ROTH IRA CONVERSIONS

If your traditional IRA has dropped in value and you expect to pay higher federal income tax rates in future years, now might be a very good time to consider converting all or part of your traditional IRA balance into a Roth IRA. Here’s why. If you convert, it will trigger a current tax hit on the amount you convert. But, with your traditional IRA balance at a depressed level (and possibly your overall income too), the tax hit will be less. After the conversion, your new Roth IRA balance can build up federal-income-tax-free. Eventually you can take tax-free withdrawals after age 59˝ when your marginal tax rate may be higher (perhaps much higher) than it is right now.

Roth Conversion Basics

A Roth conversion is treated as a taxable distribution from your traditional IRA because you’re deemed to receive a taxable payout from your traditional IRA with the money then going into the new Roth account. So, a conversion will generally trigger a current federal income tax bill (and maybe a state income tax bill too). But the following positive factors may outweigh the current tax hit.

·         The conversion tax hit is reduced if the value of your traditional IRA has been beaten down by stock market losses.

·         Today’s tax rates might be the lowest you’ll see for the rest of your life. If so, converting would allow you to completely avoid higher future federal income tax rates on the entire post-conversion increase in the value of your Roth account.

The Roth conversion privilege is not available to everyone this year. For 2009, it’s only available if your modified adjusted gross income (not including any additional income triggered by the conversion itself) will be $100,000 or less.

Good News: For 2010, the $100,000 restriction is scheduled to completely disappear, which will allow all individuals to take advantage of the Roth conversion strategy no matter how high their income. If your income level prevents a 2009 Roth conversion, you can do one in 2010. And 2010 is almost here!  In addition, for conversions done during 2010 only, the taxes owed are paid over two (2) equal installments on your tax return for 2011 and 2012.  You may, however, elect to report the entire amount in 2010, the year of conversion.

You Can Reverse an Ill-advised Roth Conversion

Another great thing about the Roth conversion strategy is you can always change your mind well after the fact. Believe it or not, you have until October 15 of the year following the conversion year to recharacterize (unwind) your converted account. For example, say you convert two traditional IRAs into Roth accounts in early 2010. Later next year, the values of the converted accounts plummet due to poor performance of the investments held in the accounts. In this bleak scenario, you would pay 2010 income tax on value that later disappeared. Bad idea! Thankfully, however, you have until October 15, 2011 to recharacterize the two converted accounts back to traditional IRA status. It’s as if the ill-advised conversions never happened. So, you won’t owe any 2010 income tax on the now-unwound conversions.

Conclusion

Low current tax cost for converting plus the chance to avoid higher future tax rates on income and gains that will accumulate in your Roth account as the economy recovers (we hope) may add up to the perfect storm for the Roth conversion idea. That said; please contact me before pulling the trigger. There are a number of variables to consider, and I would welcome the opportunity to work with you to ensure a well-informed and thoughtful decision.

As we approach year-end, it’s again time to focus on last-minute moves you can make to save taxes—both on your 2009 return and in future years. The federal income tax environment is very favorable right now, but it is not likely to continue much longer. Now is the time to take advantage of the tax breaks that Congress has provided before they disappear.

Some General Comments before We Get Started...

First of all, the goal of year-end tax planning is to identify strategies that will allow you to pay the lowest overall tax. One means of accomplishing this if you expect your income to stay about the same during the next few years, is to postpone when taxable income must be reported and accelerate the time when expenses can be claimed as deductions. Still another smart move for many people is to convert ordinary income (taxed at rates up to 35%) into long-term capital gains that are subject to a tax rate of no greater than 15%.

Regardless of the approach taken, however, it’s important to limit tax planning to achieving your financial goals in a tax efficient manner. In addition, you should look at your tax situation for at least a two-year period, with the objective of reducing your tax liability for the two years combined rather than just for 2009.

With these general principles in mind, let’s take a look at some specific tax planning ideas that apply to the vast majority of taxpayers—that is, those in a regular tax situation. Call me if you would like to discuss those that may be appropriate for you or if you want to consider other tax-saving strategies.

