It should be of little surprise that 2011 has been another year of Congress changing the tax landscape. It looks like this trend may continue into 2012 as well, depending on what Congress chooses to act on in an election year.
That said below are actions that could be taken to help you save tax dollars. Not all actions will apply in your individual situation.
Year End Moves for Individuals
- Make HSA contributions. Under Code Sec. 223(b)(8)(A), a calendar year taxpayer who became an eligible individual under the health savings account (HSA) rules on December 1, 2011, is treated as having been an eligible individual for the entire year. Thus, he may make a full year's deductible-above-the-line contribution for 2011. That means a deduction of $3,050 for individual coverage, and $6,150 for family coverage (those age 55 or older get an additional 1,000 catch-up amount).
- Nail down losses on stock while substantially preserving your investment position. A taxpayer may have experienced paper losses on stock in a particular company or industry in which he wants to keep an investment. He may be able to realize his losses on the shares for tax purposes and still retain the same, or approximately the same, investment position. This can be accomplished by selling the shares and buying other shares in the same company or another company in the same industry to replace them. There are several ways this can be done. For example, an individual can sell the original holding, then buy back the same securities at least 31 days later.
- Convert a regular IRA to a Roth IRA. Individuals who believe a Roth IRA is a better strategy than a traditional IRA, and want to remain in the market for the long term, should convert traditional-IRA money invested in beaten-down stocks (or mutual funds) into a Roth IRA if eligible to do so. Note, however, that such a conversion shouldn't be done without considering the individual's overall tax situation. Even at depressed market levels, a 2011 rollover or conversion still will increase a taxpayer's AGI, possibly propelling him or her into a higher tax bracket, and diluting (or eliminating) those tax breaks that have AGI-based phaseouts or “floors.”
- Recharacterizing a traditional IRA to Roth IRA conversion. If an individual converted assets in a traditional IRA to a Roth IRA earlier in the year, the assets in the Roth IRA account may have declined in value. If things are left things as-is, the individual will wind up paying a higher tax than is necessary. However, there's a way to back out of the transaction, namely by recharacterizing the rollover or conversion. This involves transferring the converted amount (plus earnings, or minus losses) from the Roth IRA back to a traditional IRA via a trustee-to-trustee transfer. The individual can later reconvert to a Roth IRA.
- Accelerate deductible contributions. Individuals should keep in mind that charitable contributions and medical expenses are deductible when charged to their credit card accounts (e.g., in 2011) rather than when they pay the card company (e.g., in 2012).
- Solve an underpayment problem. An individual who expects to be underwithheld for 2011 should consider asking his employer—if it's not too late to do so—to increase income tax withholding before year-end. Generally, income tax withheld by an employer from an employee's wages or salary is treated as paid in equal amounts on each of the four installment due dates. Thus, if an employee asks his employer to withhold additional amounts for the rest of the year, the penalty can be retroactively eliminated. This is because the heavy year-end withholding will be treated as paid equally over the four installment due dates.
- Accelerate big ticket purchases into 2011 to get sales tax deduction. Unless Congress acts this year or next to extend it, the option for itemizers to deduct state and local sales taxes in lieu of state and local income taxes will expire at the end of 2011. As a result, individuals who will elect on their 2011 return to claim a state and local general sales tax deduction instead of a state and local income tax deduction, and are considering the purchase of a big-ticket item (e.g., a car or boat), should consider accelerating the purchase into this year to achieve a higher itemized deduction for sales taxes.
- Pre-pay qualified higher education expenses for first quarter of 2012. Unless Congress extends it, the up-to-$4,000 above-the-line deduction for qualified higher education expenses will not be available after 2011. Thus, individuals should consider prepaying eligible expenses if doing so will increase their deduction for qualified higher education expenses. Generally, the deduction is allowed for qualified education expenses paid in 2011 in connection with enrollment at an institution of higher education during 2011 or for an academic period beginning in 2011 or in the first 3 months of 2012.
- Be sure to take required minimum distributions (RMDs). Taxpayers who have reached age 70- 1/2 should be sure to take their 2011 RMD from their IRAs or 401(k) plans (or other employer-sponsored retired plans). Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn. Those who turned age 70- 1/2 in 2011, can delay the first required distribution to 2012. However, taxpayers who take the deferral route will have to take a double distribution in 2012—the amount required for 2011 plus the amount required for 2012.
- Make year-end gifts. A person can give any other person up to $13,000 for 2011 without incurring any gift tax. The annual exclusion amount increases to $26,000 per donee if the donor's spouse consents to gift-splitting. Annual exclusion gifts take the amount of the gift and future appreciation in the value of the gift out of the donor's estate, and shift the income tax obligation on the property's earnings to the donee who may be in a lower tax bracket (if not subject to the kiddie tax).
