Year-end tax planning in 2009 may be more important than it has been for many years. That’s because major tax hikes, including increases to help pay for health-care reform, are all but certain, and they may arrive as early as next year.
Many of the increases will likely target high earners — people in today’s 35%, 33% and maybe even 28% federal tax brackets. Those high earners can expect increases in ordinary income taxes and capital gains taxes.
Now for the good news: When you calculate your gains and losses for 2009, you probably won’t get hit as hard as in past years when paying taxes on capital gains distributions from mutual funds. Most funds have capital losses (realized and unrealized) from the crash of 2008, and those losses likely will offset all or most gains from 2009, so there won’t be much, if anything, in net gains to distribute.
How can you trim the tax bill you will owe next April? Follow these steps as 2009 draws to a close…
1. Take losses. Sell any securities, especially stocks and stock funds, trading at prices below your original cost. This works only in taxable accounts.
Your net capital losses for the year will be added to any net losses carried over from previous years. Then up to $3,000 of net losses can be deducted from your 2009 ordinary income. Excess losses are carried into 2010.
2. Double up… soon. You might want to take a capital loss on a stock that you still want to own. You can’t get a capital loss tax break if you sell shares of a stock and then buy shares of the same stock within 30 days.
Better way: Let’s say you own 100 shares, in which you have experienced a loss. Start by buying an equal number of new shares. Wait 31 days, then sell your original 100 shares and take a loss if those shares still are underwater. You will have the newly purchased 100 shares going forward, and you will have a valid capital loss for tax purposes.
As you can see, you need to start this strategy by the end of November if you want to take your capital loss in 2009.
3. Take short-term gains. Thanks to this year’s stock market rebound, you may have some short-term gains. Profits on securities held for one year or less are taxed as ordinary income, where rates are now up to 35%.
Loophole: Net capital losses can offset short-term as well as long-term gains. If you have net short- and/or long-term losses from 2009 or prior years, you might be able to match them with short-term gains and avoid paying tax.
4. Take 0% gains… in the family. In 2009 and (at least for now) 2010, there’s a 0% tax bracket for long-term capital gains realized by low-income taxpayers.
If your children are full-time students age 23 or younger, give them some appreciated securities that they can sell by year-end. As long as the investment income is no more than $1,900, the gains won’t be taxed.
You can give larger amounts of securities to older children or to your parents for tax-free selling if they have relatively low incomes. In 2009, the 0% rate on long-term gains is in effect for taxable income up to $33,950 (up to $67,900 for couples filing joint returns).
5. Take 15% gains… yourself. You might intend to realize long-term capital gains soon, perhaps to raise funds so that you can buy a retirement home. If you take gains before year-end, you will owe no more than 15% on them. Higher tax rates might be coming next year.
6. Consider converting a traditional IRA to a Roth IRA. After five years, if you are at least age 59½, all withdrawals from a Roth IRA will be tax-free even if tax rates are higher in the future. Unlike with a traditional IRA, you will never have to take any required distributions, although your heirs will.
You will owe tax when you convert your traditional IRA to a Roth IRA. That tax may be relatively low in 2009 because the stock market crash has reduced IRA balances and tax rates are historically low.
Trap: Your adjusted gross income (AGI) can be no higher than $100,000 this year, on a single or joint return, to execute a Roth IRA conversion in 2009. If your income is higher, you will have to wait until 2010, when the $100,000 income ceiling will be abolished.
7. Top the 7.5% threshold. Your health-care expenses are deductible only to the extent that they exceed 7.5% of your AGI.
Example: If your AGI is $100,000 this year and you spend $8,000 on doctors, lab tests, etc., you can deduct $500 — the excess over your $7,500 threshold. If your health-care outlays total $7,000, you would get no deduction. (With the alternative minimum tax — AMT — the threshold is 10% of AGI.)
Say that you’re not subject to the AMT and that you’re already beyond the 7.5% threshold. Before year-end, you can buy prescription eyeglasses, have elective dental work done, etc., and pay with tax-deductible dollars. If you’re far from the 7.5% threshold, defer elective expenses until 2010, when you might qualify for a deduction.
8. Calculate the 2% solution. The reasoning is similar for miscellaneous itemized deductions, such as investment expenses, tax advice and unreimbursed business expenses, except that the floor for tax deductions is 2% of your AGI, and AMT payers can’t take any of these write-offs.
If you’re over the 2% threshold, pay now for investment-related publications, financial-planning software programs and other investment expenses. If you’re far from the 2% mark, defer your spending until next year if you can.
9. Drain your flex plan. At work, you may be participating in a flexible spending account (FSA). This employee benefit lets you pay expenses such as health care and child care with pretax dollars.
However, money you have placed in the account may be forfeited if it is not used by December 31. (Your employer can extend this deadline to March 15, 2010, but that’s not a requirement.) If you still have unused funds in a health-care FSA by mid-December, for example, arrange to spend the money before year-end on checkups, eyeglasses and other medical needs to avoid wasting it.
10. Plug in your new computer. If you’re a business owner or if you have self-employment income, you can buy up to $250,000 worth of business equipment and take a full tax deduction in 2009.
To qualify, the equipment must be placed in service by year-end. Then you can deduct the purchase price on your 2009 tax return even if you finance the equipment and don’t start payments until after 2009.
