20 Tax Saving Tips before the Year End

Great tips courtesy of Grant Thornton:

1. Make up any estimated tax shortfall with increased withholding, not estimated tax payments
If you’re in danger of being penalized for not paying enough tax throughout the year, try to make up the shortfall through increased withholding on your salary or bonuses. Paying the shortfall through an increase in your last quarterly estimated tax payment can still leave you exposed to penalties for underpayments in previous quarters. But withholding is considered to have been paid ratably throughout the year. So a big bump in withholding on high year-end wages can save you in penalties when a similar increase in an estimated tax payment might not.

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2. Bunch itemized deductions to get over AGI floors
Bunching deductible expenses into a single year can help you get over AGI floors for itemized deductions, such as the two-percent AGI floor for miscellaneous expenses and the 7.5-percent floor for medical expenses. Miscellaneous expenses you may be able to accelerate and pay now include:

•deductible investment expenses, such as investment advisory fees, custodial fees, safe deposit box rentals and investment publications;
•professional fees, such as tax planning and preparation, accounting and certain legal fees; and
•unreimbursed employee business expenses, such as travel, meals, entertainment, vehicle costs and publications — all exclusive of personal use.
Bunching medical expenses is often easier than bunching miscellaneous itemized deductions. Consider scheduling your non-urgent medical procedures and other controllable expenses into one year to take advantage of the deductions. Deductible medical expenses include:

•health insurance premiums,
•prescription drugs, and
•medical and dental costs and services.
In extreme cases, and assuming you are not subject to AMT, it may even be possible to claim a standard deduction in one year, while bunching two years’ worth of itemized deductions in another.

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3. Take full advantage of above-the-line deductions
Above-the-line deductions are especially valuable. They aren’t reduced by AGI floors like many itemized deductions and have the enormous benefit of actually reducing AGI. Nearly all of the tax benefits that phase out at high income levels are tied to AGI. The list includes personal exemptions and itemized deductions, education incentives, charitable giving deductions, the alternative minimum tax exemption, some retirement accounts and real estate loss deductions. Above-the-line deductions that reduce AGI could increase your chances of enjoying other tax preferences. Common above-the-line deductions include traditional Individual Retirement Account (IRA) and Health Savings Account (HSA) contributions, moving expenses, self-employed health insurance costs and alimony payments.

Take full advantage of these deductions by contributing as much as possible to retirement vehicles that provide them, such as IRAs and SEP IRAs. Don’t skimp on HSA contributions either. When possible, give the maximum amount allowed. And don’t forget that if you’re self-employed, the cost of the high deductible health plan tied to your HSA is also an above-the-line deduction.

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4. Accelerate income to “zero out” the AMT
You have to pay the AMT when it results in more tax than your regular income tax calculation, typically because the AMT has taken away key deductions. The silver lining is that the top AMT tax rate is only 28 percent. So you can “zero out” the AMT by accelerating income into the AMT year until the tax you calculate for regular tax and AMT are the same.

Although you will have paid tax sooner, you will have paid at an effective tax rate of only 26 percent or 28 percent on the accelerated income, which is less than the top rate of 35 percent that is paid in a year you’re not subject to the AMT. If the income you accelerate would otherwise be taxed in a future year with a potential top rate of 39.6 percent, the savings could be even greater. But be careful. If the additional income falls in the AMT exemption phaseout range, the effective rate may be a higher 31.5 percent. The additional income may also reduce itemized deductions and exemptions, so you need to consider the overall tax impact.

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5. Avoid the wash sale rule with a bond swap
Bond swaps are a way to maintain your investment position while recognizing a loss. With a bond swap, you sell a bond, take a capital loss and then immediately buy another bond of similar quality from a different issuer. You’ll avoid the wash sale rule because the bonds are not considered substantially identical.

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6. Don’t fear the wash sale rule to accelerate gains
Remember, there is no wash sale rule for gains, only losses. You can recognize gains anytime by selling your stock and repurchasing it immediately. This may be helpful if you have a large net capital loss you don’t want to carry forward or want to take advantage of today’s low rates. Waiting until after 2010 to pay tax on unrealized gains could result in a larger tax bill, if rates do indeed go up.

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7. Defer investment interest for a bigger deduction
Unused investment interest expense can be carried forward indefinitely and may be usable in later years. It could make sense to carry forward your unused investment interest until after 2010, when tax rates are scheduled to go up and the 15-percent rate on long-term capital gains and dividends is scheduled to disappear. The deduction could save you more at that time if rates do go up.

