- 2011 Year-End Tax Planning
- December 15, 2011 | Author: Gregory M. Winters
- Law Firm: Burke, Warren, MacKay & Serritella, P.C. - Chicago Office
In 2011 we saw much political debate about job creation and deficit reduction, but very little in the way of legislative accomplishment. The Congressional “Super Committee” charged with reducing the country’s long-term debt failed to reach an agreement. While we cannot predict what Congress may do moving forward, you can still take steps now to insure you are well positioned from a tax perspective before we close this year’s books.
Income Tax Considerations
Assess Your Tax Situation First
An important step you or your business can take is to conduct a full assessment of your current tax situation. Such an assessment should include a review of current year income and deductions (including capital gains and losses); an estimate of income and deductions for future years; a review of any carryover items (e.g., net operating loss or charitable contribution carryover); and identification of taxable items for which you can control the timing.
Once you have a full understanding of your current tax situation, you will be able to make more informed decisions about what steps should be taken to minimize your tax exposure going forward. Below is a brief summary of some planning opportunities you may consider prior to year-end.
Review Capital Gains and Losses
The stock market has experienced significant fluctuations this past year. If you have realized losses in your portfolio, consider selling some of your securities with losses to offset capital gains. Even if you did not sell securities at a gain during the year, you may have had capital gain income allocated to you from your mutual fund investments. By selling securities with losses you will be able to offset some or all of your capital gain income and reduce your overall tax obligation. If you do consider selling a security at a loss, be mindful of the “wash sale” rule which prohibits an investor from recognizing a loss if he or she repurchases the identical security during the period beginning 30 days prior to the sale date and elapsing 30 days following the sale date.
Max Out Your 401(k) & IRA
Consider contributing the maximum amount to your 401(k) plan. The contribution limit for 2011 is $16,500. In addition, individuals who will be at least 50 years of age by the end of 2011 may make an additional “catch-up” contribution of $5,500 in 2011. The contribution limit for 2012 will be $17,000 and the catch-up contribution limit for 2012 will be $5,500.
The maximum contribution that you can make to a traditional or Roth IRA is the lesser of $5,000 or the amount of your taxable compensation for 2011. If you are at least 50 years of age by the end of 2011, you can make an additional catch-up contribution of $1,000, or $6,000 in total. The contribution must be made on or before April 15, 2012.
Roth IRA Conversion
If you converted an IRA to a Roth IRA in 2010, you were given an option: recognize all the income in 2010 or defer that income, half into 2011 and half into 2012. If you elected to defer that income into 2011 and 2012, do not forget to include that income in your year-end planning for 2011.
If you initiated a Roth conversion earlier in 2011 and that Roth account has declined in value since, then consider a “Roth reconversion.” Reconverting your Roth IRA back to a regular IRA before year-end will allow you to avoid paying income tax on an account balance at its higher value.
Gifts to Charity
A charitable contribution made before year-end can be claimed as a deduction on your 2011 income tax return. Also, by contributing publicly traded stock to a charity, you will avoid tax on the stock’s appreciation and be able to deduct the full value of the stock. Regardless of the type of contribution, you must maintain a proper record of your gifts. For gifts made in 2011, a donor contributing money to a charitable organization (regardless of the amount) must maintain a cancelled check, bank record or receipt from the donee organization showing the name of the donee organization, the date of the contribution and the amount of the contribution. If you give a non-cash gift, ask for a letter estimating the value of the gift. Gifts over $5,000 that are not cash or publicly traded stock require an appraisal.
Tax-Free Distributions From IRAs for Charitable Purposes
Legislation enacted in late 2010 extended the provision allowing the transfer of funds from an IRA to charity through 2011. As a result of the legislation, individuals age 70½ or older are permitted to make direct transfers of up to $100,000 annually from an individual retirement account to a charitable organization. By distributing funds directly from your IRA to charity, the distribution is not included in your taxable income. Consequently, you are not allowed to claim a tax deduction for the charitable contribution. Without this provision, if an individual wished to contribute IRA assets to charity, the individual would be required to take a distribution from his IRA and then contribute the funds to charity. The individual would be required to include the distribution in income, but would be allowed a charitable deduction for his contribution. Unfortunately, the deduction does not make a taxpayer completely whole because of (among other things) the fact that charitable deductions are not allowed by most states, including Illinois.
Avoid Underpayment Penalties
Make sure that you have paid enough in federal and state withholding taxes to avoid penalties. For 2011, you will avoid a penalty for the underpayment of estimated tax if your tax payments (including withholdings) have been timely made and are at least equal to 100% of the tax shown on your 2010 federal income tax return (110% for individuals with adjusted gross income in excess of $150,000 - $75,000 for married individuals filing separately) or 90% of the tax shown on your 2011 federal income tax return, whichever is less.
Illinois raised its tax rate from 3% to 5% in 2011. For estimated tax purposes, you will avoid a penalty for the underpayment of estimated tax if your tax payments (including withholdings) have been timely made and are at least equal to 150% of the tax shown on your 2010 Illinois income tax return or 90% of the tax shown on your 2011 Illinois income tax return, whichever is less.
