Bonus Credit for Retirement Savings Contributions

Generally, taxpayers with lower incomes do not have sufficient financial resources to make retirement savings contributions, often leading to inadequate resources when it comes time to retire in the future. Recognizing this problem, Congress added the Retirement Savings Contributions Credit (Savers Credit) to the tax code a few years back.

What this means is that lower-income taxpayers can have a portion of their retirement savings contributions returned to them in the form of a tax credit—a dollar-for-dollar offset of tax—of as much as 50% of the retirement savings contribution. The credit is phased out as a taxpayer’s modified AGI increases over set limits (see table below), and this credit applies only to the first $2,000 of contributions to retirement savings, even though the law allows substantially larger contributions.

If you make or would like to make eligible contributions to an employer-sponsored retirement plan or to an individual retirement arrangement, you may be eligible for a tax credit. Here are some things you need to know about the Retirement Savings Contributions Credit:

Income Limits – For 2010, the Savers Credit applies to individuals with a filing status and income of:

• Single, Married Filing Separately, or Qualifying widow(er), with income up to $27,750
• Head of Household, with income up to $41,625
• Married Filing Jointly, with income up to $55,500

Eligibility Requirements - To be eligible for the credit in 2010, you: (1) must have been born before January 2, 1993, (2) must not have been a full-time student during the calendar year, and (3) cannot be claimed as a dependent on another person’s return.

Credit Amount - If you make eligible contributions to a qualified IRA, 401(k) and certain other retirement plans, you may be able to take a credit of up to $1,000 (or up to $2,000 if filing jointly). The credit is a percentage of the qualifying contribution amount, with the highest rate for taxpayers with the least income. The table below includes the credit percentages for taxpayers with various income levels.

Let’s say that you file as a single individual. Your wages for the year are $25,000 (your only income), and you contributed $2,000 to an IRA account. You would receive a credit of $200 figured as follows: using the “other” column for a single individual with a modified AGI of $25,000, the credit percentage would be 10. Ten percent of the $2,000 contribution to the IRA is $200. Assuming that you take the standard deduction, you would be in the 15% tax bracket and the $2,000 contribution would save you $300 in federal income taxes. Thus, your tax is reduced by a total of $500 and the IRA contribution will only cost you $1,500 out-of-pocket after taxes. Depending on your state’s rules, your state tax also may be reduced because of the IRA contribution, furthering lowering your out-of-pocket cost.

 

Caution - This credit is nonrefundable, which means it can only be used to reduce your tax liability to zero and any unused credit is lost.

 

Distributions - When figuring this credit, the amount of distributions (not including rollovers) you have received from your retirement plans must be subtracted from the contributions you have made. This rule applies for distributions starting two years before the year the credit is claimed and ending with the extended filing deadline for that tax return. Thus, for tax year 2010, distributions received in 2008, 2009, 2010, and up to October 15, 2011, must be taken into account and reduce the 2010 contributions amount eligible for the credit.

 

Attention Parents and Others - To assist a young adult, parents or others with the financial means might consider gifting the after-tax cost of the retirement savings contribution. This gift, coupled with the tax benefits described above, would start the young adult down the road to retirement savings with no out-of-pocket cost.

 

If you would like additional information on how this tax benefit can help you build a retirement account, please give our office a call.

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Did Congress Save You From the AMT in 2010?

Alternative Minimum Tax (AMT) – For several years, Congress has failed to permanently resolve the nagging issue of the AMT, and instead, each year has applied a one-year patch without which an estimated 28 million taxpayers would be hit with this punitive tax.

This year, Congress took the AMT issue to the brink, but in the eleventh hour decided to patch it again, this time for two years, 2010 and 2011. For a change, taxpayers will be able to factor the AMT into their tax planning for 2011. The patch continues the inflation adjustments to the AMT exemption amounts and allows personal tax credits to be used against the AMT. For 2010, the AMT exemption amounts will be set at $47,450 for individuals, $72,450 for married taxpayers filing jointly, and $36,225 for married taxpayers filing separately.

AMT is a different (alternative), and generally punitive, method of computing income tax when either certain types of income receive preferential tax treatment or there are excessive deductions in certain categories. Congress originally implemented it to impose a minimum tax on higher-income taxpayers who were avoiding taxes through tax shelters and other legal means. However, years of inflation without corresponding adjustment to the AMT components have, each successive year, caused an increasing number of taxpayers (who mostly were not the originally intended targets of the AMT) to be subject to the AMT.