Ideas for Increasing Deductions

One way to reduce your 2009 tax liability is to look for additional deductions. Here’s a list of suggestions to get you started:

Make Charitable Gifts of Appreciated Stock. If you have appreciated stock that you’ve held more than a year and you plan to make significant charitable contributions before year-end, keep your cash and donate the stock (or mutual fund shares) instead. You’ll avoid paying tax on the appreciation, but will still be able to deduct the donated property’s full value. If you want to maintain a position in the donated securities, you can immediately buy back a like number of shares

However, if the stock is now worth less than when you acquired it, sell the stock, take the loss, and then give the cash to the charity. If you give the stock to the charity, your charitable deduction will equal the stock’s current depressed value and no capital loss will be available. Also, if you sell the stock at a loss, you can’t immediately buy it back as this will trigger the wash sale rules, which means your loss won’t be deductible, but instead will be added to the basis in the new shares.

Maximize the Benefit of the Standard Deduction. For 2009, the standard deduction is $11,400 for married taxpayers filing joint returns. For single taxpayers, the amount is $5,700. Currently, it looks like these amounts will be about the same for 2010. If your total itemized deductions are normally close to these amounts, you may be able to leverage the benefit of your deductions by bunching deductions in every other year. This allows you to time your itemized deductions so that they are high in one year and low in the next. You claim actual expenses in the year they are bunched and take the standard deduction in the intervening years.

For instance, you might consider moving charitable donations you normally would make in early 2010 to the end of 2009. If you’re temporarily short on cash, charge the contribution to a credit card—it is deductible in the year charged, not when payment is made on the card. You can also accelerate payments of your real estate taxes or state income taxes otherwise due in early 2010. But, watch out for the AMT, as these taxes are not deductible for AMT purposes.

Bunch Deductions Subject to an Adjusted Gross Income Limit. Miscellaneous itemized deductions (such as unreimbursed employee business expenses) are deductible to the extent they exceed 2% of your adjusted gross income (AGI). (Your AGI is the number at the bottom of the first page of your return.) Medical expenses are deductible only to the extent they exceed 7.5% of AGI. To lessen the affect of these AGI limitations, try to bunch your miscellaneous and medical expense deductions into every other year.

Purchase Certain Big Ticket Items in 2009. Thanks to a couple of expiring temporary tax breaks, it may pay to purchase certain big-ticket items before the end of the year:

·         The optional itemized deduction for state and local sales and use taxes (in lieu of deducting state income taxes) will expire at the end of this year unless Congress takes further action. Therefore, if you live in a state with low or no state income tax and plan on making big-ticket purchases (such as a car, boat, or motorcycle, or airplane) in the near future, you may want to go ahead and make the purchase this year to cash in on the expiring sales tax break for 2009. There is no AGI based limit for this deduction, but you have to itemize to benefit and it is not allowed for AMT.

·         If you live in a state with high state income taxes and plan on deducting state income taxes instead of state sales taxes this year, legislation passed earlier this year created a one-year federal income tax deduction that might interest you. For 2009, you can deduct state and local sales and excise taxes on purchases of new (not used) passenger autos, pickups, and SUVs, as well as motorcycles and RVs made between 2/17/09 and 12/31/09. The write-off is limited to the amount of taxes on the first $49,500 of purchase price. However, a phase-out rule can reduce or completely eliminate the break if your AGI exceeds $250,000 ($125,000 if you are single). 

Ideas for Investments

Harvest Capital Losses. If you are sitting on some investments that have dropped in value since you acquired them, now might be a good time to dump part or all of them to cut your tax bill. You can deduct capital losses up to the amount of any capital gains that you’ll have for the year (for example, from mutual fund distributions or sales of stocks or bonds). Also, you can claim up to an additional $3,000 of losses ($1,500 if you’re married but filing a separate return) against your other income. Any losses in excess of these amounts carry over to next year.

