Safety First in Year-end Tax Planning

The end of the year is often the preferred time for tax planning. Reason: You may have the flexibility to shift income and deductions to your tax benefit. However, tax planning in 2011 is shrouded in doubt as talk of major tax reform heats up. At this writing, there has been no definitive resolution of the federal budget dilemma by the government, which has commissioned a “super panel” to make recommendations. This could ultimately result in new tax legislation.

Nevertheless, several tax strategies for individuals appear to be relatively “safe” in this uncertain environment. Here are some prime examples.

2011 Tax Strategies for Individuals

Capital gains and losses: If it is warranted, you may realize capital losses to offset capital gains from earlier in the year. Any excess can offset up to $3,000 of ordinary income in 2011. Conversely, capital gains realized at year-end may absorb prior capital losses. For 2011, net long-term capital gain for the year is taxed at a maximum rate of 15%, while the rate is 0% for taxpayers in the regular 10% or 15% brackets. (These tax breaks are scheduled to expire after 2012.)

Charitable gifts: Generally, you can deduct the full amount of cash donations made before the end of the year. If a donation is made by credit card, you can deduct the gift on your 2011 return, even if the charge is not actually paid until next year. Caveat: The tax law includes strict substantiation rules for monetary contributions and additional record-keeping requirements for gifts of property.

Alternative minimum tax: Despite another bump in the exemption amounts, you still may be among the millions who owe the alternative minimum tax (AMT). Have your professional tax adviser estimate your AMT liability for 2011. Depending on the outcome, it might make sense to shift certain “tax preference items” to 2012 to avoid or reduce AMT liability. Alternatively, you might accelerate income into this year if the AMT rate is lower than your expected top tax rate. The AMT rate is 26% on taxable income up to $175,000; 28% above that figure.

Family income-splitting: You may be able to reduce the overall family tax bill by shifting income-producing assets to family members, such as your children, in lower tax brackets. However, the “kiddie tax” may undermine this strategy. Generally, unearned income over $1,900 received in 2011 by a child younger than 19 or a full-time student younger than 24 is taxed at the parents’ top marginal tax rate.

Medical and dental expenses: You may deduct unreimbursed medical and dental expenses to the extent the annual total exceeds 7.5% of your AGI. When it is feasible, try to bunch nonemergency expenses (e.g., new eyeglasses or dental cleanings) in the tax year that provides the best opportunity for a deduction. For instance, if you have already cleared the 7.5%-of-AGI hurdle for 2011, any additional expenses are deductible.

Estimated tax penalties: An “estimated tax penalty” may be assessed if you do not pay sufficient income tax during the year through any combination of withholding or quarterly installments. But no penalty is imposed if payments equal to 90% of your 2011 liability or 100% of your 2010 liability (110% if AGI was above $150,000) are made. When possible, adjust withholding to qualify under one of these “safe harbor” exceptions.