Some commonly encountered factors (there are more) that can create an AMT for the average taxpayer include the following:

Medical Deductions – Medical deductions are allowed for the AMT computation, but only to the extent that they exceed 10% of a taxpayer’s income. In contrast, the regular tax computation limit is a lesser 7.5%. When a taxpayer knows that they are going to be affected by the AMT, it sometimes is possible to defer or accelerate medical expenses from one year to another, such as paying the orthodontist in installments or all at once. If your employer offers one, consider participating in a flexible spending plan. It allows you to pay medical expenses with pre-tax dollars and avoid both the regular tax and AMT deduction limitations.

Tax Deductions – When itemizing deductions, a taxpayer is allowed to deduct a variety of taxes, including real property, personal property and state income tax. But for AMT purposes, none of the itemized taxes are deductible. For most taxpayers, this represents one of their largest tax deductions and frequently triggers the AMT. If you are affected by the AMT, conventional wisdom would dictate deferring tax payments to a subsequent year when the AMT may not apply. When deferring, care should be exercised in regards to late payment penalties and interest on underpayments for certain taxes. In addition, taxpayers can annually elect to capitalize taxes on unimproved and unproductive real estate. This means foregoing the deduction currently and adding the tax paid to the cost basis of the real property.

Home Mortgage Interest – For both the regular tax and AMT computations, interest paid on a debt to acquire or substantially improve a home or second home is deductible as long as the debt limit (generally $1.1 million) is not exceeded. This is true of refinanced debt, except that any increase in debt is treated as equity debt. For regular tax purposes, the interest on up to $100,000 of equity debt on the two homes can also be deducted. However, equity debt is not deductible against the AMT; neither is the acquisition or equity debt interest on a motor home or boat that qualifies as a second home. Therefore, taxpayers should exercise caution when incurring home equity debt. Generally, loan brokers are not aware of these limitations, and there are numerous pitfalls.

Miscellaneous Itemized Deductions – The category of miscellaneous deductions that includes employee business expenses and investment expenses is not deductible for AMT purposes. For certain taxpayers with deductible employee business expenses, this can create a significant AMT. Employees with significant employee business expenses should attempt to negotiate an "accountable" reimbursement plan with their employer. Under this type of plan, the reimbursement for qualified expenses is tax-free. Because the employee has been reimbursed, he or she no longer claims a deduction for the expenses, thus eliminating the miscellaneous deduction. Another strategy would be to defer the expenses to a year not affected by the AMT.

Personal Exemptions – Personal exemptions for dependents provide no benefit when taxed by the AMT method. Therefore, divorced or separated parents should carefully consider which party should claim the exemption for a dependent child.

Standard Deduction – For AMT purposes, there is not a standard deduction as there is with the regular tax computation. Thus, taxpayers affected by the AMT should always itemize. Granted, the benefit of some deductions will be lost, but there is still a partial advantage. Even the smallest of charitable deductions will benefit at a minimum of 26% (the lowest bracket for the AMT).

The AMT is an extremely complicated area of tax law that requires careful planning to minimize its effects. Please contact our office for further assistance.

Caution: Although not frequently encountered, incentive stock options (ISO) can have a profound impact on the AMT, and clients are strongly encouraged to seek advice prior to exercising incentive stock options.

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Increased Year-End Withholding May Avoid or Reduce Underpayment Penalties

Taxpayers are required to prepay their taxes for the year through withholding or estimated tax payments. The amount that must be paid in advance is an amount equal to the lesser of 90% of the current year’s tax liability or 100% of the prior year’s tax liability. Higher-income taxpayers, those with a 2009 AGI of $150,000 or more, are required to prepay the lesser of 90% of 2010’s tax liability or 110% of 2009’s tax liability. There is no penalty if the amount of federal tax due is $1,000 or less. (The threshold amount and required payment percentage rules may differ for state purposes.)

The penalty is figured on a quarterly basis. Generally, the prepayments for each period must be commensurate with the income for that period. Estimated tax payments are credited in the period paid. Thus, an individual who has underpaid an estimated tax installment can't avoid the penalty for that period by increasing his estimated tax payment for a later period (although payment in a later period will reduce the penalty for the quarter in which the payment was made).

However, income tax withholding is treated as being paid ratably over the entire year no matter when it was withheld. Thus, if you are underpaid for income received earlier in the year, you can possibly make up the shortage by increasing your withholding late in the year.

So, if you are an individual who had an income windfall earlier in the year and did not prepay taxes on that windfall, and your current withholding level will not cover the additional tax liability, it may be appropriate to increase withholding late in the year. The strategy will apply to any circumstance where your 2010 tax return will result in a tax due in excess of the threshold mentioned earlier. The following are two techniques that can be used to substantially increase your withholding in the latter part of the year.

