Pending legislation complicates year-end tax planning

As 2009 comes to a close, it’s a good time to review your year-end tax planning strategies. Many traditional strategies are still effective for this year but you need to keep in mind the impact of pending federal legislation. Congress is debating health care reform, a possible second stimulus bill, extending many temporary tax breaks, and more.
Health care reform

Lawmakers are searching for ways to fund health care reform. The House Ways and Means Committee proposed a surtax on higher-income taxpayers. The Senate Finance Committee would impose a tax on high-dollar health insurance plans. Both proposals are controversial and it is unclear at this time if either or none will be part of a final bill. We’ll keep you posted on developments.

More definite are new restrictions on health flexible spending arrangements (FSAs) and health savings accounts (HSAs). Lawmakers are expected to cap annual maximum contributions to health FSAs at $2,500 (there is no limit under current law, although an employer is free to impose a limit). Moreover, you would no longer be able to purchase over-the-counter medications with health FSA dollars; only medicines with prescriptions would qualify. Congress may also double the additional tax for HSA withdrawals before age 65 that are not used for qualified medical expenses. If you have a health FSA or HSA, please contact our office and we can discuss ways to maximize its benefit.

Second stimulus

Congress is expected to approve an extension of federal unemployment benefits before year-end and may also extend the $2,400 exclusion of those benefits from tax. That’s good news for individuals without employment. The bill would have even broader impact if lawmakers use it as a vehicle for a “second stimulus.”

One of the most likely incentives to be attached to an unemployment benefits bill is the first-time homebuyer credit, which expires after November 30, 2009. For many individuals, the window of opportunity for taking advantage of the credit has already passed because you must close on a new home before December 1, 2009 to qualify for the credit rather than just sign of contract of sale before that date.

Several bills are pending in Congress to extend the first-time homebuyer credit. One proposal would extend the credit through December 1, 2010 and raise it to $15,000 (the current cap is $8,000). Another bill would eliminate the rules that generally limit the credit to lower and moderate-income individuals. If you are considering a home purchase, please contact our office and we can discuss this valuable credit in more detail.

Other provisions that could be attached to an unemployment benefits bill include extending COBRA premium assistance, the American Opportunity Tax Credit for college tuition, and the state and local sales tax deduction for motor vehicle purchases. Congress is also considering a new tax credit to reward employers that create jobs. Several ideas have been floated. One proposal would provide a $3,000 tax credit for each qualified new job created in 2010. Even though there is support for extending these provisions, Congress will want to keep the cost of any bill as low as possible.

Extenders

Taxpayers are often surprised to learn that many popular tax breaks, such as the state and local sales tax deduction, are only temporary. Congress made them temporary so they would not permanently add to the federal budget deficit. Because they are so popular, however, Congress usually has extended them in the past. Some of the incentives, like the research tax credit, have been extended so many times that some taxpayers incorrectly believe they are permanent.

For year-end tax planning purposes, it’s important to remember when these tax breaks will expire. Many of them are scheduled to sunset after December 31, 2009, unless Congress extends them.

Here are some of the tax breaks for individuals that are scheduled to expire after December 31, 2009:

• Temporary tax relief to victims of all federally-declared disasters;
• State and local sales tax deduction;
• Teachers’ classroom expense deduction;
• Higher education tuition deduction;
• Non-itemizers state and local real property tax deduction; and
• Tax-free distributions from IRAs for charitable contributions.

Some of the incentives for businesses that are scheduled to expire after December 31, 2009 include:

• Code Sec. 179 small business expensing;
• Bonus depreciation;
• Expanded net operating loss carrybacks for small businesses;
• Enhanced recovery periods for qualified leasehold improvements and restaurant property;
• 15-year recovery period for qualified retail improvement property;
• Brownfields remediation expensing;
• Subpart F active financing and look-through exceptions;
• Deduction for corporate donations of computer equipment for educational purposes; and
• Special expensing rules for film and production costs;

Because these incentives are popular, there’s a high likelihood that Congress will extend many, if not all, of them. Congress could extend these provisions before year-end or wait until next year and make them retroactive to January 1, 2010. Our office will alert you of developments.

Please contact our office is you have any questions about pending federal tax legislation

Businesses should consider asset purchases before 2009 tax incentives end

As the economic downturn took a toll on businesses, small and large, Congress reacted with legislation aimed at stimulating business investment. The Economic Stimulus Act of 2008, Emergency Economic Stabilization Act of 2008, and American Recovery and Reinvestment Act of 2009 all provide tax incentives for businesses, including additional 50 percent bonus depreciation, higher limits for first-year expensing, and shorter recovery periods for asset depreciation.