If you’re selling less than your entire interest in an investment, you can maximize the amount of deductible loss that you realize by telling your broker or mutual fund company to sell the highest basis shares first (and then have them confirm your instructions in writing within a reasonable time after the sale). In addition, if you think your investments that are currently underwater are poised for a comeback, you can buy them back after taking a loss as long as you don’t reacquire them within 30 days before or after the sale.

Take Advantage of 0% Capital Gains Rate before It is Too Late. For 2009, the federal income tax rate on long-term capital gains and qualified dividends is 0% when they fall within the 10% or 15% regular federal income tax rate brackets. This will be the case to the extent your taxable income (including long-term capital gains and qualified dividends) does not exceed $67,900 if you’re married and file jointly ($33,950 if you’re single). This 0% rate will likely continue to apply in 2010, but is scheduled for repeal in 2011.

Secure a Deduction for Nearly Worthless Securities. If the dismal economy has left you with securities that are all but worthless with little hope of recovery, you might consider selling them before the end of the year so you can capitalize on the loss this year. You can deduct a loss on worthless securities only if you can prove the investment is completely worthless. Thus, a deduction is not available, as long as you own the security and it has any value at all. Total worthlessness can be very difficult to establish with any certainty. To avoid the issue, it may be easier to just sell the security if it has any marketable value. As long as the sale is not to a close family member, this allows you to claim a loss for the difference between your tax basis and the proceeds.

Ideas for Your Business

Consider Paying a Dividend in 2009. If you’re a shareholder in a closely held C corporation, the current federal income tax rate structure is helpful to your cause. If the company pays you a taxable dividend, the maximum federal rate is only 15%. The maximum federal rate on dividends is scheduled to skyrocket from the current 15% to 39.6% starting with 2011.

Take Advantage of Temporary Tax Breaks for Equipment and Software Purchases. If you have plans to buy a business computer, office furniture, equipment, vehicle, or other tangible business property, you might consider doing so before year-end to maximize your 2009 deductions. Here’s why:

·         Bigger Section 179 Deduction. Your business may be able to take advantage of the temporarily increased Section 179 deduction. Under the Section 179 deduction privilege, an eligible business can often claim first-year depreciation write-offs for the entire cost of new and used equipment and software additions. For tax years beginning in 2009, the maximum Section 179 deduction is a whopping $250,000. However, the allowable deduction is reduced dollar-for-dollar to the extent the amount of qualifying property placed in service during the year exceeds $800,000. For tax years beginning in 2010, the maximum deduction is estimated to drop back to about $134,000, with reductions estimated to begin when more than $530,000 of qualifying property is placed in service.

·         50% First-year Bonus Depreciation. Above and beyond the bumped-up Section 179 deduction, your business can also claim first-year bonus depreciation equal to 50% of the cost (reduced by the Section 179 deduction) of most new (not used) equipment and software acquired and placed in service by December 31 of this year. The 50% first-year bonus depreciation break will expire at year-end unless Congress takes further action.

Avoid the Hobby Loss Rules. A lot of businesses that are just starting out or have hit a bump in the road thanks to the dismal economy may wind up showing a loss for the year. The last thing the business owner wants in this situation is for the IRS to come knocking on the door arguing the business’s losses aren’t deductible because the activity is just a hobby for the owner. Surprisingly, the IRS has been fairly successful recently in making this argument when it takes taxpayers to court. Thus, if your business is expecting a loss this year, we should talk before year-end to make sure we do everything possible to maximize the tax benefit of the loss and minimize its economic impact.

Ideas for the Office

Maximize Contributions to 401(k) Plans. If you have a 401(k) plan at work, it’s just about time to tell your company how much you want to set aside on a tax-free basis for next year. Contribute as much as you can stand, especially if your employer makes matching contributions. You give up “free money” when you fail to participate to the max for the match.

