Tax Saving Strategies for Your 2011 Form 1040

There is no better source for saving taxes than your AICPA member accountant.  Here is what the AICPA recommends that will not only help you complete your tax return, but may also help you minimize your 2011 tax bill.

Whether you’re training for a marathon, landing the job of your dreams or closing a sale, you’re not going to succeed without being well prepared and fully informed.  The same holds true when managing and preparing your taxes.

Waiting until the return due date of April 17th for the 2012 filing season to put your financial house in order is a straight path to paying higher taxes. To manage your taxes and minimize your tax bill, you need to know the rules of the game, which are constantly changing, and you want to take advantage of year-round tax-planning opportunities.

The Basics

An understanding of the tax-return filing process can make tax season a more positive experience, so we’ll begin by taking a quick look at a few of the basics, beginning with the standard deduction.

Standard Deduction

The standard deduction is the basic deduction all taxpayers can take.  Every year, the IRS adjusts the standard deduction to account for inflation. For 2011, the standard deduction is $5,800 if single or married filing separately and $11,600 if married filing jointly or qualifying widow(er)s. It’s $8,500 if head of household.  Taxpayers age 65 and older or taxpayers who are blind receive an additional standard deduction of $1,450 (single or head of household) or $1,150 (married filing jointly, married filing separately or qualifying widow/er).

Itemizing Deductions

An alternative to claiming the standard deduction is itemizing your deductions. To determine the best strategy, total all of your deductions. In general, if your total allowable itemized deductions are more than the standard deduction, then you should probably itemize, although there are exceptions. Itemized deductions include medical expenses, certain state and local taxes, sales taxes (in lieu of income taxes), mortgage interest, charitable contributions, casualty and theft losses, and other miscellaneous items such as tax-return preparation fees, investment advisory fees and unreimbursed employee business expenses. Tables for the sales tax deduction are provided in the IRS instructions.

In years past, high income taxpayers were required to reduce their itemized deductions by means of a “phaseout”.  There is no phaseout of itemized deductions for 2011.

If you find you’re getting close to exceeding the standard deduction limit, try bunching your tax breaks every other year. This allows you to claim the standard deduction one year and itemize the next, but it also allows you to plan for the maximum tax benefit.

Also, since itemized deductions are a factor in determining if you’re subject to the AMT, which we will be discussing in detail, some pre-planning might help if you’re in this situation.

Charitable Deductions

Making charitable contributions can instill a feeling of goodwill and tax laws have been created to recognize philanthropic efforts.

Donations you make by cash, check or credit card to qualified religious, charitable, educational or other philanthropic institutions are deductible up to 50% of your AGI, if you itemize your deductions. Contributions that are not deductible include those made to political groups, fraternities and sororities, certain scholarships, for-profit hospitals, and blood banks.  In general, if your cash donations exceed 50% of your income, you can carry them forward for up to five years.

Also, remember to obtain and keep a record to substantiate all donations, regardless of the amount, even cash donated to charitable organizations such as the Salvation Army’s Red Kettle drive during the holidays and when attending religious services. Substantiating documents range from a cancelled check and credit-card statement to a W-2 form and a written statement from the organization. The type and extent of documentation is usually determined by the amount of the donation.

Your charitable donations of more than $75 require a disclosure statement from the organization stating the value of any received benefit. Also, you can only deduct a charitable donation of $250 or more if you have a statement from the charitable organization showing the amount of money contributed, and a description, but not value, of any property donated and whether the organization did or did not provide you with any goods or services in return for the contribution.

Donating appreciated assets that qualify for the long-term capital gains treatment can actually do more to cut your tax bill. However, in most cases these donations are limited to 30% of income, with excess amounts carried forward for up to five years. When you give appreciated long-term securities to a nonprofit, you deduct the full market value of the asset at the time of the donation and you avoid paying capital gains tax on the appreciation. Be sure to follow substantiation and other requirements.

A tax deduction for clothing and household items is generally allowed only if the items are in good condition. Automobiles may be contributed to a charity, but the amount of the deduction may depend on what the charity does with the vehicle. These types of donations, as with other donations of tangible property, are included with your cash contributions to determine your annual limit. A single item with a value greater than $500 is subject to special substantiation rules.

Alternative Minimum Tax (AMT)

In addition to the regular income tax, more and more taxpayers are subject to the AMT.

The AMT applies to both higher-income taxpayers as well as to lower-income taxpayers with a large number of exemptions or other tax adjustments. Since the AMT is not indexed for inflation, taxpayers are increasingly finding themselves affected by the AMT.

Some items that can trigger the AMT include:

• A higher-than-average number of dependency exemptions
• Large deductions for state and local income taxes
• High real estate taxes
• Miscellaneous itemized deductions and medical expenses

Congress has attempted to limit the impact of the AMT by increasing the amount of exempt income.

For 2011, the AMT exemption amounts are $48,450 for single filers and $74,450 for married taxpayers filing jointly. However, the exemption amount begins to phase out when AMT income exceeds $112,500 if single or $150,000 if married filing jointly. Exemption amounts may decrease in 2012.Unfortunately, the AMT defies most traditional tax-planning strategies. If you’ve been close to the threshold, you’ll need to consult with your CPA for specific advice on how the AMT may affect you this tax season.

TAX STRATEGIES & INCENTIVES

Now that we have the basics behind us, it’s time to move further ahead.   Let’s consider six categories that every taxpayer can relate to:

• Family
• Education
• Job
• Home
• Investments
• Retirement

FAMILY

Let’s start with some tax breaks for which you may be eligible if you are raising a family. If you’re a parent, you want to be sure to take advantage of every tax-saving opportunity available. In this section, we’ll discuss:

• Kiddie Tax
• Child Tax Credit
• Adoption Credit
• Health Savings Accounts
• Health Flexible Spending Arrangements
• Dependent Care Tax Credit
• Long-term Care Premium
• Shifting Income

A credit is the best tax break you can get. Deductions reduce the amount of taxable income on which you must pay taxes, but tax credits reduce, dollar-for-dollar, the taxes you actually owe.

Kiddie Tax

A tax strategy long employed by parents was to shift assets to a child’s name with the result that the investment income would be taxed at the child’s lower tax bracket. However, recent changes make this strategy less beneficial.

To discourage income splitting of investment income between parents and minor children, the tax law has imposed a Kiddie Tax under which any investment income over $1,900 will be taxed at the parent’s tax rate. If a child has unearned income of $1,900 or less, the tax is computed based on the child’s regular tax liability. Thus, the first $950 of unearned income would not be taxed – that is the standard deduction amount for a child. The next $950 of unearned income would be taxed at the child’s tax rate. Even if the Kiddie Tax does apply, regular tax liability must be computed, with the child paying the higher tax liability.

The tax does not apply if both of a child’s parents were deceased at the end of 2011 and regular rules are followed to determine the child’s tax.

The Kiddie Tax applies to investment income of children in these three categories: (1) children under age 18 at the end of 2011, (2) children who are age 18 at the end of 2011 and do not have earned income exceeding 50% of their support for the year and (3) children age 19 through 23 at end of 2011 and who are full-time students and who do not have earned income exceeding 50% of their support for the year. The tax also applies if the child is married and files separately.

