Opportunities Abound

As we move on from the easy living days of summer and get the kids back to school, it’s a great time to begin thinking about the 2009 tax strategies that will enable you to minimize what you hand over to Uncle Sam. This year, there’s plenty to consider. First, the recession prompted Washington to provide a variety of tax credits to stimulate spending on homes and cars and help people cope with layoffs. What’s more, the falling values of investment accounts have created a significant silver lining in the current financial cloud that’s beyond simply using tax loss harvesting to reduce your taxable income by $3,000. Finally, the clock is ticking on some lucrative tax policies that soon will expire. Let’s roll up our sleeves and consider our options:

IRA distributions to charities excluded from income. If you are age 70½ or older, you can transfer up to $100,000 from your individual retirement account (IRA) directly to your favorite eligible charitable organizations tax-free. Because this contribution counts toward your IRA’s required minimum distribution (which, by the way, is not required for 2009), but is not added to your taxable income, your gift could make you eligible for other tax breaks. Note distributions must be from IRAs; employer-sponsored retirement plans, including SIMPLE IRAs and simplified employee pension (SEP) plans, do not qualify. To learn more, review “Publication 590” from the Internal Revenue Service (IRS).

Home Improvement Tax Credits. If you need a new roof, windows, doors, insulation, HVAC, or a non-solar water heater, it pays to consider energy efficiency. From January 1, 2009 through December 31, 2010, you can claim a total of $1,500 for products you place in service in 2009 and 2010 for your principal residence. If you make improvements this year, you can claim the credit on your 2009 tax return. Credits for geothermal heat pumps, solar water heaters, solar panels, fuel cells, and small wind energy systems, which are not subject to this cap, are in effect through 2016. Save your receipts and the Manufacturer’s Certification Statement for each product for record keeping purposes. If you are building a new home, you can qualify for tax credits for geothermal heat pumps, photovoltaics, solar water heaters, small wind energy systems and fuel cells, but not for windows, doors, insulation, roofs, HVAC, or non-solar water heaters. If you have questions, visit the “Energy Star” website from the U.S. Department of Energy.

Additional standard deduction. Again, for 2009, we have the option to deduct state and local sales tax instead of state and local income tax. That’s obviously most attractive for folks living in states with little or no income tax who bought a big ticket item, such as a car. In recent months, with a number of states increasing their sales tax, the option has become even more attractive. Additionally, if you don’t qualify to itemize your deductions, this year you can add your local real estate taxes, up to $500 for single filers and $1,000 for joint filers, to your standard deduction. To learn more visit the IRS website to read about the “Additional Standard Deduction for Real Estate Taxes.”

No capital gains tax for some middle-income investors. The Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) passed by Congress in May 2006 established that U.S. taxpayers in the 10 and 15 percent tax brackets would pay no capital gains taxes on long-term investments (held for more than one year) sold in 2008, 2009 and 2010. Currently, the maximum long-term capital gains tax rate is 15 percent. Dividend income to taxpayers in the 10 and 15 percent brackets is also tax-free, but that, too, is set to change post 2010. (See the chart below.) For parents in lower tax brackets, the absence of taxes on long-term holdings may provide even greater incentives for making lifetime gifts.

Capital Gains Tax Rates—Now and After 2010

Type of Asset

Current Tax Rate

Post 2010 Tax Rate

Short-term capital gains (STCG) Ordinary income tax rates up to 35% Ordinary income tax rates up to 35%
Long-term capital gains (LTCG) 0% for taxpayers in the 10% and 15% tax brackets; 15% for taxpayers in the 25%, 28%, 33%, and 35% tax brackets Capital gains taxes will revert to pre-2003 rates, which in most cases were 20% and 18% for qualified five-year property.
Dividends 0% for taxpayers in the 10% and 15% tax brackets; Maximum rate of 15% in higher tax brackets In the past, dividends were taxed at ordinary income rates up to 35%. That’s how they likely will be taxed again.

Sales tax deduction on new-vehicle purchases. If you purchase a car, light truck, motor home, or motorcycle between February 17 and December 31, 2009, you may be able to deduct the state and local sales and excise taxes. You can take this deduction regardless of whether or not you itemize on your tax return, but it phases out for taxpayers with modified adjusted gross income (MAGI) between $125,000 and $135,000 for individual filers and $250,000 and $260,000 for joint filers. You can deduct the tax for a vehicle costing up to $49,500. You can learn more about the “New Vehicle Tax Deduction” at the IRS website.

$8,000 credit for first-time homebuyers. If you are in the market for your first home, falling real estate prices and low interest rates are obviously good news. Additionally, the American Recovery and Reinvestment Act of 2009 authorizes a tax credit equal to 10 percent of the home’s purchase price up to a maximum of $8,000 for qualified first-time home buyers purchasing a principal residence on or after April 8, 2008 and before December 1, 2009.

Note that the law defines “first-time home buyer” as a buyer who has not owned a principal residence during the three-year period prior to the purchase. For married taxpayers, the law tests the homeownership history of both the home buyer and his/her spouse. The tax credit is subject to income limits: $75,000 for single taxpayers and $150,000 for married taxpayers filing a joint return. The tax credit amount is reduced for buyers with a MAGI of more than $75,000 for single taxpayers and $150,000 for married taxpayers filing a joint return. Many of your questions about the “First-Time Homebuyer Tax Credit” can be answered at the IRS website.

Unemployment benefits excluded from income. Normally, unemployment benefits are taxable but, thanks to the American Recovery and Reinvestment Act, this year, the first $2,400 of unemployment benefits is tax-free. Also, workers who were terminated involuntarily between September 1, 2008, and December 31, 2009 may qualify for a subsidy that allows them to pay only 35 percent of the cost of extending their health insurance benefits for nine months. This subsidy begins to phase out for individuals whose MAGI exceeds $125,000 and ends when MAGI tops $145,000. For joint filers, the phase-out begins at $250,000 and ends at $290,000.

Conversion to Roth IRA. It’s easy to appreciate the benefits of converting a traditional IRA to a Roth IRA where qualified withdrawals are tax free. However, coming up with the cash to pay the taxes due at conversion can be difficult. However, because many investment accounts have declined in value over the past year, if you convert your traditional IRA this year it’s likely you will owe less tax than you might have in the past. Your new Roth will capture gains from the market’s eventual rebound on a tax-free basis — and you will withdraw those appreciated assets tax-free at a time in the future when it’s likely the tax rate will be higher than it is today.

This year, you can convert your traditional IRA to a Roth IRA if your MAGI is under $100,000. Note, however, that the income cap is scheduled to disappear in 2010, courtesy of the Tax Increase Prevention and Reconciliation Act of 2006. After 2010, there are no income limits for a conversion.

Inter-family sale of businesses or real estate. Down values for non-tradable assets are creating estate planning opportunities. If you have a business worth $8 million and revenue’s down 50 percent, consider selling 25 percent to a child via an interfamily loan where they have a promise to pay. Ten years later, the 25 percent you sold could be back to being worth $2 million—but sitting outside of your estate.

There’s always a certain amount of anxiety as tax season rolls around, but to ensure you’re in the best shape this April 15th, please let us know if you would like to discuss these opportunities and to consider others that may pertain to your unique situation. As you consider these options, remember that we never make investment decisions based solely on tax rates—whether it’s an expiring perk or expected future change. Finally, as always, please feel free to contact me with your questions.

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