When reviewing your 2011 tax payments, keep in mind that income tax withholdings are considered paid equally throughout the year, even if withholdings are made near the end of the year. If you anticipate that you have underpaid your estimated taxes for 2011, consider adjusting withholdings for the remainder of the year to avoid penalties for underpayment of estimated taxes.
What if Congress Fails to Act?
Congress continues to debate various options relative to reining in the debt. If no legislative action is taken, the following are a few of the changes that will automatically occur in 2013:
- Higher Income Taxes for High Earners - Today’s top income-tax rates of 33% and 35% will return to 2000 levels: 36% and 39.6%.
- Steeper Taxes on Investment Gains - Instead of being taxed at 15%, capital gains will be subject tax at 20%. All dividend income will be subject to tax at ordinary income tax rates (up to 39.6%).
- Fewer Write-Offs for High-Income Earners - Itemized deductions and personal exemptions will again be subject to partial phase-out for high income earners.
- Surtax on Investment Income - The Patient Protection and Affordable Care Act (commonly referred to as “Obamacare”) creates a new 3.8% surtax on investment income for high income taxpayers (individuals with taxable income above $200,000 and married couples filing jointly with taxable income above $250,000). Investment income includes both capital gain items and most other items of unearned income. Assuming the Bush tax cuts expire in 2013, this would result in a cumulative tax on long-term capital gains of 23.8% and a cumulative tax on interest, dividends and other unearned income of up to 43.4% (39.6% + 3.8%).
Estate & Gift Tax Considerations
Current Federal Gift or Estate Tax
We still have a Federal gift and estate tax. The current gift and death tax-free exemption amount is $5 million and is scheduled to increase to $5.12 million in 2012. The top gift and estate tax rate is currently 35% and is scheduled to remain at 35% for 2012. Unless legislative action is taken, the gift and estate tax is scheduled to revert to its pre-Bush tax cut levels of only $1 million per taxpayer in 2013, with a top rate of 55%.
Annual Exclusion Gifts
In 2011, you may make a gift of $13,000 to any individual and certain trusts without any gift tax consequences. Married individuals may make gifts of up to $26,000. Gifts may be made outright or in trust and may be in the form of cash, securities, real estate, artwork, jewelry or other property. Giving property that you expect to appreciate in the future is an excellent way of utilizing your annual exclusion gifts because any post-gift appreciation is no longer subject to gift or estate tax. To take advantage of your annual exclusions for 2011, gifts must be made by December 31. Gifts over $13,000 or gifts that will be “split” between spouses must be reported on a gift tax return, which must be filed in April 2012. The annual exclusion amount is not scheduled to increase in 2012.
Payment of Tuition and Medical Expenses
In addition to annual exclusion gifts, you may pay tuition and medical expenses for the benefit of another person without incurring any gift or generation-skipping transfer (“GST”) tax or using any of your estate or GST tax exemption. These payments must be made directly to the educational institution or medical facility. There is no dollar limit for these types of payments and you are not required to file a gift tax return to report the payments.
Lifetime Gifts Using Gift Tax Exemption
In addition to annual exclusion gifts and the payment of tuition and medical expenses, individuals are also allowed a lifetime gift tax exemption. As noted above, the gift tax exemption amount is currently a flat $5 million for 2011, and is scheduled to increase to $5.12 million in 2012. Many clients make use of their $5 million lifetime exemptions by gift strategies such as Grantor Retained Annuity Trusts and other techniques that leverage the use of the exemption. A gift of appreciating property during your lifetime removes all future appreciation from your taxable estate at your death.
The Congressional Super Committee is said to have considered the timetable for reinstating the pre-Bush exemption and tax rates for gift and estate tax purposes. In fact, there was speculation that the pre-Bush tax provisions could have been be reinstituted by Thanksgiving. While that possibility did not come to fruition, there continues to be concern that the current gift and estate tax regime could see considerable change before the end of 2012. Many individuals have taken proactive steps to accelerate gifts that were planned for 2012 in order to insure such gifts are completed before any changes in the law.
Generation Skipping Transfer Tax
The generation-skipping transfer (“GST”) tax is still in place. Generally, the tax applies to lifetime and death-time transfers to or for the benefit of grandchildren or more remote descendants. For 2011, the rate is a flat 35%. The tax is in addition to any gift or estate tax otherwise payable. Each taxpayer is allowed a $5 million GST tax exemption for 2011, which is scheduled to increase to $5.12 million in 2012. Without further legislation, the GST exemption is scheduled to fall to $1.36 million in 2013 and the top rate is scheduled to increase to 55%.
Consider Lifetime Gifts that take Advantage of both the Gift Tax Exemption and GST Exemption
Many clients utilize a portion or all of their $5 million gift tax exemption ($10 million for a married couple) by structuring long-term GST exempt trusts benefiting multiple generations. Such trusts will remain exempt from all gift and estate tax as long as the trust remains in existence. Under Illinois law, such trusts can last in perpetuity, thereby allowing you to create a family “endowment fund” for your children, grandchildren and future descendants. Because of the possibility that the estate tax regime may change prior to 2013, many individuals are considering accelerating the timing of such gifts.