Child Tax Credit

The Tax Relief, Unemployment Insurance Reauthorization and Jobs Creation Act of 2010 extended the Child Tax Credit to tax years 2011 and 2012.  The credit is worth $1,000 for each qualifying child who is under age 17 at the end of the calendar year and who qualifies as a dependent – your son, daughter, adopted child who lived with you all year, stepchild or eligible foster child, brother, sister, stepbrother, stepsister, or a descendant of any of these individuals. The child must also be a U.S. citizen, resident or national. The Child Tax Credit is in addition to the child’s dependency exemption.  That means if you have three children, the child credit can potentially reduce your tax bill by $3,000.

Adoption Credit

There is good news for people who are planning to adopt a child under age 18 or a person incapable of self-care due to physical or mental challenges because there are two tax benefits that offset escalating adoption expenses.

In 2011, the adoption credit, which is fully refundable, rose to a maximum of $13,360 per child. Parents who work for companies with an Adoption Assistance Program can receive up to a $13,360 reimbursement from their employer for qualified adoption expenses without paying taxes on that benefit.

When adopting a child who is a United States citizen or resident, the family is permitted to take the credit in the year following the year when the actual expense was incurred. These expenses may be taken as a credit even if the adoption ultimately is not completed. Where a foreign adoption is involved, the family may not deduct any expenses, regardless of the year incurred, until the adoption is final.

When you adopt a child with special needs, you are allowed to claim the full credit regardless of actual expenses paid.

Health Savings Accounts

Health Savings Accounts (HSAs) are designed for individuals covered by a High Deductible Health Plan (HDHP) and are not covered by Medicare. HSAs offer a wide range of tax advantages: contributions within certain limits are tax deductible and earnings that accumulate within the account are not taxed until withdrawn, and even under those circumstances, withdrawals to pay for qualified medical expenses are tax free. However, withdrawals you may make for medical expenses that are not qualified are both taxable and subject to a 20% penalty unless you are age 65 or older or disabled.

Health Flexible Spending Arrangements

Although employees are increasingly responsible for some or all of their medical expenses, many companies are offering Flexible Spending Arrangements (FSAs) to help employees pay for these expenses. Employees can contribute some of their wages to these special accounts and the amounts are not taxed in 2011. Funds can be accessed any time during the year to pay for health insurance premiums as well as medical costs and other expenses not covered by insurance, although they must qualify as a deductible medical expense. Reimbursable medical expenses include prescription medications such as over-the-counter drugs prescribed by your doctor. Beginning in 2011, the cost of non-prescription drugs other than insulin can no longer be reimbursed by an FSA. The company’s plan determines contribution terms and limits. It is important to remember that funds not used during the year, or by the end of any grace period the plan may offer, are lost.

Dependent Care Tax Credit

Working parents know how expensive child care can be. The Dependent Care Tax Credit aims to ease some of the burden. Basically, the credit works like this: If you pay someone to care for a dependent under age 13, you may be eligible for a tax credit of up to $2,100. The credit is a percentage of qualifying expenses that range from 20% to 35%, depending on your AGI. You must have earned income to receive the credit and if married, file a joint return.

The dollar limit on the expenses toward which you can apply the credit percentage is $3,000 for the care of one qualified dependent and $6,000 for the care of two or more. Thus, the maximum credit allowed in 2011 is $1,050 if you have one qualified dependent and $2,100 if you have two or more qualified dependents.

Taxpayers should note that the dependent care credit is reduced by the value of qualifying day care provided by your employer under a written, non-discriminatory plan, which generally is not taxable up to $5,000 ($2,500 if married filing separately).

This credit is not restricted to child-related care costs. If you pay someone to look after an incapacitated spouse or dependent of any age, such as a parent or disabled family member, you may also be eligible for this tax break.

Long-term Care Premium

An increasing number of Americans require long-term care due to advanced age or chronic conditions. Unfortunately, nursing homes and their high costs, which can exceed $70,000 annually, are not covered by Medicare or supplemental Medicare insurance. However, long-term care insurance pays for this type of care and a portion of your premiums, based on your age, is tax deductible as a qualified medical expense. The deductible increased in 2011.

You can include your premiums for qualified long-term care services as medical expenses up to the following amounts:

• Age 40 or under - $340
• Age 41 to 50 – $640
• Age 51 to 60 - $1,270
• Age 61 to 70 - $3,390
• Age 71 or over – $4,240

Shifting Income

Investment strategies have to be right for you and appropriate for the economic environment. The current economy makes some of the following strategies more or less beneficial, depending on your circumstances. Income tax rates may increase after 2012, although there is also some movement to see the rates decreased. Regardless of what may ultimately happen, you need to be prepared to react to any change so I recommend that you first check with your CPA financial advisor on these matters.

Kiddie Tax

Let’s begin with strategies for how parents can save on taxes.  As we discussed earlier, shifting income to a child in a lower tax bracket can be a smart strategy and may provide the Kiddie Tax with a place in your overall tax plan. However, as I mentioned, it won’t pay to shift a significant amount of income to a child falling under the Kiddie Tax rules, but transferring a few income-producing assets to a child might still lower your overall tax bill.

Gift Tax

Be sure to also consider the gift tax when shifting assets. For 2011, you generally can give a gift to a child, or anyone else, valued at up to $13,000 each without being subject to the gift tax. It rises to $26,000 if your spouse agrees to split the gifts. The exclusion is allowed only for cash gifts or present interests in property.

Family Business

If you’re a sole proprietor, you can shift income by hiring your minor children to help in your business. In addition to providing valuable work experience for your child, this arrangement can offer tax savings to the business. As long as the work your children do is legitimate, you follow all the rules and your children receive reasonable wages, you can deduct their wages as a business expense and shift the money to your children in lower tax brackets. And as an added bonus, if your son or daughter is under age 18, you don’t have to pay Social Security or Medicare taxes on the wages you pay.  Also, since their wages are earned income, they are not subject to the Kiddie Tax.

EDUCATION

Education Strategies

Since in most cases education accounts for the greatest cost associated with raising kids, you’ll want to read carefully to learn all you can about the credits and deductions for education expenses. Keep in mind that these benefits are available to college students of every age.

Tax Credits

Two popular tax credits – the American Opportunity Tax Credit and the Lifetime Learning Credit – can help defray education expenses for you and your children. And because they are credits rather than deductions, they take a bigger bite out of your tax bill.However, you cannot claim both credits for the same student’s expenses in the same tax year so you’ll need to decide which credit delivers the greater tax savings.

American Opportunity Tax Credit

For 2011 and 2012, the American Opportunity Tax Credit, previously known as the Hope Scholarship Credit, is available to each eligible student and for the first four years of college or other postsecondary school that leads to a degree, certificate or other recognized educational credential. It does not apply to graduate-level courses.

The maximum credit is $2,500 per student for each year and 40% of the credit is refundable, meaning it can reduce your liability below zero and you can receive up to $1,000 even if you owe no taxes.The credit applies to 100% of the first $2,000 of costs and 25% of the next $2,000 of costs. This means you must spend at least $4,000 to obtain the maximum credit of $2,500.  Costs include tuition as well as student-activity fees required for enrollment and attendance. They also include books, supplies and equipment needed for a course of study that must be purchased from the educational institution as a condition of enrollment or attendance. This credit is allowed against the AMT.

