2009 Year-End Tax Planning

Checklist - Actions to Be Taken by December 31, 2009

Note: Be sure to include both regular tax and AMT tax projections in your planning.

• Make final state and local estimated tax payments (unless in AMT posture) early rather than waiting until January 2010.
• Consider making January mortgage payment early
• Ensure all charitable gifts are made before year-end, consider gifting low cost basis, appreciated securities
• Realize capital gains or losses as appropriate
• Make family gifts (up to $13,000 per recipient, gift tax free), try to ensure checks are cashed by year-end
• Consider additional contributions to 401(k) and other qualified retirement plans or IRAs to maximize allowed deferrals - including catch-up contributions allowed for taxpayers aged 50 years or older by end of year
• Make contributions to Code Section 529 education savings plans for potential state tax savings and to Coverdell Education Savings Accounts (ESAs) - deadline for Coverdell ESA contributions is April 15, 2010.
• Consider making payments toward 2010 tuition and expenses
• Ensure medical and dependent care expenses are sufficient to exhaust health and dependent care flexible spending account balances - if not, consider scheduling routine medical, dental, and eye exam appointments. You have until the end of March, 2010 to finish getting treatment and submitting those bills through your reimbursement account at work.
• Purchase big ticket depreciable business equipment (including off-the-shelf computer software) to take advantage of increased Code Section 179 expensing (See details below)
• Purchase vehicles to be used in trade or business
• Be generous.- Charitable contributions must be made by December 31 in order to claim a tax deduction for 2009. A few strategies for charitable giving:
  • Be aware of changes in car donations: The rules on donating an automobile to a qualified charity changed in 2005. In the past, you could often deduct the full market value of the car, regardless of whether or not the charity resold the car. Now, however, you may only do so if the charity you select actually uses the car. If they resell it, as many organizations do, your deduction should be limited to the amount the charity receives for your car. Stricter recordkeeping requirements are also required to claim a deduction for donated cars, so be sure to ask the charity for appropriate documentation. It also pays to ask what will be done with your vehicle before you donate.
  • Documentation requirement for small cash gifts, Current IRS provisions require you to have documented evidence, such as a canceled check or a receipt from the charity, for contributions of any amount. Previously, you needed proof of your donation only for amounts of $250 or more.
  • Consider donating appreciated securities: If you own shares of stock, or other securities that have appreciated in value, you can potentially save taxes in several ways by donating them to qualified charities. Provided certain requirements are met, you may be able to take an income tax deduction equal to the fair market value of the securities at the time they are donated, rather than the amount you originally paid. And by donating appreciated securities, rather than selling them and donating the proceeds, you should not owe taxes on the appreciation.
  • Consider a donor-advised fund: By contributing to a donor-advised fund (DAF), you are eligible to take an immediate tax deduction (provided certain requirements are met) and then recommend grants to IRS-qualified public charities now or even several years later.
  • Donations from IRAs - Taxpayers who are 70½ or older to give away as much as $100,000 a year from their IRA directly to qualified charities without triggering federal income taxes. Here's how it works: In a typical case, a taxpayer can get an exclusion from gross income for otherwise taxable distributions of as much as $100,000 from an IRA -- as long as the money is paid directly to a qualified charity. This money counts toward taxpayers' required minimum distributions for that year. This break expires at the end of 2009.

Partnership (and LLC) Losses

The rules behind the deductibility of losses reported on Schedule K-1 from investments in partnerships, limited liability companies (LLCs), and S corporations (collectively referred to herein as “pass-throughs”) are complicated. However, individuals may often control when losses are deductible or carried forward. The key to ending the mystery is being aware of the three loss limitation rules.

Basis limitation — To deduct pass-through losses, a taxpayer must have sufficient basis in the entity. Basis is obtained when you make capital contributions to the entity, by guaranteeing debt (or being legally responsible for debt which is common in general partnerships), or by reporting income in prior years. Your basis is reduced by distributions received from the entity or from losses reported in prior years. The rules behind basis allocations for debt differ between partnerships and LLCs (easiest to have debt allocations) and S corporations (where debt must generally be direct loans from shareholders).

At risk limitation — When debt is allocated to a partner in a partnership, it will generally only count as basis to the extent the partner is personally responsible for the debt.

Taxpayers who run the risk of incurring AMT should consider the following before the end of the year:

Because Code Section 6654(f) requires that estimated tax payments must include a taxpayer’s estimated AMT liability, adjustments to withholding or an additional one-time withholding contribution should be made. Even large one-time contributions made through withholding against wages are treated as though they were made throughout the year and, will, thus, avoid underpayment of estimated tax penalties and interest.