With many of these tax provisions set to expire at the end of 2009, business taxpayers with the cash and the credit score considering purchases of business equipment may want to maximize their potential tax savings before the end of the year. Taking advantage of these tax benefits can reduce current taxable income and increase cash flow.

Bonus depreciation

Bonus depreciation and Code Sec. 179 expensing are the primary business incentives set to expire at the end of 2009. Congress extended 50 percent additional first-year bonus depreciation through December 31, 2009 in the 2009 Recovery Act. You deduct 50 percent of the property’s cost basis in the first year, before reducing the basis for normal depreciation computed over the property’s recovery period (formerly called its useful life), including the first year. However, you can irrevocably “elect out” of bonus depreciation.

Bonus depreciation is available for property with a depreciation (recovery) period of 20 years or less, water utility property, off-the-shelf computer software, and qualified leasehold property (farming equipment also qualifies for bonus deprecation, as well as first-year expensing). The property must be new, and therefore begin with the taxpayer. It must be purchased and “placed in service” before December 31, 2009.

Vehicle depreciation

Through 2009, Congress raised the limits on depreciation of “luxury” automobiles for 2009. The first-year depreciation limit, which is ordinarily $3,060 for vehicles purchased in 2009, has been raised to $11,060 (an $8,000 increase) through the end of the year for property that would otherwise qualify for bonus depreciation. The both limits are higher for vans and trucks. To qualify, the vehicle must be used more than 50 percent for business. For the additional $8,000 deduction, the vehicle must be new. Used vehicles first used in a taxpayer’s business still qualify for a deduction, but only up to the $3,060 limit.

First-year expensing

In lieu of bonus depreciation, you can elect to write off part, or all, of the cost of one or more assets, up to the limit on “Code Section 179 expensing.” The limit is $250,000 through 2009. Unlike bonus depreciation, first-year expensing applies to tax years beginning in 2009. Therefore, a fiscal-year taxpayer is not faced with a December 31, 2009 deadline for acquiring property and placing it into service. Additionally, expensing can be claimed on used as well as new property, unlike bonus depreciation.

Note. If you expense property that is also eligible for bonus depreciation, you should deduct the expensed amount from the property’s basis before claiming deprecation. First-year expensing is limited to your taxable income for the year, and cannot be used to generate or increase a net operating loss for the current year. Thus, if you are operating at a loss you should not claim expensing.

The amount that you can expense must be reduced dollar-for-dollar by the amount of the Code Section 179 property placed in service during the year exceeds a specified threshold. The threshold for 2009 is $800,000. The benefit does not fully phase out until investment reaches $1.05 million.

Shortened recovery period

Congress reduced the recovery period from 39 years to 15 years for leasehold improvements, restaurant property and retail improvement property placed in service by December 31, 2009. Leasehold improvements also qualify for bonus depreciation as well.

Investing in assets for your business is not just about taxes. You need to consider whether buying business assets makes financial sense this year. However, if you are contemplating investing in your business this year, act before the end of 2009 to take advantage of these incentives.

If you have questions about these and other tax incentives for investing in your business, please call our office. In customizing a plan to your special business needs, we also will be ready to revisit any year-end strategy should Congress decide to extend, with or without modification, any of the depreciation and expensing tax benefits now available.

How Do I? Net capital gains and losses for year-end tax planning?

In order to effectively plan your investment transactions, you have to understand how, under federal tax law, you need to net or “offset” capital gains and losses that you experience. Netting your capital gains and losses can help achieve lucrative tax savings benefits and should be part of your year end tax strategy if you sell capital assets that result in gains and losses in 2009.

Historic lows

The current, historically low capital gains tax rates for 2009 and 2010 are only temporary. The current maximum rate of 15 percent is scheduled to sunset after 2010, as will the zero percent rate for individuals in the 10 and 15 percent income tax brackets. For 2011 and thereafter, the maximum long-term capital gains rate of 15 percent reverts to 20 percent, and for taxpayers in the 10 and 15 percent tax brackets, the capital gains rate increases to 10 percent, unless Congress takes action to extend the lower rates.

The Obama administration has signaled support for maintaining the lower capital gains rates for all but higher-income taxpayers. The Obama administration has proposed to increase the tax rate to 20 percent for single individuals with incomes above $200,000. The tax rate would also increase to 20 percent for married couples filing jointly whose incomes exceed $250,000. The higher rates would apply to tax years beginning after December 31, 2010.

