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Tax Newsletter
November, 2009

Another year end is fast approaching, so it is time to take a look at your financial picture. Our year-end newsletter reviews various concepts and rules with regard to managing your portfolio and the potential tax ramifications, as well as other year-end opportunities. For many taxpayers, the real challenge is in implementing a multi-year financial plan in an uncertain economic environment. Making a commitment to a planning strategy while maintaining maximum flexibility can be a daunting task.

This year, there are a number of significant variables that may affect planning—

  • An unsettled economy
  • The prospect of higher ordinary income and capital gain tax rates in 2011
  • Future limitations on itemized deductions, charitable contribution deductions
  • Low interest rates
  • Estate tax reform
  • California economy

Presently there are many different proposals being bantered about in political circles. Absent legislation, our tax landscape may look like the following in the next few years:

  • The top rate for ordinary income, including dividend income, may increase from 35% to 39.6%, beginning in 2011;
  • The rates for long term capital gains may revert from 15% to 20%, beginning in 2011;
  • The Estate Tax is scheduled to be repealed at the end of 2009. However, after one year, in 2011, the Estate Tax will be reinstated with a top marginal rate of 55% and a $1 million exemption;

With the prospect of higher income tax rates on the horizon, taxpayers may wish to consider both 2009 and 2010 in their planning. Against a backdrop of shifting economics, taxpayers should consider traditional year-end tax strategies:

  • Shifting income by deferring income and accelerating deductions
  • Retirement plan contributions
  • Charitable contributions
  • Harvest capital losses; possibly accelerating capital gains
  • Accelerated deductions for business property

In the discussion that follows, we highlight a number of areas that present additional planning opportunities and challenges for taxpayers.

Investments. The market over the past few years has depressed the value in many portfolios. Now might be a good time to review and rebalance your portfolio. This activity might involve selling stocks or mutual funds to generate losses that will offset capital gains and up to $3,000 of ordinary income.

Wash sales. For those who are considering selling a security with an unrealized loss and replacing it with the same security, the wash sale rules must be considered. A “wash sale” is a transaction where you sell the loss security and, within a short time after or before the sale, you reacquire the same security. A deduction is not allowed for the loss generated if you acquire substantially identical securities within a 61-day period beginning 30 days before the sale and ending 30 days after it.

The following techniques will help you to avoid the “wash sale” rules:

  • Wait at least 31 days before repurchasing the loss securities. The risk is the potential loss of any gain on the stock that occurs during the “waiting” period.
  • “Double up”, buy a second lot that is equal to the original holding, wait 31 days, and then sell the original lot, thereby recognizing the loss.
  • Sell the loss stock and reinvest in the stock of another company in the same industry that has historically performed in a similar way as the loss stock. After 31 days, you can reverse the process to restore your original holding.

Should you accelerate capital gains? Should one consider accelerating capital gains to take advantage of lower rates? Certainly, if the investor knows they will be selling in the next few days or weeks, the strategy can make sense, but to a long-term holder, the benefits are less certain.

If a sale is to be made today, investors need to consider the “costs” as well. For example, is a 20 percent tax paid in 2013 actually worse than a 15 percent tax paid in 2009? Investors who sell today will deplete the amount of money available for investing. If they hold off paying the tax, those tax dollars could still be at work in the markets. Accelerating a gain in order to take advantage of a lower tax rate could be a case of the tail wagging the dog; that is, a tax result driving an economic decision which may ultimately turn out to be unfavorable.

Alternative Minimum Tax. The Alternative Minimum Tax (“AMT”) system was put in place to ensure that all taxpayers pay a minimum level 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.

While the alternative tax is a burden, it also may present a planning opportunity, particularly for taxpayers who are subject to the AMT in one year but not in the next (or vice versa). In order to determine whether AMT is a factor in the current year, and to assess year-end planning opportunities, a projection of taxable income for the year is generally required.

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

Charitable contributions. Charitable contributions continue to be one of the most flexible of the deductible expenses. As a general rule, gifts of appreciated property (e.g., stocks) 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. With investment assets that have decreased in value, consider selling the asset to recognize the loss and contribute the cash received in the transaction.