• Avoid paying estimated state and local taxes until January 2010. Contrary to the usual advice to make the last estimated payment slightly early, i.e., by December 31, 2009, in order to maximize the state and local tax deduction for 2009, taxpayers who are in an AMT posture for the year will receive no benefit from the acceleration of the payment and may be better off making their last estimated payment on time in January 2010, thereby allowing them to potentially benefit from the corresponding deduction on their 2010 income tax returns.
• Avoid exercising qualified stock options for which the difference between the exercise price and the fair market value of the option on the date of exercise will be subject to AMT as ordinary income to the exerciser /purchaser subject to AMT.

Energy Tax Breaks:

Home improvement tax credits are available for home improvements "placed in service" from January 1, 2009 through December 31, 2010.

Home improvement tax credits are available for insulation, replacement windows, non-solar water heaters, and certain high efficiency heating and cooling equipment. The maximum amount that a taxplayer may claim from all of these tax credits combined is $1,500 for the 2009 and 2010 period.

If you are building a new home, you do not qualify for the tax credits for “eligible building envelope components” (windows, doors, insulation, roofs) or “qualified energy property” (HVAC & non-solar water heaters). However, the tax credit for photovoltaics, solar water heaters, small wind systems and fuel cells is available for homeowners building new homes.

Starting January 1, 2009, there is a new tax credit for Plug-in hybrid electric vehicles, starting at $2,500 and capped at $7,500 for cars and trucks (the credit is based on the capacity of the battery system). The first 250,000 vehicles sold get the full tax credit (then it phases out like the hybrid vehicle tax credits).

Tax credits are available to buyers of hybrid gasoline-electric, diesel, battery-electric, alternative fuel, and fuel cell vehicles. The tax credit amount is based on a formula determined by vehicle weight, technology, and fuel economy compared to base year models. These credits are available for vehicles placed in service starting January 1, 2006. For hybrid and diesel vehicles made by each manufacturer, the credit will be phased out over 15 months starting after that manufacturer has sold 60,000 eligible vehicles. For vehicles made by manufacturers that have not reached the end of the phase-out, the credits will end for vehicles placed in service after December 31, 2010.

Tax credits are available for qualified solar water heating and photovoltaic systems. The credits are available for systems "placed in service" from January 1, 2006 through December 31, 2016. The tax credit is for 30% of the cost of the system. Beginning with 2009 there is no limitation on the 30% credit. This credit is completely separate from the $1,500 home improvement credit.

Tax credits are available to homeowners who install residential small wind turbine systems. The credits are available for systems placed in service from January 1, 2008 to December 31, 2016. The tax credit is for 30% of the cost of the system.

There is a consumer tax credit of up to 30% of the cost (up to $500 per 0.5 kW of capacity maximum) for installing a “qualified” fuel cell and microturbine systems. The credits are available for systems "placed in service" from January 1, 2006 through December 31, 2016.

Green Building Deductions

Tax deductions for energy-efficient buildings or improvements were extended through 2013 earlier this year. If your company is building or retrofitting a commercial building with energy-saving features that include lighting, HVAC systems, or building envelope upgrades, you may be eligible for an immediate deduction of costs rather than capitalizing and depreciating the costs over 27.5 or 39 years. This deduction is available for costs up to $1.80 per square foot.

Primary designers of schools, government offices, military bases, libraries, courthouses, and hospitals receive an unusual benefit from this provision. While the government users of the buildings enjoy the energy savings from energy-efficient designs, they’re also tax exempt and would claim no benefit from the additional deductions. The provision allows the primary designer of the lighting, HVAC, and building systems to claim the deduction that would not be claimed by the government entity. 

Kiddie Tax

Congress has increased the number of children whose income is subject to their parents' higher tax rate, by raising the age limit. If a child receives dividends, interest and other "unearned income," the first $950 typically is tax free and the next $950 is then taxed at the child's lower rate. Income above $1,900 is subject to the parents' top rate.

Upper-income investors should consider investments for their children that generate little or no current taxable income, such as U.S. savings bonds or index funds. Consider avoiding high-yielding corporate bonds, since the interest currently would be taxable as ordinary income.

Long-term Capital Gain and Dividend Income

The maximum tax rate for net capital gains is 15%. The tax rate is 5% for taxpayers whose ordinary income is taxed at the 10% or 15% rate. These reduced rates are currently scheduled to be in effect through 2010 (with the 5% rate going to zero in 2008). All of these changes are set to expire for tax years beginning after 2010.