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8. Consider an 83(b) election on your restricted stock
With an 83(b) election, you immediately recognize the value of the restricted stock as ordinary income when the stock is granted. In exchange, you don’t recognize any income when the stock actually vests. You only recognize gain when the stock is eventually sold.

So why make an 83(b) election and recognize income now, when you could wait to recognize income when the stock actually vests? Because the value of the stock may be much higher when it vests. The election may make sense if the income at the grant date is negligible or the stock is likely to appreciate significantly before income would otherwise be recognized. In these cases, the election allows you to convert future appreciation from ordinary income to long-term capital gains income. The biggest drawback may be that any taxes you pay because of the election can’t be refunded if you eventually forfeit the stock or the stock’s value decreases. But if the stock’s value decreases, you’ll be able to report a capital loss when you sell the stock.

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9. Set salary wisely if you’re a corporate employee-shareholder
If you are an owner of a corporation who works in the business, you need to consider employment taxes in your salary structure. The 2.9-percent Medicare tax is not capped and will be levied against all income received as salary. S corporation shareholder-employees may want to keep their salaries reasonably low and increase their distributions of company income in order to avoid the Medicare tax. But C corporation owners may prefer to take more salary (which is deductible at the corporate level), because the Medicare tax rate is typically lower than the 15-percent tax rate they would pay personally on 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.

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10. Give directly from an IRA if 70½ or older
Congress just extended a helpful tax provision that allows taxpayers 70½ and older to make tax-free charitable distributions from individual retirement accounts (IRAs). Using your IRA distributions for charitable giving could save you more than taking a charitable deduction on a normal gift. That’s because these IRA distributions for charitable giving won’t be included in income at all, lowering your AGI. You’ll see the difference in many AGI-based computations where the below-the-line deduction for charitable giving doesn’t have any effect.

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11. Give appreciated property to enhance savings
Think about giving property that has appreciated to charity. You avoid paying the capital gains taxes you would incur if you sold the property, so donating property with a lot of built-in gain can lighten your tax bill. But don’t donate depreciated property. Sell it first and give the proceeds to charity so you can take the capital loss and the charitable deduction.

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12. Make payments directly to educational institutions
If you have children or grandchildren in private school or college, consider making direct payments of tuition to their educational institutions. Your payments will be gift-tax free, and they will not count against the annual exclusion amount of $13,000 (for 2009) or your $1 million lifetime gift tax exemption. Just make sure the payments are made directly to the educational institution and not given to children or grandchildren to cover the cost.

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13. Plan around gift taxes with your 529 plan
A 529 plan can be a powerful estate planning tool for parents or grandparents. Contributions to 529 plans are eligible for the $13,000 per beneficiary annual gift tax exclusion, so you can also avoid any generation-skipping transfer (GST) tax when you fund a 529 plan for a grandchild — without using up any of your $3.5 million GST tax exemption. Plus, a special break for 529 plans allows you to front-load five years’ worth of annual exclusion gifts ($65,000) in one year, and married couples splitting gifts can double this amount to $130,000. And that’s per beneficiary.

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14. Wait to make your retirement account withdrawals
Taxpayers have no choice but to begin making distributions from IRAs, 401(k) and 403(b) plans, and some 457(b) plans, once they reach 70½. (Learn about the temporary reprieve from required minimum distributions in 2009). But many taxpayers want to know whether they should begin making distributions earlier or wait and make only the required distributions.

If your account is appreciating and you don’t need the money immediately, consider waiting to make withdrawals until required. Your assets will continue growing tax-free. Not only will your account balance likely be larger if you wait, but if you live long enough, your total distributions should also be greater.

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15. Get kids started with a Roth IRA
It’s never too early to start saving, and a Roth IRA can offer your children unique benefits. For one, Roth IRA contributions can be withdrawn tax- and penalty-free at any time and for any reason. Early withdrawals are subject to tax and a 10-percent early withdrawal penalty only when they exceed contributions. Additionally, if a Roth IRA has been open for five years, there are two exceptions to early withdrawal penalties that can be particularly helpful to young IRA owners:

•Withdrawals in excess of contributions used to pay qualified higher education expenses are penalty-free, but they’re subject to income tax.
•Withdrawals up to $10,000 in excess of contributions used for a first-time home purchase are both tax- and penalty-free.
To make IRA contributions, children must have earned income. If your children or grandchildren don’t want to invest their hard-earned money, consider giving them the amount they’re eligible to contribute — but keep the gift tax in mind.

