“THE PEOPLE ARE THE ONLY SURE RELIANCE FOR THE PRESERVATION OF OUR LIBERTY”
– THOMAS JEFFERSON

With just a little over a quarter left before the end of the year, this fall promises to be a busy one for Congress. As we write this newsletter, Congress and the White House are busy jockeying for position on the Bush tax cuts. Should the Bush tax cuts be extended? If so, should they be extended for everyone or just the so-called middle class? What about the estate tax? What happens to the estate tax if no action is taken by Congress this year?

Given the level of uncertainty that presently exists in Washington, this year is more challenging than ever for income tax planning. Nonetheless, there are some steps you can take to protect yourself going forward regardless of the actions that are ultimately taken in Washington. To be successful, you want to be able to cut your tax bill over both 2010 and 2011, not just one of those years. Many, but not all, of you will benefit by accelerating your deductions from 2011 into 2010. If, however, you expect to be in a higher income tax bracket in 2011, consider accelerating income into 2010 and delaying deductions until 2011.

Income Tax

LOCK IN CAPITAL GAINS. If the Bush tax cuts do not get extended into 2011, the long-term capital gains tax rate will rise from 15% to 20%. Furthermore, as Congress grapples with deficit issues, it is possible that the rate may go higher in years to come. Sell winners, pay tax at the 15% capital gains rate in 2010 and buy the position back right after you sell it. As long as you sell a position for a gain, there is no prohibition against reacquiring the same position right away.

GIVE SHARES TO YOUR CHILDREN. If you want to help your adult kids transition into real life, give them shares of stocks or mutual funds instead of cash if they are in a lower income tax bracket. If the children earn under $34,000, their long-term capital gain tax rate for 2010 is 0%. So, instead of selling shares to give cash to your children, give them the shares and let them sell them. This only works with children who are old enough to be exempt from the “kiddie tax” which means they must be 19 or older and out of school, or 24 or older if they are still in school.

ITEMIZED DEDUCTIONS. There is no limit to your itemized deductions in 2010. In 2011, however, people earning more than $100,000 are likely to see their itemized deductions limited. It makes sense then to pay charitable contributions, state and local taxes and health care expenses in 2010. This strategy doesn’t necessarily work for those making more than $200,000 – $250,000 if you file jointly ? because your tax rates could rise significantly in 2011 if Obama prevails with his plan to let the Bush tax cuts expire for high income earners. If this happens, then you will want to save your deductions and capital losses for 2011 when they are worth more.

FUND RETIREMENT PLANS. Regardless of income tax rates, it is always a good idea to fund your retirement plan to get the benefit of tax-deferred growth. Make sure you are contributing as much as your budget allows you too. We talk about retirement plan contribution limits later in this newsletter

HIGH EFFICIENCY TAX CREDIT. You can weatherize your home and be rewarded for your effort in 2010. If you purchase a highly efficient water heater, boiler, heat pump, air-conditioner, window or door you can take a credit of up to 30% of the cost of the equipment. There is a $1500 cap on the credit and the equipment must be placed in service by December 31.

ROTH IRA CONVERSIONS. If you are thinking about converting a traditional IRA to a Roth IRA this may be the year to do it. The tax on 2010 conversions can be deferred and spread out over the next two years. You can have 50% of the conversion income taxed in 2011 and the balance in 2012. Furthermore, the ban on conversions by individuals with adjusted gross incomes over $100,000 doesn’t apply in 2010. Note, however, that if you are in the top marginal income tax bracket and you convert to a Roth in 2010, you may want to consider paying the tax in 2010 as the top marginal income tax bracket is likely to go up to 39.6% after 2010 if the Bush tax cuts are not extended.

• Taxpayers can make IRA contributions for 2010 up to April 15th of 2011. Contribution limits are 100% of compensation up to $5000 per taxpayer for individuals who were less than 50 years old in 2010. Catch-up contributions for those individuals 50 and older in 2010 are $1000, bringing the total contribution limit for the 50 and older crowd to $6000.

• Taxpayers who did not participate in a retirement plan in 2010 can fully deduct their IRA contribution, regardless of the level of their income. However, taxpayers who were “active participants” in either a defined contribution or defined benefit retirement plan can be phased out of a deductible IRA contribution, depending on the amount of their adjusted gross income (AGI). Those limits are $66,000 for single taxpayers and $109,000 for married taxpayers who file jointly. For married couples filing jointly, where one spouse is an active participant and one spouse is not, the deduction for the spouse who is not an active participant is phased out if the couples’ joint income exceeds $177,000. If you do exceed the aforementioned income limits, you can still make a non-deductible IRA contribution which will also grow on a tax-deferred basis.

• 2010 contributions to a Roth IRA are phased out for single taxpayers at an AGI of $120,000 and $177,000 for married taxpayers filing jointly. Roth IRA contributions are not deductible but grow tax-free, distributions are withdrawn tax-free and mandatory distributions are not required at age 70 ½.

Contribution limits for qualified plans for 2010 are as follows:

401(k) contributions: $16,500
401(k) catch-up contributions: $5,500

Estate Tax

Because of Congress’ inaction, the estate tax lapsed at the end of 2009. While there is no estate tax in 2010, beneficiaries of those dying in 2010 may owe capital gains tax when they go to sell inherited property and may actually owe more tax then they would have if they had inherited in 2009. Many, including us, believe Congress will address the estate tax issue before the end of the year. If Congress doesn’t step in, the estate tax will return in 2011 with a $1,000,000 exemption amount and a top tax rate of 55%. What will happen if they step in? That is anybody’s guess; however, the most prevalent line of thinking is that the estate tax will return to its 2009 level, with a $3,500,000 exemption amount and top tax rate of 45%.

We will keep you informed of any changes that occur in the weeks ahead. Given the complexity of some of the aforementioned topics and the sheer number of tax issues that you may be faced with, THOR is ready, willing and able to help you sort through them. Give us a call at your convenience if you would like our assistance.