While we are in somewhat of a holding pattern waiting for Congress to sort out all of its pending legislation, the breadth and variety of tax relief provisions in the American Recovery and Reinvestment Act (ARRA) of 2009, as well as the continuing impact of provisions in prior year tax legislation, certainly assure that there is plenty to keep us all focused on tax issues as we head toward the close of another year.
Below is a brief summary of current tax law, including planning tools to help reduce your 2009 tax bill, as well as ideas to assist with your tax and financial planning in 2010.
Individual marginal tax rates for 2009 remain the same. The tax brackets are 10%, 15%, 25%, 28%, 33% and 35%. However, we may see a tax increase in 2010, and are almost certain to see an increase in the top tax rates by 2011.
For Wisconsin residents, the top tax bracket was increased from 6.75% to 7.75% starting in 2009.
AMT rates for 2009 remain 26% and 28% (depending on income levels) and no significant tax law changes are in sight for providing relief to the increasing number of taxpayers subject to AMT. However, the American Recovery and Reinvestment Act of 2009 increased the 2009 AMT exemption amounts slightly from 2008 figures, to $70,950 for married couples, and $46,700 for single taxpayers.
Personal exemptions, indexed for inflation, increased from $3,500 to $3,650 in 2009. The phase-out thresholds for exemptions increased by inflation to $250,200 for married filing jointly, and $166,800 for single taxpayers. For 2010, the phase-out is eliminated.
The 2009 standard deduction amounts increased by inflation, from $10,900 to $11,400 for married filing joint, from $5,450 to $5,700 for singles, and from $8,000 to $8,350 for head of household.
The possibility of an increase in federal regular and capital gain tax rates throws a wrench in the usual basic planning strategy of accelerating deductions and deferring receipt of taxable income. Higher tax rates might mean taking the opposite position for 2009 by accelerating income and deferring deductions. However, the Alternative Minimum Tax may cause your strategy to need closer evaluation. For example, taxpayers who typically have a considerable AMT tax bill and have significant capital gain and qualified dividend income will not necessarily see a tax increase. In this situation, while the regular tax bill is likely to increase, the AMT tax bill will decrease, resulting in the exact same net tax bill. Be sure to consult with your tax advisor, or try out shifting techniques on a tax program to be certain your tax planning efforts produce the desired impact.
FICA taxes remain 7.65% (15.3% for self-employed persons). The maximum Social Security limit for 2009 is $106,800. For 2010, the limit remains $106,800. Medicare tax payments continue on all wages.
The age at which full benefits are available (full retirement age) has been increased from 65 to 67, on a phased-in schedule. This affects everyone born after 1937, and varies based on the year of birth. For those born between 1943 and 1954, full retirement is age 66. While early retirement at age 62 is still possible, benefits are reduced.
Retirees who have reached full retirement age may work without any reduction in Social Security benefits. However, the earnings limit still applies to workers who have not reached full retirement age. In 2010, benefits are reduced $1 for every $2 earned over $14,160 for those age 62 to full retirement age. In the year full retirement age is reached, benefits are reduced $1 for every $3 earned over $37,680, but only earnings before the month you reach full retirement age are subject to the reduction.
There is no change in the computation of how much Social Security will be taxed for 2009. For those with "provisional" income above $44,000 ($34,000 if single), you will be taxed on 85% of those benefits. The 50% tax rate remains for income between $32,000 and $44,000 ($25,000 and $34,000 if single). This differential in tax rates makes it very important to plan receipt of income to take advantage of the 50% rate.
Only children 19 and over, and non-dependent students over 24, are assured to be taxed on their income at their lower tax rate. While the increase in the age at which “kiddie” tax rules apply warrants careful review of educational and overall financial savings goals, income shifting, and hiring your children in your business, may still yield good results.
In 2009, for children under 18 and full-time students under 24, the kiddie tax rules are as follows:
· Income of up to $950 is tax-free.
· Investment income of between $951 and $1,900 is taxed at the child's lower tax rate (as low as 0% for qualified dividends and capital gains).
· Investment income of more than $1,900 is taxed at the parent's marginal tax rate.
