As 2010 draws to a close, the thoughts of many shift to turkeys, eggnog, holiday shopping and bowl games. But for the attorneys in the McGrath North Tax Group, our thoughts shift to year end tax planning ideas and looking for ways to help our clients reduce their 2010 taxes.
2010 presents a potentially fruitful opportunity for year end tax planning, an opportunity which may not be seen again in the foreseeable future. There are several reasons for this. First, many Washington observers believe that significant portions of the gift and estate tax laws, which will impact the ability of taxpayers to reduce those taxes through planning techniques, may change in 2011. These changes are likely to reduce the availability of certain gift and estate tax planning techniques. Therefore, persons who could benefit from such planning should strongly consider the implementation of planning ideas now while they are still allowed under federal law.
In addition, numerous expiring provisions within the income tax code, as well as the conventional wisdom that income taxes will only go up (and not down) in 2011, mean that many taxpayers should consider income tax planning techniques in 2010. Many taxpayers should take steps now that will reduce their long-term tax obligations.
Accordingly, we have identified ten significant tax planning ideas or opportunities that you or your clients should consider before 2010 runs out (and preferably before Christmas so we would have time to implement these ideas). They are as follows:
1. Make The Most Of The 2010 IRA To Roth IRA Conversion Rules. 2010 is the first year in which taxpayers can convert funds in regular IRAs (as well as qualified plan funds) to Roth IRAs regardless of their income level. Furthermore, taxpayers who make this conversion in 2010 have the choice of paying any resulting tax when they file their 2010 returns or deferring that tax until 2011 and 2012.
In light of the potentially increasing income tax rates, taxpayers may want to consider whether to make the regular IRA to Roth IRA conversion in 2010 and which year to pay the taxes in. Electing to defer the taxes may not be the best choice. A detailed article by Tom J. Kelley which reviewed this idea appeared in the January/February 2009 McGrath North Tax Planning Newsletter. A copy of such article is also available on McGrath North’s website.
2. Careful Handling Of Capital Gains And Losses Can Save Taxes. Because tax rates on short term capital gains (gains on assets held less than 1 year) can be as high as 35%, and long term capital losses can be used to offset short term capital gains, a taxpayer may be able to avoid taxes on short term capital gains by also realizing long term capital losses in 2010. To accomplish this, a taxpayer must ensure that he or she does not first use those long term capital losses to offset long term capital gains, since the long term capital gains are taxed at 15% (or less for certain taxpayers). Accordingly, the tax value of long term capital losses is more valuable when those losses are used to offset short term capital gains.
To accomplish this goal for 2010, a taxpayer must make sure that long term capital gains, which would eliminate the value of long term capital losses, are not realized in 2010. Of course, this is not solely a tax issue, so this planning will need to be done in conjunction with your or your clients’ investment advisor.
Whenever gain or loss recognition planning ideas are implemented, taxpayers must be mindful of the IRS’ “wash sale” rules. These rules preclude the recognition of certain capital losses when substantially identical securities are bought 30 days before or after a sale of such securities. However, certain strategies can be taken which will allow a taxpayer to preserve an attractive investment position even after recognizing a gain or loss from that position. The McGrath North Tax Group would be happy to discuss such strategies with you or your clients.
3. Taking Capital Gains Now To Lock-in More Favorable Rates. At this point, there is only uncertainty regarding the 2011 maximum capital gains tax rate and whether that rate will rise for only wealthy taxpayers or all taxpayers. To avoid this uncertainty on a potentially significant long term capital gain, taxpayers may choose to sell the investment in 2010 to lock in the favorable 15% rate.
4. Make Energy Saving Improvements To Your Home. Without sounding too much like a home improvement ad, 2010 is your last chance to make certain energy saving improvements to your home and qualify for a 30% tax credit. Eligible improvements include putting in extra insulation, installing energy saving windows, or buying and installing an energy efficient furnace. A taxpayer’s total aggregate credit for 2009 and 2010 improvements is $1,500, so taxpayers should keep this in mind when planning improvements.
5. Purchase Qualified Small Business Stock. For “qualified small business stock” purchased between September 27, 2010 and December 31, 2010, there will be no tax on the gain from the sale of such stock if the stock is held for more than 5 years. In addition, such sales will not cause AMT preference problems. “Qualified small business stock” is stock which: a) is acquired at its original issue; b) is acquired for money, property, or as compensation; c) when issued, the corporation has aggregate gross assets of $50 million or less; and d) represents ownership in a corporation which uses 80% or more of the value of its assets in the active conduct of its business.
6. Charitable Giving Without Itemized Deduction Phase Outs. As many higher income taxpayers were well aware, previous Internal Revenue Code rules phased out the charitable deductions available for higher income taxpayers. That phase out effectively reduced the tax benefit – up to 80% – that such higher income taxpayers would receive from making charitable deductions. For 2010, Congress eliminated the itemized deduction phase out rules. However, the phase-outs are back in 2011 (we did not miss them). Therefore, 2010 may be the year to make tax efficient, larger charitable gifts for many higher income taxpayers, who could realize a full 35% deduction for such gifts (rather than a net deduction of only 7% following the potential phase out). Of course, charitable gifts are still limited to 20%, 30% or 50% of a taxpayer’s gross income, based on the type of gift made. Excess charitable gifts are carried over for use in future years, which may defeat the purpose of making such gifts today. Therefore, the charitable gift limitations must be considered when performing 2010 planning.
