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Carefully Weigh A Tax Contingency Plan

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Jolita Paulauskaite
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Carefully weigh a tax contingency plan
It's a tough year to plan taxes. Postponing income into 2011 may be unwise, for example, if the usual rules don't apply.

Carefully weigh a tax contingency plan
WASHINGTON – Nov. 1, 2010 – Normally, at this time of year taxpayers would be busy following tried and true ways to cut their taxes before the year ends.

They’d be trying to solidify as many deductions as possible while also trying to push some income, such as bonuses, into the following year.

But this is no normal year, because the nation’s tax rates are in limbo. Tax reductions enacted in 2001 and 2003 will end this year if Congress doesn’t act before Jan. 1. And in that case, taxes will go up on every taxpayer.

Political leaders have been sending mixed messages about intentions. Some claim they will make sure they renew the so-called Bush cuts before the end of the year so the middle class doesn’t face higher taxes next year. Others say higher-income people can live without tax cuts, and still others say all Americans need to keep tax cuts while the economy heals.

Regardless of their positions, taxes will remain in limbo until Congress makes a move. Financial advisers expect some type of action by Congress after the November elections but say it could come so late in the year that taxpayers will have little time to plan their best moves in the few days remaining before 2010 ends.

Rather than acting now on a guess, Mark Nash, a financial planner and certified public accountant with PricewaterhouseCoopers, suggests clients establish contingency plans so they can adjust fast to whatever occurs. “Make plans, but don’t pull the trigger until we see what Congress does after the election,” he said.

While few expect middle-income clients to face higher taxes next year, advisers say people with incomes over $200,000 and couples with incomes over $250,000 need to be ready to protect themselves from higher taxes in 2011 if Congress moves in that direction.

Under measures discussed by President Barack Obama, people in today’s 33 percent tax rate could see their tax rate climb to 36 percent, and the current 35 percent rate would jump to 39.6 percent. Also, capital-gains taxes could rise from 15 percent to 20 percent, and the zero-percent capital-gains rate for low-income taxpayers could disappear. High-income people could end up with dividends taxed at as high as 39.6 percent.

If Congress decides this year to increase taxes on the affluent in 2011, then the normal practice of moving income from 2010 to 2011 could be a mistake. Also, deductions might be more helpful in 2011 than 2010. So basic contingency plans would involve delaying deductions and taking income this year rather than next.

For example, if you were going to provide a large contribution to a charitable organization, you might wait and do it after Jan. 1, when it might reduce a higher tax bill than this year’s. Likewise, if you have a business, and typically wait until the end of the year to bill a client, you might send out the bill now and hound the client to pay before the end of December. That way you can pay taxes at this year’s lower rates to avoid higher rates in 2011.

Keep in mind, however, where you stand on income. Financial advisers are still telling middle-income people, who are not likely to have a tax increase next year, to think about cutting taxes this year with these typical steps.

If you are more affluent, consider these steps, but weigh 2010 and 2011 tradeoffs:

• Go through closets to find clothing and other items that can be donated to charitable organizations. List the items and values, and get a receipt stating the value.

• To get a deduction for medical expenses, you need the expenses to total 7.5 percent of your adjusted gross income, so try to meet that threshold by bunching dental work, eye care, prescriptions or other nonemergency procedures in a single year.

• Consider selling stocks, bonds, mutual funds or property that have increased in value since it was purchased, but only if that makes sense for investments as well as taxes. By selling this year, you can lock in a 15 percent tax on gains if investments have been held at least a year. If you wait, the gain could be taxed at a higher rate. Also, if you have losing investments, you can sell them to reduce this year’s taxes and maybe future taxes. If the loss exceeds $3,000, you can carry the amount over that threshold into 2011 and other years to reduce future gains.

• Pay property taxes and January mortgage payments in 2010 to reduce 2010 taxes, but wait if you can until 2011 if you think your taxes will go up then. Also, consider whether you are likely to be hit with the alternative minimum tax in either year, because property tax and mortgage deductions don’t serve you well in the AMT.

• Finish off energy-saving improvements on your home or buy one of the few cars that qualify for energy tax credits that will expire.

• Add money to your 401(k) before Dec. 31 to slash this year’s income. The maximum annual contribution is $16,500, or $22,000 if you are 50 or older. Anything you save in a 401(k) reduces your income. Now is the time to pay attention if you are near a valuable threshold for an income credit like the child tax credit or earned income credit, although you can tinker with an IRA contribution after Dec. 31.

• Convert IRAs to Roth IRAs to make sure they are not taxed at higher rates in the future. The $100,000 limit for converting to a Roth does not apply this year, and by doing it by the end of this year you can spread the tax you will owe over 2011 and 2012. You have until Oct. 15, 2011, to change your mind, unwind the Roth and go back to the IRA, said Ed Slott, a certified public accountant and founder of IRAhelp.

• Pay college bills to qualify for education tax credits up to $2,500 a year per student. Also, pay student loans to get deductions.

• If you are in a state where sales-tax deductions are more advantageous to you than state income-tax deductions, make any necessary large purchases 2010 rather than 2011 if the sales tax deduction runs out without Congress intervening.

• If you refinance your mortgage before the end of the year, you can deduct the points you pay on the mortgage.

For affluent clients and those with small businesses, contingency planning gets more elaborate:

• Financial planner Mark Balasa, of Itasca, Ill., says that as clients rebalance their investment portfolios at the end of the year, he might have them divide stock portfolios half in growth and half in value-stock funds versus his previous preference for 60 percent in value-stock funds. If dividend taxes go up, value – which tends to include dividend-paying stocks – could inflict higher taxes on investors. Another approach: Put the dividend payers in Roth IRAs if possible.

• With the end-of-the-year close, clients trying to sell a business or a huge chunk of real estate are considering ways to prevent a large tax hit in future years. Balasa says one client might move to Florida to reduce the impact of the sale of a business in the future. Nash, of PricewaterhouseCoopers, said a client is considering selling a huge piece of property to a family member before the end of the year. The ultimate plan is to sell the property to an outsider. But by selling it this year at the 15 percent capital gains rate, the family insulates itself from a larger tax at a higher rate later. If the family member buys the property this year, Nash said, any gain on a sale to an outsider later will be based only on the appreciation that has happened to the property since the family member bought it this year – probably a limited amount of appreciation.

• Small businesses that pay dividends to owners might want to accelerate payments to this year, rather than waiting, if the dividend tax rises from 15 percent to as high as 39.6 percent, said Robert Keebler, a Green Bay, Wis., certified public accountant.

• With estate tax changes not made – and the possibility that estates as low as $1 million could be taxed – advisers are encouraging people to consider giving large gifts to family members. Opportunities to do that are likely to disappear next year if Congress acts, as some expect.

© 2010 Chicago Tribune, Gail MarksJarvis, personal finance columnist. Distributed by McClatchy-Tribune News Service.

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