Caution. Although qualified dividends are also taxed at the long-term capital gain rate (a maximum 15 percent), you cannot treat them as long-term capital gains for purposes of netting capital gains and losses. They are taxed independently of that process.
Important holding periods

Capital gains are taxed at different rates depending on how long you have held the asset. Capital gains and losses are classified as long-term (you’ve held the property for more than 12 months) or short-term (you’ve held the property for 12 months or less), also depending on how long you hold the property before you sell it. Net capital gain is the amount by which your net long-term capital gain is more than your net short-term capital loss.

Note. Capital gains and losses are reported on Schedule D, Capital Gains and Losses, and then transferred to line 13 of Form 1040.

Netting

Under the basic netting procedure, your total short-term capital gains and losses, and your total long-term capital gains and losses must be figured separately.

Note. Netting applies to all capital assets. There is no separate netting of stocks with stocks, for example. However, many individuals find that stocks are the only capital assets they have sold each year on a regular basis.

Your short-term capital losses (including short-term loss carryovers from a prior year) are applied first against your short-term capital gains (which would be taxed at ordinary income tax rates), if any.

If you have a net short-term loss at this point, it would then be applied against your net long-term gain. If you have a net short-term gain after netting against long-term losses, then your short-term gain is taxed at ordinary income tax rate. The netting process lets you offset your net long-term capital loss against any net short-term capital gain.

You can deduct from your ordinary income a net capital loss of up to $3,000. You can carry forward any unused net capital loss for an unlimited number of years until it is used up. Unlike a corporation, however, you generally cannot carry a capital loss back to an earlier year (although there are some specific exceptions).

Net short term capital gain (from assets held for 12 months or less) is taxed at the same rates as your ordinary income. Both long-term and short-term capital losses can always be used to offset capital gains, as well as up to $3,000 of ordinary income. However, an individual can only use $3,000 ($1,500 for married individuals filing separately) of net capital losses left after reducing capital gains by capital losses to off set ordinary income in any one year.

Moreover, if your net capital losses exceed the $3,000 deduction limit, you can deduct $3,000 of your losses against ordinary income and carry over the excess loss to the following year. The excess losses that are carried over can then be netted against capital gains in that year with any excess again deductible against ordinary income up to $3,000.

The $3,000 amount has not changed for many years. It is one of the few provisions in the Tax Code that is not indexed for inflation. Bills to increase the allowable amount have been introduced in Congress but so far none has come close to passage.

Example

In 2008, Mary had $30,000 of ordinary income, a net short-term capital loss of $2,000, and a net long-term capital loss of $3,000. Mary’s total capital loss deduction is $5,000. She can use $3,000 of her net losses to offset her ordinary income in 2008, and then carry over the remaining $2,000 of net capital losses to be used in 2009.

Caution. In selling securities, you also may have to contend with what’s known as the “wash sale” rule. This rule prevents you from realizing a capital loss if you engage in buy and sell transactions of “substantially identical” assets within 30 days of each other.

FAQ: Can I prepay mortgage interest and taxes to maximize 2009 deductions?

If you own a home, the interest you pay on your home mortgage may be one of your most valuable tax breaks available each year. The home mortgage interest deduction is a particularly important tax break in the early years of a home loan, when most of a homeowner’s payments each month go toward interest. In addition to home mortgage interest, two other valuable home-related deductions include the “points” (also known as loan origination fees or loan charges) associated with the loan as well as your property taxes.

To claim all of these deductions, however, you must itemize. In 2009, you might consider pre-paying a portion of your mortgage interest due in 2010, as well as possibly your real estate taxes, subject to certain limits. Prepaying your mortgage interest and real property taxes can be an effective year-end tax strategy, boosting the value of these tax deductions for 2009.

Mortgage interest and points

You may deduct “qualified residence interest” that you incur on up to $1 million that you borrowed to buy, build, or “substantially improve” your principal and/or a second residence, as long as the debt is secured by the home. You can also deduct interest paid on up to $100,000 of home equity debt incurred for any purpose. Moreover, you can generally deduct late fees and prepayment penalties incurred in connection with your mortgage debt.

Points. Points (also referred to as loan origination fees, loan discounts, discount points, or maximum loan charges) may also be deductible as interest. Points generally represent the cost of borrowing money (and can also include certain charges paid by the seller to a lender for the buyer’s mortgage). Points must generally be amortized over the life of the mortgage. However, you may deduct points in full in the year they are paid if:

– The loan is used to purchase or improve your principal residence;

– The loan is secured by the residence;

– The points did not exceed the points usually charged in the area where the loan was made; and

– The points were computed as a percent of the amount of the loan.