7. Sell Assets To Dynasty Trusts. Considering the historically low AFR rates (which are the minimum rates which the IRS will recognize without other tax effects), 2010 may be a great time to sell assets to grantor or dynasty trusts. This is also true because many assets, such as real estate or certain business interests, have currently depressed asset values which will likely rebound in upcoming years. Therefore, clients may want to lock in sales at such depressed values at the same time that the minimum interest rates applicable to such sales are at historic lows. Frankly, this is a planning opportunity which may not be seen again in the lifetime of many of our clients.
8. Create And Fund “GRATs” Before The Utility Is Curtailed. Many Washington commentators have predicted that the end is near for GRATs (Grantor Retained Annuity Trusts) as we currently know them. For a more detailed review of GRATs, feel free to review the lead article on GRATs by Jeff Pirruccello which appeared in the January/February 2008 Newsletter and which is currently available on our website.
As we understand it, most of the discussion in Washington has focused on the following potential changes to GRATs:
- GRATs may be required to have a ten year or greater minimum term.
- GRATs may not be allowed to have declining payouts.
- GRATs may be required to have value of their remainder. This means no more zeroed out GRATs.
If these changes are enacted, the potential value for many of our clients for doing a GRAT will be reduced. Thus, the time for doing a GRAT is definitely now.
9. Act On FLPs Before Their Utility Is Reduced. Similar to GRATs, we understand there has been discussion in Washington this year regarding the elimination of intra-family discounts. In fact, the President’s budget proposal to Congress had included this change. Thus, clients with family limited partnership (FLP) or family limited liability company (FLLC) interests should consider gifting and/or selling those interests in an attempt to potentially lock-in their intra-family discounts before the laws change and those discounts are gone. Due to a recent U.S. Tax Court case, transferring FLP or FLLC interests with the intent to qualify those transfers for the annual gift tax exclusion (i.e. the $13,000 exclusion from federal gift tax) became a bit more difficult this year. However, there may be certain ways to plan around the Tax Court’s ruling. Clients considering making a gift of FLP or FLLC interests, with the intent to qualify those gifts for the annual exclusion, may wish to discuss this with a member of the McGrath North Tax Group before going forward with such a plan.
10. Business Owner Year-End Planning. Finally, business owners may want to take advantage of certain tax preferences which will expire after 2010. Accordingly, it may be tax efficient for business owners to do the following in 2010, rather than later years:
- Hire a worker who has been unemployed for at least 60 days. Your business will be exempt from paying the employer’s 6.2% share of Social Security tax for the remainder of 2010. In addition, if the business keeps that new hire on the payroll for a continuous 52 week period, the business will be eligible for a nonrefundable $1,000 tax credit. This will be claimed on the business’ 2011 tax return.
- Put new business equipment and machinery in service before the end of 2010 to qualify for the 50% first year depreciation allowance. Under current law, this 50% bonus depreciation will not be available for property placed in service after 2010.
- Buy a new automobile for business purposes. For cars which are new, acquired, and placed in service in 2010, the first year business auto write-off was increased for 2010 by $8,000 (e.g. from $3,060 to $11,060 for autos and from $3,160 to $11,160 for light trucks or vans). This increased limit is for vehicles that are qualified property for bonus depreciation purposes.
- Take advantage of the $500,000 business property expensing option, which is now available for certain real property costs. For 2010 and 2011, the maximum amount of business property which may be expensed (under Code § 179) has been increased to $500,000 (from $250,000). This $500,000 limit is reduced by the amount of qualifying business property placed in service in 2010 which exceeds $2 million. In addition, up to $250,000 of the $500,000 limit may consist of “qualified real property,” which includes certain restaurant property, leasehold improvements, and retail improvements.
- Increase your basis in a partnership or S corporation to potentially deduct a loss from the business in 2010. Federal tax rules will only permit a taxpayer to deduct a loss from a partnership to the extent of the partner’s basis in the business at the end of the tax year. In addition, a taxpayer may only deduct a loss from an S corporation to the extent of the total of the taxpayer’s (a) S corporation stock; and (b) debt owed to the shareholder by the S corporation. Therefore, business owners may wish to increase their basis in the partnership or S corporation in order to deduct a 2010 loss from that business.
- Defer cancellation of debt income from the reacquisition of a debt instrument in 2010. A business may elect to have the cancellation of debt income from the reacquisition of such debt instrument included in gross income over a five year period beginning with the 2014 tax year (fourth year following the year in which the repurchase occurs). Clients and advisors should feel free to discuss any of these planning ideas with a member of the McGrath North Tax Group. We look forward to potentially helping you plan to reduce your or your clients’ tax liability in 2010.