Dear H&M Clients and Friends:
As 2011 closes, time remains for reducing your 2011 taxes and planning for 2012. This letter highlights several potential tax-saving opportunities for you to consider. We would be happy to meet with you to discuss specific strategies.
AGI Income Acceleration and Deferral:
A key tax planning aspect is estimating both your 2011 and 2012 “adjusted gross income” (“AGI”). Many tax benefits are tied to/limited by your AGI such as IRA deductions. Deciding to accelerate or defer income or deductions, can impact your AGI which in turn impacts every component of your taxes tied directly or indirectly to your AGI. Your 2010 tax return and your 2011 pay stubs as well as anticipated deductions and related materials are a good estimated AGI starting point.
2011 IRA, Retirement Savings Rules:
Tax-saving opportunities continue for retirement planning due to Roth IRAs, changes making regular IRAs more attractive and other retirement savings incentives. Contributions to IRAs for 2011 must be made by April 17, 2012.
Traditional IRAs: Individuals who are not active participants in an employer pension plan may make deductible contributions to an IRA. The annual deductible contribution limit for an IRA for 2011 is $5,000. For 2011, a $1,000 “catch-up” contribution is allowed for taxpayers age 50 or older by the close of the taxable year, making the total limit $6,000 for these individuals. Individuals who are active participants in an employer pension plan also may make deductible contributions to an IRA, but their contributions are limited in amount depending on their AGI. For 2011, the AGI phase-out range for deductibility of IRA contributions is between $56,000 and $66,000 of modified AGI for single persons (including heads of households), and between $90,000 and $110,000 of modified AGI for married filing jointly. Above these ranges, no deduction is allowed.
In addition, an individual will not be considered an “active participant” in an employer plan simply because the individual’s spouse is an active participant for part of a plan year. Thus, you may be able to take the full deduction for an IRA contribution regardless of whether your spouse is covered by a plan at work, subject to a phase-out if your joint modified AGI is $169,000 to $179,000 for 2011. Above this range, no deduction is allowed.
Spousal IRA: If an individual files a joint return and has less compensation than his or her spouse, the IRA contribution is limited to the lesser of $5,000 for 2011 plus age 50 catch-up contributions, or the total compensation of both spouses reduced by the other spouse’s IRA contributions (traditional and Roth).
Roth IRA and Conversion Rule:
Roth IRAs permit annual nondeductible contributions of $ 5,000 with catch-up contribution of an additional $ 1,000 for people at least 50 years of age. Its earnings grow tax-free and its distributions are tax-free provided (a) no distributions are made until more than five years after the first contribution and (b) the individual reached age 59 1/2. Earlier tax-free distributions may be made due to the individual’s disability or death.
The maximum Roth IRA contribution is phased out in 2011 for AGIs above certain amounts: $169,000 to $179,000 for married filing jointly, and $107,000 to $122,000 for single taxpayers (including heads of households); and between $0 and $10,000 for married filing separately who lived with the spouse during the year.
Funds in a traditional IRA (including SEPs and SIMPLE IRAs), §401(a) qualified retirement plan, §403(b) tax-sheltered annuity or §457 government plan may be rolled over into a Roth IRA. But a rollover is a taxable event. The person converting to a Roth IRA pays tax on the amount converted. No penalties apply if all IRS requirements are satisfied. The AGI limitation does not apply to conversions from a Roth designated account in a §401 or §403(b) plan. Likewise during and after 2011, the $100,000 AGI limit on Roth IRA conversions no longer applies.
For a 2011 Roth IRA conversion you are taxed on the entire pretax converted amount. If you already made a Roth IRA conversion earlier this year, you have the option of undoing the conversion. A new, subsequent conversion could lower your taxes on the same assets. This is a useful option if the Roth IRA investments lost value post-conversion. This is a complicated calculation so we should meet to determine your best options.
401(k) SIMPLE Plan Contributions:
The 2011 §401(k) elective deferral limit is $16,500. If your §401(k) plan allows for catch-up contributions and you will be 50 years old by December 31, 2011, you may contribute an additional $5,500. The 2011 SIMPLE plan deferral limit is $11,500. If your SIMPLE plan allows for catch-up contributions and you will be 50 years old by December 31, 2011, you may contribute an additional $2,500.
Catch-Up Contributions for Other Plans:
A nonrefundable tax credit is available based on an eligible individual’s qualified retirement savings contributions to an employer plan. For 2011, eligible individuals are taxpayers filing joint returns with AGI of $56,500 or less, head of household returns with AGI of $42,375 or less, or single returns (or separate returns filed by married taxpayers) with AGI of $28,250 or less. The credit amount equals the applicable percentage (10% to 50%, based on filing status and AGI) of qualified retirement savings contributions up to $2,000.
