Here Are Some Things You Can Do To Save Taxes in 2011
By Robert W. Craig, E.A.
Tel: (805) 264-3305
This is a longer than usual post but if you find just one strategy that can save you some tax dollars, the read will be worth your while, so please take the time and go through the whole thing.
Albert Einstein said, “The hardest thing in the world to understand is the income tax.”
First A Warning – Emails from the IRS: Beware of phony emails from the IRS. The IRS does NOT contact taxpayers by email. These are phony phishing scams so do not open them or give out any of your personal information.
Year-end tax planning generally is all about reducing taxes by accelerating deductions or timing income recognition. This newsletter offers some strategies for keeping your 2011 taxes as low as possible. Remember, most of these strategies must be implemented before the end of the year, so plan now and act fast.
Not all strategies will apply or be beneficial in your particular situation, so it’s important to consult with a tax advisor before implementing them.
There are a number of ‘basic’ year-end strategies that I’ll list below, and I’ll also take it a bit deeper in some specific areas that affect a lot of taxpayers.
It’s year end and you want to reduce this years taxes. Many times, reducing this years taxes may potentially increase next years taxes, so again, do your homework or consult with your tax advisor. Try some of these:
- Prepay your January 1, 2012 mortgage payment. Since interest is paid in arrears on your mortgage, if you pay your January payment say on December 20th, the interest will show up on your 2011 Form 1098 for a mortgage interest deduction. Note that doing this will lower your interest deduction in 2012.
- Prepay your April 10, 2012 property tax payment on your real estate. Same as above you’ll be able to deduct it on your 2011 return, but you’ll just be moving it from a 2012 deduction to a 2011 deduction. Be wary of the Alternative Minimum Tax (AMT) if it applies to you as it may render this strategy totally or partially useless.
- If you think you will owe on your state tax return at tax time, you can estimate it and get it paid in by December 31, 2011. This way you can deduct it on your 2011 federal return if you itemize your deductions. Watch AMT as it is subject to limitations in number 2 above.
- Donate money to charities. You can donate to charities by year end and deduct them on your 2011 taxes. For cash charities you can charge them on a credit card and deduct.
- Contribute the maximum to your company retirement or 401k plan. If you have not maxed out your allowable contribution for 2011, contact human resources or payroll and have them make up the difference by December 31st. Be careful as your net pay will drop by the same amount.
- If you think you have really underpaid your 2011 tax you may be subject to a penalty, even if you plan to pay it off with your tax return. You can have additional withholding from your final paychecks, or make an estimate tax payment to avoid or reduce the penalty. By doing this through payroll, the withholding will spread out through the year and you may reduce the penalty more this way.
- Give up worthless Dependency Exemption. When high-income taxpayers with children in college lose the full dependent exemption, you can remove the dependent from your return to allow the child to get education credits on his or her own return, if any.
- Bunch Expenses. Group expenses subject to AGI floors into the same tax year in order to exceed the limits. For example, medical expenses are deductible only if they exceed 7.5% of adjusted gross income (AGI). You can try to bunch payments by accelerating or deferring expenses into a single year, usually a year that may have larger than normal medical or dental expenses.
- Donor Advised Funds. Take larger charitable deductions in the year of contribution and distribute gifts over time.
The standard mileage rate for business use of vehicles for 2011 is two rates depending on the date of business use. For January 1, 2011 thru June 30, 2011 is 51 cents per mile. For July 1, 2011 thru December 31, 2011 the rate is 55.5 cents per mile. Therefore, when you give me your mileage information from your log, you’ll need to break it down for the first half of the year and the second half of the year.
New heavy SUVs put into service in 2011 are eligible for a bigger tax break. As of this writing, up to 100% (assuming no personal use) of the cost can be written off under the bonus depreciation rules through December 31, 2011. The $25,000 ceiling on expensing SUVs doesn’t apply if bonus depreciation is taken. The vehicle must be NEW, used vehicles do not qualify for bonus depreciation, tho they may qualify for up to $25k section 179.
Required Minimum Distributions. If you are required to take annual minimum distributions fom your IRAs and other retirement plans, the distributions must be taken out by December 31, 2011.
Did You Turn 70 ½ in 2011? If so, you are required to begin taking out minimum distributions from your IRA accounts. If you turned 70 ½ in 2011, you may delay the 2011 distribution until April 2, 2012. For subsequent years you will need to take out the distribution for the year by December 31st. Note that if you elect to delay your 2011 distribution, you will need to take the 2011 and 2012 distribution amounts in 2012. This may not be advisable if the increased income will affect other taxable income or deductions that are driven by your income. Check with first on this if it applies.
Tax Audits. IRS statistics on audits report that the overall audit rate of all taxpayers rose to 1.11%, the highest figure since 1997. If your income was $1 million or more your audit rate was 8.36% of these filers, which equates to 1 in 12 of these returns being audited. Filers with incomes over $200,000 also experienced more than twice the average audit rate, as did business returns, such as Schedule C filers, with gross income over $25,000, and filers claiming the earned income credit (EIC). As usual, keep great records. Note part of Obama’s proposed tax plan includes the hiring of more IRS agents. The IRS claims that it brings in $6 for every dollar spent on tax enforcement.