Lifetime Learning Credit

The Lifetime Learning Credit provides a credit of up to $2,000 per year. It applies so long as the American Opportunity Tax Credit is not also being claimed for the same student and can be claimed for every year that you qualify to receive it. As its name suggests, the Lifetime Learning Credit can be used by you, your spouse or your dependent(s) for undergraduate, graduate and professional-degree expenses at an eligible educational institution – tuition as well as student-activity fees required for enrollment and attendance. It also applies to books, supplies and equipment needed for a course of study that must be purchased from the educational institution as a condition of enrollment or attendance. Unlike the American Opportunity Tax Credit that applies to each student, the Lifetime Learning Credit applies to each taxpayer and courses taken do not need to be toward a recognized educational credential.

Student Loan Deduction

If you’re paying off student loans, you’ll be happy to know that the rules for deducting student loan interest remain liberal. Taxpayers can continue to deduct up to $2,500 of the interest paid on a qualified student loan as an adjustment to gross income, regardless of how long it takes to repay the loan. And you don’t have to itemize in order to take this deduction. However, there is no deduction if you file as married filing separately, you are claimed as a dependent or the loan is from a related party or a qualified employer plan.Similar to many other provisions, the deduction is limited for certain income amounts.

Higher Education Tuition and Fees Deduction

In 2011, you can claim a tuition and fees deduction – up to $2,000 or $4,000 – as an adjustment to gross income for qualified expenses that you paid for higher education at an eligible educational institution. This deduction, which is available each year you qualify for it, generally applies to the same expenses as those covered by the American Opportunity Tax Credit and Lifetime Learning Credit. The deduction applies to you, your spouse and any dependents who you claim as an exemption. The deduction is barred if your filing status is married filing separately, you can be claimed as a dependent, or if you claimed the American Opportunity Tax Credit or Lifetime Learning Credit.  Similar to many other provisions, there are limits for certain income thresholds.

Qualified Tuition Programs (529 Plans)

Qualified Tuition Programs, also known as 529 Plans, give parents and other family members a tax-advantaged way to save money for college expenses. While there is no tax deduction or credit available on contributions to the plan, the money in the plan grows tax free and no tax is due on withdrawals if the distribution is used to pay for qualified higher-education expenses. There may also be state income tax breaks for plan contributors. Expenses include tuition, room and board, books, supplies, and fees. There is no dollar limit for these expenses. Unlike 2010, computers and other technology equipment and services are no longer qualified expenses.

529 Plans are often used as vehicles for gifts from family members, especially grandparents.

Prepaid Tuition Plans

When saving for tuition, you are not restricted to using your state’s savings plans and can use any state’s plan. The Internet is an invaluable research tool. However, if you select another state’s plan, you may lose a state tax deduction that some states offer to residents who use their state’s prepaid or 529 Plans. Many states have instituted savings plans substantially similar to 529 Plans that propose to create a prepaid tuition account for a student in that state. The amount contributed will depend on when the plan is begun and the child’s age. States have created actuarial tables that they believe will result in a fully funded tuition based on a schedule of deposits and investment-return rates.The advantage of these plans is that they guarantee tuition costs will be covered. However, they do not guarantee admissions, and they do not cover room and board and the cost of books. These expenses would have to be funded separately. The plans provide assistance if the student decides not to attend an in-state school; however, it may not cover the full tuition costs of these schools.In general, the tax treatment of these prepaid tuition plans is similar to 529 Plan rules.

U.S. Savings Bonds

Generally, investors who redeem U.S. savings bonds to pay for qualified higher education expenses may exclude the interest redeemed from gross income. The exclusion has no dollar limit and it applies to Series EE bonds issued after 1989 or Series I bonds.

JOB

Job Search Tax Benefit

For many of us, we spend the majority of our day on the job and the hours we typically devote to our work seem to grow even greater during rocky economic times. However, in addition to a paycheck, experience and hopefully some degree of satisfaction, we receive a number of benefits that have important tax implications, one of which pertains to our job search efforts.  Many unreimbursed expenses incurred as a result of employment are deductible as miscellaneous itemized deductions, though they can only be claimed to the extent they are greater than 2% of adjusted gross income. Included among these expenses are job search costs. These expenses are deductible if the search is for a job in the same line of work, regardless of whether a new position is obtained. However, if a period of unemployment is lengthy, the IRS may disallow the deduction. Also, expenses for finding a first job are not deductible.

HOME

Homeowner Strategies

Now let’s turn our attention to the tax benefits of owning a home, because as a homeowner there are many tax-saving opportunities available to you.

Deductions

Mortgage Interest

In most cases, you can deduct all of the interest you pay on any loan secured by your home if you itemize your deductions. Interest is generally deductible on up to $1 million ($500,000 if married filing separately) of home-acquisition loans. These are loans used to buy, build or substantially improve your principal residence or second home, and are secured by that same residence. Interest on a home-equity loan up to $100,000 ($50,000 if married filing separately) is also deductible. You can also use this deduction for one additional residence that you identify as your second home.This means you can deduct interest on total home debt up to $1.1 million ($550,000 if married filing separately).

As long as the home-equity loan is secured by your home, it doesn’t matter how you spend the proceeds. Home improvements, college tuition, debt consolidation or an exotic vacation – it’s up to you. Just be sure you have a plan to pay it back.

The IRS defines points as any extra charges paid by a home buyer at closing in order to obtain a mortgage. In effect, points are prepaid interest. Points paid to secure a loan for the purchase, construction or improvement of a principal residence are usually fully deductible in the year you paid them. Points paid to buy or improve a second home must be deducted ratably over the term of the loan.

Real Estate Taxes

After the home-mortgage interest deduction, the next most important tax break for homeowners is the deduction for real estate taxes. You can deduct as an itemized deduction real estate taxes and state and local property taxes on all the real estate you own. There are no limits on the dollar amount of real estate taxes you can deduct or on the number of homes for which you can claim the deduction. The only decision you may need to make is whether you prepay the coming year’s taxes or delay the current year’s taxes to see which way it might benefit you.

Selling Your Home

Excluding the gain on the sale of a home is another major incentive for buying a home. If you meet certain requirements, you can keep a significant portion of the profit of the sale of your principal residence without having to pay tax on the gain. Any gain is taxed as a capital gain so the amount owed is not as high. However, any losses on the sale of a principal residence are not deductible.

When you sell your principal residence, you can exclude from income up to $250,000 in gains ($500,000 if married filing jointly or a surviving spouse if the sale is within two years of the other spouse’s death). If you realize a gain on the sale greater than the exclusion, that amount is taxed at capital-gains rates.

To qualify, you must have owned and used your home as a principal residence for at least an aggregate of two of the five years preceding the sale.

The exclusion is available even if you took temporary absences, including vacations, or rented out the home while not living there.

Special rules are provided for sales of the home due to certain health issues, employment reasons or unforeseen circumstances, and for members of the uniformed services.

Keep in mind that if you took a First-time Homebuyer Credit, you may have to repay or recapture some or all of the loan/credit in 2011. Also, if you used your residence as a home office, you may need to make other adjustments.

First-time Homebuyer Credit

The First-time Homebuyer Credit does not apply to home purchases made in 2011 unless the taxpayer or his or her spouse is a specific public employee on extended official duty outside the United States. The credit for other homebuyers ended with purchases completed by or in contract on April 30, 2010.