Required Minimum Distributions:
In 2011, taxpayers over 70 ½ must take their required minimum distribution (“RMD”) from IRAs or defined contribution plans (§401(k) plans, §403(a) and (b) annuity plans, and §457(b) plans that are maintained by a governmental employer).
Deferring Income to 2012:
If you expect your AGI to be higher in 2011 than in 2012, or if you anticipate being in the same or a higher tax bracket in 2011, you may benefit by deferring income into 2012. Deferring income is advantageous so long as the deferral does not bump your income into a higher tax bracket.
Accelerating Income into 2011:
In limited circumstances, you may benefit by accelerating income into 2011. For example, you may anticipate being in a higher tax bracket in 2012, or perhaps you will need additional income to take advantage of an offsetting deduction or credit that will not be available to you in future tax years.
Accelerating income into 2011 is disadvantageous if you expect to be in the same or lower tax bracket for 2012. Before you accelerate income into 2011, we should “crunch the numbers.”
Deduction timing is an important year-end tax planning element. Deduction planning is complex, due to factors such as AGI levels and filing status. If you are a cash-method taxpayer, keep the following in mind:
Deduction in Year Paid: An expense is only deductible in the year it is actually paid. If your tax rate is increasing in 2012, it is smart to postpone 2011 deductions until 2012.
Payment by Check: Date checks before the end of the year and mail them before January 1, 2012.
Promise to Pay: A promise to pay or giving a note does not permit you to deduct the expense. But you can take a deduction if you pay with money borrowed from a third party. Hence, if you pay by credit card in 2011, you can take the deduction even though you won’t pay your credit card bill until 2012.
AGI Limits: For 2011, the overall limitation on itemized deductions is terminated. In addition, certain deductions may be claimed only if they exceed a percentage of AGI: 7.5% for medical expenses, 2% for miscellaneous itemized deductions, and 10% for casualty losses.
Medical Expenses: Medical expenses, including amounts paid as health insurance premiums, are deductible only to the extent that they exceed 7.5% of AGI. Consider bunching medical expenses into years when your AGI is lower.
Charitable Contributions: If you make your charitable contributions at year-end you’ll have the use of the money during the year and simultaneously claim a deduction for that year. You can use a credit card to charge donations in 2011 even though you will not pay the bill until 2012. A mere pledge to make a donation is not deductible unless it is paid by year-end. To avoid long-term capital gains, consider giving appreciated property to charity and still deduct the full fair market value as a deduction.
Remember the following contribution rules: (1) no deduction is allowed for charitable contributions of clothing and household items if such items are not at least in good used condition ; (2) the IRS may deny a deduction for any item with minimal monetary value; and (3) the restrictions in (1) and (2) do not apply to the contribution of any single clothing or household item for which a deduction of $500 or more is claimed if the taxpayer includes a qualified appraisal with his or her return.
The deduction for charitable contributions of money will be denied unless you maintain a cancelled check, bank record, or receipt from the charitable organization showing the charity’s name and the date and amount of the contribution.
Taxpayers can distribute tax-free to up to $100,000 from a traditional or Roth IRA to charity if the individual holding the IRA has reached age 701/2. Ordinarily, such distributions would be taxable to the individual, who may not be able to offset that income fully because of the percentage limitations on charitable contribution deductions. This provision expires at the end of 2011, so you may want to take advantage of it now.
Self-Employed Health Insurance Premiums: Self-employed individuals can claim as a deduction 100% of the amount paid for insurance that constitutes medical care for themselves, their spouses and dependents as an above-the-line deduction, without regard to the 7.5% of AGI floor. And, reduce their self-employment income by the deductible amount.
Equipment Purchases: If you are in business and purchase equipment, you may make a “Section 179 Election,” which allows you to currently deduct the cost of otherwise depreciable business property. For 2011, you may expense up to $500,000 of equipment costs (with a phase-out for purchases in excess of $2,000,000) if the equipment was placed in service during 2011. Also, certain real property can be expensed but no more than $ 250,000 of the $500,000 limitation can be qualified real property. In 2012, the dollar amounts for §179 expensing are scheduled to be $125,000 (with an inflation adjustment), with a phase-out amount of $500,000. Also, the allowance for real property does not apply for 2012.
Bonus Depreciation: Taxpayers can claim 100% bonus depreciation for certain qualified new assets placed in service in 2011. Bonus depreciation is also allowed for machinery and equipment used exclusively to collect, distribute, or recycle qualified reuse and recyclable materials and qualified disaster assistance property. In 2012, the bonus depreciation amount is scheduled to be reduced to 50%.
