Year-end Tax Moves Can Benefit You
Year-end planning is challenging this year because of uncertainty over whether Congress will enact tax reform that could have major impact in the future.
Regardless of what happens, there are tax savings to be realized from the breaks that are on the books now, but may be gone next year.
Here are some year-end moves for individuals to consider.
- Increase the amount set aside for next year in your employer's health flexible spending account if you contributed too little this year.
- If you become eligible to make health savings account (HSA) contributions in December of this year, you can make a full year's worth of deductible HSA contributions for 2011.
- Realize stock losses while preserving your investment position. For example, you can sell the original holding, then buy back the same securities at least 31 days later.
- Postpone income until 2012 and accelerate deductions into 2011. This strategy may enable you to claim larger deductions and other breaks for 2011 that are phased out over varying levels of adjusted gross income.
Postponing income also is desirable if you anticipate being in a lower tax bracket. However, if you expect to be in a higher tax bracket next year, you may want to accelerate income.
- If you believe a Roth IRA is better than a traditional IRA, consider converting traditional-IRA money invested in beaten-down investments into a Roth IRA if eligible to do so. Keep in mind that such a conversion will increase your 2011 taxable income.
- If you converted assets in a traditional IRA to a Roth IRA earlier this year, the assets in the Roth may have declined in value, and if you leave things as-is, you will wind up paying a higher tax than is necessary.
You can back out of the transaction by recharacterizing the conversion; that is, by transferring the converted amount (plus earnings or minus losses) from the Roth IRA back to a traditional IRA. You can later reconvert to a Roth IRA.
- It may be advantageous to try to arrange with your employer to defer a bonus that may be coming your way until 2012.
- Consider using a credit card to prepay expenses that can generate deductions for this year.
- If you expect to owe state income taxes, consider increasing withholding or paying estimated tax payments of state taxes before year-end to pull the deduction into 2011.
- Take a distribution from retirement plans before year-end if you are facing a penalty for underpayment of tax and the increased withholding option discussed above won't address the problem. Income tax will be withheld and applied toward the taxes owed for 2011.
You can then timely roll over the gross amount of the distribution to a traditional IRA so that the distribution won't be included in income for 2011, but the withheld tax will be applied pro rata over the full 2011 tax year to reduce your penalty.
- Accelerate big ticket purchases into 2011 to deduct sales tax on them, if you will elect to claim the sales tax deduction instead of the state income tax deduction. Currently, this election won't be available after 2011.
- You may be able to save taxes this year and next by applying a bunching strategy to "miscellaneous" itemized deductions, medical expenses and other itemized deductions.
- Homeowners can make energy saving improvements, such as putting in extra insulation, installing energy saving windows, or an energy efficient heater or air conditioner. You may qualify for a tax credit if installed before 2012.
- Unless Congress acts, the up-to-$4,000 above-the-line deduction for qualified higher education expenses will not be available after 2011. Consider prepaying eligible expenses if doing so will increase your deduction.
Generally, the deduction is allowed if paid in 2011 for enrollment at an institution of higher education during 2011 or for an academic period beginning in 2011 or in the first 3 months of 2012.
- If you are age 70-1/2 or older, own IRAs and are thinking of making a charitable gift, consider arranging for the gift to be made directly by the IRA trustee. Such a transfer, if made before year-end, can achieve important tax savings.
- Take required minimum distributions (RMD) from your IRA or retirement plan if you have reached age 70-1/2. Failure to do so can result in a penalty of 50% of the amount of the RMD not withdrawn.
- Make gifts sheltered by the annual gift tax exclusion before year end and save gift and estate taxes. You can give $13,000 in 2011 to each recipient. The transfers also may save income taxes where income-earning property is given to family members in lower income tax brackets.
While an explanation is beyond the scope of this article, when making any move, consider the effect on AMT for 2011, keeping in mind that many tax breaks allowed for purposes of calculating regular taxes are disallowed for AMT purposes.