Retirement contributions (whether 401(k), 403(b), profit sharing, pension, SEP, or SIMPLE) still provide a major opportunity to reduce your tax bill. Whether pretax or post-tax, if you have an employer sponsored salary deferral plan, in most situations (even with the current economy and market conditions), it makes sense to maximize your contributions. Contribution limits for year 2009 and 2010 are $16,500 for 401(k) and 403(b) plans. If you are age 50 or older, the additional annual allowable “catch-up” contribution is $5,500 for 2009 and 2010.
For business owners, the maximum you can contribute to a qualified retirement plan for 2009 and 2010 is the lesser of $49,000 ($54,500 with “catch-up”), or 25% of your compensation. The maximum compensation level for computing your contribution is $245,000 in 2009 and 2010.
The maximum IRA deduction is $5,000 for 2009 and 2010. If you are age 50 or over by year-end, you can contribute up to $6,000.
For 2009 and 2010, traditional Individual Retirement Account (IRA) contributions are not deductible if you and your spouse are covered by a company retirement plan and your combined income exceeds $109,000 for married filing joint, or $65,000 for singles. However, a deductible IRA is allowed if one spouse is covered by an employer-sponsored plan, but the other is not, as long as adjusted gross income is less than $176,000 in 2009 and $177,000 in 2010.
If you are prohibited from deducting IRA contributions, you may still make nondeductible contributions. Earnings on these contributions accumulate tax-free until they are withdrawn. If you make nondeductible IRA contributions, keep a record of contributions using IRS Form 8606 to be certain you are not taxed on the money when it is withdrawn.
Don't forget that non-working spouses are allowed to contribute the full amount to an IRA account, whether deductible or not, as long as the other spouse has sufficient earned income. This is an excellent opportunity to shelter additional income and allow earnings to accumulate tax-free.
If your adjusted gross income is below $176,000 ($120,000 for singles), a Roth IRA should be chosen instead of a nondeductible traditional IRA because earnings on a Roth IRA can escape taxation when withdrawn.
Starting in 2010, the $100,000 income ceiling for Roth IRA conversions disappears, presenting taxpayers with a quandary; should you pay more taxes now instead of paying taxes later? Your decision to convert is complex and involves many factors, such as your time horizon, tolerance for risk, tax bracket, age, marital status, the impact of Alternative Minimum Tax and whether you believe Roth IRAs will remain untaxed in the future. The ideal candidates for conversions are:
Consideration of state tax laws, and how they affect taxability of a conversion, is also important. For example, Wisconsin tax law has not been revised to conform to federal tax law. As the state law now stands, Wisconsin residents who convert traditional IRA funds to Roth IRAs will be subject to substantial state penalties and will not have the opportunity to defer the tax on the conversion over the subsequent two-year period (as allowed under federal law).
Your decision to convert a traditional IRA to a Roth IRA needs thoughtful consideration and we suggest you contact your tax or financial advisor to prepare a careful analysis that weighs all the above issues.
Keep in mind that if you convert early in the year, and there is a market downturn, you should consider recharacterizing back to a traditional IRA to save paying tax dollars on a drop in account value. You can then “reconvert” in the following tax year. To hedge your bet, consider segregating your traditional IRA into separate accounts by asset class prior to converting to a Roth. This will allow you to recharacterize some portion of the funds (but not necessarily all), based on market performance.
While tax legislation provided a reprieve that allowed taxpayers over 70 ½ to forgo 2009 required minimum distributions (RMDs), taking advantage of this opportunity may not necessarily be the best strategy. If forgoing the income drops you into a lower bracket, then your deductions are worth less as well. The best strategy is to take as much of a distribution as you can before year-end, while still staying in the same tax bracket.
Section 529 plans (like EdVest in Wisconsin) have become the most popular way to save for college. Contribution limits are generous, there are no income limitations, and withdrawals used to pay college costs are tax-free. Most states also permit a tax deduction for 529 plan contributions. Contributions must be made by December 31 each year, and withdrawals can only be used for post-secondary educational expenses.
For 2009, qualifying dividends are taxed at a top rate of 15% (or 0% if your tax rate is 15% or less). Likewise, long-term capital gains are taxed at 15% (or 0% if your tax rate is 15% or less). The best strategy remains as follows:
* In retirement (sheltered) accounts you want to own investments that are not eligible for the lower tax rate, such as taxable bonds, Real Estate Investment Trusts, high turnover stock funds and short-term stock holdings.