However, if you claimed the 2008 credit for a home you purchased after April 8, 2008 and before January 1, 2009, in most cases the credit must be repaid, though interest free, over 15 years in 15 equal installments. For all taxpayers, no matter the year claimed, if you sold or otherwise disposed of the home, or used it differently in 2011, you generally are required to repay the complete credit when you file your 2011 tax return.

Home Energy Incentives

In 2011, homeowners can again claim tax credits for making certain energy-saving improvements to their home. These credits include the (1) Nonbusiness Energy Property Credit and (2) Residential Energy Efficient Property Credit. However, the credits are not as favorable as 2010.Under the Nonbusiness Energy Property Credit, homeowners can receive a credit of 10% of the costs of qualified energy-efficient improvements and 100% of the costs of certain energy property expenditures, although dollar limitations may apply to specific types of property, including a maximum lifetime credit of $500. Energy efficient improvements include insulated walls or ceilings; energy-efficient exterior doors and windows, including skylights; specially treated metal or asphalt roofs; and a high-efficiency furnace, water heater or central air conditioning system, and energy property expenditures such as certain heat pumps, water pumps and circulating fans.

The 30% Residential Energy Efficient Property Credit applies to costs for qualified residential solar panels, a geothermal heat pump, solar water-heating equipment, qualified solar electric property costs and small wind-energy property. This credit has no dollar limit or principal-residence requirement. A second 30% credit for qualified fuel-cell plantshas principal-residence and kilowatt-capacity requirements, and cannot be greater than $500 for each 0.5 kilowatt of capacity.

INVESTMENTS

Investment Strategies

Strategy and timing are as important as skill in investing, particularly with regard to taxes. There are a number of tax-smart investment strategies you may want to consider, especially in light of legislation that has lowered the tax rate on dividends and capital gains.These same strategies can be applied during today’s difficult economic times when many people have suffered substantial investment losses. However, be aware that Congress may make changes to them in the future.

Dividends

Qualified dividend income received by an individual shareholder is taxed at a top rate of 15%. It is taxed at 0% for taxpayers in the 10% or 15% income tax bracket.

Capital Gains Tax

The maximum tax rate on net capital gains remains at 15% for 2011. If you’re in the 10%or 15% income tax bracket, your tax rate on net capital gains is zero, and you will not be taxed for 2011. The Tax Relief, Unemployment Insurance Reauthorization and Jobs Creation Act of 2010 extended these tax rates through 2012.

To qualify for long-term tax treatment, an asset must generally be held for more than one year before it is sold. Capital gains on investments held for one year or less are taxed at regular income tax rates.

Offset Capital Gains with Losses

When it comes to investment decisions, knowing when to make a move is critical. Then there are times, such as those we are experiencing today, when many of our conventional ideas about investing are dramatically challenged. Many of you may be finding yourselves buying high and selling low, creating a loss.In 2011, capital losses are netted against capital gains. If your capital losses exceed your capital gains, you can deduct up to $3,000 of your combined long-term and short-term capital losses against ordinary income.

Any remaining net capital losses may be carried forward to future years and can be used to offset future gains. It is very important to keep track of these unused losses and whether they are short-term or long-term losses.

Keep in mind that an investment sold at a loss in 2011 need not be gone forever. If you believe it was a good long-term investment, you can buy it back. Just be sure to wait at least 31 days after the sale. Otherwise you’ll get caught up in the wash sale rule. This rule disallows losses on securities sold if substantially identical securities are bought within 30 days before or after the date of the sale, creating a 61-day wash-sale period, although the definition of “substantially identical” provides some flexibility.

RETIREMENT

Retirement Strategies

We all know that contributing to a retirement plan is a key step when working toward a secure retirement, but did you know it can lower your current income tax bill as well?

Employer Sponsored Plans

Pre-tax contributions to an employer-sponsored retirement plan reduce the amount of taxable wages you report on your tax return, making qualified retirement plans an excellent way to cut your tax bill. Matching contributions and income earned within your plan are also tax deferred. If you have a 401(k) and you haven’t arranged to contribute the maximum, try to increase your contributions before year end. This is especially important if your employer makes matching contributions, which, in effect, represents free money. For 2011, if you’re under age 50, your maximum contribution to a 401(k) plan is $16,500. Taxpayers who are age 50 or older by the end of 2011 can make an additional $5,500 “catch-up” contribution for that calendar year to reach $22,000 for 2011.

Individual Retirement Accounts (IRAs)

The top annual contribution for traditional or Roth IRAs remains at $5,000 for 2011. If you’re age 50 or older by the end of 2011, you can make an additional $1,000 “catch-up” contribution. You cannot contribute more than your qualifying income for the year, but if your spouse has little or no income, you can contribute to either a traditional IRA or Roth IRA for your spouse based on your earnings.

Traditional IRA contributions may be deductible depending on your modified AGI and whether you or your spouse (if filing jointly) is covered by an employer-sponsored retirement plan. Also, you must begin to take minimum required distributions from the IRA once you reach age 70 ½, but this does not apply to Roth IRAs.

Roth IRA contributions are not deductible, but you can withdraw them at any time tax free. You can also withdraw earnings on contributions tax free after five years if you are age 59½ or older, disabled or paying qualifying first-time homebuyer expenses.

You have until the filing deadline of April 17, 2012 to open and contribute to an IRA for 2011. But why wait? The sooner you contribute, the longer your money grows tax deferred or tax free.

Conversion to Roth IRA

Regardless of your filing status or income, you can convert traditional IRAs to Roth IRAs, with no dollar limit on the amount converted. However, the entire transfer must be reported as income unless after-tax contributions were made to any of your traditional IRAs. Although income tax is due on the amount converted, the 10% early-distribution penalty does not apply if you are under age 59½ and keep the funds in the Roth IRA for at least five years.  There is no modified AGI requirement needed for a conversion and it can be reversed no later than the extended due date for the 2012 tax return.

Your Warren Averett Wilson Price CPA can help you decide whether a conversion to a Roth IRA is best for you.

Key Takeaways

This was a lot to cover, but the key takeaways for you are these:

• First, remember that your CPA can be a valuable partner in providing answers to your questions and helping to keep your tax bill to a minimum.
• Second, don’t hesitate to ask a lot of questions to make sure you understand the advice you are being given.
• Third, don’t wait until tax time to seek professional tax assistance. Your Warren Averett Wilson Price CPA can help you plan for tax savings throughout the year.

If you have any questions regarding these tax developments, please contact your Warren Averett Wilson Price Division accountant.

Circular 230 Notice: To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

As we approach year-end, it’s again time to focus on last-minute moves you can make to save taxes-both on your 2011 return and in future years. Before we get to specific suggestions, here are two important considerations to keep in mind.

First, remember that effective tax planning requires considering both this year and next year-at least. Without a multiyear outlook, you can’t be sure maneuvers intended to save taxes on your 2011 return won’t backfire and cost additional money in the future. For example, postponing a stock sale gain until next year would reduce your 2011 adjusted gross income (good), but increase the 2012 figure (bad). Higher income next year could make you ineligible for the child tax credit; reduce or eliminate the credits or deduction for college expenses; limit deductible losses from your rental real estate investments; and so on.