• Increased Payroll Withholding – If you are a salaried employee, you can have your employer withhold extra amounts from your payroll. This is the simplest and most convenient approach. The IRS Form W-4 allows you to designate specific amounts to be withheld each pay period. If necessary, your entire check after other taxes and withholding can be credited to Federal withholding tax. Contact your payroll department or company accountant.
• Eligible Rollover Distribution – Another possible option for a taxpayer who has underpaid estimated tax is to take an eligible rollover distribution from a qualified plan before the end of 2010. When distributions are made by direct transfer (not a trustee-to-trustee transfer), 20% federal withholding is required and will be applied toward the taxes owed for 2010. The gross amount of the distribution (the amount of the distribution before the withholding) can then be timely (within 60 days) rolled over to a traditional IRA. No part of the distribution will be includible in income for 2010, but the withheld tax will be applied pro rata over the full tax year to reduce previous underpayments of estimated tax. It is essential to timely complete the rollover to avoid paying tax on the distribution and possibly being subject to an early withdrawal penalty.

Other Forms of Withholding – The same rules described above in regard to amounts withheld from payroll also apply to overpayments of Social Security taxes and to income taxes withheld from: supplemental unemployment compensation benefits, sick pay, pensions, annuities, investments, gambling, etc.

If you think your taxes may be underpaid for the year and would like assistance in avoiding an underpayment penalty, please give the office a call as soon as possible.

 

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Congress Extends Tax Breaks

Congress, in an eleventh-hour compromise agreement worked out with the Obama Administration and the GOP Leadership, has extended many of the Bush era tax reductions. The following is an overview of the more frequently encountered tax changes that will have an effect on just about every taxpayer.

INDIVIDUAL PROVISIONS

Individual Tax Rates – Under the Bush era tax cuts, the individual tax rates were reduced and replaced with six tax brackets that increase with income: 10, 15, 25, 28, 33, and 35 percent. These reduced rates were scheduled to return to their original levels of 15, 28, 31, 36, and 39.6 percent beginning in 2011. That would have resulted in the lowest bracket increasing by 5 percentage points and the highest bracket 3.6 percentage points, affecting all taxpayers from the low- to the high-income. Congress has extended the lower rates for two additional years, through the end of 2012.

Capital Gains and Qualified Dividends – Under the Bush era tax cuts, the tax on long-term capital gains (assets owned for more than one year) was reduced from a 20 percent maximum rate to 15 percent for taxpayers in the 25% and higher tax brackets. The tax cuts also provided for a zero tax to the extent a taxpayer is in the 10 and 15 percent income tax brackets. Qualified dividend income, which had been taxed at ordinary tax rates, also became eligible for the lower capital gains rates under the Bush era tax cuts. These lower rates are scheduled to expire after 2010. Congress has extended the lower rates for both long-term capital gains and qualified dividends for two additional years, through the end of 2012.

Itemized Deduction Limitation – Prior to the Bush era tax cuts, itemized deductions were partially phased out for higher-income taxpayers. This phase-out was gradually eliminated beginning in 2006 and is totally repealed for 2010. However, the full phase-out was scheduled to return in 2011. Congress has extended the repeal for two additional years, through the end of 2012.

Personal Exemption Phase-Out – As with itemized deductions, prior to the Bush era tax cuts, the personal exemptions were phased out for higher-income taxpayers. This phase-out was gradually eliminated and was totally repealed for 2010. However, the full phase-out was scheduled to return in 2011. Congress has extended the repeal for two additional years, through the end of 2012.

Marriage Penalty Relief – Prior to the Bush era tax cuts, the standard deduction for a married couple was not twice the amount of the standard deduction for a single individual. Instead, it was only 167% of the single amount even though there were two people instead of one. This was often referred to as the “marriage penalty.” As part of the Bush era tax cuts, the marriage penalty was eliminated and the standard deduction for a married couple filing jointly became twice the amount for a single taxpayer. The marriage penalty also applies to the high-end cut-off point for the 15% tax bracket.

The marriage penalty was scheduled to resume in 2011. However, Congress has extended the repeal for two additional years, through the end of 2012.

Child Tax Credit – For several years, the maximum child tax credit has been $1,000 per qualified child, and, for 2009 and 2010, a portion of that credit was refundable for certain lower-income taxpayers. The credit was scheduled to drop back to $500 per child and the refundable portion reduced beginning in 2011. Congress has extended, for two additional years, the $1,000 per child credit and the enhanced refund portion, through 2012.

Earned Income Credit (EIC) – There have been a number of enhancements in the past several years including additional credit when there are three or more qualifying children and increased income beginning and end points of the EIC. Congress has extended the EIC enhancements for two additional years, through 2012.

Dependent (Child) Care Credit – As part of the Bush era tax cuts, the maximum expenses qualifying for dependent care credit were raised from $2,400 ($4,800 for two or more qualifiers) to $3,000 ($6,000 for two or more qualifiers) and the income-based maximum credit percentage was raised from 30% to 35%. However, these increases were scheduled to revert to the lower amounts in 2011. Congress has extended the higher expenses limits and credit percentage through 2012.