* In your taxable (unsheltered) accounts you want to hold investments such as index funds, tax-managed funds and long-term stock holdings, to take advantage of lower rates on capital gains and dividends.
For Wisconsin residents, effective with the 2009 tax year, the long-term capital gain exclusion was reduced from 60% to 30%. Unfortunately, for many taxpayers subject to federal Alternative Minimum Tax (AMT) this causes a double-whammy, as the increase in state taxes is almost certain to cause an increase in federal AMT.
Generally it is not a good idea to make after-tax investments in mutual funds at year-end because mutual fund companies distribute capital gains to shareholders at the end of the year. This means that you could end up paying tax on an entire year of capital gains even if you did not receive any cash, and even if you owned the fund for only a few weeks. However, in 2009 this is likely to be a rare scenario because the market has not fully recovered. This year, you are likely to recognize a modest capital loss no matter how long you have owned your investment, and buying a mutual fund in December could be a very good strategy. To find out when capital gains and losses will be posted, call your broker, or look at the website for your mutual fund company.
With some investments still down, this might be a good year to sell those securities that have decreased in value. One popular year-end strategy is to sell stocks or mutual funds where there are losses and buy similar (not the same) stocks or funds to maintain your position.
Record keeping is important when you purchase and sell investments. If you purchase investments at different price levels, the IRS will assume the first-in, first-out method of determining gain or loss for tax purposes, unless you specify (and document) a different method. Your choice can affect your tax bill. When prices on your investments were rising, the last-in, first-out method resulted in the lowest tax bill. Now with a falling market, the first-in, first-out method is likely to be best. Unfortunately, for mutual funds, most companies will provide cost basis data calculated using an average cost method. If you have sold shares of the mutual fund in the past, you must continue to use the average cost method, and cannot switch to another method.
Short-term and long-term gains and losses continue to be netted together, and net long-term losses are deductible to a maximum of $3,000 per year, with an indefinite carry-forward. Also remember that brokerage costs decrease your taxable gain, and bonds purchased between interest dates require an interest adjustment for tax purposes. If you have questions, call your financial advisor.
The Internal Revenue Service allows one extra payment of monthly interest in one year. Therefore, if you make your January loan payment before
December 31, it can be deducted this year. Be sure to verify that your lender has reported this payment correctly when they mail you your statement at year-end. Because of mail delays, send your payment on or before December 21, 2009 to allow enough time for it to be credited to your account before year-end.
You may deduct 14 cents per mile for travel in providing services to a charitable organization.
If payment for a charitable contribution is mailed or charged to a credit card before December 31, the deduction can be taken in the current year.
There is a bonus if you donate to a qualified charity stocks or mutual funds that have increased in value, and have been held for more than 12 months. You can deduct the full fair market value of the security and avoid paying capital gain tax on the appreciation. The strategy of donating securities works best for shares that have increased in value. If you have shares to donate that have dropped in value, you are better off selling these shares to recognize a tax loss, and then contributing the cash to the charity.
Every cash donation must now be supported by a cancelled check, credit card receipt or written communication from the charity. Moreover, to be deductible, non-cash clothing and household donations must be in at least “good condition”. Remember, if you have total non-cash contributions of $500 or more during the year, some additional information is needed about the donations, such as how you determined the worth of the donated property, what it originally cost, and how you acquired the property. If your gift is over $5,000, an appraisal is required, and specific rules about the value of your deduction now apply to donations of vehicles.
Keep in mind, you must obtain a written receipt from charities for all gifts over $250, as a cancelled check is not considered sufficient support. Also, for non-cash gifts, the receipt must describe the gift in detail, but it need not confirm its value.
Finally, if you receive something in exchange for your donation, say a meal or a complimentary ticket, the charity must tell you in writing what portion of your donation is deductible.
For those taxpayers 70½ or older, rules allowing an annual donation of up to $100,000 to a charity directly from an IRA expire December 31, 2009, so you must act soon. No tax deduction is allowed for the contribution, but savings is recognized on the tax that would otherwise have been owed on the IRA distribution. This strategy works best for those with very large estates that are likely to be assessed significant estate taxes.
For 2009, up to $2,400 of unemployment compensation is excluded from federal tax. If married, up to $2,400 of your spouse’s unemployment compensation is also excluded.