Second, be on the alert for the Alternative Minimum Tax (AMT) this year. It’s an add-on tax over and above your “regular” tax. Although you may have never owed AMT in the past, your odds of being hit are higher now. Why? Because the tax brackets, standard deduction, and personal exemption allowances used in calculating your regular tax liability are all indexed annually for inflation. Most AMT parameters are not. The odds of owing the tax go up every year due to this factor alone. The risk goes up another notch or two if you deduct a significant amount of state and local taxes or miscellaneous itemized deductions (like unreimbursed employee business expenses) or claim multiple dependents. These deductions are not allowed against the AMT. Finally, if you exercised incentive stock options or recognized a large capital gain this year, consider yourself a likely AMT victim.

Here are a few tax-saving ideas to get you started. As always, you can call on us to help you sort through the options and implement strategies that make sense for you.

Ideas for Your Business

Take Advantage of Tax Breaks for Purchasing Equipment, Software, and Certain Real Property. If you have plans to buy a business computer, office furniture, equipment, vehicle, or other tangible business property or to make certain improvements to real property, you might consider doing so before year-end to capitalize on the following generous, but temporary tax breaks:

• Bigger Section 179 Deduction. Your business may be able to take advantage of the temporarily increased Section 179 deduction. Under the Section 179 deduction privilege, an eligible business can often claim first-year depreciation write-offs for the entire cost of new and used equipment and software additions. (However, limits apply to the amount that can be deducted for most vehicles.) For tax years beginning in 2011, the maximum Section 179 deduction is $500,000. For tax years beginning in 2012, however, the maximum deduction is scheduled to drop back to $125,000.
• Section 179 Deduction for Real Estate. Real property costs are generally ineligible for the Section 179 deduction privilege. However, an exception applies to tax years beginning in 2011. Under the exception, your business can immediately deduct up to $250,000 of qualified costs for restaurant buildings and improvements to interiors of retail and leased nonresidential buildings. The $250,000 Section 179 allowance for these real estate expenditures is part of the overall $500,000 allowance. This temporary real estate break will not be available for tax years beginning after 2011 unless Congress extends it.

Note: Watch out if your business is already expected to have a tax loss for the year (or be close) before considering any Section 179 deduction, as you cannot claim a Section 179 write-off that would create or increase an overall business tax loss. Please contact us if you think this might be an issue for your operation.

• 100% First-year Bonus Depreciation. Above and beyond the bumped-up Section 179 deduction, your business can also claim first-year bonus depreciation equal to 100% of the cost of most new (not used) equipment and software placed in service by December 31 of this year. For a new passenger auto or light truck that’s used for business and is subject to the luxury auto depreciation limitations, the 100% bonus depreciation break increases the maximum first-year depreciation deduction by $8,000 for vehicles placed in service this year. The 100% bonus depreciation break will expire at year-end unless Congress extends it.

Note: 100% bonus depreciation deductions can create or increase a Net Operating Loss (NOL) for your business’s 2011 tax year. You can then carry back a 2011 NOL to 2009 and 2010 and collect a refund of taxes paid in those years. Please contact us for details on the interaction between asset additions and NOLs.

Claim the Health Insurance Tax Credit for Small Employers. Qualifying small employers can claim a tax credit that can potentially cover up to 35% of the cost of providing health insurance coverage to employees. A qualifying small employer is one that: (1) has no more than 25 Full-time Equivalent (FTE) workers, (2) pays an average FTE wage of less than $50,000 and (3) has a qualifying healthcare arrangement in place. The allowable credit is quickly reduced under a complicated phase-out rule when the employer has more than 10 FTE employees or an average FTE wage in excess of $25,000. Please contact us if you have questions about this break.

Evaluate Inventory for Damaged or Obsolete Items. Inventory is normally valued for tax purposes at cost or the lower of cost or market value. Regardless of which of these methods is used, the end-of-the-year inventory should be reviewed to detect obsolete or damaged items. The carrying cost of any such items may be written down to their probable selling price (net of selling expenses). [This rule does not apply to businesses that use the Last-in, First out (LIFO) method because LIFO does not distinguish between goods that have been written down and those that have not].

To claim a deduction for a write-down of obsolete inventory, you are not required to scrap the item. However, in a period ending not later than 30 days after the inventory date, the item must be actually offered for sale at the price to which the inventory is reduced.

Ideas for Maximizing Nonbusiness Deductions

One way to reduce your 2011 tax liability is to look for additional deductions. Here’s a list of suggestions to get you started:

Make Charitable Gifts of Appreciated Stock. If you have appreciated stock that you’ve held more than a year and you plan to make significant charitable contributions before year-end, keep your cash and donate the stock (or mutual fund shares) instead. You’ll avoid paying tax on the appreciation, but will still be able to deduct the donated property’s full value. If you want to maintain a position in the donated securities, you can immediately buy back a like number of shares. (This idea works especially well with no load mutual funds because there are no transaction fees involved.)

However, if the stock is now worth less than when you acquired it, sell the stock, take the loss, and then give the cash to the charity. If you give the stock to the charity, your charitable deduction will equal the stock’s current depressed value and no capital loss will be available. Also, if you sell the stock at a loss, you can’t immediately buy it back as this will trigger the wash sale rules. This means your loss won’t be deductible, but instead will be added to the basis in the new shares.

Maximize the Benefit of the Standard Deduction. For 2011, the standard deduction is $11,600 for married taxpayers filing joint returns. For single taxpayers, the amount is $5,800. Currently, it looks like these amounts will be about the same for 2012. If your total itemized deductions are normally close to theseamounts, you may be able to leverage the benefit of your deductions by bunching deductions in every other year. This allows you to time your itemized deductions so that they are high in one year and low in the next. You claim actual expenses in the year they are bunched and take the standard deduction in the intervening years.

For instance, you might consider moving charitable donations you normally would make in early 2012 to the end of 2011. If you’re temporarily short on cash, charge the contribution to a credit card-it is deductible in the year charged, not when payment is made on the card. You can also accelerate payments of your real estate taxes or state income taxes otherwise due in early 2012. But, watch out for the AMT, as these taxes are not deductible for AMT purposes.

Bunch Deductions Subject to an Adjusted Gross Income Limit. Miscellaneous itemized deductions (such as unreimbursed employee business expenses) are deductible to the extent they exceed 2% of your adjusted gross income (AGI). (Your AGI is the number at the bottom of the first page of your return.) Medical expenses are deductible only to the extent they exceed 7.5% of AGI. To lessen the affect of these AGI limitations, try to bunch your miscellaneous and medical expense deductions into every other year.

Making the Most of Year-end Securities Transactions

For 2011 sales, you’ll generally owe only 15% on gains from investment assets held over one year (0% if the gains would otherwise fall into the 15% regular income tax bracket). Gains from investments held one year or less are taxed at your ordinary rates. So, the framework for year-end tax selling of investment securities is fairly simple. First, list those stocks, mutual fund shares, and bonds that you feel you could easily live without. You’ll probably have some winners (current market value above your cost) and some losers (value below cost) on the list.

Between now and year-end, you can sell enough losers to offset any capital gains recognized earlier this year. Plus, you can sell enough to generate another $3,000 in losses ($1,500 for married filing separate status), which then can be deducted against your income from all other sources. Because selling the losers reduces your income, the odds are increased that you’ll qualify for various other tax breaks.

