By Grant Thorton
Managing a tax burden has never been more difficult, whether you’re managing your individual tax rates, the rates on your investments, the taxes on your privately held or pass-through business, or the income of executives and shareholders at your company. Lawmakers have been aggressively using the tax code to try to get the economy back on track, and there are now more ways than ever to reduce your tax liability – however, all of them take planning.
“It’s not too late to change what goes on your tax return when tax season rolls around,” said Justin Ransome, a partner in Grant Thornton’s Washington National Tax Office. “Just a little bit of planning in November can often go a long way on April 15.”
Fortunately, there’s still plenty of time to put last-minute planning techniques into play. But remember to consider your individual circumstances and consult a tax adviser. Here are twelve pieces of advice to keep in mind:
1. Accelerate deductions and defer income. Why pay tax now when you can pay tomorrow? Deferring tax is a cornerstone of tax planning. Generally this means you want to accelerate deductions into the current year and defer income into next year. There are plenty of income items and expenses you may be able to control, and business owners and self-employed taxpayers often have the best opportunities. Consider deferring bonuses, consulting income or self-employment income. On the deduction side, you may be able to accelerate state and local income taxes, interest payments and real estate taxes. But beware of the alternative minimum tax, which can affect timing strategies.
2. Bunch itemized deductions. Many expenses can be deducted only if they exceed a certain percentage of your adjusted gross income (AGI). Bunching itemized deductible expenses into one year can help you get over these AGI floors. Consider scheduling your non-urgent medical procedures all in one year to clear the 7.5 percent AGI floor for medical expenses. To overcome the 2 percent AGI floor for miscellaneous expenses, bunch your pass-through business’s professional fees such as legal advice and tax planning, plus any unreimbursed business expenses such as travel and vehicle costs.
3. Maximize “above-the-line” deductions. Above-the-line deductions are especially valuable because they reduce your AGI, and AGI is used to test whether you’re eligible for many tax benefits. Common above-the-line deductions include traditional Individual Retirement Account (IRA) and Health Savings Account (HSA) contributions, moving expenses, self-employed health insurance costs, alimony payments and any bank penalties you may have had to pay for early account withdrawals.
4. Consider charitable contributions carefully. Think about giving appreciated property to charity so you can deduct the full value without paying capital gains taxes. But don’t donate depreciated property. Sell it first and give the proceeds to charity so you can take the capital loss and a charitable deduction. If you’re 70½ or older, consider making charitable donations directly from any traditional IRA distributions so the gift/distribution will not be included in your AGI. This provision is scheduled to expire at the end of this year. As always, double-check the limits and substantiation rules before making any contributions.
5. Leverage retirement account tax savings. It’s not too late to maximize contributions to a retirement account. Traditional retirement accounts like 401(k)s and IRAs still offer some of the best tax savings in the tax code. Contributions reduce taxable income at the time you make them, and you don’t pay taxes until you take the money out at retirement. The 2011 contribution limits are $16,500 for a 401(k) and $5,000 for an IRA (not including catch-up contributions for those 50 and older). Remember that 2011 contributions to your IRA can be made as late as April 15, 2012.
6. Roll over into a Roth account. “Roth” versions of traditional retirement accounts, such as 401(k)s and IRAs, also provide a great savings opportunity. You don’t get a tax break when you put money into a Roth account, but the money grows tax-free and is never taxed again if distributions are made properly. Rolling over into a Roth account now may make sense. Tax rates are low, and the value of many accounts has been artificially depressed by the economic downturn. Paying tax on the rollover now could save you if tax rates go up and your account recovers. The $100,000 AGI limit on these rollovers was recently lifted, so even high-income taxpayers can convert. Understand that you will be required to pay tax on the converted amount and plan accordingly.
7. Expense business investments
Business owners have been given a great opportunity to save on taxes while investing in their businesses this year. Legislation enacted in 2010 doubles a bonus depreciation tax benefit for property a business places in service before the end of the year. Under this provision, you can fully deduct the cost of eligible equipment on this year’s return if you place the equipment in service by Dec. 31. To qualify for bonus depreciation, the property you place in service must be new and generally have a useful life of 20 years or less under the modified accelerated cost recovery system (MACRS).
8. Consider your salary as corporate employee-shareholder
If you own a corporation and work in the business, you need to think carefully about your salary structure. Your tax treatment will vary depending on whether you’re organized as a traditional C corporation or an S corporation (in which corporation income is “passed through” and taxed at the individual level). Distributions of corporate income are generally not subject to Medicare tax. That means if your business is an S corporation, you will pay Medicare tax only on business income received as salary, not income received as a distribution. C corporation distributions also escape Medicare tax, but are subject to a 15 percent dividend tax rate. So many C corporation owners will pay less overall tax on income received as salary (which is deducible at the corporate level), while S corporation owners will do better with more income received as dividends. But remember to tread carefully. You must take a reasonable salary to avoid potential back taxes and penalties, and the IRS is cracking down on misclassification of corporate payments to shareholder-employees.
9. Make up a tax shortfall with increased withholding. Don’t forget that taxes are due throughout the year. Check your withholding and estimated tax payments now while you have time to fix a problem. If you’re in danger of an underpayment penalty, try to make up the shortfall through increased withholding on your salary or bonuses. A bigger estimated tax payment can still leave you exposed to penalties for previous quarters, while withholding is considered to have been paid ratably throughout the year. To avoid any penalties, the best action plan is to make sure you pay estimated taxes equal to 110 percent of your estimated tax liability.
10. Don’t forget to use annual gift tax exclusion. If you may have to pay estate taxes eventually, consider establishing a gifting program for your children and grandchildren to take advantage of the annual gift tax exclusion. Gifts of up to $13,000 per donee ($26,000 for married couples) are generally excluded from gift tax in 2011 and will be removed from your estate, with no limit on the number of donees. In addition, tuition payments to an educational institution for the benefit of your children or grandchildren are excluded from gift tax.
11. Watch out for the “kiddie tax.” The “kiddie tax,” which requires a portion of a child’s unearned income to be taxed at the parents’ marginal rate, has been expanded to apply to full-time students under the age of 24 whose earned income does not represent at least one-half of their support. Be careful transferring income-producing assets to your kids.
12. Perform an overall financial checkup. The end of the year is always a good time to assess your current financial situation and your plans for yourself and your business. You should think about cash flow, health care, retirement, investment and estate planning. Check wills, powers of attorney and health care proxies for changes that may have occurred during the year. Use the open enrollment period to reconsider employer-sponsored programs that could reduce next year’s taxable income. HSAs and flexible spending accounts for dependent care or medical expenses allow you to use pre-tax dollars. Remember, it’s never too early or too late to start planning for the future!