Last week I wrote about the potential tax problems being created by congressional procrastination. If that got your attention (and I hope it did), you may want to consider some very practical year-end tax planning strategies to help minimize the blow. Here are some ideas to think about.
Manage the timing of income and expenses. If you expect tax rates to increase, you should look for opportunities to accelerate income into 2010 and push out expenses to 2011. Of course, you have to be careful not to do anything that looks like cooking the books, but there are legitimate options.
For example, if you are a corporate executive with vested, in-the-money non-qualified stock options, you may want to consider exercising them before year-end. The options' intrinsic value (the amount the stock price is above the option price) will be taxed as ordinary income. If you decide to hold the stock after exercise, any gain or loss thereafter will be a capital gain or loss.
Professionals can move revenue into 2010 by accelerating year-end billings. Business owners can decide when to pay themselves year-end bonuses based on which option gives them the best overall tax advantage. Paying them in 2010 (i.e., recognizing higher personal income in 2010) would be prudent if you want to minimize personal taxes. Delaying them until 2011 (i.e., recognizing them as a corporate expense in a higher-tax 2011) would make sense if you want to minimize corporate taxes. A note of caution: If you are a majority owner and you desire to push your bonus payment into 2011, you need to wait until after the New Year to fix the bonus amount. If you don't, the IRS will consider you to be in constructive receipt of the bonus in 2010 and you will owe taxes for 2010.
Business owners can also manage the tax timing of equipment purchases to a degree by choosing to immediately expense the investment subject to section 179 rules or depreciating the cost of equipment. If tax rates go up, it may make sense to depreciate it, thereby pushing most of the expense recognition in years with higher tax rates. On the other hand, certain types of purchases are favored by the tax code in 2010. For example, if you buy a business vehicle in 2010, you get a maximum first-year write-off of $11,060. If you wait until 2011, it drops to about $3,000.
Delay charitable contributions to 2011. Charitable deductions become more valuable as a tax planning vehicle as tax rates increase. If you think your 2011 tax rates will be higher, pushing your charitable contributions into the New Year makes a lot of sense.
Take capital gains. No matter what else happens with the tax code, it is a good bet that Congress will raise capital gains tax rates next year. If that happens, taking long-term capital gains before year-end could potentially save you a lot of money. But be careful! Depending on how close you are to triggering the dreaded Alternative Minimum Tax, taking large capital gains could reduce your AMT exemption and thereby raise your overall tax liability. This topic is so important--and complicated--I'll explore it in more detail in a separate post.
Watch for expiring tax credits. Some tax credits are set to expire at the end of 2010. One of the most popular, the American Opportunities Tax Credit, provides a credit of up to $2,500 per year for college costs. Another one, the Residential Energy Credit, which provides up to $1,500 for investments that increase the energy efficiency of your home, is also set to expire at year end.
Watch out for revisions to previous rules. Congress is tightening rules for Health Savings Accounts and, starting next year, has disallowed reimbursement for non-prescription medicines. If you need to get reimbursed for non-prescription medication, make sure you get it done before year-end.
Applying year-end tax strategies to your unique situation can be kind of tricky, so always consult with your tax advisor before implementing any of them.
One final note: it is very possible that Congress will vote to extend the Bush tax cuts into 2011, thereby giving them (and us) one more year of breathing room while they take a more considered approach to revising the tax code. But whatever happens, a careful year-end look at your personal tax situation is always worthwhile.