Dear Clients and Friends:
Year End Tax Planning
With only a couple of months left in the year, now is a great time for 2008 tax planning. Once December 31 passes, your taxable income, deductions, credits and tax liability for the year are all "set in concrete" with little if any opportunity to change the outcome. As a result, year-end tax planning should form an essential part of your financial strategy.
Changes brought about during this year, and forecasts for 2009, make that advice even more compelling for year-end 2008. Change, in 2008 in particular, has come in some unique ways over the past several months:
The impact the current financial crisis has had on the value of your assets.
- Some tax-wise ways to manage this crisis on a personal level are available.
- How the upcoming presidential election affects your 2009 income taxes.
- How the latest tax acts have impacted your tax situation.
Following are some ways you can change the outcome of your 2008 tax situation before it is too late:
Income shifting. Individuals and businesses alike can benefit from shifting taxable income and accelerating or deferring deductions between 2008 and 2009 by controlling the receipt of income and payment of expenses. Taxpayers expecting to be in a higher or lower tax bracket in 2009 should consider accelerating or deferring income and deductible expenses.
Capital losses. Capital losses can be used to fully offset capital gains. Losses taken in excess of gains can also be used to offset up to $3,000 in ordinary income. Short-term losses are taxable at your ordinary income tax rate (which can r
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h as high as 35% federal plus 9.3% state).
Life events. A birth of a child, a marriage, divorce, death, new job, loss of a job, new home, foreclosed home, and other "major life changes" also typically have significant tax implications. Many of the applicable tax rules are tied to the calendar year in which they occur.
Business losses. Business loss deductions can be taken for bad debts, losses on the sale of business assets and net operating losses. If a business had a bad year in 2008 but had profitable years in 2006 or 2007, a carry back of net operating losses, when the 2008 tax return is filed, will allow the business to apply for an immediate refund based on use of those losses. A carry forward of up to 20 years is also permitted.
Tax Law Changes
A new federal tax bill and a California Budget have passed since our last newsletter, which may affect the outcome of your 2008 tax situation. Following is a partial list of the federal tax breaks especially relevant to 2008 year-end planning:
AMT patch. For the 2008 tax year, the Alternative Minimum Tax (AMT) exemption amounts are raised to once again insulate some middle-income taxpayers from the r
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h of the AMT. The patch is only for 2008.
Property tax standard deduction. Non-itemizers have a new limited deduction for state and local real property taxes for 2008 and 2009, to a maximum $1,000.
State and local sales tax deduction. Individuals can deduct state and local general sales taxes in lieu of state and local income taxes. This deduction is now available for 2008 and 2009.
Higher education tuition deduction. Through December 31, 2009, the above-the-line higher education tuition deduction can be claimed by taxpayers. There is a limit based on income for this deduction. The deduction allows eligible taxpayers to deduct the costs of qualified higher education expenses paid during the year for themselves, a spouse, or a dependent.
Tax-free IRAs charitable contributions. Taxpayers age 70 1/2 or over can make tax-free distributions from IRAs for charitable purposes. This contribution can include any required minimum distribution that the taxpayer would be otherwise required to take.
Bonus depreciation. For businesses, 50 percent bonus depreciation of the cost of qualifying property applies to property purchased and placed in service during 2008.
Enhanced expensing. Also, specifically for businesses, the amount of deductible Code Sec. 179 expensing for small businesses for 2008 was increased to $250,000. The enhanced expensing provision applies to business property purchased and placed in service in tax years beginning in 2008. Business vehicles have lower limits.
Research tax credit. For businesses, the research tax credit has been extended to 2008 and 2009. The credit was modified through the alternative simplified credit, which promises to transform the research credit into a greater benefit for smaller businesses.
Energy Incentives. A host of energy tax incentives, targeted to consumers and others to producers and manufacturers, have been extended. The new law also introduces many favorable changes in qualifying for these tax breaks. Many of the extensions go beyond the one or two year periods that Congress authorized for non-energy extenders. New solar and wind power industries will arise due to these powerful tax breaks.
