2011 Tax Planning – Provisions and Strategies

As the end of the year is fast approaching it’s time to take a closer look at tax planning for the 2011 tax year. There is still time to reduce your 2011 tax bill and plan ahead for 2012 tax year. While there could be changes to the tax code before year end, there are currently several highly beneficial tax provisions that we can discuss.

Unlike the last couple of years, 2011 has produced little in the way of major tax legislation. At this time last year, income tax planning was far more challenging. Several tax provisions had already expired, and significant changes, including new higher income tax rates, were scheduled to take effect at the end of the year. Legislation passed at the end of 2010 extended many expiring tax provisions, and expanded other major tax provisions.

The same six federal income tax rates that applied in 2010 will continue to apply in 2011 and 2012. So, depending on your taxable income, you’ll fall into the 10%, 15%, 25%, 28%, 33%, or 35% rate bracket. Remember though, that all of your taxable income is not necessarily taxed at that rate–instead, the rate at which you pay tax generally increases as your income increases. For example, if you’re a single individual with 2011 taxable income of $100,000, you fall into the 28% tax bracket. However, your first $8,500 of taxable income is taxed at 10%, your next $26,000 of taxable income is taxed at 15%, and your next $49,100 in taxable income is taxed at 25%. Only $16,400 of your taxable income is actually taxed at 28%.

Capital gain rates will remain 15% (and a minimum of 0%) through December 31, 2012. The rates apply to qualified dividends and long-term gains from investment dispositions. That makes 2011 a good time to implement strategies for potential tax savings.

Business owners and the self-employed will continue to receive a first-year depreciation deduction of 100% of the cost of qualifying property acquired and placed in service during 2011 without limitation. The “bonus” first-year depreciation deduction drops to 50% for property acquired and placed in service during 2012. Alternatively, the maximum amount that can be expensed under Internal Revenue Code (IRC) Section 179 for 2011 is $500,000. The expense phase out is dollar for dollar and begins at $2 million of asset purchases. In 2012, the limit is currently scheduled to drop to $125,000 with the phase out beginning at $500,000. 

Additionally the federal depreciation provision allowing bonus depreciation, section 179, and a 15-year life for certain qualified real property was also extended through the end of 2011. However if electing section 179 treatment only $250,000 of the $500,000 limitation can be attributed to qualified real property.

There are two notable energy incentive credits for individuals available in 2011, The Nonbusiness Energy Property Credit and the Residential Energy Efficient Property Credit.  Property acquired in 2011 qualifying for the Nonbusiness Energy Property Credit includes windows (including skylights), exterior doors, insulation, metal roofs, advanced main air circulating fans, natural gas, propane, or oil furnace or hot water boilers, and other energy efficient building property that meets certain energy standards. For 2011, the credit is 10% of the cost of the improvement(s) up to a maximum credit of $500 (therefore, if you took any credit prior to 2011, your total cannot exceed $500). The property must be installed by the end of 2011 to qualify and only $200 of the credit can be applied to windows. Also for 2011, the energy standards are relaxed. The credit expires at the end of 2011. The Residential Energy Efficient Property Credit is available until 2016, to taxpayers who install certain energy efficient property such as photovoltaic panels, solar water heating property, fuel cell property, small wind energy property and geothermal heat pumps.  The credit is available for the expenditures incurred for such property up to a specific percentage, except that a cap applies for fuel cell property. The property purchased cannot be used to heat swimming pools or hot tubs. 

In addition there are some notable business credits of which you should be aware. The Small Employer Pension Plan Startup Cost Credit enables certain small business employers, which in 2011 did not have a pension plan for the preceding three years, to claim a nonrefundable income tax credit for the expense of establishing and administering a new retirement plan for employees. The credit applies to 50% of qualified administrative and retirement-education expenses for each of the first three plan years. However, the maximum credit is $500 per year. The Credit for Employee Health Insurance Expenses of Small Employers, available for years beginning after 2009, allows eligible small employers a credit for certain expenditures to provide health insurance coverage for its employees. Generally, employers with 10 or fewer full-time equivalent employees (FTEs) and an average annual per-employee wage of $25,000 or less are eligible for the full credit. The credit amount begins to phase out for employers with either 11 FTEs or an average annual per-employee wage of more than $25,000. The credit is phased out completely for employers with 25 or more FTEs or an average annual per-employee wage of $50,000 or more. The credit amount is 35% of certain contributions made to purchase health insurance.

The new rules for estates include a maximum tax rate of 35% and a $5 million exemption for 2011 and 2012. The exemption is the amount you can leave to heirs, tax-free, and it applies to lifetime gifts as well. Therefore, you and your spouse could gift up to $10 million of cash, investments, or ownership in a business without incurring gift tax. That’s in addition to your annual exclusion of $13,000 per recipient.

Qualified small business stock issued and acquired in 2011 will be able to exclude 100% of any capital gain from income if the qualified stock is held for at least five years and all other requirements are met. Prior to 2011 taxpayers were allowed to exclude 50% of any capital gain from the sale or exchange of qualified small business stock provided that certain requirements are met, including a five-year holding period.

While regular income tax rates and the maximum rates that apply to long-term capital gains and qualifying dividends were extended through 2012, the latest Alternative Minimum Tax (AMT) “fix” (in the form of increased AMT exemption amounts) is effective only through 2011. So, if you think you may be subject to the AMT this year, the good news is that you know ahead of time what the relevant exemption amounts are ($74,450 for married individuals filing jointly, $48,450 for unmarried individuals, $37,225 for married individuals filing separately); the bad news is that the AMT situation for 2012 remains up in the air. You can probably expect another AMT fix later this year, but as it stands now, AMT exemption amounts will drop significantly in 2012, dramatically increasing the number of taxpayers locked into this parallel tax system.