If your year-to-date sales have resulted in an overall loss in excess of $3,000, you can sell enough winners between now and year-end to get back to the “negative $3,000″ level. Cashing in gains to that extent won’t add a cent to your federal tax bill, whether or not the assets have been held over 12 months. On the other hand, if your year-to-date sales are currently standing at zero or a net gain and you want to unload some winners, but no more losers, before year-end, try to sell only those you’ve owned over 12 months. Then, the resulting gains will be taxed at no more than 15%.

When selling stock or mutual fund shares, the general rule is that the shares you acquired first are the ones you sell first. However, if you choose, you can specifically identify the shares you’re selling when you sell less than your entire holding of a stock or mutual fund. By notifying your broker of the shares you want sold at the time of the sale, your gain or loss from the sale is based on the identified shares. This sales strategy gives you better control over the amount of your gain or loss and whether it’s long-term or short-term.

Secure a Deduction for Nearly Worthless Securities. If the dismal economy has left you with securities that are all but worthless with little hope of recovery, you might consider selling them before the end of the year so you can capitalize on the loss this year. You can deduct a loss on worthless securities only if you can prove the investment is completely worthless. Thus, a deduction is not available, as long as you own the security and it has any value at all. Total worthlessness can be very difficult to establish with any certainty. To avoid the issue, it may be easier just to sell the security if it has any marketable value. As long as the sale is not to a family member, this allows you to claim a loss for the difference between your tax basis and the proceeds (subject to the normal rules for capital losses and the wash sale rules restricting the recognition of loss if the security is repurchased within 30 days before or after the sale).

Employer Stock Options. If you own appreciated stock acquired by exercising Incentive Stock Options (ISOs) and are now considering selling as part of your overall year-end strategy, remember what it takes to qualify for the 15% rate. First, the shares must be held over two years from the option grant date (the date you received the ISO). Second, the shares must be held over 12 months after the exercise date (the date you acquired the stock by exercising your ISO). Selling sooner means all or part of your gain may be taxed at your higher ordinary tax rate.

What if you own nonqualified options? It may pay to exercise now, if there’s just a modest spread between market value and your exercise price and you expect the stock to appreciate. You’ll owe tax at your ordinary rate on the spread, but any future appreciation will qualify for the 15% rate if you’ve held the shares over 12 months by the time you sell.

If you already own shares from exercising nonqualified options, remember your post-exercise gains will qualify for the 15% rate as long as more than 12 months have passed since you acquired the stock. A shorter holding period means your gains will be taxed at your higher ordinary rate, unless you have offsetting capital losses from other transactions this year.

Ideas for Seniors Age 701/2 Plus

Make Charitable Donations from Your IRA. IRA owners and beneficiaries who have reached age 70½ are permitted to make cash donations totaling up to $100,000 to IRS-approved public charities directly out of their IRAs. These so-called Qualified Charitable Distributions, or QCDs, are federal-income-tax-free to you, but you get no itemized charitable write-off on your Form 1040. That’s okay because the tax-free treatment of QCDs equates to an immediate 100% federal income tax deduction without having to worry about restrictions that can delay itemized charitable write-offs. QCDs have other tax advantages too. Contact us if you want to hear about them.

Be careful-to qualify for this special tax break, the funds must be transferred directly from your IRA to the charity. Also, this favorable provision will expire at the end of this year unless Congress extends it. So, this could be your last chance.

Take Your Required Retirement Distributions. The tax laws generally require individuals with retirement accounts to take withdrawals based on the size of their account and their age every year after they reach age 701/2. Failure to take a required withdrawal can result in a penalty of 50% of the amount not withdrawn. There’s good news for 2011 though-QCDs discussed above count as payouts for purposes of the required distribution rules. This means, you can donate all or part of your 2011 required distribution amount (up to the $100,000 limit on QCDs) and convert taxable required distributions into tax-free QCDs.

Also, if you turned age 701/2 in 2011, you can delay your 2011 required distribution to 2012 if you choose. But, waiting until 2012 will result in two distributions in 2012-the amount required for 2011 plus the amount required for 2012. While deferring income is normally a sound tax strategy, here it results in bunching income into 2012. Thus, think twice before delaying your 2011 distribution to 2012-bunching income into 2012 might throw you into a higher tax bracket or have a detrimental impact on your other tax deductions in 2012.

Ideas for the Office

Maximize Contributions to 401(k) Plans. If you have a 401(k) plan at work, it’s just about time to tell your company how much you want to set aside on a tax-free basis for next year. Contribute as much as you can stand, especially if your employer makes matching contributions. You give up “free money” when you fail to participate to the max for the match.

Take Advantage of Flexible Spending Accounts (FSAs). If your company has a healthcare and/or dependent care FSA, before year-end you must specify how much of your 2012 salary to convert into tax-free contributions to the plan. You can then take tax-free withdrawals next year to reimburse yourself for out-of-pocket medical and dental expenses and qualifying dependent care costs. Watch out, though, FSAs are “use-it-or-lose-it” accounts-you don’t want to set aside more than what you’ll likely have in qualifying expenses for the year.

Married couples who both have access to FSAs will also need to decide whose FSA to use. If one spouse’s salary is likely to be higher than what’s known as the FICA wage limit (which is $106,800 for this year and will likely be somewhat higher next year) and the other spouse’s will be less, the one with the smaller salary should fund as much of the couple’s FSA needs as possible. The reason is the 6.2% social security tax levy for 2012 is set to stop at the FICA wage limit (and doesn’t apply at all to money put into an FSA). Thus, for example, if one spouse earns $115,000 and the other $40,000 and they want to collectively set aside $5,000 in their FSAs, they can save $310 (6.2% of $5,000) by having the full amount taken from the lower-paid spouse’s salary versus having 100% taken from the other one’s wages. Of course, either way, the couple will also save approximately $1,400 in income and Medicare taxes because of the FSAs.

If you currently have a healthcare FSA, make sure you drain it by incurring eligible expenses before the deadline for this year. Otherwise, you’ll lose the remaining balance. It’s not that hard to drum some things up: new glasses or contacts, dental work you’ve been putting off, or prescriptions that can be filled early. Although, over-the-counter drugs (e.g., aspirin and antacids) no longer qualify for reimbursement by healthcare FSAs, bandages and medical equipment (e.g., thermometers and blood pressure monitoring devices) do qualify.

Adjust Your Federal Income Tax Withholding. If it looks like you are going to owe income taxes for 2011, consider bumping up the Federal income taxes withheld from your paychecks now through the end of the year. When you file your return, you will still have to pay any taxes due less the amount paid in. However, as long as your total tax payments (estimated payments plus withholdings) equal at least 90% of your 2011 liability or, if smaller, 100% of your 2010 liability (110% if your 2010 adjusted gross income exceeded $150,000; $75,000 for married individuals who filed separate returns), penalties will be minimized, if not eliminated.

Don’t Overlook Estate Planning

For 2011 and 2012, the unified federal gift and estate tax exemption is a relatively generous $5 million. However, the exemption will drop back to only $1 million in 2013 unless Congress takes action. In addition, the maximum federal estate tax rate for 2011 and 2012 is 35%. For 2013 and beyond, it is scheduled to rise from the current 35% to a painfully high 55%. Therefore, planning to avoid or minimize the federal estate tax should still be part of your overall financial game plan. Even if you already have a good plan, it may need updating to reflect the current $5 million exemption. Contact us for more information on the best ways to minimize estate taxes for someone in your situation.

