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Corporate Strategic Tax Planning

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Strategic tax planning


Tax rates                                         the deduction sooner, you usually have to
Tax rates and rate schedules may be found         lay out the dollars that fund the deduction
at the Internal Revenue Service’s (IRS)           sooner, which means you lose the use of
Web site, in the instructions for Form 1040.      those dollars. For example, an individual in
                                                  the 35 percent tax bracket who acceler-
Basic tax planning strategies                     ates a $5,000 deduction into 2009 defers
                                                  $1,750 of tax. This may make economic
As discussed in the Strategic Income Tax          sense if the deduction is shifted from
Planning chapter, there are three basic           January to December, but it is not
tax planning techniques, and in combina-          beneficial for long periods because the
tion, these techniques can produce                funds you used to generate the deduction
sizeable tax savings: accelerating or             could lose more in investment income in
deferring income (tax deferral), income           five months than the amount you would
shifting (adopting a global family                gain from accelerating the tax deduction
perspective), and converting income to            at 35 percent for one year.
categories taxed more advantageously.
                                                  Those in the lowest two tax brackets
Tax deferral                                      generally should not accelerate any
Tax deferral is achieved when you earn            deductions that could be paid later than
income now and pay tax on it in the future.       February. If you are in the highest tax
Your retirement plan is an example.               bracket, you should not accelerate
Although your retirement investments              expenses that could be deferred until May.
generate income throughout the years              Further care should be taken because not
(with some years being unfortunate                all expenses can be accelerated without
exceptions), you are generally taxed only         limit. Also, moving up certain deductions,
when you receive distributions from these         such as state income taxes, could trigger
retirement plans.                                 the AMT (see below).

Deferring the receipt of taxable income           Income shifting
can save you money, even if it produces           Income shifting generally involves
little or no tax savings, because you can         transferring income-producing property
use your money longer before paying the           to a family member or an entity in the
IRS. That means greater compounding of            family structure that is taxed at a lower
earnings for you. On the other hand,              tax rate. One example is giving a
accelerating income, even if you think you        corporate bond to a family member who
will be in a higher tax bracket in later years,   is in a lower tax bracket. For example, if
means you will pay the IRS sooner than            you’re in the 35 percent tax rate bracket
otherwise might be required. Loss of the          for 2009, you will pay $350 in taxes on
use of that money cuts down on the                every $1,000 of taxable bond interest you
advantage you hoped to attain.                    receive. If you give the bond to a child or
                                                  grandchild in the 10 percent or 15
Another deferral technique is to accelerate       percent tax rate bracket, tax on the
deductions from a later year to an earlier        interest will be cut to $100 or $150 per
year so that you get their benefit sooner.        $1,000. You should note that gift tax
But don’t “over accelerate” deduction             consequences should also be considered
items to defer taxes. Remember that to get        when making income shifting decisions.
Taking advantage of preferential rates          gain stock and fully offset your tax liability
Tax reduction occurs when you take action       with your loss. If you recognized a total of
that results in paying less tax than would      $13,000 of losses during the year, you
otherwise have been due. The savings            could offset your $10,000 capital gain and
produced by implementing tax reduction          use the extra $3,000 loss to offset $3,000
strategies are permanent savings (they are      of other fully taxable ordinary income,
not “timing” differences that shift a tax       such as interest or compensation income.
burden to another year). For example, if        If your excess losses come to more than
you switch funds from a taxable invest-         $3,000, you have to carry them over to
ment (like a corporate bond) to a municipal     future years, when they can offset capital
bond that earns tax-free interest or to         gains and up to $3,000 of ordinary income.
preferred stock that pays a dividend
qualifying for a low tax rate, you will         You have a great deal of flexibility at
reduce your tax bill. Or you may want to        year-end to control the timing of invest-
consider contributing to a Roth IRA or          ment decisions to maximize your tax
Roth 401(k) that can generate tax-free          savings. As year-end approaches, review
income instead of putting the money into a      your investment results. Calculate
taxable investment vehicle. Another option      recognized gains and losses and compare
is to shift funds from an investment, such      them with unrealized gains or losses you
as a money-market account or CD, which          currently hold.
produces ordinary income, to a stock fund
in hopes of earning some lower taxed            If a taxpayer has capital losses exceeding
dividends and long-term capital gain. By        capital gains realized for the year, he may
restructuring investments in manners such       want to use them to offset ordinary income
as these, you can save enormous tax             to the extent of $3,000-receiving up to a 35
dollars over time. If you make these            percent tax benefit-and wait to recognize
changes now, the impact for 2009 may be         additional long-term capital gains until
small since so much of the year has             2010, when he will be assured of paying no
already elapsed—but you will be position-       more than a 15 percent tax rate on them. In
ing your affairs to reap more meaningful        making these tax decisions, you must also
tax benefits for 2010 and the future.           consider your individual financial and
                                                personal situation and the economic
Year-end capital gains checkup                  viability of particular investments. Taxes are
In general, during the latter part of 2009,     but one factor to consider.
many investors experienced a recovery in
their investment portfolios. Many taxpayers     Alternative minimum tax (AMT)
may choose to harvest capital gains on
their investments. Those who took profits       Although the AMT is primarily intended to
on long-term gains will get the benefit of      ensure that wealthy taxpayers pay at least
favorable capital gains tax rates. Investors    some income tax, it applies to all taxpay-
whose gains are short-term are less             ers. The reduction in marginal tax rates
fortunate. Their gains are taxed at regular     and the lack of inflation adjustments to
income tax rates. If you have current capital   AMT rates has dramatically increased the
losses, or unused capital losses carried        number of individuals subject to the AMT.
over from earlier years, you may be able to     Year-end may bring an unpleasant surprise
get some tax advantages from them. You          to many unsuspecting individuals. It is now
can offset capital gains—even short-term        estimated that 30 million taxpayers could
gains—and up to an additional $3,000 of         be paying AMT by 2010. As a result, the
other income with your capital losses.          time to start planning is now.


