Seize Tax-Planning Opportunities at Year-end

The end of the year is usually an optimal time for tax planning. This year offers several new tax breaks under the 2009 economic stimulus law, as well as other time-tested techniques. Here are a few prime examples.

Individual Tax Strategies

Capital gains and losses: Depending on your situation, you may realize capital gains to offset capital losses from earlier in the year. Net long-term capital gain for the year is taxed at a maximum rate of 15%. For 2009, the rate is 0% for taxpayers in the regular 10% or 15% brackets. (This tax break expires after 2010.) Thus, it may make sense for children in lower tax brackets to sell securities or other property at year-end. Caveat: Be aware of potential “kiddie tax” complications (see below).

Alternative minimum tax: Despite slightly higher exemption amounts for 2009, you still may be required to pay the alternative minimum tax (AMT). At this time, have a tax professional estimate your AMT liability for 2009. It might be advisable to shift certain “tax preference items” to 2010 to avoid or reduce AMT liability. Alternatively, you might accelerate income into 2009 if the AMT rate is lower than your top marginal tax rate.

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 2009 return, even if the charge is not actually paid until next year. Caveat: The tax law imposes strict substantiation rules for contributions.

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 dilute this strategy. Generally, unearned income over $1,900 received by a child younger than 19 or a full-time student younger than 24 in 2009 is taxed at your top marginal tax rate.

New-vehicle deductions: If you purchased a qualified vehicle after February 16, 2009, and before January 1, 2010, you may deduct the sales and excise taxes attributable to the first $49,500 of the vehicle’s price. However, the deduction is phased out if your modified adjusted gross income (MAGI) exceeds $125,000 for single filers or $250,000 for joint filers.

First-time home buyer credit: A qualified first-time home buyer can claim a refundable tax credit equal to the lesser of $8,000 or 10% of the price of a home purchased before December 1, 2009. For this purpose, a “first-time home buyer” is defined as someone who has not owned a principal residence for three years prior to the purchase. The credit is phased out if your MAGI exceeds $75,000 for single filers or $150,000 for joint filers.

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 possible, try to bunch nonemergency expenses (e.g., new eyeglasses or dental cleanings) in the tax year that provides the best opportunity for a medical expense deduction. Note: Do not forget to include copayments and deductibles required under a company health insurance plan.

Business Tax Strategies

Business assets: Under Section 179 of the tax code, a business may “expense,” or currently deduct, the cost of qualified assets placed in service during the year. The new law preserves the maximum expensing allowance of $250,000. Also, a business may still qualify for 50% “bonus depreciation” deductions for certain assets placed in service in 2009. The two tax breaks may be combined for year-end purchases of business assets. 

Estimated tax: Normally, small-business owners may be liable for an “estimated tax” penalty if they don’t pay enough tax during the year. Exception: No penalty is imposed if annual payments equal 90% of this year’s tax liability or 100% of the prior year’s liability (110% if your AGI exceeded $150,000). Under the new law, you can base payments on 90% of the prior year’s liability if more than half your 2008 income came from small-business (i.e., a business with an average of fewer than 500 employees) activities.

Business travel: Travel expenses incurred by an employee—such as airfare, lodging and 50% of the cost of meals—may be deducted if the trips are business-related. When appropriate, you can move up business trips planned for January into December. This allows you to write off the travel expenses on your 2009 return instead of waiting until 2010. Caveat: Unreimbursed travel expenses must be deducted as miscellaneous expenses subject to the usual 2%-of-AGI limit.

Worker credits: A business may claim a Work Opportunity Tax Credit (WOTC) of up to $2,400 for each worker hired from one of several disadvantaged “target groups.” The new law creates two new groups eligible for the WOTC. For workers hired and starting work in 2009 or 2010, the WOTC covers unemployed veterans and “disconnected youth” between the ages of 16 and 24. Note: To be eligible for credits, workers must be properly certified.