Year-end Tax Planning - What's Different This Year?

There's an important difference to tax planning this year-end compared with most:  The expectation that income TAX RATES WILL RISE next year.

We agreed (through our elected officials) to borrow and spend billions to prop-up the economy over the past 18 months.  Maybe that was a good thing, maybe not.  Either way, we'll have to begin repaying this debt soon.

It's clear that the current Congress and administration are very inclined to tinker with the tax code to achieve desired social outcomes.  There's been so many changes in 2009 that it's become a nearly full-time job for CPAs to remain experts.  So . . . many (including me) expect that income tax rates will be increased in 2010.

What that means for year-end tax planning is that the traditional guidance to accelerate deductions and credits and defer income many need to be reversed for this month.  Why?  Because moving deductible expenses into the current year lowers your current tax bill, thus giving you the advantage of the "time value of money." In other words, a dollar today is worth more than a dollar you receive later.  However, if tax rates rise, this may more than offset this advantage.

One win-win option for many is for converting your traditional IRA into a Roth IRA in 2009, if your AGI (adjusted gross income) is less than $100,000.  This gives you the benefit of this year's tax rates.  If your AGI is over $100,000, you'll have the option in 2010 of converting and spreading the income over the following 2 years.  There's even a provision in the tax law giving you the benefit of 20/20 hindsight (by October 15, 2011) to see whether the conversion was beneficial, and to reverse it if it wasn't!

The MAIN IDEA for converting your traditional IRA into a Roth IRA is really quite simple:  Do you expect that your income tax rate will be higher when you withdraw the money?  If so, convert.  If not, don't convert.  What affects your tax rate?  Tax law and your annual taxable income.  Will the IRA withdrawals and social security payments be your only income in retirement?  Which tax bracket will that put you in?  If lower than your current backet, the traditional IRA would give you a better result.  Of course, you also need to consider your own personal cash flow.  Can you pay the tax on a current Roth conversion from personal funds or would you need to take from the account assets?

There are a few, more complex options for year-end tax planning, including harvesting gains or losses on investments, making new deductible business purchases, among others.

If the tax law doesn't change, there's still some built-in tax bracket increases coming in 2011:

The 10% bracket becomes 15%, 15% becomes 28%, 25% to 31%, 28% to 36% and the 33% and 35% brackets rise to 39.6%.

Also, for Dividends and Capital Gains:  The maximum rate is 15% in 2009. It's expected to increase to 20% in 2011 for capital gains and 39.6% for dividends.  If this isn't changed, plan to make some significant changes to your investment portfolio, as well as tax planning.

These are just a few thoughts I wanted to share while there's still a little time to do something about it before year-end.

Contact me:
kfolberg@mynetcpa.com
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