2009 year-end tax planning

Dec. 21, 2009

By Allen M. Schiff, CPA, CFE

As we approach December 31, your tax liability for the 2009 will be set in stone. Until then, year-end tax planning presents a unique last chance to lower your tax bill for 2009. It is an investment in time well worth considering.

By taking certain steps now, you can reduce the size of your tax liability. Especially this year, when Congress has inserted a handful of powerful but temporary tax breaks to get the economy moving again, you do not want to overlook any deduction or credit that you can take in 2009 to lower this year’s tax bill. Managing what income you recognize or defer can also pay dividends as you focus on balancing your tax rates between 2009 and 2010 and beyond. There is tax reform on the horizon and talk about an increase in income tax rates in the near future.

Many of the tax breaks in recent stimulus tax bills will expire at the end of this year. At this point, Congress cannot be counted on to extend any of them for 2010.

• For individuals, these expiring provisions include the itemized state and local sales tax deduction, the $4,000 higher education tuition deduction, the additional standard deduction for real property taxes, and the above-the-line $250 teachers’ classroom expense deduction.

• For businesses, bonus depreciation and enhanced “section 179 expensing,” both designed to encourage businesses to make capital investments, likely will be headed for extinction at the end of 2009.

These are a few examples of the tax incentives set to expire. As a result, accelerating qualifying expenses into 2009 to take advantage of these incentives, rather than incurring them early in 2010, may make a significant difference in your overall tax liability.

What’s on the horizon for 2010 and beyond is also crucial to effective year-end tax planning this year:

• In 2010, the opportunity to convert any IRA into a Roth IRA without the long-time $100,000 income restriction has many individuals already setting aside funds. Some people, however, may do better to convert to a Roth IRA before the end of 2009, when the value of their accounts, and the consequential income that must be recognized on conversion, are at historic lows. (See detailed article below)

• Effective for 2011, the Obama administration has proposed to increase the income and capital gains tax rates on single individuals with incomes of more than $200,000 and married couples with incomes exceeding $250,000. Stay tuned.

Year-end tax planning is not only about what is happening in Congress and the IRS. Addressing the changed circumstances in your life has always been a large part of year-end tax planning. What you planned for at the beginning of 2009 may not be what you are faced with now. Changes in your employment status, family, investments, or retirement plans raise new tax issues. For example:

• Self-employment, severance pay, sign-on bonuses, moving expenses, and COBRA health benefits — to name a few employment-related events — all present unique challenges.

• In your personal life, marriage, divorce, a larger family, and childcare or eldercare expenses that arose in 2009 can impact your tax situation.

• Investments, too, generally benefit from year-end tax strategies. You can take steps to balance out gains and losses. You also should take a year-end tally of dividends and interest to make sure they are paying the correct estimated tax for 2009.

Working to rebuild a retirement nest egg through maximizing deductible 2009 contributions, and making sure that rollovers from former employers are done correctly, should also be top priorities at year-end, along with your investment strategies. Schiff Wealth Advisers can help you with your investment strategies, if necessary.

Here is a special word about losses, especially as this difficult year draws to a close. Matching losses with gains is not necessarily a simple task in the tax law. Different rules apply to different losses. Losses can be ordinary losses, passive losses, at-risk losses, capital losses, hobby losses, casualty losses, gambling losses, or Code Sec. 1231 losses. Knowing the differences and acting before year-end to match them correctly can mean significant tax savings.

Planning for deductions and credits at year-end can also get complex but can be equally rewarding. Timing and qualification rules create traps and opportunities:

• Prepaying certain expenses, such as real estate taxes or mortgage interest, do not necessarily translate into a larger tax deduction(s) this year due to the Alternative Minimum Tax (AMT).

• Year-end charitable giving has generally been a smart way to reduce current year taxes, but strict timing rules and revised substantiation requirements for property donations cannot be overlooked.

• Homeowners should not ignore taking advantage of the new residential energy property credit, which has a unique set of rules on qualifying expenses and deadlines for installations. The credit is computed by multiplying 30% times your qualifying expenses — up to $5,000. Be sure to confirm your expenditure is “qualified” before you begin the process.