Conclusion

Through careful planning, it’s possible your 2011 tax liability can still be significantly reduced, but don’t delay. The longer you wait, the less likely it is that you’ll be able to achieve a meaningful reduction. The ideas discussed in this letter are a good way to get you started with year-end planning, but they’re no substitute for personalized professional assistance. Please don’t hesitate to call us with questions or for additional strategies on reducing your tax bill. We’d be glad to set up a planning meeting or assist you in any other way that we can.  

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Circular 230 Notice: To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

The recent storms have made the tax treatment of losses, and recoveries related to such events an important topic.  Special tax treatment is provided for Federally Declared Disaster Areas, including an option to claim the loss deduction on the 2010 (prior year) tax return and exclusion from taxation of Qualified Disaster Relief Payments.

The following counties in Alabama have been determined to be Federally Declared Disaster Areas as a result of the recent storms:

Autauga, Bibb, Blount, Calhoun, Chambers, Cherokee, Chilton, Choctaw, Clarke, Colbert, Coosa, Cullman DeKalb, Elmore, Escambia, Etowah, Fayette, Franklin, Greene, Hale, Jackson, Jefferson, Lamar Lauderdale, Lawrence, Limestone, Madison, Marengo, Marion, Marshall, Monroe,  Morgan, Perry, Pickens, Shelby, St. Clair, Sumter, Talladega, Tallapoosa, Tuscaloosa, Walker, Washington, and Winston.

The IRS provides the following information regarding casualty losses:

Casualty Losses – Definition

A casualty is the damage, destruction, or loss of property resulting from an identifiable event that is sudden, unexpected, or unusual.

• A sudden event is one that is swift, not gradual or progressive.
• An unexpected event is one that is ordinarily unanticipated and unintended.
• An unusual event is one that is not a day-to-day occurrence and that is not typical of the activity in which you were engaged.

Casualty Losses – Disaster Loss

A disaster loss is a casualty loss that occurred in an area determined by the President of the United States to warrant federal disaster assistance. These places are known as “Federally Declared Disaster Areas”.

Casualty Losses – Loss Proof

The following is information needed to support a casualty loss claim:

• The type of casualty (car accident, fire, storm, etc.) and when it occurred.
• That the loss was a direct result of the casualty.
• That you were the owner of the property, or if a lessee, that you were contractually liable for the damage.
• Whether a claim for reimbursement exists for which there is a reasonable expectation of recovery.
• Documentary evidence to support the claimed allowable loss.

Casualty Losses – To Prove a Loss

Records may have to be reconstructed. The information gathered will be used for tax purposes, as well as insurance reimbursement.

Casualty Losses – Claiming Disaster Losses on a Return

• Affected taxpayers in a Federal Disaster Area have the option of claiming disaster-related casualty losses on their federal income tax return either in the tax year the casualty occurred or the immediate preceding tax year.
• Depending on when the disaster occurred, claiming the loss on an original or amended return for last year may get the taxpayer an earlier refund. But, waiting to claim the loss on this year’s return could result in a greater tax saving, depending on other income factors.

Casualty Losses – Pub 547 and Pub 584

• Individuals may deduct personal property losses that are not covered by insurance or other reimbursements, but they must first subtract $100 for each casualty event and then subtract ten percent of their adjusted gross income from their total casualty losses for the year.
• Details on figuring a casualty loss deduction can be found in IRS Publication 547, Casualty, Disasters and Thefts.
• Publication 584, Casualty, Disaster and Theft Loss Workbook is designed to help you figure loss on personal-use property. It contains schedules to help you compute loss on your main home, personal property and your vehicles. However, the schedules are for information purposes only. You must file Form 4684 to report your loss on Form 1040.

Casualty Losses – Determination

To determine the amount of casualty loss to claim for damaged or destroyed property, you must:

• Determine the adjusted basis of the property before the disaster.
• Determine the decrease in Fair Market Value (FMV) of the property as a result of the disaster.
• Then, from the smaller of the adjusted basis or the FMV,
• Subtract any insurance or other reimbursement received.
• All individual losses are subject to:
  • 2% AGI limit if used for business by employee.
  • $100 deductible per event.
  • 10% AGI limit per annum.

Casualty Losses – Federally Declared Disaster Areas

In any federally-declared disaster area:

• No gain is recognized on any insurance proceeds received for “unscheduled” personal property that was part of the contents of a main home.
• Payments for the home and any scheduled property are treated as one payment. Any of this money used to replace any type of replacement property is not a recognized gain.
• Disaster relief payments or assistance do not reduce the casualty loss unless they replace lost or destroyed property.
• Disaster unemployment payments are unemployment income and are taxable.
• Post-disaster grants are generally not included in income. See IRC 139.  However, do not include as casualty losses any amounts covered by the grant payments.
• Taxpayers have the option to claim disaster-related casualty losses for either the year of occurrence or the prior year.  However, the State of Alabama allows a claim for the loss only in the year the loss occurs.
• Taxpayers should put the assigned Disaster Designation in red ink at the top of their tax forms. [For example, “Alabama/ Severe Storms, Tornadoes, Straight-line Winds and Flooding.” ]
• Taxpayers should include in income:
  • Temporary living payments from insurance that are in excess of the actual increase in temporary expenses.
  • The excess goes on line 21 of Form 1040.

Gains on Casualty Losses

If you receive an insurance payment or other reimbursement in excess of the adjusted basis of damaged or destroyed property you will have a gain:

• The gain is the amount received minus the adjusted basis in the property.
• If your main home is destroyed and the insurance proceeds result in a gain:
• You can treat this as a sale of residence subject to the same rules.
• If the home was not used or owned for 2 of the last five years a reduced maximum gain exclusion will apply.
• If located in a Federally Declared Disaster Area, you can postpone any “recognized” gain on your main home if you buy a new home within 4 years of the end of the year the disaster occurred, or
• You can recognize the gain and report it.
• You do not have to recognize gain on destroyed/damaged business property if it is replaced within two years of the end of the tax year in which the gain is realized.
• If received payment in 2011 resulting in a gain, you must replace the property prior to 1/1/2014 to defer the gain. 
• You cannot postpone the gain if you buy replacement property from a related party. This applies to:
  • C Corps
  • Partnerships in which more than 50% of the capital or profits is owned by a C Corp
  • All others if the total realized gain for the year is over $100,000.
• To defer the gain:
  • You must buy property specifically to replace the damaged or destroyed property in order to defer the gain.
  • The basis of the replacement property will be the adjusted basis of the property being replaced.

Reporting Casualty Gains/Losses

Report loss on return for year it occurred. If the event took place in a federally declared disaster, you can amend the prior year return.

The election to amend must be made by:

• Due date (without extensions) for filling your income tax return for the tax year in which the disaster actually occurred.
• Due date (with extensions) for filing the return for the preceding tax year.
• Once the election is made, it can be revoked within 90 days of making the election. The taxpayer must:
  • Return any refund or credit received from making the choice.
  • If revoked prior to getting a refund, must return refund within 30 days of receiving it for the revocation to be effective. 

Individual Returns:

• Losses go on Form 4684 and carry to Schedule A.
• Gains go on Form 4684 and carry to Schedule D.
• Includes losses on income-producing property and property used in performing services as an employee (held less than one year).
• Have the option to claim disaster-related casualty losses for either the year of occurrence or the prior year.