American Opportunity Tax Credit (AOTC) – For 2009 and 2010, the Hope education credit was replaced by an enhanced AOTC. The AOTC provides a maximum credit of $2,500, of which up to 40% can be refundable, whereas the Hope credit maximum is $1,800 and the credit is not refundable. Generally, tax credits can only be used to offset an individual’s tax liability and any excess is lost, thus the term “refundable” means a portion of the credit in excess of the tax liability can be refunded to the taxpayer.

Without extension, the AOTC was set to expire after 2010 and revert to the lower Hope credit levels without any refundable portion. Congress has extended the AOTC for two additional years, through 2012.

Above-the-Line Tuition Deduction - Taxpayers were allowed up to a $4,000 above-the-line deduction for qualified higher education tuition and related expenses. This deduction expired at the end of 2009. Congress retroactively reinstated this deduction for 2010 and extended it through 2011.

Coverdell Educational Accounts – Coverdell accounts are accounts where taxpayers can contribute funds to pay for future educational needs of their children. The amount contributed is not deductible, but the future earnings of the accounts are not taxable if used to pay for qualified education expenses. For several years, the annual maximum contribution limit to a Coverdell account has been $2,000, but was scheduled to revert to a maximum of $500 in 2011. Congress has extended the $2,000 limit for two additional years, through 2012. Also to be extended for the same time period for Coverdell distribution purposes is the definition of education expenses to include elementary and secondary school expenses.

Teacher’s $250 Above-the-Line Deduction – The special deduction for classroom expenses, which allows educators to deduct up to $250 of expenses whether or not they itemize their deductions, had expired after 2009, but it has been retroactively reinstated for 2010 and extended through 2011.

Option to Deduct Sales Tax In Lieu of State Income Tax - For several years through 2009, taxpayers had the option of deducting on Schedule A as part of their itemized deductions the LARGER of: (1) State and local income tax paid, or (2) State and local sales tax paid during the year. That option expired at the end of 2009. Congress has retroactively reinstated this option for 2010 and extended it through 2011.

Home Energy-Savings Improvement Credit – For 2009 and 2010, taxpayers were allowed a 30% credit for home energy-savings improvements with a 2-year combined maximum of $1,500. For 2011, that credit has been replaced by the more restrictive credit rules in place during 2006 and 2007 with a less lucrative 10% credit and a $500 lifetime cap. Additionally, certain efficiency standards that were weakened in the American Recovery and Reinvestment Act are restored to their prior levels, and the provision provides that windows, skylights and doors that meet the Energy Star standards are qualified improvements.

Unemployment Compensation – Congress has extended federal unemployment benefits through 2011; unemployment benefits continue to be taxable income. (For 2009, the first $2,400 of unemployment compensation received per person was excluded from being taxed; extension of this exclusion to 2010 or later years is not part of the new tax bill.)

Payroll Tax Reduction – The Making Work Pay credit, which was part of the 2009 stimulus package, provided a credit of up to $400 ($800 for married couples filing jointly), subject to income limitations, and expires after 2010. The credit has been replaced for one year only (2011) with a 2 percentage point reduction in the employee’s portion of the payroll tax (OASDI) from 6.2% to 4.2%. The reduction applies to all wage earners regardless of income. The employer’s share of the payroll tax is unaffected. For wage earners with payroll in excess of the $106,800 payroll tax cap, their savings for 2011 will be $2,136 (2% of $106,800). The OASDI portion of the SE tax for self-employed individuals would also be reduced by 2 percentage points, reducing the overall SE tax from 15.3% to 13.3%.

Tax-Free IRA to Charity Distributions Reinstated

The provision that permits taxpayers age 70½ and over to make direct distributions (up to $100,000 per year) from their Traditional or Roth IRA account to a charity has been reinstated for 2010 and 2011. The distribution is tax-free, but there is no charitable deduction. This provision can be very beneficial to taxpayers who have social security income and/or do not itemize their deductions.

Important - Because the extension of this benefit was passed so late in December, Congress included a provision that allows transfers made in January of 2011 to be treated as if made in 2010. Thus, the distribution counts against the 2010, not the 2011, $100,000 exclusion limitation and can be used toward a taxpayer’s 2010 minimum distribution requirement if it hasn’t already been met.

The key benefits of this provision lie in the fact that the distribution:

1. Is not included in the taxpayer’s income for the year, 
2. Counts toward the taxpayer’s minimum required distribution for the year, if any, and 
3. Does count as a charitable contribution for the year (although not a deductible contribution).

How does a taxpayer benefit from this provision? 

