End-of-Year Tax Planning (With and Without Bush Tax Cuts)

10 December, 2010

It’s already the end of the year (where did the time go, right?), which means it’s also time to put together some year-end tax strategies that will help place you in a good financial position for when it’s time to file for the 2010 tax year. There are so many considerations, including how your taxes will be affected if Bush tax cuts expire on Dec. 31, 2010. That’s why it’s good to do your tax planning now.

To help you get started, we will first look at some general year-end tax strategies that would apply according to current tax standards. Then we can zero in on how your taxes might be affected (and what strategies you could consider) if the Bush cuts actually do expire.

The Strategy Behind Preparing Your Year-End Taxes

Typically, the strategy for planning your end-of-year taxes involves reducing the amount of income that can be taxed by Uncle Sam. This is generally accomplished by doing two things:

Deferring as much income as possible to the following tax year
Accelerating your deductions, or bringing as many of them as possible into the current year

An example of deferring your income would be putting off selling a home or stocks until next year (if they would sell for a gain) to avoid having them count as income and paying the capital gains tax. As for deductions, you might pay your property tax or make your charitable donations before the year is over to claim as many as possible.

Tips for Reducing Your Total Tax in 2010 (with Bush Tax Cuts)

If you want to reduce your total tax in 2010 as you have in previous years (with Bush tax cuts intact), you could defer your income. Here are a few strategies to get that done:

See if your employer will pay out any bonuses in Jan. 2011 instead of 2010.
You could convert your pre-tax retirement savings (like flex accounts and health savings accounts) to a Roth IRA and then opt to report the income in 2011.
Avoid taking your IRA or other retirement distributions until January.

If you also want to accelerate your deductions (or claim them in 2010) to reduce your taxes, you could:

Increase your 401(k) and IRA contributions to have more to deduct.
If you owe school tuition and other fees, pay them before the end of the year.
Sell off your stocks and other investments that have lost value to claim your losses on the 2010 tax return.
Pay your tax deductible expenses (medical bills, donations, etc.) in 2010 instead of 2011.

In addition to the above tips, see if you qualify for itemized deductions by determining whether your itemizations will add up to more than the standard deduction for the year. Claiming itemized deductions helps to lower taxable income even more.

Understanding the Bush Tax Cuts Expiration

What’s interesting about the end of the 2010 tax year is that, unlike other years we’ve seen recently, we may be facing a major increase in a number various forms of personal tax thanks to the Bush tax cut expiration.

Almost a decade ago, former President George W. Bush provided Americans a number of cuts that saved taxpayers quite a bit of money. However, those tax cuts are set to expire on Jan. 1, 2011. If they do, we could see the following tax adjustments:

Income taxes: The current income tax brackets are the following rates: 10, 15, 25, 28, 33 and 35 percent. However, if the Bush tax cuts expire, the current brackets will be replaced by the following higher rates: 15, 28, 31, 36 and 39.6 percent. Big difference indeed!
Capital gains and dividends: Currently, the maximum federal rate on long-term capital gains and dividends is 15 percent. However, if the cuts expire, the capital gains rate will increase to 20 percent and the dividends rate will increase to a whopping 39.6 percent.
Marriage penalty: Currently, married couples filing jointly see a standard deduction of 200 percent of the amount of a single filer. However, if the cuts expire, their deduction amount drop to about 167 percent of what single filers receive, increasing their tax liability.
Estate taxes: Losing the tax cuts could result in taxpayers paying as much as 55 percent in estate taxes.

While no one knows for sure what will happen with the Bush tax cuts, experts suggest planning for these massive increases just in case.

Tips for Managing Taxes if Bush Tax Cuts Expire

In the event that the Bush tax cuts expire, experts recommend you consider pulling as much income as possible into 2010 to avoid it falling into the higher tax rate year. Also, you will want to push as many deductions as possible into 2011.

In order to accelerate your income (have it land in the 2010 tax year), you’ll want to:

Get your bonuses paid out in 2010.
Sell your stocks and investments that have gains before the end of the year.
Take your retirement distributions in 2010.
Convert your pre-tax IRAs and 401(k)s to a Roth account and report the income in 2010.

If you want to defer your deductions (or use them for 2011):

Avoid paying your deductible expenses until next year.
Don’t sell your investments that will lose money until next year.

By taking this route, you could take as big a hit as possible in 2010 while taxes are lower to avoid getting penalized for higher income and higher taxes in 2011.

Other Tax Strategies for 2010

Getting the most bang for your already-paid buck does not just involve deductions and income adjustments. You also want to take advantage of as many qualifying tax credits that expire this year as possible.

Here are some to make note of:

Energy efficient credit: This credit gives you money for certain energy-efficient home repairs you make, including replacing windows, doors and installing new insulation. The credit is federal and expires at the end of 2010.
Earned income credit: In 2010, claiming the credit for a third child will end. In 2011, you will only be able to claim it for two children.
American Opportunity credit: This undergraduate education credit will expire at the end of 2010 and revert back to the Hope credit, which offers money for the first two years of undergraduate education.
Child tax credit: Claim $1,000 per child in 2010. This amount will reduce to $500 per child in 2011.
Making Work Pay credit: If you haven’t already had $33 added to your paychecks each month then you can claim a $400 (single filers) or $800 (joint filers) credit in 2010.
Hybrid vehicle credit: You may be able to take advantage of this credit if you purchased a new hybrid vehicle in 2010.
Computers as a qualified expense: This credit for section 529 college savings plans expires at the end of the year.
Child and dependent care credit: This credit is available for the first $3,000 of day care expenses for one child and the first $6,000 of day expenses for two children up to 35 percent of expenses in 2010. It will be reduced to $2,400 (one child) and $4,800 (two children) with only 30 percent of expenses to claim in 2011.

There’s no doubt that filing taxes is a balancing act. It requires you to balance your income, deductions and credits wisely to minimize your tax liability while taking into consideration all adjustments that could occur in the following tax year. By planning responsibly now, you can sit back comfortably and wait to see what surprises Uncle Sam brings in the new year.

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