MID YEAR TAX PLANNING July 2009

Although this year is only about half over, we’ve already had one new tax law (a really big one), and more might be on the way (maybe not so big). Despite confusion created by never-ending legislative changes, the current federal income tax environment is still quite favorable.

Now is the time to take advantage of the tax breaks that Congress has provided before they disappear. This newsletter presents some tax planning ideas to consider this summer while you have time to think. Some of the ideas may apply to you, some to family members, and others to your business. Here goes.

The ideas I’ll be covering include:

• First-time Homebuyer Credit


• Tax Breaks for Buying a New Vehicle


• Leverage Standard Deduction by Bunching Deductible Expenditures


• Deferring Income


• Timing Investment Gains and Losses


• Converting Traditional IRA to Roth IRA


• Alternative Minimum Tax


• Temporary Business Tax Breaks

Cash in on First-time Homebuyer Credit
Legislation enacted in 2008 created a temporary tax credit for so-called first-time homebuyers. Stimulus legislation enacted earlier this year extended the credit provision to cover qualified home purchases between 1/1/09 and 11/30/09 and made the maximum credit amounts a bit more generous. More importantly, the stimulus legislation also deleted a previous requirement to repay the credit over 15 years in most cases.

For a qualified home purchase between 1/1/09 and 11/30/09, the maximum credit equals the lesser of: (1) 10% of the purchase price of a principal residence, (2) $8,000, or (3) $4,000 for those who use married filing separate status. The credit can be used to offset your entire federal income tax bill, including any Alternative Minimum Tax (AMT). The credit is also refundable. After your tax bill has been reduced to zero, you are allowed to collect any leftover credit amount in cash.

Basic Eligibility Rules. Eligibility for the credit is limited to those who have not owned a principal residence in the U.S. during the three-year period that ends on the purchase date for the residence for which the credit is claimed. The new residence must be used as your principal residence. If you are married, both you and your spouse must pass the three-year test. For a newly constructed home, the purchase date is considered to be the date you move in. Additional eligibility rules apply in certain circumstances. Please contact us if you want more information.

Phase-out Rule. The credit is phased out (reduced or completely eliminated) if your Modified Adjusted Gross Income (MAGI) is too high. The phase-out range for unmarried individuals and married individuals who file separately is between MAGI of $75,000 and $95,000. The phase-out range for married joint filers is between MAGI of $150,000 and $170,000.

Claiming Credit for 2009 Purchase on 2008 Return. Contact us for details on taking advantage of this option.

Collect Tax Breaks for Buying a New Vehicle
Thanks to the following tax breaks that won’t be around forever and a buyer’s market, now might be a very good time to purchase a new vehicle.

Vehicle Sales Tax Deduction. Stimulus legislation passed earlier this year created a new federal income tax deduction for state and local sales and excise taxes paid on new (not used) vehicles that are purchased (not leased) between 2/17/09 and 12/31/09. The write-off is limited to the amount of taxes on the first $49,500 of purchase price. You can claim the break whether you itemize or not, and it’s allowed even if you owe the AMT. An IRS spokesperson recently confirmed that you can claim the deduction on as many vehicles as you care to buy within the designated time frame. Qualifying vehicles include almost all passenger autos, pickups, and SUVs as well as motorcycles and RVs. However, a phase-out rule can reduce or completely eliminate the break for higher-income taxpayers. Contact us for details.

Hybrid Vehicle Credit. A federal income tax credit is allowed for buying (not leasing) a qualifying new (not used) hybrid vehicle. The credit can be used to offset your 2009 federal income tax bill even if you owe the AMT, and high income won’t disqualify you. Credits for most qualifying vehicles range from around $1,500 to $3,000, so they can make a meaningful difference. However, credits are phased out once the manufacturer has sold over 60,000 hybrids in the U.S. Credits for Toyota and Lexus hybrids disappeared after 2007, and credits for Honda hybrids vanished after 2008. Credits for Ford and Mercury hybrids are being phased out right now. You’ll get a bigger credit for buying a Ford or Mercury hybrid before October 1. So far, full credits are still allowed for hybrids put made by Chrysler, GM, Mazda, and Nissan.

Leverage Standard Deduction by Bunching Deductible Expenditures
Are your 2009 itemized deductions likely to be just under, or just over, the standard deduction amount? If so, consider the strategy of bunching together expenditures for itemized deduction items every other year, while claiming the standard deduction in the intervening years. The 2009 standard deduction for married joint filers is $11,400; the magic number for single filers is $5,700; it’s $8,350 for heads of households.

Consider Deferring Income
It may also pay to defer some taxable income from this year into next year, especially if you expect to be in a lower tax bracket in 2010. Deferring income may also be helpful if you’re affected by unfavorable phase-out rules that reduce or eliminate various tax breaks (such as itemized deductions, personal exemption deductions, the child tax credit, the education tax credits, and so forth). By deferring income every other year, you may be able to take more advantage of these breaks every other year.