Mortgage interest deduction

Generally, home mortgage interest is claimed as an itemized deduction on your Form 1040, Schedule A (Itemized Deductions). You cannot deduct your mortgage interest if you use Form 1040A or Form 1040EZ, however. If you paid $600 or more of mortgage interest (including certain points and mortgage insurance premiums) during the year on any one mortgage, you will typically receive a Form 1098, Mortgage Interest Statement, or similar statement from your mortgage holder. This is the statement used for reporting mortgage interest received. Your mortgage lender is required to provide you, as well as the IRS, with a copy of the Form 1098 reporting the mortgage interest you paid during the year. You should typically receive the Form 1098 for mortgage interest you paid in 2009 by January 31, 2010.

Pre-paying your January 2010 mortgage interest in 2009

Mortgage interest that you owe for January 2010 is deductible in 2009 if paid in December (by December 31). Typically, home mortgage interest is paid in the month following its accrual. For instance, a January mortgage payment generally pays December’s interest. As such, if you pay your January 2010 mortgage interest payment by December 31, 2009, you can deduct your December interest in 2009 rather then in 2010.

Prepaying interest will not reduce the principal on your loan. Paying down the principal may be a better strategy than using the funds to prepay interest. You should also consider paying down debt for which the interest is not deductible (for example, credit card debt). Additionally, you’ll need to consider your other itemized deductions for 2009. Our office can help you explore the pros and cons of all these strategies.

To ensure that your prepaid January 2010 mortgage interest payment is reflected on your 2009 Form 1098, you will want to make the mortgage interest payment by mid-December 2009. If you make your mortgage interest payment after your lender’s 1098 is calculated, and sent to the IRS, you will have to compute the additional interest yourself and add it to the amount reported on your 1098. As a practical matter, too, some mortgage lenders have a policy, or even a clause in the mortgage note, not to accept any advance payment as a pre-payment. They will often balk at issuing a Form 1098 that states otherwise. Simply picking up the phone and confirming your bank’s policy before you move ahead with this strategy is often any easy solution to any uncertainty down the road.

Pre-paying property taxes

You may also want to consider prepaying property taxes. You may be able to prepay your 2010 property taxes by December 31, 2009 if property tax prepayment is allowed by your local tax assessor. You should contact your local property tax collector’s office to determine if prepayment is allowed. If your property taxes are collected in escrow by your mortgage lender, remember also that any prepayment of taxes to your lender is not considered a property tax payment for IRS purposes until the lender remits the payment to the property taxing authorities.

Real property taxes are generally claimed as an itemized deduction on Schedule A of your Form 1040. However, a temporary tax incentive for the 2009 tax year allows taxpayers who claim the standard deduction to also claim an additional standard deduction for property taxes, up to $500 individually and $1,000 for married couples filing a joint return.

November 2009 tax compliance calendar

As an individual or business, it is your responsibility to be aware of and to meet your tax filing/reporting deadlines. This calendar summarizes important tax reporting and filing data for individuals, businesses and other taxpayers for the month of November 2009.

November 4

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates October 28-30.

November 6

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates October 31-November 3.

November 10

Employees who work for tips. Employees who received $20 or more in tips during October must report them to their employer using Form 4070.

November 12

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates November 4-6.

November 16

Monthly depositors. Monthly depositors must deposit employment taxes for payments in October.

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates November 7-10.

November 18

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates November 11-13.

November 20

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates November 14-17.

November 25

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates November 18-20.

November 30

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates November 21-24.

FAQ: What tax breaks are officially ending this year?

The end of the 2009 year will also spell the end of many tax breaks for both individuals and businesses. Some of these tax breaks are “temporary” credits and deductions that Congress typically extends for another year or two at the last moment. Other sunsetting provisions are relatively new, with no previous track record on their being extended. In either case, however, the unfamiliar economic climate in which our nation finds itself makes predicting whether Congress will find the funding necessary to extend any particular tax break this time around, beyond 2009, a matter of guesswork. The following is a list of important tax breaks expiring at the end of 2009.

A word to the wise: if you can take advantage of any tax break on this list before 2009 closes, do so. At this point, you cannot -and should not– count on having any of them available in 2010.