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16. Roll yourself over into a Roth IRA
It’s time to prepare for a unique opportunity in 2010 to roll your traditional IRA into a Roth IRA. Starting next year, there will no longer be a $100,000 AGI limit on this option. And it couldn’t have come at a better time. This type of rollover requires you to pay taxes on the investments in your IRA immediately in exchange for no taxes at withdrawal. So why pay taxes now instead of later?

•Tax rates are likely to go up. The current top individual tax rate is scheduled to increase from 35 percent to 39.6 percent in 2011.
•Your account may also be at its weakest thanks to a downturn that has battered stocks. The upside is that less value in your account means less tax you have to pay on the rollover. Taxes could be a lot higher when your account recovers.
•You pay the tax on your rollover from money outside the account. This too has a silver lining. Your full account balance after the rollover becomes tax-free, effectively increasing the amount of your tax-preferred investment.
•There are no required minimum distributions for a Roth IRA. So you can take your money out if and when you want to, and whatever is left over can be left to your heirs.
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17. Review and update your estate plan
Estate planning is an ongoing process. You should review your plan regularly to ensure it fits in with any changes in tax law or in your circumstances. Family changes like marriages, divorces, births, adoptions, disabilities and deaths can all lead to the need for estate plan modifications. Geographic moves also matter. Different states have different estate planning regulations. Any time you move from one state to another, you should review your estate plan. It’s especially important if you’re married and move into or out of a community property state.

Stay mindful of increases in income and net worth. What may have been an appropriate estate plan when your income and net worth were much lower may no longer be effective today. Remember that estate planning is about more than just reducing taxes. It’s about ensuring that your family is provided for and that you leave the legacy you desire.

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18. Exhaust your gift-tax exemption
Consider exhausting your lifetime gift tax exemption. Using all of the $1 million exemption to give away assets now can save you in the long run. That’s because giving away an asset not only removes it from your estate, but also lowers future estate tax by removing future appreciation and any annual earnings. Assuming modest five-percent after-tax growth, $1 million can easily turn into almost $2.7 million over 20 years. If you gave away the assets during your life, only the original $1 million gift will be added to your estate for estate tax purposes — not the larger value created by the appreciation of the gifted assets.

To maximize tax benefits, choose your gifts wisely. Give property with the greatest potential to appreciate. Don’t give property that has declined in value. Instead, sell the property so you can take the tax loss, and then give the sale proceeds. Be aware that giving assets to children under 24 may have unexpected income tax consequences because of the “kiddie tax.”

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19. Use second-to-die life insurance for extra liquidity
Because a properly structured estate plan can defer all estate taxes on the first spouse’s death, some families find they do not need any life insurance at that point. But significant estate taxes may be due on the second spouse’s death, and a second-to-die policy can be the perfect vehicle for providing cash to pay those taxes. A second-to-die policy also has other advantages over insurance on a single life: Premiums are typically lower than those on two individual policies, and a second-to-die policy will generally permit an otherwise uninsurable spouse to be covered. Work with a Grant Thornton estate planner to determine whether a second-to-die policy should be part of your planning strategy.

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20. Zero out your GRAT to save more
Grantor retained annuity trusts (GRATs) allow you to remove assets from your taxable estate at a reduced value for gift tax purposes while you receive payments from the trust. The income you receive from the trust is an annuity based on the assets’ value on the date the trust is formed. At the end of the term, the principal may pass to the beneficiaries. It’s possible to plan the trust term and payouts to avoid a taxable gift by zeroing out the GRAT. A GRAT is “zeroed out” when it is structured so the value of the remainder interest at the time the GRAT is created is at or just above zero. So, the remainder’s value for gift tax purposes is zero or close to zero.

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This website supports Grant Thornton LLP’s marketing of professional services and is not written tax advice directed at the particular facts and circumstances of any person. If you are interested in the subject of this document we encourage you to contact us or an independent tax advisor to discuss the potential application to your particular situation. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein. To the extent this document may be considered to contain written tax advice, any written advice contained in, forwarded with, or attached to this document is not intended by Grant Thornton to be used, and cannot be used, by any person for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.