More information about 1 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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