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YEAR END TAX PLANNING AND PREPARATION FOR INDIVIDUALS - Tax Tips for 2011

Now is the best time to start thinking about your year-end tax planning. See "WHAT HAPPENS IF I DON'T FILE" below if you believe that is an opton. These tax strategies can be put into effect by the end of the year and some as late as when the tax return is due. Planning now will save you money and reduce your tax liability not only with your federal taxes but also with your state taxes. Here are tax tips that will help you accomplish your goal.

BASIC NUMBERS YOU NEED TO KNOW

Because many tax benefits are tied to or limited by adjusted gross income (AGI)—IRA deductions for example—a key aspect of tax planning is to estimate both your 2011 and 2012 AGI. Also when considering whether to accelerate or defer income or deductions you should be aware of the impact this action may have on your AGI and your ability to maximize itemized deductions that are tied to AGI. Your 2010 tax return and your 2011 pay stubs and other income and deduction related materials are a good starting point for estimating your AGI.

Another important number is your "tax bracket," i.e. the rate at which your last dollar of income is taxed. The tax rates for 2011 are 10% 15% 25% 28% 33% and 35%. Although tax brackets are indexed for inflation, if your income increases faster than the inflation adjustment you may be pushed into a higher bracket. If so, your potential benefit from any tax-saving opportunity is increased (as is the cost of overlooking that opportunity).

SOME TAX BREAKS SET TO EXPIRE ON DECEMBER 31ST, 2011 IF CONGRESS FAILS TO ACT

There are several important tax breaks set to expire at the end of 2011. Congress may extend them, but legislation could come by the end of 2011 or in 2012 and made retroactive. You will want to take these into consideration when trying to minimize your tax liability and possibly accelerate these expenses into 2011. Examples of some of these breaks include:

Social Security tax withheld from your wages from 6.2% to 4.2% up to $106,800 in taxable wages.

Mortgage insurance premium deduction.

State and local sales tax deduction.

Mass transit monthly commuting fringe benefit of $230.

Non-business energy credit.

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 will be advantageous so long as the deferral does not bump your income to the next bracket. Deferring income could be disadvantageous if your deferred income is subject to §409A thus making the income includible in gross income and subject to a 20% additional tax. It is unknown at this time what the 2012 tax brackets will be. You should also take this into consideration. So deferring your income into 2012 can be potentially a crap shoot.

Some ways to defer income include:

Delay Billing: If you are self-employed and report your business on a cash basis, delay year-end billing to clients so that payments will not be received until 2012.

Interest and Dividends: Interest income earned on Treasury securities and bank certificates of deposit with maturities of one year or less is not includible in income until received. To defer interest income, consider buying short-term bonds or certificates that will not mature until next year. If you have control as to when dividends are paid, arrange to have them paid to you after the end of the year.

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 in order to take advantage of an offsetting deduction or credit that will not be available to you in future tax years. Note however that accelerating income into 2011 will be disadvantageous if you expect to be in the same or lower tax bracket for 2012. In any event, before you decide to implement this strategy you should "crunch the numbers" and take into consideration that it is unknown at this time what the tax brackets for 2012 will be.

If accelerating income will be beneficial, here are some ways to accomplish this:

Accelerate Collection of Accounts Receivable: If you are self-employed and report income and expenses on a cash basis, issue bills and attempt collection before the end of 2011. Also see if some of your clients or customers might be willing to pay for January 2012 goods or services in advance. Any income received using these steps will shift income from 2012 to 2011.

Year-End Bonuses: If your employer generally pays year-end bonuses after the end of the current year, ask to have your bonus paid to you before the beginning of 2012.

Retirement Plan Distributions: If you are over age 59 1/2 and you participate in an employer retirement plan or have an IRA, consider making any taxable withdrawals before 2012.

DEDUCTION PLANNING

Deduction timing is also an important element of year-end tax planning. Deduction planning is complex due to factors such as AGI levels and filing status. If you are a cash-method taxpayer remember to keep the following in mind:

Deduction in Year Paid: An expense is only deductible in the year in which it is actually paid.

Payment by Check: Date checks before the end of the year and mail them before January 1 2011.

Promise to Pay: A promise to pay or providing 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: 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.

Standard Deduction Planning: Deduction planning is also affected by the standard deduction. For 2011 returns, the standard deduction is $11,600 and will rise to $11,900 for 2012 for married taxpayers filing jointly, $5,800 and will rise to $5,950 for single taxpayers, $8,500 and will rise to $8,700 for heads of households and $5,800 and will rise to $5,950 for married taxpayers filing separately. If your itemized deductions are relatively constant and are close to the standard deduction amount, you will obtain little or no benefit from itemizing your deductions each year. But simply taking the standard deduction each year means you lose the benefit of your itemized deductions. To maximize the benefits of both the standard deduction and itemized deductions consider adjusting the timing of your deductible expenses so that they are higher in one year and lower in the following year. You can do this by paying in 2011 deductible expenses such as mortgage interest (including for 2011 mortgage insurance premiums) due in January 2012.