Homebuyer tax credit. The first-time homebuyer tax credit expires sooner rather than later in 2009. That is, the credit expires November 30 - the credit provision requires that the residence be “purchased” by November 30, with “purchase” defined as taking place when title passes and the full purchase price is paid (that is, at the “closing”) and not earlier when the contract of sale is executed and a down payment is escrowed. The credit is equal to 10 percent of the purchase price of a principal residence, up to $8,000. It applies to homes purchased after December 31, 2008, and before December 1, 2009.

Itemized state and local sales tax deduction. The ability to deduct state and local sales taxes in lieu of state and local income taxes is available until December 31, 2009, when the itemized state and local sales tax deduction expires.

Higher education tuition deduction. The higher education tuition deduction, permitting taxpayers to take an above-the-line deduction for qualified tuition and related expenses, will expire this year. The maximum deductible amount is $4,000 for taxpayers with adjusted gross income not exceeding $65,000 ($130,000 for joint filers). Taxpayers whose income exceeds that limit but does not exceed $80,000 ($160,000 for joint filers) may deduct up to $2,000 in qualified expenses.

Additional standard deduction for real property taxes. If you claim the standard deduction and also have real estate taxes, you can take an increased deduction ($500 for individuals and $1,000 for married couples filing jointly) for your real estate taxes. This tax break is scheduled to expire at the end of 2009.

Teachers’ classroom expense deduction. The $250 above-the-line deduction for qualified classroom expenses will expire at the end of 2009. The deduction benefits teachers and other educators, from teachers’ aides to school principals, who used their own out-of-pocket money to purchase qualified classroom supplies, such as notebooks, scissors, paper, pens, markers and books. As an above-the-line deduction, the $250 tax break is available to non-itemizers as well.

Bonus depreciation. For businesses, bonus depreciation and enhanced “section 179 expensing,” both designed to - temporarily - encourage business to make capital investments, are set to expire at the end of 2009. Bonus depreciation can be claimed for both regular tax and alternative minimum tax (AMT) liability unless the taxpayer makes an election out.

Enhanced Code Sec. 179 expensing. Enhanced “section 179 expensing,” is set to expire at the end of 2009 in addition to bonus depreciation, as mentioned above. Qualified taxpayers may deduct up to $250,000 of the cost of machinery, equipment, vehicles, furniture, and other qualifying property placed in service during 2009. The $250,000 amount is reduced if the cost of all Code Sec. 179 property placed in service by the taxpayer during the tax year exceeds $800,000.

Research and development credit. The research and development, or R&D credit, is set to expire at the end of 2009. The credit is available for businesses that increase their research expenses. The credit is 14 percent of qualified research expenses that exceed 50 percent of the average qualified research expenses for the three preceding tax years.

COBRA subsidy. The COBRA premium assistance provided as part of the American Recovery and Reinvestment Act of 2009 (2009 Recovery Act) will not benefit individual involuntarily terminated from employment after December 31, 2009. The COBRA subsidy is only available to individuals involuntarily terminated from work between September 1, 2008 and December 31, 2009 The COBRA subsidy under the 2009 Recovery Act provides for individuals to pay only 35 percent of their COBRA premiums with employers paying the remaining 65 percent, for nine months.

Unemployment compensation. Although unemployment compensation is typically taxable income, the 2009 tax year provides a respite from taxability for up to $2,400 of unemployment income. However, the exclusion from taxable income for unemployment compensation is only available for 2009, and will expire at the end of the year unless Congress acts to extend this benefit.

Motor vehicle sales tax deduction. The deduction for sales tax paid on the purchase a new motor vehicle is available for vehicles purchased between February 17, 2009 and December 31, 2009. Taxpayers can deduct state and local sales and use taxes paid on the first $49,500 of the purchase price of the vehicle. The deduction can be taken whether or not the taxpayer itemizes deductions. However, if you deduct state and local general sales taxes as an itemized deduction, you cannot “double dip” and take the deduction for new car sales taxes.

AMT exemption amounts. For 2009, the AMT exemption amounts increased to $46,700 for individuals and $70,950 for married taxpayers filing jointly. However, these exemption amounts will decrease in 2010 to $33,750 for single taxpayers and $45,000 married taxpayers filing jointly.

Our office will continue to monitor the situation in Washington to be ready to advise you if any of the provisions set to expire at the end of 2009 are extended. With Congress busy with health care reform, the likelihood is that the fate of most if not all of the expiring provisions will remain uncertain for some time. In fact, some in Congress have been quietly discussing the possibility of not passing any extension until next year, and then making it retroactive to January 1. Stay tuned.