Big changes may be in the offing. Absent congressional action, on January 1,
2011: the 33% and 35% individual tax brackets will increase to 36% and
39.6%; the maximum tax rate for long-term capital gains will rise from 15%
to 20% for most taxpayers; and dividends will be taxed at the ordinary income
tax rates (as high as 39.6%) instead of the capital gains tax rates. Despite this
uncertainty, many of the strategies below could potentially save you a lot of tax
dollars. This list is far from comprehensive, so let’s sit down with your tax or legal
advisors and have a conversation.
Tax planning
Carefully time your loss recognition. Consider selling assets this year in
taxable (i.e., nonretirement) accounts that have generated losses to use those
losses to offset taxable gains. If, however, you anticipate large short-term gains
in 2011, you may consider delaying tax loss harvesting of short-term losses until
next January, being careful not to delay any sales so long that the holding period
exceeds one year, which would convert the more favorable short-term losses into
long-term losses.
Net gains and losses. Match your short-term gains and losses and long-term
gains and losses to determine your capital gains and loss carry forwards. Note
that you can use $3,000 of net capital loss to offset ordinary income for 2010
as well.
Trigger gains. If you believe that income tax rates will rise next year, consider
selling assets by December 31 to trigger capital gains tax at the present 15%
rate, and defer losses until next year.
Review your deductions. To accelerate deductions, pay deductible expenses
(unreimbursed medical expenses, property tax) in 2010, or defer those
deductions to 2011 for a greater benefit if income tax rates rise.
Savvy moves to consider making
before ringing in the new year.
Roth IRA conversion. Consider whether it makes sense to convert a
traditional IRA to a Roth IRA. If you convert by December 31, you can
recognize the income in 2010 or elect to declare 50% of the income in 2011
and 50% in 2012. It may make sense in your situation to recognize all of
the income in 2010 in anticipation of potentially higher income tax rates in
the near future.
AMT liability: Review with your tax advisor to see where you stand for
2010 relative to the alternative minimum tax (AMT). If you are subject
to AMT, and you have the ability to defer income from 2010, consider
deferring if you may not be subject to AMT in 2011. If you are not subject to
AMT, consider accelerating income (like exercising ISOs) that would have
negative AMT consequences. Also consider accelerating deductions (like
property tax payments) that would not provide an equivalent tax benefit in
a year in which you were subject to AMT. In short, any analysis of the
merits of accelerating or deferring income or gains should take AMT
liability into account.
Options: You may also wish to exercise nonqualified stock options
(NQSOs) in 2010 in anticipation of potentially higher income tax rates
next year.
Investment planning: Wash sale rule. In general, the
“wash sale” rule prohibits you from recognizing losses if you purchase
substantially identical stock or securities within 30 days before or
after the sale. If you don’t want to wait 30 days to buy the same stock or
security, you may consider replacing the investment you sold at a loss with
an exchange traded fund (ETF) tied to the company’s industry or sector.
Fixed income gains. This year has been another strong year for bonds
and bond funds as interest rates are at or near all-time lows. If triggering
gains otherwise makes sense, consider selling appreciated bonds to trigger
the long-term capital gain. Assuming you can repurchase the same bond,
your new basis would be the new purchase price. Because bonds mature
at a price of 100, and your basis would be over 100, you can amortize
the premium over the remaining term of the bond, in effect realizing a
capital loss each year that can be used to offset other income.
Retirement planning: Maximize contributions to Individual Retirement Accounts.
Make 2010 contributions to Roth or traditional Individual Retirement
Accounts by April 15, 2011. The 2010 maximum deductible contribution
limits to a traditional or Roth IRA are $5,000 for those under age 50, or
$6,000 for those age 50 or older, (although the maximums may be
reduced, depending on your MAGI). RMDs. Required Minimum
Distributions (RMDs) generally must be taken from retirement plans by
December 31. If you have more than one IRA, you can take the RMDs for
multiple IRAs from one account. The same holds true for 403(b) plans,
but not for other types of employer sponsored retirement plans, like 401(k)
and 457(b) plans.Asset selection for RMDs. When
selecting assets for an RMD, you may wish to consider the transfer
of an appreciated bond held in the retirement account. If the bond is
distributed as part of an RMD, your basis in the bond will be its (premium)
price on the date of distribution. You can then amortize that premium over
the remaining term of the bond, in effect realizing a capital loss each year.
The high coupon would be earned in a taxable account rather than in the
tax-free environment of the IRA, however, so that adverse consequence
will need to be weighed against the benefit of the capital loss.
Information supplied by UBS Vice President- Investments; James Percifield