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Having worked as a financial adviser and tax accountant for nearly 20 years, I am accustomed to assisting clients with their year-end tax planning. For many, however, 2010 and its nationwide economic woes has wreaked havoc on individual financial situations.
While it is common to map out tax planning with the assumption that income is best deferred and expenses are best accelerated, 2010 defied conventional tax planning approaches as unemployment rose and many were forced to re-enter the workplace at diminished salaries. In some cases, two-earner households have become one-earner households.
For most taxpayers realizing lower incomes in 2010 corresponds to lower tax brackets. Hopefully, the economy will recover, but that could also mean a return to higher tax brackets for some workers. Depending on Congress’ movement on the tax code, those higher tax brackets may also carry higher tax rates. There are significant year-end tax planning strategies that can help reduce future tax liability by taking advantage of a currently dismal economic situation.
Take Capital Gains Now
Consider cashing in stocks with unrealized capital gains before the end of the year. If you have no need for the cash, repurchase the exact same stock and reset your basis. Wash sale rules disallowing losses realized within 30 days of a like-kind reinvestment do not apply to capital gains.
While Congress and the President have not yet agreed on which tax breaks will be renewed, the capital gains tax cap of 15 percent is still a given for 2010. If long periods of unemployment have put you in a 10-15 percent income tax bracket for 2010 and your capital gains are long-term, you may not have to pay any taxes on the realized capital gain. Once reset, all future gains will be calculated using your new basis. This should reduce your future tax liability regardless of Congressional action on taxes.
Capital losses and carryovers, on the other hand, may be much more valuable in the future, especially if tax rates rise.
Convert Your Traditional IRA to a Roth IRA
Conversion of a traditional Individual Retirement Account (IRA) to a Roth IRA requires the payment of taxes on the rollover amount. For IRA conversions made in 2010, there are special rules whereby the default method of reporting income will be to claim half in 2011 and half in 2012. However, for taxpayers to whom it would be more advantageous to claim the entire conversion amount in 2010, they may choose to do so. A plus to Roth IRAs: there is no required minimum distribution once you reach age 70-1/2, as occurs with traditional IRAs. This allows the retiree more flexibility in later years, an important factor if the taxpayer intends to continue working or wants to maintain the principal of the retirement account for beneficiaries.
If you are not interested in converting your entire individual IRA to a Roth IRA and you are over 59-1/2 you can accelerate some income into 2010 by taking an early partial distribution. While taxable, you would escape the 10 percent penalty due for those under 59-1/2.
Dates to know: IRA rollovers must be made within 60 days. Should you receive your traditional IRA distribution by December 31, 2010, and make your rollover contribution before March 1, 2011, you will be considered as having made a 2010 conversion per IRS guidelines.
Taxpayers cannot change their election to pay taxes in 2010, rather than splitting the gain between 2011 and 2012, after the filing due date for their tax return.
Recharacterization of a rollover from a traditional IRA to a Roth IRS must be completed by October 17, 2011.
Run Your Numbers
Make sure to run your projected and still manageable income and expense numbers through various tax scenarios as soon as possible. As mentioned earlier, the “delay income, increase expenses” approach often utilized in prior years may not be the best approach for 2010. Currently, there are more than 50 tax code provisions under consideration by Congress, any of which could result in increased taxes for individuals in future years. As a result, it may be more beneficial to take the tax hit on income in 2010, and delay deductible expenses into 2011.
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