Careful timing of equipment purchases can result in favorable depreciation deductions in 2011. Under the “half-year convention,” you may deduct six months-worth of depreciation for equipment that is placed in service on or before the last day of the tax year. (If more than 40% of the cost of all personal property placed in service occurs during the last quarter of the year, however, a “mid-quarter convention” applies, which lowers your depreciation deduction.)
A popular strategy is purchasing a vehicle for business purposes that exceeds the depreciation limits set by statute (i.e., a vehicle rated over 6,000 pounds). Doing so would not subject the purchase to the statutory dollar limit, $11,060 for 2011 (due to bonus depreciation rules); $11,260 in the case of vans and trucks (due to bonus depreciation rules). Therefore, the vehicle would qualify for the full equipment expensing dollar amount. However, for SUVs (rated between 6,000 and 14,000 pounds gross vehicle weight) the expensing amount is limited to $25,000. Any such deduction is limited to the business percentage use.
NOL Carryback Period: If your business suffers net operating losses for 2011, generally you apply those losses against taxable income going back two tax years. The loss could be used to reduce taxable income—and thus generate tax refunds—for tax years as far back as 2009. Certain “eligible losses” can be carried back three years; farming losses can be carried back five years.
Education and Child Tax Benefits
Child Tax Credit: A tax credit of $1,000 per qualifying child under the age of 17 is available on this year’s return. But, the taxpayer must be allowed a dependency deduction for the qualifying child who is younger than the person claiming the credit. The credit is phased out at a rate of $50 for each $1,000 (or fraction of $1,000) of modified AGI exceeding the following amounts: $110,000 for married filing jointly; $55,000 for married filing separately; and $75,000 for all other taxpayers. A portion of the credit may be refundable. For 2011, the minimum threshold earned income level to determine whether the credit is refundable is set by statute at $3,000.
Credit for Adoption Expenses: For 2011, the adoption credit limitation is $13,360 of aggregate expenditures for each child, except that the credit for an adoption of a child with special needs is deemed to be $13,360 regardless of the amount of expenses. The credit ratably phases out for taxpayers whose income is between $185,210 and $225,210. For 2011, the credit is refundable. For 2012, the credit is scheduled to become nonrefundable.
American Opportunity Tax Credit (formerly HOPE Credit) and Lifetime Learning Credit: In 2009, significant changes were made to the HOPE, including a name change to the American Opportunity Tax Credit. These changes continue for 2011. The maximum credit for 2011 is $2,500 (100% on the first $2,000, plus 25% of the next $2,000) for qualified tuition, fees, books and supplies paid on behalf of a student (i.e., the taxpayer, the taxpayer’s spouse, or a dependent) who is enrolled on at least a half-time basis. The credit is available for the first four years of the student’s post-secondary education. For 2011, the credit is phased out at modified AGI levels between $160,000 and $180,000 for joint filers and between $80,000 and $90,000 for other taxpayers. Forty percent of the credit is refundable, which means that you can receive up to $1,000 even if you owe no taxes.
The Lifetime Learning Credit maximum in 2011 is $2,000 (20% of qualified tuition and fees up to $10,000). A student need not be enrolled on at least a half-time basis so long as he or she is taking post-secondary classes to acquire or improve job skills. As with the American Opportunity Tax Credit, eligible students include the taxpayer, the taxpayer’s spouse, or a dependent. For 2011, the Lifetime Learning credit is phased out at modified AGI levels between $102,000 and $122,000 for joint filers, and between $51,000 and $61,000 for single taxpayers.
Tuition and Fees Deduction: An above the line deduction, within limits, is available for qualified tuition and related expenses of up to $4,000 for taxpayers with modified AGI that does not exceed $65,000 ($130,000 in the case of married taxpayers filing joint returns). Furthermore, taxpayers with AGI that does not exceed $80,000 ($160,000 for married taxpayers filing a joint return) can claim a reduced deduction of up to $2,000. Married taxpayers filing separately are not eligible for the deduction. Taxpayers are not eligible to claim a tuition deduction and the American Opportunity, or Lifetime Learning Credit in the same year for the same student. Taxpayers typically will benefit more by claiming one of the education credits rather than the tuition deduction unless ineligible for any credit because of AGI phase-out rules.
Coverdell Education Savings Account: For 2011, the aggregate annual contribution limit to a Coverdell education savings account is $2,000 per designated beneficiary. This limit is phased out for individual contributors with modified AGI between $95,000 and $110,000 and joint filers with modified AGI between $190,000 and $220,000. The contributions to the account are nondeductible but the earnings grow tax-free.
Student Loan Interest: You may be eligible for an above-the-line deduction for student loan interest paid on any “qualified education loan.” The maximum deduction is $2,500. The deduction for 2011 is phased out at a modified AGI level between $120,000 and $150,000 for joint filers and between $60,000 and $75,000 for individual taxpayers.