Take Advantage of Flexible Spending Accounts (FSAs). If your company has an FSA, before year-end you must specify how much of your 2010 salary to convert into tax-free contributions to the plan. You can then take tax-free withdrawals next year to reimburse yourself for out-of-pocket medical and dental expenses and qualifying child care costs. Watch out, though, FSAs are “use-it-or-lose-it” accounts—you don’t want to set aside more than what you’ll likely have in qualifying expenses for the year.

Adjust Your Federal Income Tax Withholding. If it looks like you are going to owe income taxes for 2009, consider bumping up the Federal income taxes withheld from your paychecks now through the end of the year. When you file your return, you will still have to pay any taxes due less the amount paid in. However, as long as your total tax payments (estimated payments plus withholdings) equal at least 90% of your estimated 2009 liability or, if smaller, 100% of your 2008 liability (110% if your 2008 adjusted gross income exceeded $150,000; $75,000 for married individuals who filed separate returns), interest and penalties will be minimized, if not eliminated.

Ideas for Seniors Age 70˝ or Older

Make Charitable Donations Directly from Your IRAs. If you’ve reached age 70˝, you can arrange to transfer up to $100,000 of otherwise taxable IRA money to the public charity of your choice (such as your church or other favorite charity). The distribution is federally income tax free. You don’t get to claim it as an itemized deduction on your Form 1040. However, the tax-free treatment equates to a 100% write-off, and you don’t have to itemize your deductions to get it. Additionally, since it is tax-free, it may reduce your Social Security benefits subject to tax. Be careful though—to qualify for this special tax break, the funds must be transferred directly from your IRA to the charity (you can’t receive cash and then donate it). Also, this provision expires at the end of 2009 unless Congress extends it. So, this could be your last chance.

Don’t Take Your Minimum Required Distribution for 2009. The tax laws generally require individuals with retirement accounts to take withdrawals based on the size of their account and their age every year after they reach age 70˝. Failure to take a required withdrawal can result in a penalty of 50% of the amount not withdrawn. However, a temporary tax law change made in late 2008, waives the minimum distribution requirement for 2009. This means you can leave the amounts in your account without suffering the 50% penalty. This waiver applies to IRAs and defined-contribution plans, including distributions from 401(k), 403(b), and state-sponsored 457(b) accounts and is available to everyone regardless of their total retirement account balances.

Bottom Line: If you haven’t already received your required distribution during 2009 and you do not need the funds, you can just leave them in your retirement account for another year. If you have already received the distribution and now wish you hadn’t, you may be able to roll the funds back into your retirement account, even if the normal 60-day rollover period has already expired. However, this may require action before 11/30/09. If this situation applies to you, please give me a call.

                                                         Environmentally Friendly Ideas

Make Energy Efficiency Improvements to Your Home. A great way to cut energy costs and save up to $1,500 in federal income taxes this year is to make energy efficiency improvements to your principal residence. Basically, if you install energy efficient insulation, windows, doors, roofs, heat pumps, hot water heaters or boilers, or advanced main air circulating fans to your home during 2009 or 2010, you may be entitled to a tax credit of 30% of the purchase price, up to a maximum credit of $1,500. For 2009, the credit is allowed against the AMT. However, unless Congress changes the rules, this will not be the case for 2010. If there is any possibility you’ll be subject to AMT next year, you may want to make these improvements this year.

Purchase a Qualifying Hybrid or Lean Burn Technology Vehicle If you have been considering purchasing a new hybrid or lean-burn technology vehicle, now may be a good time to do so. First of all, as we discussed earlier, the sales tax paid on the vehicle may be deductible. Secondly, purchasing a qualifying new (not used) vehicle this year may reap you an alternative motor vehicle tax credit from around $900 to $3,000, depending on the vehicle, which in 2009 can offset the AMT. However, not all 2009 purchases qualify as credits are phased out once the manufacturer has sold over 60,000 qualifying vehicles. Because of this rule, no credits are allowed for 2009 purchases of Toyota, Lexus, and Honda hybrids and only reduced credits are available for Ford and Mercury hybrids. So far, full credits are still allowed for hybrids made by Chrysler, GM, Mazda, and Nissan. Full credits are also allowed for lean-burn technology vehicles made by Mercedes, Volkswagen, BMW, and Audi. Give us a call if you want to know the available credit amount for a specific hybrid or lean-burn technology vehicle.

