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Tax Newsletter
December, 2011

As we near year end, we are faced with continuing economic uncertainty. With the government in gridlock and with tax policy as one of the key contributors to that gridlock, tax planning is more challenging than ever. There are some traditional year-end strategies that should still be considered. But planning based on future tax rates is all but impossible, as the final outcome is too difficult to predict. At best, taxpayers may want to try to lock in some short term tax savings while positioning themselves to take action if, and when, the tax future becomes more certain. Regrettably, we seem to have developed a habit of short-term tax fixes, which makes long term planning quite a challenge.

Key questions facing taxpayers are: (1) what will happen to tax rates after 2012? (2) is there any advantage to taking action in 2011 rather than waiting until 2012 or later?

We are closing in on the expiration of the “”Bush-era tax cuts.” Without congressional action, the tax cut provisions will expire at the end of 2012. Taxpayers thus have 13 months to monitor their tax situations pending a final result. If the tax cut provisions expire, the tax landscape will change in the following ways:

  • The maximum tax rate for long term capital gains will increase from 15% to 20%
  • The top tax rate for individuals will increase from 35% to 39.6%
  • Dividends will cease to be taxed at capital gains tax rates and will again be taxed at the ordinary income tax rates (as high as 39.6%)

A number of other provisions are scheduled to expire over the next 13 months, including:

  • The AMT Exemption Amount will drop in 2012.
  • The ability to use personal credits to offset AMT expires after 2011.
  • The election to deduct state and local general sales tax in lieu of state and local income tax expires in 2011
  • Credit for energy efficient improvements made to your home expires at the end of 2011.
  • 100% bonus depreciation remains in effect for 2011, but drops to 50% in 2012 and eliminated in 2013.
  • Maximum Section 179 expensing is $500,000 in 2011, but drops to $125,000 for 2012, with a further reduction to $25,000 for 2013.
  • The Exemption amount for lifetime gifts remains at $5M for 2011 and 2012, with an uncertain future after that.

Planning considerations for the remainder of 2011 may include:

  • Taking advantage of the higher bonus depreciation and section 179 expensing elections for 2011.
  • Making a tax-free distribution from an IRA to charity
  • Investing in small business stock
  • Take advantage of the $13,000 annual gift tax exclusion
  • Contribute to a health savings account

Retirement Accounts

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.

Income limits continue to exist for annual contributions to Roth IRAs. However, individuals of all income levels are eligible 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.

Whether to convert to a Roth IRA requires consideration of several factors—source of funds to pay the tax, current tax rates vs. future tax rates, number of years until use of funds, etc. Particularly for older taxpayers, we recommend a projection that reflects the economic results with and without a conversion.

Required Minimum Distributions and Charity. Required minimum distributions (RMD) for calendar year 2011 must be taken by December 31, 2011, and failure to take this distribution can result in a penalty of 50% of the amount of the RMD not taken timely. 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 2011. 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.


The turmoil in the stock market has continued in 2011 and continued to change the current makeup of many portfolios. The end of the year is an excellent time to review and rebalance your portfolio so your holdings meet your investment goals. From a tax planning view, this activity might also involve selling stocks or mutual funds to generate losses that will offset capital gains and up to $3,000 of ordinary income. However, please keep in mind that selling assets for tax losses should only take place where that decision makes sense from an investment point of view.

Should you accelerate capital gains? Should one consider accelerating capital gains to take advantage of lower rates? The 2010 Tax Relief Act extended the 15% tax rate on long-term capital gains through 2012. Accordingly, there does not appear to be an incentive to accelerate capital gains into 2011.

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.

Alternative Minimum Tax

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 has passed an AMT Patch, which raises 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.

Kiddie Tax

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 $1,900 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.

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.

Estate and Gift Tax

The 2010 Tax Relief Act reinstated the estate tax for decedents dying after December 31, 2010, with a maximum estate tax rate of 35%. The transfer tax system for 2011 and 2012 has been “reunified”, with a maximum $5 Million exemption that is available for gifts during life or transfers at death before the imposition of gift or estate tax.

Depressed asset values, combined with the new larger exemption amount of $5 Million, will allow unprecedented wealth transfers to family members free of estate tax. The traditional planning tools which include qualified personal residence trusts, grantor retained annuity trusts and family limited partnerships will continue to provide leveraging that will allow more than $10 Million to be transferred from large estates of married couples without paying transfer taxes. Assets that currently have low values but are anticipated to appreciate may be ideal candidates for gifts to family members. Accordingly, for larger estates, a gift-giving program may be an effective way to reduce transfer taxes and provide for beneficiaries.

Other Considerations

  • If total annual itemized deductions are usually close to the standard deduction amount, consider the strategy of bunching together expenditures for itemized deduction items every other year, starting with this year;

  • If you itemize, accelerating some deductible expenditures into this year to produce higher 2011 write-offs makes sense if you expect to be in the same or lower tax bracket next year, and are out of AMT;

  • If you are eligible, or become eligible, to make health savings account contributions in December 2011, you can make a full year’s worth of deductible HAS contributions for 2011;

  • Small business employers that pay at least ½ of the premiums for employee health insurance coverage under a qualifying arrangement may be eligible for the small business health care tax credit.

  • Beginning in 2013, individuals with adjusted gross income greater than $200,000 ($250,000 for joint filers), will pay an additional 3.8% in Medicare tax on net investment income. Net investment income includes interest, dividends, royalties, rents, gain from disposing of property from a passive activity, and income earned from passive activities. Social Security benefits and retirement plans are exempt from this additional tax.

  • Beginning in 2013, individuals who earn more than $200,000 for the year ($250,000 for married couples) will be paying an additional .9% (from 1.45% to 2.35%) in Medicare tax.

Running the numbers. We recommend running tax projections for 2011 and future years 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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