Understanding Roth IRA Conversions


No doubt you have heard many different opinions and various explanations about converting your Traditional IRA to a Roth IRA. Hopefully, this year-end tax planning letter will shed some light on the issue and help you decide whether to pursue conversion or not.

With a Traditional IRA you pay tax on any amount distributed to you. Additionally, once you turn 70½ you are normally required to take a “required minimum distribution” (RMD) whether you need the money or not. Roth IRA distributions are normally tax-free and there is no required minimum distribution. However, if you inherit a Roth IRA there will be required minimum distributions.

Depending upon your circumstances, you may want to consider converting some or all of your Traditional IRAs to Roth IRAs. Prior to 2010, if your modified adjusted gross income (MAGI) exceeded $100,000, you could not convert your Traditional IRA to a Roth IRA. Starting with 2010 the $100,000 limitation is being removed. Additionally, individuals electing to file married filing separate will be eligible to convert starting in 2010. The amount of the IRA converted is taxable to you. But any earnings after conversion will not be taxed as long as they remain in the Roth IRA for at least five years.

For 2010 only, you have a choice between paying the tax on the conversion all on your 2010 tax return, or splitting the income and reporting one half of it on your 2011 tax return and the other half on your 2012 tax return.

The following accounts are eligible for the Roth conversion: Traditional IRAs, 401(k) plans, Profit-Sharing Plans, 401(b) annuity plans, 457 plans, and “Inherited” 401(k) plans. “Inherited” IRAs and Educational IRAs cannot be converted.

Nonqualified distributions from a Roth are subject to taxation (for example, a distribution before the account is five years old).

The conversion amount does increase your taxable income. By doing so, you may be able to take advantage of certain tax attributes such as charitable deduction and other tax carryforwards. This additional tax is also somewhat offset by the lack of a required minimum distribution when you turn 70½, due to the RMD requirements as outlined above.

If you have a taxable estate, conversion to a Roth may save your estate taxes. Additionally, funding a Credit Bypass Trust with a Roth IRA is preferable to using a Traditional IRA. Be sure to ask your estate tax attorney about these suggestions.

If your AGI in 2009 will be slightly above $100,000, it may be possible to reduce it below $100,000 and then you will be eligible to convert to a Roth IRA in 2009.

As we have seen in recent years, investments can drop as well as increase in value. Assume you have converted a Traditional IRA valued at $150,000 in 2010. What happens if the IRA falls in value to say, $75,000? Do you still have to pay the tax on the $150,000? As long as it happens before October 15, 2011, you do not have to pay the tax. You can “recharacterize” the Roth back to a Traditional IRA. If you have already filed your tax return you may file an amended return to recoup the tax paid in error. This reverses that conversion and relieves you of any tax attributable to the conversion. You should wait 30 days and reconvert to a Roth so you pay tax on the reduced value of the account.

Planning Tip: When converting to a Roth IRA, it is advisable to set each investment or asset class in its own Roth IRA account. This way, if some investments fall in value and others increase, you can recharacterize only those asset classes that have lost value by asset class.

If your Roth IRA has declined in value and you are outside the recharacterization period, you may still be able to deduct the loss. Any loss that is recognized is shown on your tax return as a miscellaneous itemized deduction, subject to the 2% of the AGI floor (2% of your adjusted gross income). So, the loss will be limited by 2% of your AGI, but not lost forever.

Will a conversion of your Traditional IRAs to Roth IRAs make sense for you? An analysis of your situation will be necessary to answer that. As you know, all situations are different and there are too many factors to consider within the context of this newsletter.

If you would like more information on any of the planning strategies described in this article, contact Allen Schiff, CPA, CFE at [email protected], or Harold Hoffman, CPA, Tax Manager at [email protected]. For 2009 and beyond, if you need help with your investment strategies, contact Michael Schiff at [email protected], or Daniela Alpert at [email protected].

Allen M. Schiff, CPA, CFE, is the managing member of Schiff & Associates, LLC. In addition, he cofounded the Academy of Dental CPAs in October 2001. Schiff has more than 30 years of expertise in the area of dental practice management. His service offerings include business planning to obtain financing, transition planning, exit strategies, and long–range planning. Schiff has assisted dentists through the years with practice acquisitions and startups, as well as fraud prevention and associate contract analysis. He can be reached by e-mail at [email protected].