November, 2010 Tax Tip
As Year-end Approaches, I Desperately Need a Crystal Ball
Year-end tax planning is as much about 2011 as it is about 2010. Therefore, as a tax advisor, what do I do at a time when year-end planning was never more important yet, until Congress does something (or even nothing), I don’t know what the rules will be that I am working with?
In the past, tax advisors typically relied on a rather standard set of time-honored techniques such as deferring income to the following year and accelerating deductions into the currentyear. This may not be the proper strategy this year.
As I see it, there are four scenarios looking toward 2011:
1. The 2001 Bush tax cuts could be extended. There are currently six marginal federal income tax brackets: 10%, 15%, 25%, 28%, 33%, and 35%. These brackets are scheduled to expire at the end of 2010, unless Congress takes action to extend them.
2. Congress takes no action. In 2011 the 10% bracket will disappear, and the remaining brackets will return to their pre-2001 levels: 15%, 28%, 31%, 36%, and 39.6%.
3. Congress adopts Obama’s proposals. Obama has indicated that he would like to permanently extend the 2010 rates for individuals earning less than $200,000 and married couples earning less than $250,000. The two highest brackets (33% and 35%) would increase to the pre-2001 rates of 36% and 39.6%.
4. Any other possibility. The fact is that anything is possible with a lame duck Congress. If I were to predict, I would say that there is a very small possibility of Congress taking no action. Therefore, I believe that either we will have an extension of the Bush tax cuts for at least another year for reasons tied to the recession and the upcoming election results, or the tax cuts will expire for the upper two brackets only.
So, with the 2011 law an unknown at this point, how should year-end planning be approached? To start with, we do know the tax rates for 2010. We also know that there are a number of new beneficial provision that were enacted recently as part of the Small Business Jobs Act of 2010 (see my October, 2010 Tax Newsletter at www.rontaxcpa.com) that are applicable to 2010 (and possibly 2011).
In addition, there are also several benefits that are available for 2010 that are scheduled to expire at the end of the year so you will need to act in the next two months to take advantage of them. These include an exemption from the 6.2% social security tax for employers that hired unemployed workers from March 19, 2010 through December 31, 2010; 50% first- year bonus depreciation for property placed in service during 2010; $8,000 additional bonus depreciation for passenger automobiles; the up to $1,500 credit for qualified energy-efficient home improvements; deduction for mortgage insurance; and a deduction for self-employed health insurance in computing income subject to self employment tax.
Legislation is pending to extend to 2010 some popular provisions that expired after 2009, such as the deduction for state and local sales tax in lieu of the income tax on Schedule A, the additional standard deduction for real property tax for non-itemizers, teacher’s expense deduction, and the above the line deduction for qualified tuition and related expenses. Also, it is expected that Congress will again increase the AMT exemption amounts (keep your fingers crossed on this one!).
In working with a client’s tax information, how will I implement the unknown 2011 rates into the equation so that I can effectively plan for my clients? Remember, I said that year-end tax planning requires a two-year analysis, 2011 as well as 2010. I most likely will assume that Congress will do something that will prevent reversion to the pre-2001 law. Therefore, as a first step, I will need to determine whether clients’ 2011 earnings will exceed $200,000 ($250,000 if married). If it appears they will clearly be in “safe harbor” territory, in most cases I will likely use the time-honored techniques of income deferral and deduction acceleration. If, on the other hand, it appears that they will be in the higher-rate territory, the strategizing will become more complex, and that is when the crystal ball would really come in handy.
There are always a number of factors that need to be taken into account that can have great impact on a two-year tax plan, even if the 2311vtax rates were known. These include retirement plan considerations (e.g. does a Roth conversion really make sense?), changes in marital status, the effect of phase-outs in deductions and exemptions, the AMT, capital gains strategies, and a host of other important issues.
Whatever may or may not happen on Capitol Hill, I strongly encourage you to get together with a tax professional to closely review your situation. This is not the year for inaction! You need a two-year tax strategy, not a 2010 tax projection!
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