2011 Year-End Tax Planning Updates

Lacey McCarty, Tax Senior  email
November 2011



As 2010 drew to a close, there was much concern and speculation as to what would happen to tax rates and laws. Then, Congress passed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 in December, which extended many of the Bush Tax Cuts. This legislation allows us to be better prepared for tax planning strategies for 2011 and 2012. However, it is certainly not a time to sit back and wait for changes to occur in 2013.

Tax Planning for Individuals

Due to the 2010 legislation, tax rates will remain the same for the next two years. If these Bush Tax Cuts are allowed to expire, tax rates for individuals will increase in 2013 as follows:

Recall that in 2010, Congress and the administration waited until the middle of December to eventually pass legislation to defer the tax cuts, and next year could produce a similar wait and see scenario. The speculation will continue to build next year, but it may not be until after the November 2012 elections that anything gets done. It could even get moved back to January 2013. Again, legislation will need to be enacted in order for these higher tax rates not to take effect. Despite this uncertainty, there are several tax planning ideas to consider based on the current known rates and expected tax rates.

• If you are considering selling appreciated long-term (held more than one year) stock or capital gain property, complete the sale before the end of 2012 to take advantage of the 15 percent rate rather than the expected 20 percent rate in 2013. It should be noted that the increase in the capital gain rate from 15 percent to 20 percent actually represents a 33 percent increase in the capital gains tax.
   
• Consider paying qualified dividends from a C Corporation in 2011 or 2012 when the tax rates are 15 percent, rather than the higher ordinary income tax rates in 2013 that jump to 39.6 percent. Please note that while the top ordinary tax rate is scheduled to increase to 39.6 percent in 2013, there is some discussion that the tax rate on qualified dividends will only rise to 20 percent. This is so it aligns with the capital gains rate.
   
• Many closely held businesses are set up as S Corporations, and distributions from S Corporations are generally tax free to the extent of the Accumulated Adjustment Account (AAA), which essentially represents the cumulative undistributed taxable income of the S Corporation. Any distributions beyond the AAA are treated as coming from the corporation's earnings and profits generated while it was a C Corporation. Distributions out of earnings and profits are taxed as qualified dividends. Thus, S Corporations should consider, before 2013, a special election that allows for treating distributions as coming out of earnings and profits first, rather than out of its AAA. This will result in the shareholders being taxed at the lower 15 percent rate rather than potentially higher tax rates on dividends in the future. This decision to make distributions out of earning and profits can be an involved analysis, and if you are contemplating this strategy, it is better to start the process sooner rather than later.
   
• Evaluate your possible exposure to the Alternative Minimum Tax (AMT). As a result of the 2010 legislation, the AMT exemption for 2011 was not reduced, but was set near the exemption for 2010. The AMT, however, will still impact millions of taxpayers again for 2011. One possible strategy to consider if you anticipate you will be subject to AMT in 2011 and not in 2012 is to try to accelerate income into 2011 from 2012. As a result, your top marginal tax rate in 2011 may be 28 percent compared to the top regular tax rate of 35 percent in 2012. Tax planning with the AMT can be complicated, and we recommend that you leverage your tax adviser for this process.
   
• Take advantage of several energy tax credits. Purchasing an electric car in 2011 makes you eligible for a $7,500 credit. There is also a 10 percent credit, up to $500, for various home additions, such as doors and windows. (You are not eligible if you have claimed this credit up to $500 in the past.) Other additions, like solar panels, provide a 30 percent credit with no limit.
   
• If you are age 70½ or older and are thinking of making charitable contributions, you may want to consider arranging for the donation to be made directly by the IRA trustee to the qualified charity. Such a transfer, if made before December 31st, may yield valuable tax savings.
   
• If you believe a Roth IRA is better than a traditional IRA, there are many tax, financial, investment and personal factors to consider. You will need to explore the advantages and disadvantages of the Roth IRA strategy for contributions and/or conversions for 2011.
   
• Gift, estate, and generation-skipping transfer tax rates are reunified with an exemption of $5 million ($10 million per couple) with a top tax rate of 35 percent for 2011 and 2012. At the end of 2012, the rates may change again, and without legislative changes, the prior law of a $1 million exemption at a 55 percent tax rate will apply. Consider making gifts now to children and grandchildren to take advantage of these exemptions and rates. An overall update of your estate situation may also be warranted.

Tax Planning Items for Businesses

The 2010 tax legislation also enacted several business tax provisions. Many of these included limited effective dates, in fact many items expire at the end of 2011. So please consider the following business items for 2011.

• Businesses should consider making certain capital expenditures that qualify for 100 percent bonus depreciation if they are placed in service this year. This 100 percent first-year write-off will not be available next year unless Congress acts to extend it. Thus, companies planning to purchase new depreciable property this year or next should try to accelerate their buying plans into 2011, if doing so makes prudent business sense.
   
• Businesses should also consider the timing of when to make planned capital expenditures that qualify for the business property expensing option. For tax years beginning in 2011, the expensing limit is $500,000 and the investment ceiling is $2,000,000. In addition, a limited amount of expensing may be claimed for qualified real property. However, unless Congress changes the rules for tax years beginning in 2012, the dollar limit will drop to $139,000, the beginning-of-phase-out amount will drop to $560,000, and expensing will not be available for qualified real property. Many small businesses that make timely purchases will still be able to deduct most, if not all, of their outlays for machinery and equipment in accordance with the generous limits that apply for 2011. What is more, the expensing deduction is not prorated for the time that the asset is in service during the year, as long as it is purchased and placed into service by December 31, 2011. This opens up significant year-end tax planning opportunities.
   
• You should determine whether it would be more beneficial to utilize this special 100 percent bonus depreciation and/or expanded expensing provisions for 2011, or depreciate these additions under the regular tax depreciation rules to defer larger depreciation deductions until later years and perhaps offset income at higher anticipated tax rates. More often than not, it is better to claim the tax depreciation sooner rather than later, but this can vary in certain situations We would be willing to assist you in evaluating your planned fixed asset purchases as well as the proper tax strategy to follow.
   
• If you own an interest in a Partnership (LLC) or an S Corporation you may need to increase your basis in the entity so you can deduct expected losses from it for the 2011 year. The increase in basis can be in the form of capital infusions or a direct loan to the entity, but these steps need to be taken care of and funded before the end of the tax year.
   
• If your business has not claimed the research tax credit (or R&D credit), you should explore this opportunity for the 2011 tax year. Last year's tax bill extended this credit through December 31, 2011. There are several provisions that must be satisfied in order to claim this credit, but one item to keep in mind is that the research your company conducts does not need to be new or cutting edge within the industry; it just needs to be new to your company. Click here for more information on the R&D credit.
   
• Under the HIRE Act of 2010, there were payroll tax savings available through December 31, 2010 for hiring certain unemployed workers. While the payroll savings are not around in 2011, a related employee retention tax credit of up to $1,000 per employee is permitted for employees hired in 2010 that are still working for your company. Also, consider taking advantage of the Work Opportunity Tax Credit (WOTC) by hiring qualifying workers (such as certain veterans) before the end of 2011. Under current tax laws, the WOTC will not be available for workers hired after this year.
   

Not knowing the future may be unsettling at times, especially with respect to your tax situation. Sound tax planning strategies often help you anticipate future tax liabilities and may even help to reduce them.

If you have any questions regarding your situation and year-end tax planning, please contact Lacey McCarty at lmccarty@KolbCo.com.