 10% and 15% ordinary income tax brackets). Without this extension, the rate would have risen to 20% in 2011 (10% for taxpayers in the 15% tax bracket).
The extension also applies to the tax rates for qualified dividends. Without the extension, such dividends would have been subject to ordinary income tax rates as high as 39.6% this year. Qualified dividends include dividends received from a domestic corporation or a qualified foreign corporation.
Planning tip: Taxes on your investments may be less of a concern for the time being, but you may want to take action to lock in the 15% tax rate while it’s available. Consider divesting your portfolio of highly appreciated assets. Or, if you’re considering making gifts to take advantage of the high gift tax exemption (see the sidebar “Time for those really big gifts”), gift appreciated assets to a family member who would qualify for the 0% long-term capital gains rate. Looking for other opportunities? Review C corporation earnings and profits, because 2012 might be the last time the dividend tax rate is at 15% for the foreseeable future. And if you own an interest in a reinsurance company that has excess cash, consider having a dividend issued in 2011 or 2012.
Fact: For 2011 only, the Tax Relief act reduces the employee’s share of Social Security taxes from 6.2% to 4.2% on earnings up to the taxable wage base of $106,800 this year. So, for example, if you earn $100,000 this year, you’ll save $2,000 in payroll taxes.
Planning tip: This is an excellent opportunity to increase contributions to your retirement plan without the sacrifice. Because of the lower payroll taxes, you receive more in take-home pay. So, for instance, if you increase your contribution to your 401(k) by two percentage points, your net paycheck will be the same as if the Social Security portion of payroll taxes were still at 6.2%.
Fact: The Tax Relief act extends some education-related tax breaks, including the higher education tuition deduction, the exclusion for employer-provided educational assistance and enhanced Coverdell Education Savings Accounts. The act also extends the American Opportunity tax credit (formerly the Hope education credit) through 2012.
Planning tip: Your ability to claim an education credit may be phased out based on your income. So if you have a child in college, consider allowing him or her to claim the credit instead. You’ll have to forgo your dependency exemption for the child, but the credit may result in overall tax savings for your family.
Fact: Although federal tax credits on the purchase of hybrid gas-electric cars and trucks expired at the end of 2010, you can still qualify for up to a $7,500 federal tax credit (depending on battery capacity) if you purchase an all-electric car.
Planning tip: Maybe you or one of your children would be happy with one of the sporty new all-electric cars, such as the Nissan Leaf or Chevy Volt, if it matches up with your dealership’s product line or you don’t mind crossing over to another manufacturer. Your tax advisor can assist you in taking advantage of this limited-time tax break as well as other provisions of the Tax Relief act that provide estate planning opportunities.
Auto dealership owners with deep pockets may want to take advantage of a large but temporary boost in the gift tax exemption. The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 raises the exemption from $1 million to $5 million for 2011 and 2012. The exemption, which will be indexed for inflation in 2012, is scheduled to fall back to $1 million in 2013.
So, for example, an auto dealership owner can give interests in the dealership worth $5 million (less any gift tax exemption used previously) to his or her children without being taxed on the gift. If the business interests qualify for minority and/or marketability discounts, the savings can be even greater.
For instance, if a gift of limited partnership interests is subject to a 30% discount, a dealer could, under the $5 million exemption, give interests worth $7,142,857 ($7,142,857 × 30% = a $2,142,857 discount; $7,142,857 - $2,142,857 = $5 million). So, by making the resulting $5,000,000 gift, the dealer would really move $7,142,857 of family wealth to the next generation tax-free.
If the dealer is married, the couple can use both spouses’ $5 million exemptions and gift $10 million tax-free.
Dealers who act now — while not only the higher exemption is available but also dealership values are down due to the recession — can transfer a higher percentage of their estate to heirs without incurring gift or estate tax than they could have, say, a few years ago.
Dealer Insights – May/June 2011