For example, suppose you have a $10,000         AMT is a separate but parallel tax system
gain on stock in a company that has done        to the regular income tax system. It has its
well over the year, but that you think is due   own set of tax rates and its own rules for
for a fall. If you sell some other stock at a   income and deductions that are usually
$10,000 loss, you will be able to sell your     less generous than the regular tax rules.
Both systems require a calculation of         / Subtract the AMT exemption amount           3

annual taxes, and the taxpayer must pay         (i.e., $46,700 for single or head of
the tax under whichever system produces         household, $70,950 for married filing
the higher amount. The AMT system               jointly or qualified widower, and
includes, in general, a broader base of         $35,475 for married filing separate) to
income due in large part to a smaller range     arrive at Alternative Minimum Taxable
of allowable deductions. Many favorable         Income (AMTI).
tax treatments available under the regular    / Multiply the AMTI (excluding long-term
tax system are curtailed for the AMT by a       capital gain and qualified dividend
system of adjustments and preferences. If       income) by the AMT tax rate (i.e., 26
you typically claim deductions, or have         percent up to $175,000, 28 percent
tax-preference items or other adjustments,      thereafter, and add the tax at the
you may calculate the numbers under both        reduced rate on long-term capital gain
regular tax and AMT and find that you are       and qualified dividend income).
required to pay tax under the AMT system.     / Subtract AMT credits.