Now, for some more sophisticated tax saving strategies…
Capital Gains and Losses
Assets like stocks, bonds, mutual funds, real estate and other securities owned and then sold may generate a capital gain or loss. By planning when to sell them and take tax losses or gains, you may be able to time sales of other investments before year-end to help achieve the best tax results.
As a general rule, if you have realized capital gains or losses over a given year, you can offset the gains with the losses. For example, if you have net capital gains, you can consider which securities that you still hold that have losses that could be sold before year end to save on capital gains tax. On the other hand, if you have net capital losses, you can use some or all of those net capital losses to offset income on other positions you may hold and wish to sell.
Understand that you must sell the position to lock in the gain or loss on that sale. A mere increase or decline in value does not affect your taxes. Also, the investments I’m talking about here cannot be investments you hold in a retirement plan such as an IRA, SEP or 401k as transactions in these accounts do not affect your current year taxable income.
The difference between Long-term and Short-term Capital Gains
Assets that have been held longer than one year are considered long-term and are taxed at a maximum 15% rate for ordinary income tax and the Alternative Minimum Tax until year-end 2012. Assets held for less than a year are short-term and are taxed at ordinary income tax rates which can be higher than the 15% rate. This distinction is an important one.
In calculating tax on asset sales, a taxpayer must first net the short-term gains and losses; then net the long-term gains and losses independently. Then the short-term and long-term gains and losses are netted against one another. If a net capital loss is generated, it may be used to offset up to $3,000 of ordinary income ($1,500 if the taxpayer is filing as Married Filing Separately).
Any unused portion may be carried forward indefinitely until the death of the taxpayer, when the carryforward expires. Capital losses realized on the sale of securities may also be used to offset capital gains on other classes of assets, such as real estate, and vice versa, on Schedule D. It is important to determine whether you are already carrying losses over into 2011 from previous years.
In general, capital losses are more tax-effective if they can be used to offset income taxed at higher tax rates (short-term capital gains and ordinary income).
- Long-term losses used against short-term gains are tax-efficient.
- Short-term losses used against long-term capital gains are tax-inefficient.
For that reason, a taxpayer normally should try to avoid having long-term capital losses offset long-term capital gains, as the losses will be more valuable if used to offset short-term gains or ordinary income. To do this requires ensuring that the long-term capital losses are not taken in the same year as the long-term capital gains. This can be tricky so you must know your portfolio or meet with your investment advisor.
Big Tax Break Potential for 2011 and 2012 for Those in Lower Tax Brackets (or those with children in lower tax brackets)
For investors with lower taxable income (e.g. those who, for 2011, were in the 10% and 15% federal tax brackets, with taxable income less than $34,500 for a single individual and $69,000 for a married couple), the tax rate on capital gains would be 0%. For these investors, harvesting of capital losses would be wasted, since they will not be taxed on their gains. For these investors, it may make sense to harvest gains instead of losses—and sell appreciated securities without having to pay capital gains tax on the sale.
But what if I’m not in these lower brackets, is there a way I can benefit from this 0% rule? Maybe, if you are willing to part with the money. If you have adult children in one of these tax brackets (beyond the reach of the Kiddie tax rules), consider using your $13,000 annual gift tax exclusion to transfer appreciated or dividend-producing assets to them so they can enjoy the 0% rate, which also applies to qualified dividends. Beware – to be a real gift you are giving it all away, which is okay if you wish to gift away money to your kids, or sock it away for college.
It’s important to remember that you can “gift away a gain” and have the recipient taxed on the appreciation on the subsequent sale of the asset, but you cannot “give away a loss” in the same way.
Your Investment and Tax Goals Must Be Aligned
Both investment objectives and tax strategies must be factored in when deciding to sell or hold to take advantage of tax benefits. If you sell a stock or fund for tax purposes that you expect to rise in value, you lose out on that increase. You can buy it back, but you must wait 30 days or your loss will be disallowed under the wash sale rules, which say that no tax loss can be taken if you purchase the same investment (or option to buy such a security) within 30 days before or after the sale. Check with an expert as this can get tricky, and there may be some ways around the wash sale rules.
Appreciated Mutual Funds
If you own appreciated mutual funds, you may wish to consider selling those funds prior to the December capital gains payment made by fund managers to shareholders as that distribution is capital gain. It is considered a long-term capital gain so care must be taken to be sure it is part of your overall investment and tax strategy.
Loss carryovers can be a powerful tax-saving tool in future years if you have an investment portfolio that might generate substantial future capital gains. They will be even more valuable if tax rates go up in 2013. You must understand the value and potential uses of these carryovers so learn them or hook with a great tax professional.
A Couple of Details to Note
1. In determining whether a sale is short-term or long-term we use the ‘trade date’.
2. You may have bought the same security at different times and prices, and you may want to specifically identify which block of shares is being sold. In this way you may be able to control the size of the gain or loss by matching lower or higher cost basis shares to a specific sale depending on what your specific outcome is.