• By making a contribution directly from the IRA, taxpayers are able to exclude the amount that was contributed from their income for the year, which is essentially the same as deducting the contribution without itemizing their deductions. 
• This technique also lowers a taxpayer’s adjusted gross income (AGI) for other tax breaks pegged at various AGI levels, such as medical expenses, passive losses, etc., allowing them greater benefits from the AGI-limited deductions. 
• For taxpayers receiving Social Security (SS), the taxability of the SS is also based on income. Thus, excluding the portion of the IRA distribution directly distributed to the charity can, in some cases, reduce the taxable portion of the SS. 
• Taxpayers who wish to make very large contributions (up to the 100,000 limit) can do so with IRA funds that would have otherwise been taxable to them.

Caution – It is important to stress that a qualified charitable IRA contribution must be directly distributed to the qualified charity. Otherwise, the distribution is taxable as income and the charitable deduction would be taken on the taxpayer’s itemized deductions subject to all the normal limitations. It may be appropriate to call this office before attempting to execute this strategy.

Alternative Minimum Tax (AMT) – For several years, Congress has failed to permanently resolve the nagging issue of the AMT, and instead, each year has applied a one-year patch without which an estimated 28 million taxpayers would be hit with this punitive tax.

This year, Congress took the AMT issue to the brink, but in the eleventh hour decided to patch it again, this time for two years, 2010 and 2011. For a change, taxpayers will be able to factor the AMT into their tax planning for 2011. The patch continues the inflation adjustments to the AMT exemption amounts and allows personal tax credits to be used against the AMT. For 2010, the AMT exemption amounts will be set at $47,450 for individuals, $72,450 for married taxpayers filing jointly, and $36,225 for married taxpayers filing separately.

Federal Estate Tax Retroactively Reinstated - The Bush era tax cuts slowly phased out the federal estate tax and abolished it altogether for decedents dying in 2010, and replaced it with a rather complicated modified carryover basis regime. Just about everyone assumed Congress would reinstate the estate tax for 2010. As the year wore on, opinions began to change to where just about everyone predicted Congress would not reinstate the estate tax for 2010. Then out of the blue, mixed in with the GOP/Obama Administration compromise agreement tax provisions, was a proposal to retroactively reinstate the estate tax with a $5 million per person exemption and a tax rate of 35%.

Because the reinstatement occurred so late in the year, Congress is allowing a choice for 2010, providing the following two options:

1. Tax Option - Subject the estate to the estate tax provisions for 2010 and provide the beneficiaries with an inherited basis equal to the fair market value (FMV) of assets inherited from the decedent.

2. Modified Carryover Basis Option - Not pay the retroactive estate tax and instead utilize the modified carryover basis regime for determining the basis of inherited items.

For estates worth $5 million or less, the obvious choice would be the tax option of filing an estate tax return and taking advantage of the $5 million exemption, resulting in no tax and providing beneficiaries with an inherited basis of items equal to the items’ FMV at date of death. For larger estates, the question becomes more complex: pay the tax now and provide the beneficiaries with a FMV basis and perhaps a lesser tax in the future when the asset is sold, or avoid the tax now and possibly saddle the beneficiaries with a larger tax when they dispose of an asset in the future? These decisions will have to be made after considering the beneficiaries’ financial and tax circumstances, the intended use of the inherited property, and the makeup of the estate and the ability to pay the estate tax.

Another twist is a new provision that permits the executor of a deceased spouse’s estate to transfer any unused exemption to the surviving spouse, thus eliminating the need by most couples for complicated estate planning such as certain trust arrangements; this provision would take effect for decedents dying after 2010. But don’t get rid of that trust just yet! This extension is only through 2012, and based on prior performance, can we really trust Congress to develop a permanent solution to the estate tax by then? They had eight years to devise a permanent fix last go-around and waited until the 11th hour, only to come up with a two-year, temporary fix.

The $5 million per person exemption and top tax rate of 35% applies to estate, gift and generation skipping taxes through 2012, except the exemption amount will be inflation adjusted beginning in 2012, and the increase from $1 million to $5 million for the lifetime exemption for gifts applies for 2011 and 2012, but not 2010.

BUSINESS PROVISIONS

Bonus Depreciation – Generally, business assets cannot be written off in the year of purchase and must be depreciated over their useful life. As an incentive to jump start the economy and promote business investment in recent years, Congress has allowed a bonus depreciation of 50% of the cost of the investment in equipment and certain leasehold improvements. Congress has increased the bonus depreciation to 100% for qualified investments made from Sept. 9, 2010 through Dec. 31, 2011. New business equipment placed in service in 2012 will be eligible for a bonus depreciation of 50%. This generally provides a tax break for large businesses and others that can’t take advantage of the Section 179 expensing deduction because of income limitations.

