You have less than two months to take advantage of several favorable tax opportunities including:
- Is a Roth Conversion Strategy Right For You?
- Should you accelerate income to 2010?
- Will Alternative Minimum Tax Add To Your Tax Bill?
- What About Capital Gains?
- Should You Defer Deductions to 2011?
2010 is a year with an unusual degree of uncertainty about the ground rules for the 2010 tax planning. After a decade of predictable tax rates, 2010 and 2011 will bring a multitude of changes which could impact you in unpredictable ways.
There is a good chance that income tax rates will increase next year for a majority of our clients as the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001 expires. Over the past decade, tax rates have steadily declined under this law. Absent Congressional action, certain tax cuts, credits, and other tax provisions referred to as the “Bush Tax Cuts” will become history.
The following are just a few examples of the complexities that impact this year’s tax planning decisions.
Should you accelerate income to 2010?
As tax rates decreased over the past 10 years, conventional wisdom was to defer income to the next year whenever possible. This may not be true this year. Ordinary income tax rates for 2011 may increase by 3% to 5% over the 2010 tax rates especially for clients who are currently in the 33% to 35% brackets.
A taxpayer who can control the timing of income may be able to pay lower taxes in 2010 than in 2011. In prior years, forcing a large amount of income into one year did not always make sense because the higher income would trigger a phase out of exemptions and itemized deductions. But in 2010 there are no phase outs regardless of the amount of adjusted gross income. In 2011, however, these phase outs come back and revert to amounts which were in effect in 2000. This can make moving income into 2010 make even more sense.
Will Alternative Minimum Tax Add To Your Tax Bill?
Many people do not realize that there are two separate tax computations used to determine the amount of income tax that individuals must pay. The first tax calculation is the one that is widely known. The second method of calculating tax is referred to as the “Alternative Minimum Tax” or AMT. The AMT is calculated using different rules than the regular Income Tax; these do not permit deductions for state and local income taxes, property taxes, miscellaneous itemized deductions subject to 2% of Adjusted Gross Income, as well as some other less common items. The tax is calculated using different rates and if the AMT Tax is higher than the regular tax, then you have to pay the higher amount.
As the AMT began to affect more taxpayers; on a year by year basis, Congress has approved a “patch” that increased the amount of the AMT exemption. To date, for 2010, no patch has been approved; and the exemption amounts will revert to 1986 levels. It is important to determine whether you may be affected by the AMT, because if you are, different tax planning strategies apply. We will be following year end legislative developments to determine whether another “patch” will be approved for 2010. This fall, we will be projecting your tax due with and without the AMT to demonstrate the amount of tax that you would have to pay under alternative tax planning scenarios.
Should You Defer Deductions to 2011?
Over the past decade, conventional wisdom has suggested that due to declining tax rates, it makes sense to accelerate deductions into the current year. Logically then, you would think that when rates are increasing you should defer deductions into the following year when the rates go up. While this may be true in many cases, it should be remembered that when the phaseouts return in 2011, some of these deductions may be lost. Certain deductions are also lost when you are subject to AMT.
What About Capital Gains?
Accelerating capital gains into 2010 makes sense for most taxpayers. The 15% long term capital gains rate is scheduled to increase to 20%, and the short term rate will increase with the ordinary income tax rates. The 0% capital gains tax rate for those in lower tax brackets is also disappearing. In addition, the favorable 15% tax rate for qualified dividend income is also being eliminated, so that the dividends will be taxed at your highest marginal tax bracket.
Is a Roth Conversion Strategy Right For You?
Over the next several months, be prepared to be bombarded with a media blitz about Roth Conversion opportunities. The Roth Conversion decision involves paying taxes up front to move assets from a retirement plan that contains pre-tax dollars to a Roth Conversion account that holds after-tax dollars. While the pre-tax dollars will be taxed when they are withdrawn; the after-tax dollars grow and are distributed tax-free.
This year, 2010, is the first year that taxpayers with incomes over $100,000 are permitted to take advantage of the Roth Conversion. It is difficult to come up with any standard recommendation as to whether or not you should convert, how much should be converted, and in what year income should be recognized. While the Roth Conversion strategy is not right for everyone, it is important to examine the opportunity in the context of you financial goals and resources.
The previous examples illustrate why there are no “one size fits all” recommendations. This year, your personalized tax projections, which consider the impact of both scheduled and potential tax law changes, will be particularly beneficial.
We look forward to assisting you in making smart tax planning decisions this fall.
Pamela Landy, MBA, JD, CFP®, CSA®
Cambridge Connection, Inc.
Franklin, Michigan Office