Ideas for Your Estate

The federal estate tax exemption for 2009 is $3.5 million. For 2010, the federal estate tax is supposed to be repealed—but just for that one year. It now seems clear that if the promised repeal ever happens at all, it will just be for 2010. The more likely scenario is that we will continue to have a federal estate tax for 2010 and beyond with a $3.5 million or somewhat larger exemption. Therefore, planning to avoid or minimize the federal estate tax should still be part of your overall financial game plan.

Make Annual Gifts to Reduce Your Estate. Whittling your estate down by making annual gifts continues to be a tax-smart strategy. If you have some favorite relatives or unrelated persons, you and your spouse both can give each of them up to $13,000 this year. These gifts will reduce your estate tax exposure without any adverse gift tax effects. Making multiple gifts over multiple years can dramatically reduce your exposure to the estate tax. So, the sooner you start an annual gifting program, the better.

Capitalize on Depressed Security Values to Boost Giving Power. The current depressed security values may mean that more assets can be transferred within the limits of the gift tax annual exclusion amount ($13,000 for 2009) and the lifetime applicable exclusion amount ($1 million). Thus, if a security’s value is expected to participate in the inevitable (we hope) economic recovery (and especially if the security is expected to significantly appreciate) this may be the perfect time to give the security to the intended recipients. However, do not give away loser shares (currently worth less than what you paid for them). Instead, sell the shares, and take advantage of the resulting capital loss, and then give away the cash.

Detailed Federal Employment Tax Audits to Begin in November

There is an old proverb, the age and source of which I do not know, that states, "a word to the wise is sufficient".  No words more accurately describe the reaction small business employers should have to the news that the Internal Revenue Service will initiate a nationwide, intensive audit program know as a National Research Program (NRP).  The goal of the IRS National Research Program is to collect data that will help the IRS “improve its compliance programs and better use its resources.” As a result, this NRP study involving employment taxes (Form 941 and Form 940) is currently under development. During the project, the IRS will conduct detailed employment tax examinations of certain taxpayers with the program beginning in November. In fact, the selection process for an NRP audit has already begun. The Service reiterated that is based “on a statistical sample and it does not necessarily mean that an employer has incorrectly filed a return.” The program is scheduled to last for three years and “could easily encompass 2,000 tax examinations during each of the three years.

Although the IRS may look at any line on an employment tax return during the examination, it will primarily focus on the following issues:

(1) worker classification (employee vs. independent contractor)

(2) fringe benefits

(3) officer's compensation

(4) reimbursed expenses (ascertaining whether accountable plans meet the needed requirements).

The IRS is now expected to do more of these random employment tax audits than it first planned: About 6,000 exams will be done over three years vs. the 4,500 originally scheduled. And, the Service is getting plenty of potential leads especially in the area of misclassified workers. In the last year alone, “tens of thousands” of Form 8919 (which is used by taxpayers who insist that they are being incorrectly treated as independent contractors) have been filed with the IRS by workers claiming that they do not self employment tax on their earnings.

Vehicles with GVWRs Above 6,000 Pounds[1]

If widely fluctuating energy costs and environmental concerns have you looking for ways to go green, here are some tips on how going green can cut energy costs and reap tax saving energy credits. Better yet—all of these tax credits are available against Alternative Minimum Tax (AMT) this year and none of them are subject to any annoying phase out limits designed to prevent higher income taxpayers from benefiting from them. So, just about everyone should be eligible to take advantage of these tax saving credits.

Making Energy Efficient Improvements to Your Home

A great way to cut energy costs and save up to $1,500 in federal income taxes is to make certain energy efficiency improvements to your home. You just need to be sure to pick the right product.