Charitable remainder trusts and private foundations are additional planning tools that may help you reduce income taxes while helping you achieve your charitable goals. In the current low-interest rate environment, one might consider a Charitable Lead Annuity Trust (CLAT) as a vehicle to achieve both charitable and estate planning objectives. Under the terms of a CLAT, annuity payments are made to charity for the term of the trust. At the end of the CLAT’s term, the remaining assets are distributed to one or more non-charitable beneficiaries. While the gift of the remainder interest constitutes a gift, the value of the gift using IRS-prescribed interest rates may be lower than the amount actually transferred to the beneficiaries at the end of the term if the trust outperforms the prescribed rate. The November 2009 IRS rate is 3.2%.

Retirement plan contributions. Contributions to tax deferred retirement plans remain a valuable financial planning tool. Retirement planning decisions are affected by annual contribution limits, taxable income limitations and whether there is coverage under an employer plan.

Roth IRAs have been popular retirement vehicles since their introduction more than a decade ago. The attraction of the Roth IRA is that distributions from such accounts are tax-free, even to the extent of earnings. In addition, there is no required minimum distribution as is the case with traditional IRAs. Historically, the use of Roth IRAs has been limited to individuals with income under certain income levels.

Effective for 2010, income limits will still exist for annual contributions to Roth IRAs. However, individuals of all income levels will be permitted to convert traditional IRAs to Roth IRAs. The conversion entails moving the IRA funds into a new Roth IRA, and paying income tax on the transferred funds either in the year of conversion or spread out over the next two years. The decision to convert from a traditional to a Roth IRA should involve consideration of several issues including one’s long-term plan for use of IRA assets and anticipated changes in income levels and tax rates. Partial conversions are permitted.

Gift and estate tax opportunities. One positive aspect of our current economic situation is that it has created an environment with gifting opportunities, due to depressed asset values. Assets that currently have low values but are anticipated to appreciate may be ideal candidates for gifts to family members. The current top marginal rate is 45% for estate and gift tax purposes. For larger estates, a gift-giving program may be an effective way to reduce transfer taxes and provide for beneficiaries:

  • The first $13,000 (per donee) of annual gifts is not subject to gift tax.
  • The first $1,000,000 (excluding annual $13,000 gifts) of lifetime gifts is not subject to gift tax.
  • Direct payments of medical and/or educational expenses to the institutions on another person’s behalf, do not count against the $13,000 annual exclusion.
  • Contributions to Section 529 plans to fund education may be made utilizing the annual exclusion. The IRS also permits a multiyear contribution to be made in one year (e.g., a contribution of $65,000 to an individual’s 529 plan in 2009 will represent the annual exclusion by the donor for the ensuing 5 years). 529 plans are beneficial in that the earnings on the contributed funds may ultimately escape taxation.
  • Gifts of appreciated stock to children are a good planning tool, but keep in mind the “kiddie tax”, which applies to children under the age of 19 and full time students under age 24.
  • Parents with children who 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.
  • With interest rates at their lowest level in nearly 20 years this may be an opportune time to establish a grantor retained annuity trust (GRAT) or a grantor retained unitrust (GRUT). By establishing a GRAT or GRUT now, the gift tax value of the remainder interest is reduced to reflect the increased value of the fixed annuity.

Other Notable Items

  • As of today’s date, there has been no suspension of the 2010 Required Minimum Distribution requirement from IRAs.
  • The credit for First Time Homebuyers has been extended to purchases on or before April 30, 2010.
  • The ability to make tax-free distributions, up to $100,000, from IRAs to charities is set to expire at the end of 2009.
  • The credit for residential energy efficient property (up to $1,500) is available for those items placed in service in 2009 and 2010.
  • Bonus depreciation and enhanced section 179 expensing are set to expire in 2009. Accordingly, business taxpayers may wish to accelerate new equipment acquisitions into 2009. The “bonus” depreciation provisions allow for an immediate write off of 50% of the cost of assets. The §179 election allows a current deduction of up to $250,000 for items that would normally be capitalized and depreciated. The property must be purchased and placed in service by December 31, 2009.
  • The California State Board of Equalization (BOE) now requires a “qualified purchaser” to register with the BOE and report and pay use tax annually. A “qualified purchaser” generally means a person who receives at least $100,000 in gross receipts from business operations per calendar year and who is not otherwise registered with the BOE.

Running the numbers. We recommend running tax projections for 2009 and 2010 (and perhaps beyond) 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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