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.

State Taxes: If you anticipate a state income tax liability for 2011 and plan to make an estimated payment, consider making the payment before the end of 2011.

Charitable Contributions: Consider making your charitable contributions at the end of the year. This will give you use of the money during the year and simultaneously permit you to 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 the end of the year. Note however for claimed donations of cars, boats, and airplanes of more than $500, the amount available as a deduction will significantly depend on what the charity does with the donated property not just the fair market value of the donated property. If the organization sells the property without any significant intervening use or material improvement to the property, the amount of the charitable contribution deduction cannot exceed the gross proceeds received from the sale. The IRS has tightened rules on this considerably.

To avoid capital gains you may want to consider giving appreciated property to charity.

Additionally the IRS has restrictions on claiming charitable contributions. These rules are the following: (1) no deduction is allowed for charitable contributions of clothing and household items if such items are not in good used condition or better; (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. Effective January 1, 2007, charitable contributions of money regardless of the amount will be denied a deduction unless the donor maintains a cancelled check bank record or receipt from the donee organization showing the name of the donee organization and the date and amount of the contribution.

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. 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.

Credit for Adoption Expenses: For 2011 due to the expanded adopton credit included in the Affordable Care Act the adoption credit limitation is $13,170 and will be $12,650 for 2012 of reasonable and necessary expenses related to a legal adoption for each child. The credit ratably phases out for taxpayers whose income is between $189,710 and $229,710 for 2012.

American Opportunity Credit (Hope Scholarship Credit) and Lifetime Learning Credit: The American Opportunity Credit can be up to $2,500 per eligible student. The credit is available for the first four years of the student's post-secondary education.

The Lifetime Learning credit is 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.

Coverdell Education Savings Account: The aggregate annual contribution limit to a Coverdell education savings account is $2,000 per designated beneficiary of the account. 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.

Rules are in effect to coordinate education provisions such as the qualified higher education expense deduction, the American Opportunity and Lifetime Learning credits, Coverdell education savings accounts, and qualified tuition plans to prevent double benefits.

INVESTMENT PLANNING

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 the taxpayer is in the 10% or 15% marginal tax bracket).

Review your capital gains and losses for the year including taxable investment accounts and taxable real estate sales. If you have net capital gains, you may want to sell some of your investments that have a loss to offset the gain. You should also check your 2010 tax return for any loss carry forwards to 2011.

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). In general, when you take losses you must first match your long-term losses against your long-term gains and short-term losses against short-term gains. If there are any remaining losses you may use them to offset any remaining long-term or short-term gains or up to $3,000 (or $1,500) of ordinary income. When and whether to recognize such losses should be analyzed in light of the changes in the capital gains rates applicable to your specific investments. If Congress takes no action, the capital gains tax rates will revert back to the previous higher rates effective January 1, 2013. If they do not change the law effective for January 1, 2013, you may want to sell part or all of your assets which have a capital gain in 2011 since you could pay a higher rate if you sold them after 2012.

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.

OPEN AN INDIVIDUAL RETIREMENT PLAN ACCOUNT (IRA)

See IRA and Retirement Savings Rules for an example of what you can do to defer income until retirement. You can open your 2011 IRA as late as April 15th of 2012. You may want to consider a Roth IRA. They are not tax deductible but also are not taxable when withdrawn at retirement.

GET ORGANIZED

Clients always ask me what I need in order to do their taxes. For 90% of the population, with a little organization, your tax preparation doesn't have to be overwhelming and can cost less if you submit organized documents to your tax professional. First, when you receive tax documents in the mail, have a folder ready to drop them in and forget about them until tax time. Most tax documents are required to be mailed by January 31st so you should have almost everything by the first week of February. If not, call to have them send a duplicate. Next, go through your check book, credit card statements and cash payouts for the basic deductible items. This would include your medical expenses including eye glasses, taxes paid, donations and any employer expenses that were not reimbursed. Don't forget day care expenses, student loan interest and tuition if any of those apply to you.

WHAT HAPPENS IF I DON'T FILE?

Go to YEAR END TAX PLANNING FOR BUSINESSES for what you can do to prepare your business for year end.

These are just some tax tips you should consider when thinking about your year-end tax planning.

This article was intended to provide general information about year-end tax planning. It does not contain all the rules and exceptions that may apply to your situation. If you have further questions regarding year-end tax planning, I can be reached at www.dgoodmancpa.com.

About the Author

Dianne Goodman, CPA, FCPA - Specializes in servicing Small Businesses and Individuals. Visit www.dgoodmancpa.com for relevant and current information on a variety of financial and tax issues focusing on small businesses and individuals or call at 1-888-851-1975.

CONTACT INFORMATION:

Dianne Goodman, CPA, FCPA
Comprehensive Small Business Solutions, PC
505 323-2307
1 888-851-1975 toll free
www.dgoodmancpa.com