Section 179 Expense Deduction – For 2011, taxpayers are able to expense (rather than depreciate) up to $500,000 of the cost of certain capital expenses. Under the compromise agreement starting in 2012, the maximum Sec.179 expense will drop to $125,000, indexed for inflation.

Research Tax Credit – The research tax credit expired at the end of 2009. Congress has reinstated the credit for 2010 and extended it through 2011.

If you have questions related to these changes, please give the office a call.

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Limited Liability Companies Must File Annual Reports Starting in 2011

Pursuant to Section 79-29-215 Miss. Code Ann. (1972), all limited liability companies operating in Mississippi will be required to file an Annual Report with the Secretary of State starting with the calendar year 2011. The new LLC Annual Reporting Form will be available to the public beginning Monday, January 3, 2011, on the Secretary of State's website, www.sos.ms.gov. The deadline for completing the report is April 15th of each year.

Mississippi LLCs may submit their report without charge. The report can be completed and submitted online. The form is also available to print off for mailing.

For out-of-state or 'foreign' LLCs, a fee of $250.00 is required. Foreign LLCs must print off their report and submit it with payment. There is no online filing for foreign LLCs.

Click here to see Mississippi Secretary of State's LLC Annual Filing Form and other information.

If you have any questions, please contact our office.

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Dividing an Inherited IRA Before Year-End Can Improve Tax Results for Each Beneficiary

December 31, 2010 is an important deadline for individuals who inherited an IRA from an IRA owner who died in 2009. Where there are multiple beneficiaries for the IRA, splitting up the account into several accounts can yield important tax and other benefits for each beneficiary.

When an inherited IRA has several beneficiaries and is left in one account, the required minimum annual distributions are based on the age of the oldest beneficiary (shortest life expectancy) rather than the life expectancy of each beneficiary. This can be a disadvantage for younger beneficiaries by making them withdraw from the IRA in a shorter period of time than would be required based on their own age.

In addition, having the funds of all beneficiaries in one account forces them to utilize the same investment strategy.

These issues can be overcome by splitting the IRA into separate sub-accounts for each beneficiary. Thus, the annual required distribution will be minimized (based on each individual beneficiary’s life expectancy), allowing each to employ their own individual investment strategy.

However, splitting the IRA into sub-accounts for each beneficiary must be accomplished by December 31 of the year following the death of the IRA owner. Thus, for IRA owners that passed away in 2009, the deadline to split the IRA into sub-accounts is December 31, 2010.

If you have any questions related to this strategy, please give our office a call.

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Maximizing Credits to Reduce Taxes

There are a number of credits that can help reduce your tax bite for 2010. Unlike a deduction (which reduces your taxable income and thus provides a benefit equal only to the deduction amount times your tax rate), a tax credit is a dollar-for-dollar reduction of your tax. For some credits―such as the Earned Income Tax Credit, Child Tax Credit, Child and Dependent Care Credit, and others―there’s not much you can do to change the outcome. However, there are some credits, described below, that offer year-end tax planning opportunities.

Maximize Education Credits – If you have a child in college for whom you claim a dependent exemption and you or someone else is paying the tuition for that child, you probably qualify for either the American Opportunity Credit or the Lifetime Learning Credit. The credits begin to phase out for higher-income taxpayers whose modified adjusted gross income is $80,000 or more ($160,000 for married couples filing a joint return). 

• American Opportunity Credit - Maximum credit is obtained from $4,000 of tuition and qualified expenses that provides a credit up to $2,500 (100% of the first $2,000 and 25% of the balance). Under normal circumstances, education credits are non-refundable; that is, they offset only a taxpayer’s tax liability. However, for this credit, up to 40% can be refundable.
• Lifetime Learning Credit - Maximum credit is obtained from $10,000 of tuition and qualified expenses that provide a 20% credit up to $2,000.

 

If you have not already paid the maximum expenses for the year, it may be appropriate for you to prepay certain expenses that apply to the first quarter of 2011. The laws generally allow you to prepay tuition for an academic period that begins during the first three months of the next tax year, and then you can claim the prepaid amount for the current year’s credit. Please contact this office for additional information on this tax strategy or other issues relating to education tax benefits and credits.

Take Advantage of the Home Energy Property Tax Credit – 2010 is the final year to take advantage of the “Home Energy Property Credit” that provides a tax credit for energy-saving improvements made to a taxpayer’s principal residence. The credit is limited to $1,500 (30% of up to $5,000 of qualified expenditures) for improvements made in 2009 and 2010. So, if you claimed this credit in 2009, the most you can claim for energy property improvements for 2010 is the $1,500 maximum less any amount claimed in 2009.