The credit (which is called the nonbusiness energy property credit) you’re entitled to equals 30% of what you pay for (a) qualified energy efficiency improvements (such as, certain energy efficient insulation, windows, doors and roofs), and (b) qualified residential energy property (such as, certain energy efficient heat pumps, hot water heaters or boilers, and advanced main air circulating fans) on your principal residence (no vacation homes). Expenditures made from subsidized energy financing can qualify for the credit if they otherwise meet the requirements for those credits. However, there is a $1,500 cap on aggregate credits claimed in 2009 and 2010 for all types of eligible expenditures. In other words, the $1,500 cap applies to the aggregate amount of credits claimed in both years combined.

A good place to start your search for products that qualify for this credit is at www.energystar/taxcredits where you’ll find a table listing requirements for various products. Then, to ensure the product satisfies the required energy saving conditions for the nonbusiness energy credit, be sure to check the product package materials or manufacturer website before making the purchase. According to the IRS, you can rely on the manufacturer’s written certification statement, which is typically included with the product package materials or on the manufacturer’s website. You just need to keep a copy of this certification as part of your tax records.

Purchasing a Hybrid Vehicle

If you are considering a hybrid vehicle purchase in 2009, the hybrid vehicle credit of up to $3,400 may be enough to get you going. Thanks to the Stimulus Act, the really good news for 2009 purchases is that the credit is now allowed against AMT. Top this with the fact that the credit has no AGI phase-out limit and you’ve got a whole new ballgame. But, you need to be careful—the amount of credit available depends on the hybrid you buy and some of the most popular models are no longer eligible for the credit. Also, only purchases of new (not used) vehicles qualify.

The actual credit allowed varies by vehicle. Furthermore, the credit is phased out once a manufacturer sells 60,000 hybrid vehicles. Lexus, Toyota, and Honda all hit this mark in previous years, so no 2009 purchase of their hybrids qualifies for a credit. Ford and Mercury hit this mark in the last quarter of 2008. This means the full credit will be allowed for purchases of their hybrids through 3/31/09, 50% of the credit will be allowed for purchases made from 4/1/09–9/30/09, and 25% of the credit will be available for purchases made from 10/1/09–3/31/10. So, if you’re interested in a Ford or Mercury hybrid, you’ll want to make the purchase before 10/1/09 to get 50% (rather than 25%) of the credit.

Using the Solar, Wind, Geothermal or Fuel Cell Energy to Power Your Home

Although the costs of qualifying expenditures tend to be pretty steep, if you install solar, wind, geothermal, or fuel cell energy saving equipment in 2009, you may be able to take advantage of the residential energy efficient property (REEP) credit. The REEP credit equals 30% of expenditures to install: (1) qualified solar water heating equipment, (2) qualified small wind energy equipment, (3) qualified geothermal heat pumps, (4) qualified solar electricity generation equipment, and (5) qualified fuel cell equipment (up to $1,000 per kilowatt hour). Expenditures made from subsidized energy financing can qualify for the REEP credit if they otherwise meet the requirements for those credits.

The credit only applies to equipment you place in service in your U.S. residence, and it cannot be claimed for equipment used to heat a swimming pool or hot tub. The credit for fuel cell equipment is only available for your principal residence; however, the two solar credits apply to any residence (including vacation homes).

As with the nonbusiness energy property credit, a good place to start your search is at www.energystar.gov/taxcredits . Then, be sure the product satisfies the required energy saving conditions for the REEP credit, be sure to check the product package materials or manufacturer website before making the purchase. According to the IRS, you can rely on the manufacturer’s written certification statement, which is typically included with the product package materials or on the manufacturer’s website. You just need to keep a copy of this certification as part of your tax records.

Conclusion

As you can see, there are some pretty nice tax savings to be had from making certain energy saving and environmentally friendly expenditures in 2009.

If you have any questions or need any assistance, please give us a call.