Year-End Tax Planning in 6 Easy Steps
December 30, 2010, By Art Giacosa 0 comments
Gentlemen, it's that time of the year again. You're up to your eyeballs in gifts, party planning and shoveling snow off your driveway. What's different this year is that your government has yet to make a decision as to what your taxes will be in 2011 and beyond. As I write this, the House is taking up a last minute debate on the amount of taxes you will be paying next year. If they don't agree before the end of the year, our taxes are all going up next year. So, while this soap opera is playing out, what year-end planning should you be thinking about?
Here are some tips for you to think about:
1. Pay yourself. The most basic way to reduce your income taxes is to lower the income that today is subject to income taxes. If you have a retirement plan such as a 401K or IRA, see if you can make a lump sum contribution in December. The amount that you contribute reduces the amount of tax you will have to pay. Contributions to IRA and Keogh plans can even be made up to the time of your tax filing deadline and still get the benefit for 2010.
2. Give away money. Donations to charities are deductible expenses. If you are going to itemize deductions this year, make the donations you are planning to make early next year in December instead. There are also special charitable deductions such as the Haiti Relief Efforts that allows you to deduct donations to charities providing relief to the Haiti earthquake victims between January 12 and February 28, 2010. These deductions may be applied to your 2009 or 2010 tax return.
3. Prepay for stuff. It's called "accelerating deductions." By prepaying for deductible things that you would be paying next year like property taxes, city taxes or even mortgage interest payments, you can lower your tax hit this year.
4. Take your losses. In tax-speak this is called "loss use optimization." If you have taxable investment accounts, check to see if you have any investment losses. If you sell these positions (i.e., recognize the tax loss), you can use up to $3,000 of it to offset ordinary income. The full amount can be used to offset any capital gains that you may have recognized this year. Of course, don't make a decision to buy or sell investments based solely on taxes. However, if it makes sense economically, it's certainly something to consider.
5. Share your savings. With the estate tax coming back next year (rate to be determined), it may be important for you to begin thinking about passing assets out of your estate. One great way to do so is by making annual gifts to kids. You can gift up to $13,000 per year, per person without a gift tax.
A great use of this gift is to fund section 520 plans for your kids. Funds inside a Section 529 plans grow tax free and withdrawals for qualified educational expenses are nontaxable. You can even over fund it by contributing five year's annual exclusion if you make a proper election on your gift tax return.
6. Think strategically. Consider converting your traditional IRA into a Roth IRA that offers tax-free growth and no tax on withdrawals. Although you may have to recognize income on the conversion, it may be split between 2011 and 2012. And if you're lucky enough to have a sizable taxable investment portfolio, talk to your estate planner about setting up a grantor retained annuity trust (GRAT) in December. The rate for December is 1.8 percent and it's never been lower. Any appreciation in the GRAT above 1.8 percent passes tax-free to your beneficiaries.
The more you focus on this during this time of the year, the happier you will be in April. After all, managing your taxes is as much your responsibility as shoveling that driveway.
