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Tax Newsletter
December 2008

The uncertain economy has increased the need for effective tax planning while making implementation more challenging. Tax planning is always fluid, and is even more so in times of economic uncertainty. Effective year-end tax planning for 2008 combines use of traditional techniques of acceleration and deferral of income/deductions with appropriate responses to a changing tax landscape. Traditional year-end tax planning incorporates a standard set of considerations but is not a one size fits all process. Every plan must account for the particular needs and circumstances of each individual or business.

Individual Planning

Stock losses. Many people have taken huge hits in their investment and retirement portfolios from the crisis in the financial markets. Not only have many stocks declined in value in recent months; others have become worthless. In today's market, you are likely to have in your investment portfolio holdings that are currently priced below your purchase price. Now might be a good time to sell those stocks or mutual funds to generate losses to offset capital gains and then up to $3,000 of your ordinary income.

Alternatively, you may own a stock that has currently lost value, but wish to keep the stock for investment purposes because you believe the stock will likely recover its value. One option would be to sell the stock to recognize the loss and then reacquire it to continue your investment. However, to use the loss on your 2008 tax return, you must wait 30 days after the sale to repurchase the security. One strategy to avoid lost investment opportunities while fulfilling the 30-day rule is to purchase additional shares of the security now, especially if you anticipate that the stock price may rise during the next 30-day period. After you have held the newly acquired stock for 30 days, you can sell the original shares at a loss that will be recognized for tax purposes. Another strategy is to sell now and then reinvest the proceeds immediately in shares of a company in the same industry that are likely to perform similarly to the stock you just sold. In either case, your loss qualifies for full capital loss treatment and can offset capital gains, with any excess used to offset up to $3,000 of ordinary income.

Worthless stock also generates an immediate deduction. The rules for "worthless" stocks are very strict. Your definition of worthless may be very different from the IRS' definition. Stocks and securities must be totally worthless for a taxpayer to take a loss deduction. A mere diminution in value, no matter how great, will not trigger a loss deduction.

Relief of Debt Income - Exclusion for Homeowners. Legislation passed in 2008 extends a temporary rule for cancellation of indebtedness income, through 2012. When a lender forgives all or part of an individual’s mortgage debt (due to foreclosure or sale of property), the tax code treats the cancelled debt as taxable income to the homeowner. The laws enacted in 2007, excludes from federal tax those discharges involving up to $2 million of indebtedness secured by a principal residence and incurred in the acquisition, construction or substantial improvement of the residence.

California has partially conformed to this new legislation. California limits the income exclusion, providing the amount excluded from gross income shall not exceed $250,000, for calendar years 2007 and 2008 only.

AMT. The Alternative Minimum Tax (“AMT”) system was put in place to ensure that all taxpayers pay a minimum amount of tax. Unfortunately, for California residents, the current AMT system often results in higher taxes due. This is because deductions are not allowed for California income tax paid and real property taxes in the AMT calculation.

Congress recently passed an AMT Patch, which raises for 2008 the AMT exemption amount before AMT tax applies. The patch is intended to insulate most middle income taxpayers from the reach of AMT, but will have little relief for California taxpayers who have California tax liabilities and real property taxes.

One aspect of the AMT Patch provides relief to those who were left holding worthless or low value stock that was acquired from the exercise of options, and a large tax bill based on the AMT calculation back when the tech industry collapsed. The new law allows all individuals, including those who paid their AMT liabilities attributable to the exercise of incentive stock options, to accelerate the refund of the minimum tax credit that has not been used.

Kiddie Tax. Beginning in 2008 the kiddie tax will apply to a child under the age of 19 and full time students under age 24; that is, the child’s unearned income in excess of $1,700 is taxed at his or her parents’ marginal rate. The kiddie tax does not apply if the child provides more than half of the cost of his or her support with earned income.

Prepayment of expenses. As the year-end approaches, evaluate if you are subject to AMT, and consider prepaying tax deductible expenses, such as state taxes and real estate taxes, to the extent you get a current year tax benefit.

Charitable contributions. Charitable contributions continue to be one of the most flexible of the deductible expenses. Gifts of appreciated property (e.g., stocks) may have a significant tax advantage over cash contributions. You receive a charitable contribution deduction for the fully appreciated value of the property, while avoiding tax on the capital gain that would have been realized if you had sold the property and contributed the proceeds. Charitable remainder trusts and private foundations are additional planning tools that may help you reduce income taxes while helping you achieve your charitable goals.