Business and income producing property:

• Losses are reported on Form 4684 and carry to various forms.
• Business use of home carries to Form 8829
• .Other business property carries to Form 4797.

Rental Properties:

• Report on Form 4684 and then on Form 4797.
• Have 2 years from the close of tax year when you realize the gain to replace the property and defer the gain.
• Losses are not limited by Form 8582.

Insurance Reimbursement after filing:

• If less than expected (and accounted for on casualty loss) include the difference as a loss on the return for the year when you can reasonably say you’re not getting any more money.
• If greater than expected (and accounted for on casualty loss) include the difference as income in the year received.

Reporting Casualty Gains/Losses –Net Operating Losses

• Individual or Business casualty losses can generate Net Operating Losses (NOL).
• NOLs generated by casualty losses can be carried back or forward the same as any other NOL.

Reporting Casualty Gains/Losses -What’s Not Included

Losses do not include:

• A reduction in profits or
• Loss of income.

The recent storms have been traumatic for many.  There is some tax relief to assist with recovery from these disasters.  Please contact us and we will help you take full advantage of the available tax relief.

Background

The Self-employed Health Insurance Deduction has long been available for the health insurance of the self-employed individual, his or her spouse, and any dependent children. But, there are a number of important taxpayer-friendly developments for 2010, including a surprising change in interpretation by the IRS.

IRC Sec. 162(l)(2) allows self-employed proprietors and partners, and more-than-2% S shareholders treated as partners for fringe benefits, to deduct 100% of their health insurance as a page 1, for-AGI income tax deduction. To be eligible for this deduction, the taxpayer must have a health insurance plan that can be considered as associated with a business activity. Also, the taxpayer must not be eligible to participate in a health insurance plan that is subsidized by any other employer. The deduction is limited to the taxpayer’s self-employment income, or in the case of an S shareholder, the wages subject to payroll taxes.

Nondependent Children under Age 27 Can Now Be Covered

One of the features of the Health Care legislation passed last March provides that effective as of 3/30/10, an employee may receive tax-free treatment for employer-provided health insurance for a child who has not attained age 27 by the end of the year, regardless of whether the child is eligible as a tax return dependent. Prior to this legislation, an employee would have had taxable compensation to the extent an employer paid for health insurance for a nondependent child.

This legislation made a corresponding change to the self-employed health insurance deduction of a self-employed taxpayer. If a self-employed individual pays the health insurance premium for a nondependent child who has not attained the age of 27 by 12/31/10, premiums paid after 3/30/10 are includable in the self-employed health insurance deduction.

Example 1: Phil, a self-employed proprietor, has been claiming the self-employed health insurance deduction for his family. The health policy covers himself, his spouse, and their 20 year-old dependent daughter, a college student. Phil’s older child, Flip, age 25, was recently laid off from his W-2 job in a nearby community and is again living at home. Phil is helping Flip by paying his separate health insurance policy and also covering a few other essential expenses. Beginning 3/30/10, Phil may include Flip’s health insurance premiums in computing the self-employed health insurance deduction on his Form 1040 .

Medicare Part B Premiums Can Count as Part of the Deduction

For several years, the IRS instructions to Form 1040, for the self-employed health insurance deduction line on page 1, have stated at that Medicare Part B premiums could not be treated as part of the deduction. Of course, this guidance was only applicable to someone over age 65 and older enrolled in Medicare who also had self-employment income. But many self-employed taxpayers stay active past age 65.

Surprisingly, the 2010 Form 1040 instructions, at line 29, now state “Medicare B premiums can be used to figure the deduction.”

We have not seen any other IRS guidance explaining this change in position. Earlier guidance on this point was informal: IRS instructions, an IRS Publication, and a 1995 Field Service Advisory memo (FSA 3042, 12/19/95). However, the current Form 1040 instructions can be relied upon, and apparently reflect an updated position of the IRS. Accordingly, the Medicare B premium should be claimed as part of the line 29 self-employed health insurance deduction beginning in 2010.

The Medicare B premium amount, of course, is disclosed on the Form SSA-1099 . For the last several years, the Medicare B premiums assessed by the Social Security Administration have been income-sensitive. For 2010, the annual amount ranges from approximately $1,300 to $4,200. Further, if both spouses are enrolled in Medicare, these amounts will generally be doubled.

Example 2: Ed and Edna, each age 67, both are enrolled in Medicare and receiving social security retirement benefits. Ed is still active as a self-employed partner in the farming partnership with their two sons. While Ed’s share of the partnership K-1 self-employment income is not large, he receives substantial rental income from the partnership for the use of his land, and he and Edna report a substantial AGI in their Form 1040. Their Medicare B premiums withheld from their social security benefits were the maximum in 2010 of $4,243 each. In preparing their Form 1040 for 2010, the IRS instructions indicate that Ed and Edna may claim the Medicare Part B premiums of $8,486 as additional self-employed health insurance.

For 2010 Self-employed Health Insurance

Is Deductible for SE Tax Purposes

In the September Small Business Jobs Act, Congress also adjusted the self-employed health insurance deduction in another manner. The legislation amended IRC Sec. 162(l)(4) to allow the deduction to be claimed both for income tax purposes and self-employment tax purposes in 2010. Previously, of course, the health insurance deduction had only been allowable for the income tax computation.

For 2010, this SE tax break makes the ability to claim post-3/30/10 health insurance for nondependent children (who do not attain age 27 by 12/31/10) more beneficial, and also makes the Medicare B premium deduction of greater value.

Other Implications of Reduced Self-employment Income in 2010

Does the reduction in self-employment income for 2010, because of the one-year deductibility of self-employed health insurance premiums, also affect other calculations driven by self-employment (SE) income? For example, a self-employed taxpayer’s earnings for qualified retirement plan purposes are based on SE income. So, for 2010, must SE income for this purpose be reduced by the health insurance deduction? And, the self-employed health insurance deduction itself is limited to the amount of the taxpayer’s SE income. Do we need to do a dreaded simultaneous equation to determine the health insurance deduction if SE income was low?

Here’s our analysis of these questions:

1. SE Income for Qualified Retirement Plan and IRA Funding. For both qualified plan and IRA purposes, earned income is defined by reference to IRC Sec. 401(c)(2) . In turn, IRC Sec. 401(c)(2) refers to net earnings from self-employment as defined in IRC Sec. 1402(a) . If the story ended here, we would need to reduce self-employed earnings for retirement plan funding in 2010 by the health insurance deduction. But the Committee Report to the legislation enacting the one year cut in SE income for health insurance says that “It is intended that earned income within the meaning of section 401(c)(2) be computed without regard to this deduction for the cost of health insurance.” It goes on to note that a technical correction to the legislation may be needed. As a result, SE income for retirement plan funding in 2010 should not be reduced for the health insurance deduction.

Income Limit for Self-employed Health Insurance Deduction. We won’t bore you with the citations on this one, as it is also addressed directly in the Committee Report of the September legislation. That language states that “earned income for purposes of the limitation applicable to the health insurance deduction is computed without regard to this deduction.” So again, we use SE income without the health insurance deduction as the business net income limit for this health insurance deduction (and no need to remember how to calculate a simultaneous equation!).