An individual’s qualified dividend income is also taxed at the lower capital gains tax rates.

Note: Unlike the lower tax rates for ordinary income reduced capital gain and qualified dividend income rates do apply for AMT purposes and, therefore, will not cause otherwise exempt taxpayers to be subject to the AMT.

Exhaust health and other flexible spending accounts

Because taxpayers must either use or lose any pre-tax income deferred into their health and other flexible spending accounts, taxpayers should always make sure that they have fully utilized the dollars they elected to set aside before the end of the calendar year. Taxpayers who still have balances in their flexible spending accounts (FSAs) should accelerate their expenditures to avoid forfeiting any remaining balances. For example, by scheduling doctor and dentist visits and eye exams, filling prescriptions, and completing other types of medical care procedures prior to the end of the year, taxpayers can fully utilize their pre-tax deferrals and take care of expenditures they were going to make anyway.

Importantly, the IRS has ruled that the costs of even non-prescription drugs, such as pain-killers and cold medicines, are eligible to be reimbursed under a health FSA. As a result, taxpayers with excess funds in their health FSAs should consider locating receipts for these types of expenditures and submitting them for reimbursement. Note, however, that some health FSA plans might not allow reimbursement for non-prescription drugs. Amendments to these plans may only apply for 2004 and subsequent years. Finally, taxpayers should be aware that many reimbursement plans require only that the expense be incurred prior to the year-end. You have until the end of March, 2008 to finish getting treatment and submitting those bills through your reimbursement account at work.

Maximize Retirement Savings Contributions and Catch-up Contributions

Those taxpayers that have not fully funded their maximum retirement savings deferrals may want to be reminded that they can elect to make large year-end contributions to lower their taxable income for the year.

For 2008, the maximum elective deferral for a 401(k) plan is $16,500 and individuals who will reach their 50th birthdays on or before December 31, 2009, may defer an additional $5,500 of income to a 401(k) plan.

Similarly, eligible taxpayers can make tax-free contributions of up to $5,000 to an individual retirement account (IRA) for 2009. Taxpayers who are at least 50 years old by the end of 2009 may contribute an additional $1,000 to their IRAs. IRA contributions do not have to be made by December 31, 2009. Taxpayers have until April 15, 2010 (i.e., the due date of the return, without regard to extensions) to make their contributions for the calendar 2009 tax year.

For SIMPLE plans, the maximum allowed deferral is $11,500 ($14,000 for taxpayers age 50 or older) for 2009.

Pre-pay Tuition and Expenses and Fund Education Savings

For education expenses incurred in 2009 for academic periods that began in 2009, taxpayers may be eligible for the lifetime learning credit and/or the Hope Scholarship Credit. The maximum lifetime learning credit is $2,000 (i.e., an amount equal to 20% of so much of the qualified tuition and related expenses paid during the year as do not exceed $10,000), and the Hope Scholarship Credit is $1,800

The MAGI (Modified Adjusted Gross Income) limitation under which both the Hope and the lifetime learning credits are reduced is $60,000 ($120,000 for joint returns) in 2009.

A new tax credit for 2009 and 2010: the American Opportunity Tax Credit is a refundable tax credit for undergraduate college education expenses. This credit provides up to $2,500 in tax credits on the first $4,000 of qualifying educational expenses. Forty percent of the credit (up to $1,000 maximum) is refundable. That means students who have reduced their tax liability to zero can still get extra money back from the federal government by utilizing this credit. The tax credit is scheduled to be available only for the years 2009 and 2010, unless Congress decides to extend the credit to other years.

Unlike the Lifetime Learning Credit or the Hope credit, the American Opportunity credit expands the definition of qualifying educational expenses. In addition to tuition and required school fees, students can also include the cost of course materials such as books, lab supplies, software and other class materials are part of their tax credit calculations. Students should keep receipts for their tuition, books, and other course materials as supporting documentation.

Taxpayers have until April 15, 2010, to make contributions to Coverdell Education Savings Accounts of up to $2,000 per beneficiary. While contributions to Coverdell ESAs are not deductible, the contributions are allowed to grow on a tax-deferred basis (so long as the proceeds are used for qualified education expenses). Qualified education expenses include elementary and secondary education expenses.

Time Year-End Income and Expenses for Tax-Saving Results

Most small businesses operate as pass-through entities (meaning S corporations, partnerships, and LLCs). These outfits pass their business income and deduction items through to their individual owners, who then report them on their personal 1040s. Most small businesses also use the cash method of accounting for tax purposes.