Tax-preference items or adjustments           Compare the result with the amount of
include, but are not limited to:              regular tax and pay the AMT to the extent
                                              it exceeds regular tax. This formula should
/ state and local income taxes,               only be used to estimate the amount of
/ real estate taxes,                          your AMT liability. To determine your
/ miscellaneous itemized deductions such      actual liability, you must calculate the
  as investment expenses and tax return       actual AMT liability using IRS Form 6251.
  preparation fees,
/ certain tax-exempt interest income,        AMT exemption
/ some depreciation expenses,                While the AMT exemption is not adjusted
/ the difference between AMT and regular     for inflation, recent legislation has
  tax gain on the sale of property,          increased the AMT exemption amount,
/ and nontaxable income on the exercise      providing AMT relief to middle-income
  of incentive stock options (ISOs).         taxpayers. When taxable income reaches
                                             a certain level, the benefit of this exemp-
The basic formula for calculating            tion must be reduced or phased out,
the AMT is:                                  creating a greater likelihood that the AMT
                                             will apply to many surprised and unhappy
/ Start with regular taxable income.         taxpayers. The American Recovery and
/ Add any personal exemption amount          Reinvestment Act of 2009 did not alter the
  claimed.                                   income levels at which the AMT exemption
/ Add back certain itemized deductions       begins to phase out. For the 2009 tax year,
  disallowed for AMT calculation,            for married individuals filing jointly or
  including medical and dental (7.5          surviving spouses, the phaseout begins at
  percent limitation for regular tax versus  an AMTI of $150,000 and ends at
  10 percent limitation for AMT); state and $433,800. For singles or heads of
  local taxes, certain home equity interest, households, the phaseout range is
  and miscellaneous itemized deductions). $112,500 to $299,300. For married filing
/ Subtract itemized deductions that could separately, the phaseout range is $75,000
  not be claimed on Schedule A because       to $216,900.
  of certain limits for high-income
  individuals (i.e., the phaseout amount).   The phaseout of the AMT exemption
/ Subtract refunds for state and             amount results in $1.25 of additional AMTI
  local taxes.                               for every dollar earned in the phaseout
/ Adjust taxable income for specific         range. In the phaseout range, the marginal
  tax preferences and other adjustments AMT rate on ordinary income could be 35
  (i.e. the bargain element on ISOs that     percent, which may be higher than the
  you exercise, private activity bond        regular tax rate. Additionally, the marginal
  interest, etc).                            AMT rate on capital gains in the phaseout
4   range could be 22 percent, rather than 15          1. ISOs triggering an AMT preference.
    percent. This means that, in some cases,           2. A transaction that creates significant
    AMT planning for those in the phaseout                long-term capital gain income taxed
    range can require just the opposite action            at preferential rates, relative to
    from those normally subject to AMT. That              ordinary income.
    is, in this phaseout range, effective AMT          3. Investments generating significant
    planning may suggest the deferral of                  qualified dividend income taxed
    income and acceleration of deductions.                at preferential rates, relative to
                                                          ordinary income.
    Minimum tax credit                                 4. Paying income taxes to states with
    All hope is not lost if you are subject to the        high income tax and/or property tax
    AMT. The IRS allows a credit for prior year           rates (e.g., New York, California, and
    AMT if you meet certain requirements. Two             the District of Columbia).
    types of adjustments—deferral items and            5. A significant operating loss (NOL)
    exclusion items—generally trigger AMT.                from a flow-through entity (e.g., family
    Deferral items generally do not cause a               business owner).
    permanent difference in taxable income             6. Expenses that exceed 2 percent of
    over time. They are essentially timing                income for investment management
    differences (i.e., depreciation). Exclusion           or tax-planning services or unreim-
    items do cause a permanent difference                 bursed employee business expenses.
    (i.e., state taxes, standard deduction). To        7. Tax-exempt municipal bond income
    the extent you are paying AMT due to                  from private activity bonds.
    deferral items, you may claim a minimum            8. Ownership of businesses operating
    tax credit in a subsequent year if you are            as S corporations or partnerships that
    not subject to AMT in that particular year.           flow through tax attributes to the
                                                          owner, including AMT adjustments
    Starting with the 2007 tax year, the Tax              from the business (e.g., depreciation).
    Relief and Health Care Act of 2006 allowed         9. Passive activity losses that differ
    individuals who have unused minimum tax               for regular tax purposes versus
    credits to claim a refundable credit equal            AMT purposes.
    to 20 percent of the long-term unused              10. Interest on home equity debt,
    minimum tax credits per year (a minimum                 deductible for regular income tax
    of $5,000) for the next five years. The AMT             purposes, where the loan proceeds
    credit is phased out for higher income                  were not used to improve the home.
    taxpayers, so you should check with your
    tax advisor to see if this provision is          AMT planning
    applicable to your tax situation.                Planning for the AMT can be difficult
                                                     because many factors can trigger it. If you
    Top 10 items that may cause the AMT              believe that you are within the range of the
    An increasing number of individuals are          AMT, it may make sense to consider
    becoming subject to the AMT. As previ-           formulating year-end tax-planning
    ously mentioned, reasons for the expected        strategies geared toward reducing the
    swell in the number of AMT taxpayers             AMT rather than the regular tax. Again, the
    include the lack of inflation adjustments to     factors contributing to both regular tax
    tax-rate brackets and exemption amounts,         and AMT must be considered.
    and the disallowance of deductions for
    state and local taxes. If your calendar year     If you believe you may be subject to the
    includes any of the following ten items,         AMT this year, you may want to consider
    you may need tax planning to avoid or            a counterintuitive approach and do the
    reduce the AMT:                                  opposite of the normal year-end planning
                                                     strategy. For example, AMT planning
                                                     frequently focuses on shifting more
income to the tax year in which the AMT         5

applies and deferring deductions to the
next year. This accelerated income is
effectively taxed at the 26 percent or 28
percent AMT rate (rather than the higher
regular income tax rates that may apply
in a year in which the AMT is not
anticipated). Deferring deductions until
the next year may result in a 35 percent
tax benefit in the next year (compared to
no tax benefit at all or a 28 percent tax
benefit in the current year to the extent
that the AMT applies). However, both of
these strategies presume that the AMT
will not apply in the succeeding year,
which may not be the case.


AMT relief related to ISO exercises
On October 3, 2008, the Emergency
Economic Stabilization Act of 2008 was
enacted providing relief to many taxpayers
who incurred alternative minimum tax
liabilities due to the exercise of incentive
stock options. The Act provides several
changes to help taxpayers with ISO AMT
liabilities. First, the Act requires the
abatement of any tax liability attributable
to the requirement to include amounts in
alternative minimum taxable income due
to the exercise of the ISO for taxable years
ending prior to January 1, 2008, as well as
related penalties and interest, to the extent
that the liability remains unpaid as of
October 3, 2008. Second, the Act
accelerates the allowance of the long-term
unused minimum tax credit allowing 50%
of such amount to be used to reduce the
tax liability or to create an overpayment for
the tax years beginning before 2013. Third,
the Act allows taxpayers a minimum tax
credit for the 2008 and 2009 tax years that
is refundable if not otherwise allowable in
reducing current tax liability, equal to 50%
or more of the related interest and
penalties paid by the taxpayer prior to
October 3, 2008, attributable to the
exercise of incentive stock options.

				
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