2011 is also the last year for individuals age 70½ or older to make qualified charitable distributions (QCDs) of up to $100,000 from an IRA directly to a qualified charity, unless Congress passes additional legislation. These charitable distributions can be excluded from your income, and count towards the annual required minimum distribution.

Equally as important as taking advantage of expiring and temporary tax provisions are implementing and understanding tax planning strategies that revolve around timing. Below are some timing related tax planning strategies that can bring about significant tax savings.

Defer Income to 2012. If you expect your Adjusted Gross Income (AGI) to be higher in 2011 than in 2012, or if you anticipate being in the same or a higher tax bracket in 2011, you may benefit by deferring income into 2012. Deferring income will be advantageous so long as the deferral does not bump your income to the next bracket. Some ways to defer income include: 

• Delay Billing: If you are self-employed and on the cash-basis, delay year-end billing to clients so that payments will not be received until 2012. 
• Interest and Dividends: Interest income earned on Treasury securities and bank certificates of deposit with maturities of one year or less is not includible in income until received. To defer interest income, consider buying short-term bonds or certificates that will not mature until next year. If you have control as to when dividends are paid, arrange to have them paid to you after the end of the year. 

Accelerate Income into 2011. In limited circumstances, you may benefit by accelerating income into 2011. For example, you may anticipate being in a higher tax bracket in 2012, or perhaps you will need additional income in order to take advantage of an offsetting deduction or credit that will not be available to you in future tax years. Note, however, that accelerating income into 2011 will be disadvantageous if you expect to be in the same or lower tax bracket for 2012. If accelerating income will be beneficial, here are some ways to accomplish this:

• Accelerate Collection of Accounts Receivable: If you are self-employed and report income and expenses on a cash basis, issue bills and attempt collection before the end of 2011. Also see if some of your clients or customers might be willing to pay for January 2012 goods or services in advance. Any income received using these steps will shift income from 2012 to 2011.
• Year-End Bonuses: If your employer generally pays year-end bonuses after the end of the current year, ask to have your bonus paid to you before the beginning of 2012.

• Retirement Plan Distributions: If you are over age 59 1/2 and you participate in an employer retirement plan or have an IRA, consider making any taxable withdrawals before 2012. 

Deduction timing is also an important element of year-end tax planning. Deduction planning is complex, however, due to factors such as Adjusted Gross Income (AGI) levels and filing status. If you are a cash-method taxpayer, remember to keep the following in mind: 

• Deduction in Year Paid: An expense is only deductible in the year in which it is actually paid. Under this rule, if your tax rate is going to increase in 2012, it is a smart strategy to postpone deductions until 2012. 
• Payment by Check: Date checks before the end of the year and mail them before January 1, 2012. 

• Promise to Pay: A promise to pay or providing a note does not permit you to deduct the expense. But you can take a deduction if you pay with money borrowed from a third party. Hence, if you pay by credit card in 2011, you can take the deduction even though you won't pay your credit card bill until 2012. 
• AGI Limits: For 2011, the overall limitation on itemized deductions is terminated. In addition, certain deductions may be claimed only if they exceed a percentage of AGI: 7.5% for medical expenses, 2% for miscellaneous itemized deductions, and 10% for casualty losses.  

• Standard Deduction Planning: Deduction planning is also affected by the standard deduction. For 2011 returns, the standard deduction is $11,600 for married taxpayers filing jointly, $5,800 for single taxpayers, $8,500 for heads of households, and $5,800 for married taxpayers filing separately. If your itemized deductions are relatively constant and are close to the standard deduction amount, you will obtain little or no benefit from itemizing your deductions each year. But simply taking the standard deduction each year means you lose the benefit of your itemized deductions. To maximize the benefits of both the standard deduction and itemized deductions, consider adjusting the timing of your deductible expenses so that they are higher in one year and lower in the following year. You can do this by paying in 2011 deductible expenses, such as mortgage interest due in January 2012. 
• Medical Expenses: Medical expenses, including amounts paid as health insurance premiums, are deductible only to the extent that they exceed 7.5% of AGI. Consider bunching medical expenses into years when your AGI is lower.

• State Taxes: If you anticipate a state income tax liability for 2011 and plan to make an estimated payment, consider making the payment before the end of 2011. Note that in 2011, taxpayers may elect to deduct as an itemized deduction state and local sales taxes instead of state and local income taxes. This benefits taxpayers that reside in states without an income tax. This provision expires at the end of 2011, so you may want to take advantage of it now by making large purchases in 2011 rather than waiting until 2012. 
• Charitable Contributions: Consider making your charitable contributions at the end of the year. This will give you use of the money during the year and simultaneously permit you to claim a deduction for that year. You can use a credit card to charge donations in 2011 even though you will not pay the bill until 2012. A mere pledge to make a donation is not deductible, however, unless it is paid by the end of the year. Note, however, for claimed donations of cars, boats and airplanes of more than $500, the amount available as a deduction will significantly depend on what the charity does with the donated property, not just the fair market value of the donated property. If the organization sells the property without any significant intervening use or material improvement to the property, the amount of the charitable contribution deduction cannot exceed the gross proceeds received from the sale.

• Capital Gains Tax: To avoid capital gains tax, you may want to consider giving appreciated property to charity.  

This broad discussion of tax planning and strategies by no means covers the multitude of provisions and options available to taxpayers for 2011. All taxpayers have unique situations and tax planning is a highly personalized process.  As your tax professionals at Dawson & Associates it is our intention to demonstrate the importance of taking a proactive approach to your taxes and motivate all our clients to take advantage of the tax saving options available. Because tax planning is a time sensitive endeavor we encourage you to contact us as soon as possible to implement an effective 2011 tax strategy,