As 2010 nears its end, many Americans are beginning to think about year-end tax planning. This carried with it a great deal of uncertainty throughout November 2010, as Bush-era tax cuts were a hot issue in Congress. As of December 7, 2010, however, President Barack Obama announced a deal that would extend all Bush-era tax cuts. This deal assured that Americans, including wealthy Americans, would not see any unexpected rise in taxes in the year-end filing process. It also, however, announced pending changes in other areas of tax law, including estate tax and Social Security.
Extension of Tax Cuts
Bush-era tax cuts represent a decrease of approximately 3 percent for each individual filing. This tax break was enforced unilaterally, despite income. Initially, Democrats wanted to remove this break for individuals earning more than $200,000 ($250,000 for joint filers) as of January 1. However, with the breaks extended, all Americans will still receive the break benefit.
In addition to extending the cuts, the new tax program will extend unemployment benefits through 2011 for individuals currently facing an end to this government insurance program. The need for long-term unemployment insurance, according to President Obama, is the main reason Democrats were willing to compromise on other tax break issues. For example, the legislation will not extend the "Making Work Pay" benefit that was introduced in the stimulus bill. This means you cannot count on a $400 refund if your income is under $75,000. Instead, the legislation does include a 2 percent payroll tax holiday. This means individual tax payers will see about a 30 percent reduction in the total figure they must contribute to payroll tax on each paycheck.
Individual Tax Credits
You will be able to declare tax breaks and credits for energy efficiency improvements to your home or vehicle throughout 2010. These credits include improvements to make your home more energy efficient, credits for purchasing hybrid vehicles between 2006 and December 2010, credits for purchasing plug-in vehicles or hybrid vehicle conversion options. The amount of the credit varies based on your cost basis. The marriage tax refund will still be available. This means that if you are married filing jointly and this results in a higher tax bracket for one member of the couple--what is called the "marriage penalty"--you may be eligible for a refund. Further, the extension of cuts exempts estates valued at $5 million for singles and $10 million for couples from the standard 35 percent estate tax.
As you approach your year-end tax planning, it is critical to take a long look at how the legislation will affect individuals, retirement funds, estates and small businesses. Since tax cuts have been extended, you may find you are eligible for critical savings you were not expecting. However, the date when your qualifying events occurred will be critical in determining if you are eligible. For example, the date you purchased a hybrid, the date you were married, the date you hired a new employee, and other such factors will affect whether you can file for credits and tax cuts. For this reason, it is important to keep sales documents and certificates to be entered into your tax filing.
Year-End Tax Planning for Individuals
Year end tax planning can become complicated based on the number and types of income you have over the course of the year. Individuals earning no more than $200,000 (no more than $250,000 for married filing jointly) will see your Bush-era tax cuts extended through 2011. This means you are still eligible for a 3 percent reduction in your income tax, and you may also find key credits thanks to stimulus bill incentives. Applying these incentives at the right time can lead to a much lower tax liability in the future.
Energy Efficiency Tax Credit
You may be eligible for an energy tax credit up to 30 percent or $1,500, whichever is lower, for improvements to your home designed to increase its energy efficiency. The changes must fall into the energy efficient tax credit legislation introduced in the stimulus bill, but if so you will still be eligible for the credit in the coming tax season. You may also receive credits for purchasing a hybrid vehicle prior to December 30, for purchasing a plug-in vehicle or converting your current car to an electric vehicle. The credit you receive is based on your personal cost.
Retirement Plan Deductions
If you contribute to a tax deductible retirement plan, such as a 401k or IRA, you will still receive the same deductions in the coming year. Married individuals filing jointly can deduct up to $10,000 in contributions to an IRA if they are younger than 50 and up to $12,000 if they are between 50 and 60. The maximum deductible contribution to a 401k is $16,500 for 2010. If you earn more than $200,000 as a couple, your modified adjusted gross income will be phased out for catch-up contributions.
College Saving Plan Deductions
If you contribute to a 529 college savings plan for your children or a Coverdell account, you can deduct a portion of contributions. For a 529 plan, the maximum amount you can put into the account is between $100,000 and $350,000 depending on your state of residence. This drops to a much lower $2,000 if you elect to use the more flexible Coverdell account.
Estate Tax Reductions
Estate tax will be eliminated for individual estates valued under $5 million and joint estates valued under $10 million. This means the standard 35 percent estate tax will not apply to an inheritance smaller than this amount. This legislation has not yet gone into effect, so it will not change your inheritance if you received an estate in 2010. However, it will certainly affect the way you choose to save for your beneficiaries.
Payroll Tax Holiday
There is no payroll tax holiday for 2010. However, starting in 2011, there will be a 2 percent temporary payroll tax holiday. This may reduce the amount you contribute to taxes on each of your paychecks without compromising your Social Security benefits in the future. This holiday will go into effect unilaterally, so it will not depend on your income level. Regardless, if you earn no more than $200,000, or $250,000 married filing jointly, you should be well-under the limit for "wealthy" Americans whose tax breaks may be threatened if Bush-era cuts do end in the future.