Only medical expenses in excess of 7.5% of adjusted gross income are allowed as a deduction. In most cases, this means you receive a tax benefit only when there is a major illness. The standard rate for use of your car for medical reasons (or when computing deductible moving expenses) is 24 cents per mile for 2009. This rate drops to 16.5 cents for 2010.
Casualty losses, such as flood damage are allowed, but only if losses exceed 10% of adjusted gross income.
Miscellaneous deductions (such as IRA fees, subscriptions to trade magazines, tax and investment advice, safe deposit box fees and employee business expenses) must exceed 2% of adjusted gross income before they are deductible.
Certain credits for residential energy-saving improvements, such as home insulation, new windows, water heaters and central air, are available for 2009 and 2010. Other credits are available for energy-efficient property such as solar cells and solar water heaters. There are numerous limitations associated with each type of credit, so a close review of the rules will be needed to determine the amount of your credit.
Most rental real property is considered a “passive” investment. For adjusted gross income under $100,000, up to $25,000 of losses are deductible, but only if you actively participate in managing the property.
For adjusted gross income over $100,000, the deduction is phased-out, with no deduction available for taxpayers having income over $150,000. However, you can deduct all rental real estate losses from regular income (and the $25,000 loss limit does not apply) if you spend over half your total working time (at least 750 hours a year), on realty development or management.
For 2009 and 2010, all individuals are eligible to give $13,000 per year to as many persons as they wish and avoid gift taxes. Married couples can give up to $26,000 per year to one individual and avoid gift taxes. In addition to these limits, tuition and medical expenses paid on someone’s behalf also avoid gift and estate tax, regardless of the dollar amount, as long as the payments are made directly to the educational or medical institution.
Most people do not realize that proceeds paid to beneficiaries from your insurance policies may be included in your taxable estate. In addition, proceeds from IRAs and retirement plans are taxed twice when you die, once as part of your estate, and once on the beneficiary’s tax return. Consult your estate planning attorney for details, and techniques to avoid double-taxation.
The federal estate tax exclusion amount is $3.5 million for 2009, and is scheduled to drop to zero for 2010, so that there is no federal estate tax next year. However, it is expected that tax legislation will reinstate the federal estate tax for 2010, with the exclusion most likely at the $3.5 million level.
If you have not had an estate planning attorney review your situation in the past 5 years or so, now would be a good time to do so.
The deduction for business meals and entertainment continues to be 50%, but you may not claim any part of club dues, even if your membership is solely for business reasons. In addition, business travel deductions are limited
to expenses for yourself and your employees. You are not allowed to claim expenses for a non-employee spouse, dependent or other individual traveling with you.
Receipts are not required (but are recommended) for business expenses under $75. However, upon audit you still need some evidence to support the expense.
The standard mileage rate for business use of an automobile is 55 cents per mile for 2009. Effective January 1, 2010 the standard mileage rate for business use of an automobile decreases to 50 cents per mile.
Form 1099 is required for all purchases of services over $600, unless you paid the money to a corporation. One exception - Form 1099 needs to be issued for legal services, even if the law firm is a corporation.
Don’t forget that Wisconsin and most other states continue to have a strong focus on "Use Tax". If you make any out-of-state purchases (using the Internet or catalogs for example) without the payment of sales tax, you should be reporting Use Tax on your state tax return. In an attempt to increase revenue generation many states continually update sales and use tax legislation. For example, effective October 1, 2009, Wisconsin's sales and use taxes apply to the sales of, and the storage, use, or other consumption of, digital goods. This means that iTunes and movie downloads are now taxable.
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Happy holidays and best wishes for the start to a healthy new year!
Arnow & Associates
7402 North Seneca Road
Fox Point, Wisconsin 53217
(414) 964-4000
Notice and Disclosure
We are required by Internal Revenue Service regulation to include a disclaimer whenever certain types of written advice are provided. To the extent this document contains written advice relating to a matter of Federal tax, this advice is not intended, was not written to be used, and cannot be used by the intended recipient or any other taxpayer, for the purpose of avoiding Federal tax penalties.
The information contained in this document does not cover all tax strategies that may apply, is not a complete guide to tax planning, and does not constitute the rendering of legal, accounting, or other professional advice or opinions on specific facts or matters. Before implementing any ideas suggested here, consult with your tax advisor regarding your specific tax situation.
LJA xtax2 11/18/09