Note: For higher-income taxpayers, it may not be advisable to repeat the income deferral drill in 2010 because pushing income from 2010 into 2011 could expose them to higher marginal tax rates in 2011. For that year, it is widely expected that the top two federal income tax rates will be increased to 36% and 38.6% (up from the current 33% and 35%).

Time Investment Gains and Losses and Consider Being Bold about It
As you evaluate investments held in your taxable brokerage firm accounts, consider the impact of selling appreciated securities. The maximum federal income tax rate on long-term capital gains from 2009 securities sales is only 15%. Therefore, it often makes sense to hold appreciated securities for at least a year and a day before selling. On the other hand, now may be a good time to cash in some long-term winners to benefit from historically low tax rates.

If capital losses for this year exceed capital gains, you will have a net capital loss for 2009. You can use that net capital loss to shelter up to $3,000 of this year’s high-taxed ordinary income from salaries, bonuses, self-employment, and so forth ($1,500 if you’re married and file separately). Any excess net capital loss is carried forward to next year.

Important Point: Selling enough loser securities to create a net capital loss that exceeds what you can use this year also might make sense. You can carry forward the excess net capital loss to 2010 and beyond and use it to shelter both short-term gains and long-term gains recognized in those years. This will give you extra investing flexibility in 2010 and beyond because you won’t necessarily have to hold appreciated securities for over a year to get better tax results. Remember: It is widely expected that the maximum federal income tax rate on long-term capital gains will be increased to 20% for 2011 and beyond (up from the current 15%). Also, the top two federal rates on ordinary income (including short-term capital gains) are widely expected to be increased for 2011 and beyond to 36% and 39.6% (up from the current 33% and 35%). Contact us if you want help in identifying your best tax-smart options in a world where future tax rates are uncertain.

Convert Traditional IRA into Roth IRA
Here’s the best scenario for this idea: Your traditional IRA is (or was) loaded with equities and took a major beating during the stock market downturn. So, your account is now worth a lot less than it once was. Correspondingly, the tax hit from converting your traditional IRA into a Roth account right now would also be a lot less than before. Why? Because a Roth conversion is treated as a taxable liquidation of your traditional IRA followed by a nondeductible contribution to the new Roth account. While even the reduced current tax hit from converting is unwelcome, it may be a small price to pay for future tax savings. After the conversion, all the income and gains that accumulate in your Roth account, and all withdrawals, will be totally free of any federal taxes—assuming you meet the tax-free withdrawal rules. In contrast, future withdrawals from a traditional IRA could be hit with tax rates that are much higher than today’s rates.

Of course, conversion is not a no-brainer. You have to be satisfied that paying the up-front conversion tax bill makes sense in your circumstances. In particular, converting a big account all at once could push you into higher 2009 tax brackets, which would not be good. You must also make assumptions about future tax rates, how long you will leave the account untouched, the rate of return earned on your Roth account investments, and so forth. To be eligible for a Roth conversion this year, your 2009 adjusted gross income cannot exceed $100,000. In 2010, the $100,000 restriction will go away unless Congress changes the deal. Also, taxes on income recognized in 2010 from a Roth conversion are deferred until 2011 and 2012. So, 2010 may be an ideal time to convert, assuming your account doesn’t appreciate substantially in the mean time. If the Roth conversion idea intrigues you, please contact us for a full analysis of all the relevant variables.

Watch Out for Alternative Minimum Tax
While many recent tax-law changes have been helpful in reducing your regular federal income tax bill, they didn’t do much to reduce the odds that you’ll owe the dreaded AMT. Therefore, it’s critical to evaluate all tax planning strategies in light of the AMT rules before actually making any moves. Because the AMT rules are complicated, you may want our assistance. We stand ready to help!

Take Advantage of Generous But Temporary Business Tax Breaks
Several favorable business tax provisions have a limited shelf life that may dictate taking action between now and year-end. They include the following.

Bigger Section 179 Deduction. Your business may be able to take advantage of the temporarily increased Section 179 deduction. Under the Section 179 deduction privilege, an eligible business can often claim first-year depreciation write-offs for the entire cost of new and used equipment and software additions. For tax years beginning in 2009, the maximum Section 179 deduction is $250,000 (same as last year). For tax years beginning in 2010, however, the maximum deduction is scheduled to drop back to about $130,000 (depending on the inflation adjustment). Various limitations apply to the Section 179 deduction privilege, so please contact us if you want more information.

50% First-year Bonus Depreciation. Above and beyond the bumped-up Section 179 deduction, your business can also claim first-year bonus depreciation equal to 50% of the cost of most new (not used) equipment and software acquired and placed in service by December 31 of this year. The first-year bonus depreciation break is scheduled to expire at year-end unless Congress takes further action. Contact us if you want more details about this generous, but temporary, tax break.

Conclusion
As we said at the beginning, this letter is intended to give you just a few ideas to get you thinking about tax planning moves for the rest of this year. Please don’t hesitate to contact us if you want more details or would like to schedule a tax planning strategy session. We are at your service.

Best regards,

Brian Berlage

Past newsletters :

January 2009
February 2009
March 2009
April 2009
May 2009
June 2009
July 2009
August 2009

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