Year End Tax Planning for Retirement Funds
Year end tax planning is a time to get your retirement accounts in line in order to maximize your deductions. Regardless of your income, retirement planning is essential and can result in a much higher income both this year and in the future. Consider these final tips to ensure you are not penalized for your savings behavior and to further assure you are getting the most benefit possible from your account.
Avoid Excess Contributions
It is essential to know your contribution limits annually. Your limits will vary depending on your income, the type of account you are using and the options your employer offers, if any. For the year 2010, maximum contributions to a traditional 401k or IRA were topped at $16,500, and maximum contributions to a Roth IRA were topped at $5,000. These limits go up if you are married filing jointly or over the age of 50. You may also be permitted a certain amount of catch-up contributions from a previous year. However, you cannot exceed these figures without penalty. If you have deposited too much money into your tax deductible or tax deferred account, you should receive a notice from your plan administrator. You have until December 30 to take the money out of the account. Do not rely wholly on your administrator; keep track personally and know your limits.
Assure Funds Are Fully Vested
If you want to get a deduction for funds placed into a deductible account this year, you actually have until April 15 of 2011 to place the funds into the account. This gives you several months of wiggle room after your 2010 income has been earned and vested into your account. You may find you have a little extra income to place into your fund, or you may find your tax liability can be reduced by depositing more. In either case, make sure the funds are fully vested by April to gain the benefits.
Rollovers to a different type of account can be very beneficial if they are done under the right conditions. For example, you can roll over funds from a traditional account to a Roth account to gain tax benefits in the future. Any rollover must be completed by the Roth IRA deadline of April 15, 2011 to count for the 2010 tax year. You may have increased tax liability when rolling over from a deductible account to a nondeductible account, but this liability applies only in the current year and can save you money in the future.
Meet Required Distribution Deadlines
Once you reach the maximum retirement age of 72-1/2, you must begin taking withdrawals from your retirement account. These withdrawals are called required minimum distributions. You must take the money out of your accounts by December 30, 2010 in order to meet the IRS's deadlines. If you fail to withdraw the money, it will be withdrawn for you at an additional penalty of 6 percent. Avoid this scenario by making a final review of your accounts to leave no account untouched. In some scenarios, if you have two accounts of the same form, you can take the money out of one and have it apply to both. Otherwise, you will need to take money out of each retirement account.
Year-End Tax Planning for Small Businesses
Year-end tax planning for small businesses provides them with opportunities to maximize profit and minimize tax liability in the future. This is particularly critical if your business opened its doors this year, meaning this is the inaugural tax filing and will set the standard for the future. You will have important decisions to make regarding which expenses to capitalize and which to deduct. You will also have to determine how to distribute earnings to shareholders, where applicable, to avoid double taxation in the future.
As a business owner, you can deduct or capitalize each of your capital assets. In some cases, you will not have a choice in which strategy you pursue; however, in many cases, the choice will be yours. Capitalizing assets is the process of declaring them as a part of the business's capital expenses. They are not deducted in the given year. Instead, the amount of depreciation in the future is deducted each year. For example, if you purchase a large piece of machinery for $50,000 and anticipate it will last you 10 years, it depreciates at a rate of $5,000 per year. You could choose to deduct the $50,000 expense this year, but by capitalizing the asset instead, you can spread out the deductions and potentially recognize a greater deduction overall.
If you do choose to deduct an asset, it counts as a dollar-for-dollar deduction against your business's income this year. You can deduct a number of one-time expenses, such as advertising costs, shipping costs and insurance costs. These expenses affect your profitability in this year, and they will not continue to serve you in future years. As a result, deduction is a better method than capitalization. In fact, you are not legally allowed to capitalize an expense that does not fit the narrow definition of a depreciating capital asset.
Special Deduction Consideration in the First Year
New business owners have a unique choice to make in their first year of operation. During this year, all rules about which expenses can be capitalized or deducted go out the window. Every single expense can be deducted. This includes the expense you went to in determining whether to go into business, the loan application process, meetings, and the purchases of start-up equipment for your office. In the future, the types of expenses you can deduct rather than capitalize will be determined for you. In the first year, though, you will set a pace for your tax filings in the future by making the decision on your own.
Distributing Earnings to Shareholders
If you have shareholders, you will have a whole new set of considerations to make in your year-end tax planning. For example, you can choose to accelerate your distribution of accumulated earnings and profits to 2010. Rather than allowing shareholders to consent to dividends, consider paying out cash distributions this year and allowing shareholders to loan the money back to you. This can allow you to avoid double taxation. You may also consider distributing real estate from a C or S corporation to accelerate capital gains. This is also a good time to consider converting to an LLC in a statutory conversion. Taking advantage of liquidation laws would allow you to avoid double taxation in the future.