If that sounds like your situation, and you expect to be in the same or lower tax bracket next year, it's a smart move to defer taxable income into 2010 and accelerate deductible expenditures. Here are some suggestions on how to do that:

• Charge deductible business expenses on credit cards before year end. That way, you'll create 2009 tax writeoffs even though the actual credit-card bills won't be paid until 2010. Beware: this taxpayer-friendly rule doesn't apply to store revolving charge accounts. So if you charge expenses on your Home Depot credit card, you can't claim any deductions until you actually pay the bill.
• Cut checks before year end to pay other deductible expenses. You can claim 2009 deductions even though the checks might not be cashed or deposited until early next year. To fail-safe your writeoffs against an IRS challenge, send large year-end checks via registered or certified mail. That proves you shipped the checks off this year.
• On the income side of the equation, consider deferring some of your billings until right at the end of the year. That way, you'll be paid — and taxed — next year instead of this year. Of course, you should never defer billings when there's any chance that would decrease the odds of collecting your money.
• Try to keep your inventory as low as possible on December 31st. Since you are taxed based on the value of your goods in stock, it makes sense to minimize your inventory.
  

Vehicle Depreciation Limitations

Depreciation Bonus At A Glance

• The Economic Stimulus Act allows additional first-year depreciation of 50 percent of purchase cost
• Depreciation bonus helps businesses that buy equipment this year cut their 2009 tax bill
• Applies, among other things, to purchases of tangible personal property (including construction, mining, forestry, and agricultural equipment) with a MACRS recovery period of 20 years or less
• Equipment must be purchased and placed in service in 2009
• Equipment must be new
• Allowed for both regular and alternative minimum tax purposes
• Discretionary - Taxpayer need not claim the depreciation bonus
• Depreciation bonus will expire at end of 2009

Sec. 179 Expensing At A Glance

Code Section 179 allows a taxpayer to elect to treat the cost or a portion of the cost of certain property (now including computer software) acquired by purchase for use in the active conduct of a trade or business as a currently deductible expense.

• ESA increases Sec. 179 expensing limit to $250,000 and phase-out cap to $800,000
• Companies can expense up to $250,000 in purchases as long as they don't spend more than $800,000
• Expensing is phased-out for each dollar that purchases exceed $800,000
• Companies with total purchases of $1,050,000 cannot use Sec. 179
• New and used equipment is eligible for expensing
• Applies to tax years that start in 2009
• Can be combined with depreciation bonus
• Sec. 179 expensing levels will drop at end of 2009 (without ESA, the 2010 expensing amount will be $134,000 and the phase-out level would be $530,000)

Standard Mileage Rates

For 2009, the optional standard mileage rates are:

• The standard mileage rate for business travel was 55 cents per mile.
• 24 cents a mile when computing deductible medical or moving expenses; and
• 14 cents a mile when giving services to a charitable organization.

Domestic Production Activities Deduction

For tax years beginning after December 31, 2006, the domestic production activities deduction percentage increases from 3% to 6%. It rises to 9% beginning January 1, 2010. For more information on this deduction, see Form 8903, Domestic Production Activities Deduction, and its instructions.

Sunsetting  Tax Provisions 

The “Bush Tax Cuts” passed in June 2001 reduced marginal tax rates for all taxpayers, provided relief for the marriage penalty, increased child tax credits, expanded education-related tax benefits, and phased out the estate tax. However, because the tax law did not get 60% support in the Senate the tax cuts expire (or “sunset”) on December 31, 2010 (due to Congressional procedural rules). If Congress does not act, most of these tax benefits will disappear, and taxes will automatically increase to pre-2001 levels on January 1, 2011.

With no Congressional action on the sunsetting provisions, tax liabilities for individuals will increase by 10-22% in 2011 from 2010 liabilities. Maximum tax rates will increase from 35 to 39.6% for income tax rates, from 15 to 28% for capital gain rates, from 15 to 39.6% for qualified dividend rates, and from 0 to 55% for estate tax rates. Though legislation may address these issues, the final result is always a mystery until the final bill is passed.

Taxpayers should review their current situation and be prepared to implement some or all of the following strategies, depending upon what the final legislation includes (or doesn’t include):

• Pay dividends from closely held corporations prior to 2011
• Consider locking in capital losses from 2010 and prior years to use against capital gains after 2010
• Accelerate income to 2010 from years after 2010
• Defer expenses from 2010 to years after 2010