- Claim the nonbusiness energy property credit while you can. Of the many energy-saving provisions in the Code, few are more accessible to ordinary taxpayers than the $500 credit for nonbusiness energy property. The Code Sec. 25C credit can apply to relatively inexpensive, easy-to-do (perhaps even do-it-yourself) items—the installation of insulation (e.g., exterior caulking and weather-stripping), doors, and windows—as well as slightly more expensive but standard items such as central air conditioning and heat pumps. However, currently this credit only applies through 2011, and the prospects for an extension are uncertain. As a result, homeowners should consider accelerating energy-saving home improvements into this year if doing so will generate a credit.
Year End Moves for Business Owners
- Put new business equipment and machinery in service before year-end to qualify for accelerated depreciation
- Set up a self-employed retirement plan if you are self employed and haven’t done so. While contribution to your account can be made before April 15, 2012, the account must be opened by December 31, 2011
Put new business equipment and machinery in service before year-end to qualify for 50% bonus first-year
Little-known change affects 2011 income tax deduction for SE tax
Most practitioners and clients know that, for 2011, the Old Age, Survivors, and Disability Insurance (OASDI) portion of the self-employment (SE) tax is reduced by 2%, from 12.4% to 10.4%. What they may not know is that, as explained below, the SE tax deduction also was revised for 2011 to reflect an employer's equivalent portion of tax.
The Federal Insurance Contributions Act (FICA) imposes two taxes on employers and employees—one for Old Age, Survivors and Disability Insurance (OASDI; commonly known as the Social Security tax), and the other for Hospital Insurance (HI; commonly known as the Medicare tax). Likewise, the Self-Employment Contributions Act (SECA) imposes two taxes on self-employed individuals: an OASDI tax and an HI tax.
For 2010, the FICA tax rate for employees and employers was 7.65% each—6.2% for OASDI and 1.45% for HI. For self-employed persons, for 2010, the OASDI tax rate was 12.4% and the HI tax rate was 2.9%.
The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the 2010 Tax Relief Act, P.L. 111-312) reduced the employee OASDI tax rate under the FICA tax by two percentage points to 4.2% for remuneration received in 2011. Similarly, for self-employment income for tax years beginning in 2011, it reduced the OASDI tax rate under the SECA tax by two percentage points to 10.4% percent. (2010 Tax Relief Act Sec. 601) As a result, for 2011, employees pay only 4.2% Social Security tax on wages up to $106,800, and self-employed individuals pay only 10.4% Social Security self-employment taxes on self-employment income up to $106,800. The 2010 Tax Relief Act did not reduce the HI tax rate (for the employer and employee, 1.45% of total wages, for the self-employed, 2.9% of all self-employment income).
These are just a few of the actions you can take. Additionally there are several more changes to 2011 including:
- First installment of taxes owed on 2010 Roth conversions. Individuals who did a Roth conversion in 2010 and elected to spread the tax payment over 2011 and 2012 will have to pay one-half of the tax owed on their 2011 income tax return. However, if a taxpayer took a distribution in 2011 from their 2010 Roth conversion, they may be required to pay more to cover taxes on the distributed amount. In addition, tax on any additional conversions done in 2011 will have to be included on the 2011 tax return.
- Changes to Form 1040. Changes affecting the 1040 include a new line (Line 59b) for repayment of the First-Time Homebuyer Credit. The repayment installment can be entered directly on Line 59b without the use of Form 5405 if the taxpayer continued to own the home and use it as their main home throughout 2011. In addition, there is no longer a line on the Form 1040 for the Making Work Pay Credit, which expired at the end of 2010.
- Changes for investors in reporting basis. Investors will see that Form 1099-B has been revised to provide for their broker to report the basis of transactions during the year. The IRS will check to see that this information matches the basis reported on the taxpayer’s return. Additionally, these transactions should now be reported on the new Form 8949, rather than directly on Schedule D.
- Carryover basis on inherited assets may be lower than expected for some. Taxpayers who inherited assets where the estate elected to use the 2010 estate tax repeal option will receive a Form 8939 in January or February from the estate executor providing the basis information for those assets. Estates that used the 2010 estate tax repeal option will use as the basis the basis of the asset in the hands of the decedent, or carryover basis, unless a limited stepped-up basis is allocated to that asset. This carryover basis is often significantly less than the stepped-up basis – or the value of the asset at the time of the decedent’s death.
“An heir of a 2010 estate using the 2010 estate tax repeal option who sold the asset before receiving the Form 8939 may be surprised at the amount of capital gain owed from the sale,” Luscombe noted.
- New requirements for reporting foreign assets. Foreign Account Tax Compliance Act (FATCA) reporting requires foreign assets to be reported if they have a total value of more than $50,000 ($100,000 if married filing jointly). FATCA is broader than what is defined under the Report of Foreign Bank and Financial Accounts, or FBAR. For example, FATCA includes stock or securities issued by someone other than a U.S. “person,” any interest in a foreign entity, and any financial instrument or contract that has an issuer or counterparty other than a U.S. “person.” In addition to the prior obligation to report FBAR accounts on Form TDF90-22.1, FATCA must now be reported on a new Form 8938.
As always navigating taxes can be complex. Please contact us and we can tailor a plan that best meets your situation.
Very Truly Yours,
Thomas & Associates CPA’s Inc