Charitable provisions to keep in mind

  • Consider gifting stock where its fair market value exceeds the cost basis. This will result in a tax deduction based on fair market value, while avoiding the tax on the capital gain.
  • There are two sets of rules for cash contributions. For contributions greater than $250, you must obtain a written acknowledgement from the charitable organization to support a charitable deduction. For contributions under $250, you must obtain a bank record (e.g., cancelled check) or a written acknowledgment from the charity. Without appropriate documentation, a contribution deduction is not available.
  • For taxpayers, age 70 ½ or older, the ability to make tax-free distributions from IRAs to charities has been extended to the end of 2009. The distributions must be made directly from the IRA to charity. The maximum amount per year is $100,000. While a charitable contribution deduction is not available, the withdrawal from the IRA will not generate taxable income, and will satisfy the Minimum Distribution Requirement for the year.
  • A deduction is not allowed for used clothing and household items unless the items are in “good” condition. There is no guidance as of yet on what constitutes “good condition”.

Maximize retirement plan contributions. Contributions to tax deferred retirement plans remain a valuable financial planning tool. One of the easiest and least expensive ways to save for your retirement is to take advantage of your employer qualified plans and/or IRAs, by making annual pre-tax contributions to such plans. Increased contribution limitations and catch-up provisions allow older workers to increase their retirement savings. Parents with children that have earned income may want to consider making a gift to a child, which the child can contribute to an IRA up to the amount of his or her earned income.

Retirement planning decisions are affected by annual contribution limits, taxable income limitations and whether there is coverage under an employer plan.

  • In 2008, the contribution limit for 401(k)s and SEP/Keoghs is $15,500 and $46,000, respectively. (An additional $5,000 catch-up is allowed for those age 50 and over).
  • In 2008, the IRA (regular and Roth) contribution limit is $5,000. ($6,000 for those age 50 and over).
  • To qualify for the maximum Roth contribution, married taxpayers filing a joint return must have a 2008 combined Adjusted Gross Income (AGI) of less than $159,000 and earned income must be at least as much as the amount of the contribution to the Roth IRA. For singles, AGI must be less than $101,000 and earned income must be an amount at least equal to the contribution amount.
  • Taxpayers covered by an employer plan are precluded from making deductible contributions to a regular IRA. If one spouse is covered by an employer plan, the non-participant spouse may make a contribution to a regular IRA, subject to certain limitations based on AGI.

Business Planning

Income Shifting. Taxpayers expecting to be in the same or lower bracket in 2009 should consider deferring income until next year and accelerating expenses in 2008. Cash basis businesses can shift income to next year by delaying their billing cycles. Accrual based businesses can defer income by delaying shipment of products or the provision of services until 2009.

Business Losses. Business loss deductions can be taken for bad debts, losses on sale of business assets and net operating losses. A carryback period of two years exists for business losses, so a loss in 2008 can be carried back to 2006 and 2007, and a request can be made for a refund for the taxes paid in those years.

Bonus Depreciation. Business taxpayers may wish to accelerate new equipment acquisitions into 2008. The “bonus” depreciation provisions allow for an immediate write off of 50% of the cost of assets.

Section 179 Deductions. The §179 election allows a current deduction for items that would normally be capitalized and depreciated. The amount eligible for the election has been increased to $250,000, for the calendar year 2008.

California Highlights. Included in the new budget for California: Net Operating Loss Deductions are suspended for 2008 and 2009 (exception for small businesses); the LLC Fee is accelerated and calendar year LLCs must pay their estimated 2009 fee on June 15, 2009; and beginning January 1, 2009, the first two estimated tax payments are increased from 25% to 30% and the last two are reduced to 20%.

Running the numbers. We recommend running tax projections for 2008 and 2009 before implementing year-end tax strategies. Please let us know if you would like our assistance in preparing a projection.

We often remind our clients that tax considerations should generally not drive financial decisions. However, once financial objectives are defined and understood, it becomes easier to determine the tax planning strategies that are consistent with overall objectives. Unfortunately, frequent changes in the income tax rules, coupled with the changes and uncertainty in the estate tax area, make both short and long-term planning more complex. With the year-end approaching, it may be a good time to review your financial objectives with a view toward assessing whether any of the recent tax incentives can be incorporated into the financial plan.


The information contained in this newsletter is general in nature and does not constitute tax advice or opinion. Applicability to specific situations should be determined through consultation with your tax advisor.

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