 

Qualified improvements (those certified by the manufacturer to qualify for this credit), the use of which must originate with the taxpayer, must have a reasonable expected life of at least five years, and include: 

• Energy-efficient Exterior Windows and Skylights,
• Energy-efficient Exterior Doors,
• Energy-efficient Metal Roofs with appropriate pigmented coatings,
• Energy-efficient Asphalt Roofing with appropriate cooling granules, 
• Energy-efficient Heating Systems,
• Energy-efficient Air Conditioning Systems and
• Insulation Materials or Systems designed to reduce heat loss or gain.

Credit is not allowed for onsite preparation, assembly, or installation of the component. It is a non-refundable personal credit; thus, the credit can be used only to bring your tax (including the alternative minimum tax) down to zero. Any excess is not refundable and cannot be carried over to a subsequent year.

 

Pick a Hybrid or Lean-Burn Vehicle – If you are planning to purchase a new automobile before the end of the year, it might be appropriate to purchase either a hybrid or lean-burn vehicle. Credits for these types of vehicles range from $900 to $2,350. However, this credit has phased out for most manufacturers and is currently available only on qualified vehicles manufactured by General Motors, Chrysler, Nissan, Mazda, BMW, and Mercedes for hybrid vehicles, and by Volkswagen, Audi, and Mercedes for qualifying lean-burn vehicles.

 

This credit is a non-refundable personal credit, which means it can reduce your tax only to zero, and any balance is lost. However, if the vehicle is used partially for business, the portion of the credit attributable to business use becomes a general business credit, and any amount not used in 2010 carries back one year and forward for 20 years until used up.

 

If you have questions about how any of these credits will impact your specific circumstances or would like to schedule a year-end planning appointment, please call our office.

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Tips for Year-End Donations

The year-end brings the holidays and a barrage of charitable solicitations. It is also your last chance to make a charitable contribution and obtain a deduction for 2010.

Over the past few years, the IRS has tightened the recordkeeping rules for charitable contributions. Therefore, it might be appropriate to review the recordkeeping requirements before making your year-end donations to your favorite charities.

Rules for Clothing and Household Items - To be deductible, clothing and household items donated to charity generally must be in good used condition or better. A clothing or household item for which a taxpayer claims a deduction of over $500 does not have to meet this standard if the taxpayer includes a qualified appraisal of the item with the return. Household items include furniture, furnishings, electronics, appliances and linens.

Guidelines for Monetary Donations - To deduct any charitable donation of money, regardless of amount, a taxpayer must have a bank record or a written communication from the charity showing the name of the charity and the date and amount of the contribution. Bank records include canceled checks, bank or credit union statements, and credit card statements. Bank or credit union statements should show the name of the charity, the date, and the amount paid. Credit card statements should show the name of the charity, the date, and the transaction posting date.

Donations of money include those made in cash or by check, electronic funds transfer, credit card and payroll deduction. For payroll deductions, the taxpayer should retain a pay stub, a Form W-2 wage statement or other document furnished by the employer showing the total amount withheld for charity, along with the pledge card showing the name of the charity.

Reminders – Here are some additional reminders to help taxpayers plan their holiday-season and year-end giving:

• Contributions are deductible in the year made. Thus, donations charged to a credit card before the end of 2010 count for 2010. This is true even if the credit card bill isn't paid until 2011. Also, checks count for 2010 as long as they are mailed in 2010 and clear the bank shortly thereafter.
  
• Verify that the organization is qualified. Only donations to qualified organizations are tax-deductible. IRS Publication 78, available online, lists most organizations that are qualified to receive deductible contributions. The searchable online version can be found at IRS.gov under Search for Charities. In addition, churches, synagogues, temples, mosques and government agencies are eligible to receive deductible donations, even if they are not listed in Publication 78.
  
• For individuals, only taxpayers who itemize their deductions can claim deductions for charitable contributions. This deduction is not available to individuals who choose the standard deduction. A taxpayer will have a tax savings only if the total itemized deductions (mortgage interest, charitable contributions, state and local taxes, etc.) exceed the standard deduction. If you only marginally itemize your deductions, it may be appropriate for you to "bunch" your deductions in alternating years to maximize your itemized deductions in one year and then take the standard deduction in the other.
  
• For all donations of property, including clothing and household items, you must have written confirmation from the charity that includes the name of the charity, date of the contribution, and a reasonably-detailed description of the donated property. If a donation is left at a charity's unattended drop site, a written confirmation from the charity is not required, provided that all such undocumented contributions for the year are less than $250 and a written record of the donations is kept that includes the information listed above, as well as the fair market value of the property at the time of the donation and the method used to determine that value. Additional rules apply for a contribution of $250 or more.
  
• The deduction for a motor vehicle, boat or airplane donated to charity is usually limited to the gross proceeds from its sale. This rule applies if the claimed value is more than $500. Form 1098-C, or a similar statement, must be provided to the donor by the organization and attached to the donor's tax return.
  