Kiddie Tax: For 2011, the kiddie tax applies to: (1) children under 18; (2) 18-year old children who have unearned income in excess of the threshold amount, do not file a joint return and who have earned income, if any, that does not exceed one-half of the amount of the child’s support; and (3) children between the ages of 19 and 23 and if, in addition to the above rules, they are full-time students. For 2011, the kiddie tax threshold amount is $1,900. Essentially the child’s unearned income about this amount is taxed at the parents’ tax rate.
Residential Energy Efficient Property Credit: Until 2016, tax incentives are available to taxpayers who install certain energy efficient property, such as photovoltaic panels, solar water heating property, fuel cell property, small wind energy property and geothermal heat pumps. A credit is available for the expenditures incurred for such property up to a specific percentage, except that a cap applies for fuel cell property. The property purchased cannot be used to heat swimming pools or hot tubs. If you have made improvements to your home or plan to by the end of 2011, please contact us to discuss the credit.
Nonbusiness Energy Property Credit: For 2011, property qualifying for the nonbusiness energy property credit includes windows (including skylights), exterior doors, insulation, metal roofs, advanced main air circulating fans, natural gas, propane, or oil furnace or hot water boilers, and other energy efficient building property that meets certain energy standards.
For 2011, the credit is 10% of the cost of the improvement(s) up to a maximum credit of $500 (therefore, if you took any credit prior to 2011, your total cannot exceed $500). The property must be installed by the end of 2011 to qualify.
For 2011, only $200 of the credit can be applied to windows. Also, for 2011, the energy standards are relaxed. The credit expires at the end of 2011.
Small Employer Pension Plan Startup Cost Credit: For 2011, certain small business employers that did not have a pension plan for the preceding three years may claim a nonrefundable income tax credit for expenses of establishing and administering a new employee retirement plan. The credit applies to 50% of the qualified administrative and retirement-education expenses for each of the first three plan years. However, the maximum credit is $500 per year.
Work Opportunity Credit: The work opportunity credit is an incentive provided to employers who hire individuals in groups whose members historically have had difficulty obtaining employment. This gives your business an expanded opportunity to employ new workers and be eligible for a tax credit against the wages paid. Wages paid after 2011 are not eligible for the credit.
Enhanced Work Opportunity Credit: Employers will, however, be able to claim the Work Opportunity Credit for qualified veterans who begin work for the employer after November 21, 2011 and before January 1, 2013.
Credit for Employee Health Insurance Expenses of Small Employers: For tax years beginning after 2009, eligible small employers are allowed a credit for certain expenditures to provide health insurance coverage for its employees. Generally, employers with 10 or fewer full-time equivalent employees (FTEs) and an average annual per-employee wage of $25,000 or less are eligible for the full credit. The credit amount begins to phase out for employers with either 11 FTEs or an average annual per-employee wage of more than $25,000. The credit is phased out completely for employers with 25 or more FTEs or an average annual per-employee wage of $50,000 or more. The credit amount is 35% of certain contributions made to purchase health insurance.
The following rules apply for most capital assets in 2011:
• Capital gains on property held one year or less are taxed at an individual’s ordinary income tax rate.
• Capital gains on property held for more than one year are taxed at a maximum rate of 15% (0% if an individual is in the 10% or 15% marginal tax bracket).
Note that Congress did extend the reduced capital gains rates, through 2012.
Timing of Sales: You may want to time the sale of assets so as to have offsetting capital losses and gains.
Capital losses may be fully deducted against capital gains and also may offset up to $3,000 of ordinary income ($1,500 for married filing separately).
Dividends: Qualifying dividends received in 2011 are subject to rates similar to the capital gains rates. Therefore, qualifying dividends are taxed at a maximum rate of 15%. Qualifying dividends include dividends received from domestic and certain foreign corporations. Note that Congress did extend the reduced dividend rates through 2012.
Alternative Minimum Tax
For 2011, the alternative minimum tax exemption amounts will remain high enough to spare millions of taxpayers from the AMT effect. The 2011 exemption amounts for 2011 are: (1) $74,450 for married individuals filing jointly and for surviving spouses; (2) $48,450, for unmarried individuals other than surviving spouses; and (3) $37,225 for married individuals filing a separate return.
Also, for 2011, nonrefundable personal credits can offset an individual’s regular and alternative minimum tax.
Some of the standard year-end planning ideas will not reduce tax liability if you are subject to the alternative minimum tax (AMT) because different rules apply. Because of the complexity of the AMT, it would be wise for us to analyze your AMT exposure.
If you have any questions, please call us here at H&M. We would be happy to meet with you to discuss the strategies outlined above. While we are getting very close to the end of the year, there is still time to minimize your 2011 taxes by implementing these strategies.
Holbrook & Manter
Certified Public Accountants