Residential energy property. The energy incentive impacting most individuals is the credit for the purchase of residential energy property. A credit of up to $500 is available in 2009 for non business energy property that meets the requirements for qualified energy efficiency improvements or qualified residential energy property expenditures. Eligible improvements include insulation materials, exterior windows, including skylights and exterior doors. Note the credit is not available for 2008 so if you are planning any of these improvements soon, waiting to complete them until early 2009 may make sense because of this credit’s new effective date.
Commercial buildings. A deduction for energy efficient commercial buildings is extended through December 31, 2013. Congress also modified the energy efficient appliance credit for manufacturers of qualifying dishwashers, clothes washers, and refrigerators.
New
California
Budget Tax Changes
Following is a partial list of the
California
tax increases especially relevant to 2008 year-end planning:
The LLC fee is accelerated, and calendar-year LLCs must pay their 2008 fee on April 15, 2009, and estimated 2009 fee on June 15, 2009.
- Business credits are limited to 50% of tax liability for 2008 and 2009, with an exception for small businesses.
- The Net Operating Loss (NOL) deduction is suspended for 2008 and 2009, with an exception for small businesses with gross income of less than $500,000. However, for taxable years beginning on or after January 1, 2008, NOLs may be carried forward for 20 years; NOLs may be carried back for two years for losses generated in taxable years beginning on or after January 1, 2011.
- Beginning January 1, 2009, the first two estimated payments for individuals and corporations are increased from 25% to 30%, and the last two are reduced to 20%.
- Individual taxpayers with income over $1 million may no longer use the 110% of prior-year tax as a safe harbor for years beginning in 2009.
Didn’t get a rebate check? It’s not too late.
The rebates are for 2008 but checks were based on taxpayer’s 2007 tax data. If you received a check but don’t technically qualify because your 2008 income is too high, the government will not make you return your check. However, if you did not receive a check based on your 2007 data, you still could qualify for a rebate based on your 2008 return.
Property tax reduction
Planning to convert your vacation home into a primary residence?
The new rules may not bite you too badly if you owned the house for many years before converting it. The portion of the profit that is subject to tax is based on the ratio of the time after 2008 when the house was a second home or a rental to the total time you owned it. So, if you have owned a vacation home for 18 years and make it your main residence in 2011 for two years before selling it, only 10% of the gain is taxed (2 years rental 2009-2010 / 20 years total). The rest qualifies for the exclusion of up to $500,000 ($250,000 for a single individual). Homes owned for a short time prior to a post 2008 conversion fare the worst tax wise. You can completely avoid the tax hit by converting the property to a principal residence before January 1, 2009.
Investments
Risk and reward are two sides of one coin. Right now risks are high, volatility is high and outcomes are uncertain. This may not be the time (as of this writing) to commit funds to the market, but that time may be drawing near. Once the volatility is back to normal levels and answers are known about the economic problems, the risk will be greatly reduced (but so will the potential rewards).
If you are contemplating selling real estate, talk to us first.
If you have investments in 401(k)s and brokerage accounts, you should consider professional management. Professional managers earn their fee during the tough times. Anybody can make money during the good times.
If your income will be greatly reduced this year, perhaps it may be to your benefit to withdraw funds from IRAs (and even pay the penalty tax). This strategy should not be undertaken without first “running the numbers.”
If you have traditional IRAs and qualify to convert those IRAs to Roth IRAs (adjusted gross income of less than $100,000), this may be a great year to make the conversion.
This is probably not a good time to make gifts of appreciated assets to charity, since there is less appreciation. However, low interest rates make charitable lead trusts more attractive. A charitable lead trust is one that the charity of your choice receives a stream of income from the gift for a number of years and the principal (including appreciation on the assets) is transferred to your heirs.
The low interest rate climate makes GRATs (Grantor Retained Annuity Trusts) a more attractive vehicle to transfer assets to heirs. This strategy is complex. If you would like to read about it, ask us for a copy of the Alliance Bernstein article that does a good job of explaining the mechanics and benefits.
Give our office a call
Because of the complexity of the tax law, understanding what planning provisions to incorporate into your year-end tax planning strategy can be a daunting task. While this letter hopefully gives you a heads-up on at least several tax opportunities on which you might follow through before year end, there are many more techniques that can be used depending upon your individual circumstances.
Sincerely yours,