• If the amount of a taxpayer's deduction for all noncash contributions is over $500, a properly-completed Form 8283 must be submitted with the tax return.
  

If you have questions, please give our office a call.

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Is it Best to Maximize or Minimize Deductions?

As the end of the year approaches, it's a good time to review your potential tax deductions and develop a strategy that maximizes the benefits. Most taxpayers may deduct the higher of two amounts from adjusted gross income when figuring their taxable income. These amounts are either a fixed amount set by law (the "standard deduction") or a listing of the expenses the taxpayer paid during the year that the government allows (known as "itemized deductions").

The basic federal standard deductions for 2010 are: $11,400 for joint filers, $8,400 for head of household, and $5,700 for others. Add-ons to the standard deduction are allowed for taxpayers (and their spouses, if filing jointly) who are blind and/or age 65 or older. In some years, other add-ons—such as a limited amount of real property tax—are also allowed.

It would seem to be a simple choice—use the larger of the standard or itemized deductions. However, strategies may be used to maximize the benefits that add complexity. For example:

• Bunching Strategy – If your itemized deductions and your standard deduction are about the same, it may be possible to maximize your itemized deductions every other year and take the standard deduction in alternate years. Methods of doing this are discussed below.

• The Alternative Minimum Tax (AMT) Effect - If you are subject to the AMT, the standard deduction is not allowed at all, but some itemized deductions are. Therefore, if you are subject to the AMT, you should always itemize your deductions.
  

Here are some tips on maximizing your itemized deductions:

• Medical – Medical deductions for regular tax purposes are deductible only to the extent that they exceed 7.5% of your Adjusted Gross Income (AGI). That percentage increases to 10% for the AMT. Where possible, consider prepaying or deferring medical expenses to match your deduction strategy. In addition to the normal medical deductions, don't overlook the costs of fertility procedures, learning disability expenses, nursing home expenses, pregnancy tests, certain special education, prescribed smoking-cessation programs, certain weight-loss program expenses, and certain impairment-related expenses.
  
  A child's medical expenses paid for by divorced parents are generally deductible by the parent who pays the expense. You can also deduct medical expenses for an adult "medical dependent." Generally, one who would qualify as your dependent except for gross income limitations.

• Taxes – Deductible taxes include real and personal property taxes as well as state and local income taxes. Generally, real property taxes are paid in two or more installments during the year. This gives you the opportunity to "bunch" tax payments by paying an entire year's tax bill plus one or more installments from the prior year all in one tax year.
  
  If you are paying state estimated taxes, the fourth quarter's payment is due by January 18, 2011 in most states. However, you have the option to pay it before the end of the year and move the deduction into 2010. Keep in mind that taxes are not deductible for AMT purposes.
  

• Charitable Contributions – Charitable contributions are deductible for both the regular tax and the AMT. Because they are discretionary, a taxpayer can choose when to make a payment. For example, you could prepay your 2011 tithes in 2010, thereby doubling up deductions in 2010.
  
  Don't overlook year-end non-cash contributions of items lying around the house that are never used. As long as they are in good or better condition and are contributed to a charity before the close of the year, the contribution will count as a deduction for 2010 (provided you have proper documentation).

• Miscellaneous Deductions – This is a catch-all category that generally includes investment and employee business expenses. These deductions are only allowed to the extent that they exceed 2% of your AGI—but not at all for AMT purposes. Don't overlook potential losses from IRA and variable annuity accounts that have declined in value during the recession. However, utilizing these losses requires special action, so please call for details.
  
  Because of the 2% of AGI limitation, certain otherwise-deductible expenses might be handled differently, such as working out a reimbursement plan from your employer for employee business expenses. Doing so may mean reducing your salary, but you will be converting taxable income to non-taxable reimbursement—always a desirable outcome. If your miscellaneous deductions are less than 2% of your AGI, consider paying IRA fees from the IRA account instead of making a separate payment.
  

If you believe you are a candidate for deduction planning, please call our office for an appointment.

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Pick a Hybrid or Lean-Burn Vehicle

If you are planning to purchase a new automobile before the end of the year, it might be appropriate to purchase either a hybrid or lean-burn vehicle. Credits for these types of vehicles range from $900 to $2,350. However, this credit has phased out for most manufacturers and is currently available only on qualified vehicles manufactured by General Motors, Chrysler, Nissan, Mazda, BMW, and Mercedes for hybrid vehicles, and by Volkswagen, Audi, and Mercedes for qualifying lean-burn vehicles.

This credit is a non-refundable personal credit, which means it can reduce your tax only to zero, and any balance is lost. However, if the vehicle is used partially for business, the portion of the credit attributable to business use becomes a general business credit, and any amount not used in 2010 carries back one year and forward for 20 years until used up.

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