Planning Next Year’s Tax with This Year’s Return
Don’t close your income tax return file just yet. You need that tax return to plan for the rest of this year and next year. Tax planning used to be something you could do near year-end. These days, it should be more of a year-round activity, and last year’s tax return is the best place to start. Here are issues to consider when using your return to lower future taxes.
Is the AMT a possibility in 2010? The alternative minimum tax traps more middle income Americans each year. The last few years Congress passed a one-year “patch” that increased the AMT exemption and kept it from trapping many Americans. So far, Congress hasn’t passed an AMT patch for 2010, so you could be at risk. Silver taxpayers tend to be among those who are trapped, because they can have a lot of charitable and other deductions relative to their incomes.
The AMT is a separate tax system, almost a flat tax. When your income starts to get “too high” you lose some deductions and other tax breaks. The top AMT tax rate is 28%, but you don’t benefit from the graduated lower rates on any of your income if you are subject to the AMT. For 2009, single taxpayers were exempt from the AMT if taxable income was up to $46,700 and $70,950 for married taxpayers. Without a patch, these exemptions could fall to $33,750 and $45,000. If you are subject to the AMT in 2010, you may want to defer some deductions or shift some income. We’ve discussed AMT strategies in past issues, and these discussions are in the Tax Watch section of the Archive on the members’ web site.
What is your 2010 tax rate? You need to estimate your income and deductions for the year. That means comparing what will be the same in 2009 and 2010 with what will be different. Then, you can estimate 2010 taxes and tax rates, and this leads to tax planning strategies. Consider whether you are likely to have one-time changes such as large capital gains or losses from asset sales, distributions from IRAs or other accounts, charitable contributions, or changes in your income.
When you know your likely 2010 situation you can make changes. A high tax rate could make you want to defer income by reducing IRA distributions or avoiding sales of assets. If you have investments generating taxable interest and dividends you don’t need for spending, you may want to change those investments into tax-exempt bonds or other investments that won’t generate current income. A higher tax rate also means you may want to increase charitable contributions or other deductions.
Should you convert a traditional IRA to a Roth IRA? We’ve covered this issue extensively, and it is the main tax planning issue for 2010. To help make your decision you can purchase the conversion spreadsheet from our web site at www.RetirementWatch.com and also review the articles in the IRA Watch section of the Archive on the members’ web site.
How many loss carryforwards do you have? Investors sold a lot of assets at losses from 2007-2009. Capital losses can be deducted in full against capital losses for the year, and an additional $3,000 of capital losses can be deducted against other income. Excess losses can be carried forward to future years. Investors who sold during the market decline likely have losses they haven’t used. Knowing the amount of these loss carryforwards now helps your planning for 2010. You may be able to sell appreciated assets without having to pay capital gains taxes because of carryover losses.
You also should look for opportunities to generate tax losses during the year. Most people wait until the last quarter of the year. But market declines can occur any time during the year. You should be alert for investment declines that create substantial losses. One way to recover these losses it to sell the assets and have the losses available to shelter capital gains from other assets.
What about 2011 taxes? Tax rates are set to rise in 2011 for upper-income taxpayers, long-term capital gains, and dividends. This should affect your planning for 2010. Assets you were strongly considering selling in 2011 or 2012 perhaps should be sold in 2010 to capture the lower tax rates. When you have flexibility in recognizing income, you may want to accelerate other income into 2010 instead of paying higher rates in 2011.
May 2010. RW