Special Capital Gain Rules for Collectibles
Generally, gold coins or bullion are treated as a “collectibles,” for which the maximum long-term capital gain rate is 28%, not 15%. The beneficial long-term capital gain rates are not available on collectibles. The “wash sale rule” does not apply to “collectible” losses.
Deductions Expiring in 2011:
Tax laws come and go, the following tax deductions, credits and opportunities extend only through the end of 2011—and then, if not extended, are gone:
• The election to take an itemized deduction for state and local general sales taxes in lieu of the itemized deduction permitted for state and local income taxes
• The above-the-line deduction for qualified higher education (tuition) expenses
• The $250 above-the-line deduction for certain expenses of teachers
• Deductibility of premiums paid on mortgage insurance on a qualified residence
• The tax credit for energy-saving home improvements
• Increased contribution limits and a carryforward period for contributions of partial and complete interests in appreciated real property for conservation
• For those age 70½ or older, making tax-free distributions to charity from an IRA of up to $100,000 per taxpayer, per tax year.
If these opportunities and benefits save you money, take advantage of them but know they are gone after December 31, 2011
Income Timing Considerations
Planning for taxes on your income involves strategies seeking opportunities to generate income in ways that are tax-deferred, tax-free or taxed at favored rates—and managing the timing of income recognition, that is, when you are taxed on it. If you expect that your marginal tax rates (the rate on the last dollar you earned) will be lower in the future, timing of income flows may be used to delay income recognition into a future year.
On the other hand, if income tax rates are expected to be higher in future years, recognition of income in this year (2011) may be preferable. Changes in tax rates could come from changes in tax laws and regulations and changes in your personal tax circumstance, income and deductions.
Be careful of the ever present Alternative Minimum Tax (AMT) when planning strategies to accelerate or defer income or expenses. It can be complex so utilize your tax advisor for help you in this area.
There are a number of ways to give to charities, from contributions of cash (see below) and property to a specific charity, to donor-advised funds, foundations, and charitable trusts.
Tax Tip: You might consider gifting stocks, funds, or other securities that you have held for at least one year. You get the full fair market value deduction for the donation and you will not have to pay capital gains tax on the appreciation as you would if you first sold the security and donated the proceeds.
There are strict substantiation rules on charitable contributions. For all donations, get a receipt, save the cancelled check or credit card charge. Do not give cash as IRS regulations do not allow a deduction for ‘green’ cash.
For non-cash donations of clothes, furniture, household items and the like, get a receipt, take photos of your items, list the items and you must value the items at their fair market value. This value could be; thrift shop value, comparable sales, appraisals, etc.
Gift Tax Exclusion
You can give $13,000 annually to anyone ($26,000 for a couple). It often makes sense to gift investments that you expect to appreciate in the future.
Tax Savings for Business Owners
There are a number of ways to save money on taxes as a business owner. One of the best pieces of advice I can give is…keep good records. A nice tax write-off is worthless if it slips through the crack and isn’t deducted. It’s also no good if you deduct it but can’t substantiate it in an audit, nuff said.
Expenses of buying equipment and other business asset benefits are:
- The 100% bonus first year depreciation
- A $500,000 cap on “Section 179” expensing
- Deducting up to $250,000 for qualified real property
- The tax credit for qualifying research expenses.
Cash basis businesses need to look at their prospects of deferring or accelerating business income and deductions.
A business owner may be eligible to set up a retirement plan for the company’s employees. Generally, this should be done before year end.
A solo business owner has a few options in the retirement plan arena:
- The IRA deduction, which can be opened and funded by April 15th of the following year.
- A SEP plan which can be opened and fund by the tax return due date including extensions.
- A solo 401k plan which, in most cases, will yield the largest contribution and tax deduction.
Under current law, on January 1, 2013, the top income tax rate will rise from 36% to 39.6%, qualified dividends will become subject to ordinary income tax rates, the long-term capital gains tax will rise from 15% to 20%, and the 3.8% Medicare surtax (see below) will apply (unless the health care reform act is struck down or repealed). It is also possible that Congress will change tax laws later this year or in 2012. This makes even medium term tax planning very challenging. It is important to watch for any changes that may affect your situation.
The Medicare Surtax.
If you expect your income to be over $200,000 single, or over $250,000 married filing joint, and you have investment income, you need to be very aware of the 3.8% Medicare surtax that, under current law, will kick in after December 31, 2012. Investment income includes interest, dividends, royalties, rents, gains from dispositions of property and income from passive activities (limited partnerships, rental property income, etc). Lots can happen between now and then, but it’s a good idea to prepare and plan early.
What You Put Into Anything Corresponds To What You Get Out Of It.
The strategies in this newsletter can really help save you taxes but you must determine which ones may apply to your situation and do what it takes to implement them by the deadline, usually December 31st. If you need assistance, please feel free to contact me at (805) 264-3305 as early as possible to give us both enough time to assess your situation and give you time to take the proper action necessary.
Thank you for reading and be sure to call if you have any questions. — Bob
Robert W. Craig, E.A. Tax and Business Services
1444 Aarhus Drive, Solvang CA 93463
Tel: (805) 264-3305
Fax: (805) 617-1879