Checklist of things to do before the end of 2017.
There are many tax-saving steps that can be taken before the end of this year. Here is a list of the most important actions that should be taken no later than Dec. 31, 2017 to save taxes:
… Realize losses on stock while substantially preserving investment position,
… Convert investment income taxable at regular rates (e.g., interest income) into qualifying dividend income,
… Arrange with employer to defer bonus until 2018,
… Increase basis in S corporation or partnership to make possible a 2011 loss deduction,
… Use credit card to prepay expenses,
… Make energy saving improvements to your home that qualify for tax credits in 2011,
… Pay contested taxes to deduct them this year while continuing to contest them next year,
… Put equipment in service before year-end to qualify for the 100% bonus first-year depreciation allowance,
… Make expenditures qualifying for the $500,000 business property expensing election,
… Settle insurance or damage claim if this will maximize casualty loss deduction,
… Apply bunching strategy to “miscellaneous” itemized deductions , medical expenses, and other itemized deductions to increase deductible amounts.
… Increase withholding to eliminate or reduce estimated tax penalty,
… Set up self-employed retirement plan,
… Make gifts taking advantage of the $13,000 gift tax exclusion,
… Watch out for marriage penalty in regard to year-end marriage or divorce plans,
… Consider deferring a debt cancellation event until 2012,
… Decide whether to elect to deduct investment interest against capital gains and/or qualified dividends,
… Avoid personal holding company tax by making dividend payments,
… Take steps to avoid or minimize income tax on Social Security benefits,
… Structure real estate deal to avoid paying interest on tax deferred under installment method,
… Step up level of participation in business activity to meet material participation standard under passive loss rules,
… Dispose of passive activity to free up suspended losses,
… Ask employer to increase withholding of state and local taxes to pull the deduction of those taxes into 2011,
… Extend subscriptions to professional journals, pay union or professional dues, enroll in (and pay tuition for) job-related courses, etc., to bunch into 2011 miscellaneous itemized deductions subject to the 2%-of-AGI floor,
… Accelerate a big ticket purchase (such as a boat or car) into 2011 to qualify (if the taxpayer itemizes) for state and local sales tax deductions instead of state and local income taxes.
How to shift expenses
How cash-method taxpayers shift expenses. If a taxpayer is permitted to, and does, keep his tax records on a cash basis, his expenses are deductible when paid. Thus, he can accelerate 2012 expenses into 2011 by doing the following:
(1) Pay in 2011 all bills already received for expenses rather than deferring payment until 2012.
(2) Choose to incur and pay in 2011 expenses that would normally be incurred and paid in 2012. For instance, the taxpayer might order and take delivery of office supplies or have repair and maintenance work performed before the end of 2011 instead of waiting until early 2012.
(3) Prepay expenses where feasible. Certain other prepayments made by cash method taxpayers, such as prepaid compensation, must be prorated over the period to which they apply. have permitted deduction in the year of payment for a business insurance premium that overlaps portions of the year of payment and of the following year, when the taxpayer has followed a consistent practice of doing so. IRS has held that a cash basis taxpayer may deduct in the year of payment a full year’s rent, even though most of the payment would be applied to the following year.
(4)Step up withholding of state and local taxes. If the taxpayer expects to owe state and local income taxes when he files his return next year, he should consider asking his employer to increase withholding on those taxes. That way, additional amounts of state and local taxes withheld before the end of the year will be deductible in 2011.
(5) Pay the last installment of estimated state and local taxes for 2011 by Dec. 31 rather than on the 2012 due date.
(6) Use credit card charges to accelerate deductible expenses. Charitable contributions and medical expenses are deductible when charged to a taxpayer’s credit card account (e.g., in 2011) rather than when he pays the card company
In 2010, the federal government permanently dropped the income limit for moving savings to a Roth IRA from a traditional individual retirement account. Once you have met certain holding requirements, future withdrawals from a Roth are income-tax free—even for your heirs.
But to get that future tax break, you have to pay income tax upfront on the value of the pretax assets you move into a Roth. With market volatility denting many investors’ returns, they could get stuck paying tax on investment value that no longer exists.
But there is a fix—if you act fast. The federal government allows the tax-law equivalent of a do-over, says Maria Bruno, an investment analyst at fund giant Vanguard Group, whose customers converted more than 230,000 traditional IRAs to Roths last year, and which has processed 3,900 do-overs this year, as of Monday.
Up until the final tax-return filing deadline for extensions—Oct. 17 this year—investors who transferred traditional IRA holdings to a Roth in 2010 can move them back to a traditional IRA and avoid tax. If you filed your 2010 tax returns already, you can amend them.
Careful handling of capital gains and losses can save taxes.
Individuals who lost money in the stock market or in investment real estate in 2011 may have other investment assets that have appreciated in value. These taxpayers should consider the extent to which they should sell appreciated assets (if their value has peaked) and thereby offset gains with pre-existing losses.
Long-term capital losses are used to offset long-term capital gains before they are used to offset short-term capital gains. Similarly, short-term capital losses must be used to offset short-term capital gains before they are used to offset long-term capital gains. Noncorporate taxpayers may use up to $3,000 of total capital losses in excess of total capital gains as a deduction against ordinary income in computing AGI.
For 2011 and 2012, a noncorporate taxpayer is subject to tax at a rate as high as 35% on short-term capital gains and ordinary income. On the other hand, most long-term capital gains are taxed at a maximum rate of 15%. However, for 2011 as well as 2012, the maximum rate is 0% to the extent the gain would otherwise be taxed at a rate below 25% if it were ordinary income. Restricting annual payouts from retirement plans and IRAs to the required minimum distribution (RMD) (and taking cash from other accounts as needed) may help some taxpayers to take advantage of the 0% capital gains rate.
A taxpayer should try to avoid having long-term capital losses offset long-term capital gains since those losses will be more valuable if they are used to offset short-term capital gains or ordinary income. To do this requires making sure that the long-term capital losses are not taken in the same year as the long-term capital gains are taken. However, this is not just a tax issue. As is the case with most planning involving capital gains and losses, investment factors need to be considered. A taxpayer won’t want to defer recognizing gain until the following year if there’s too much risk that the value of the property will decline before it can be sold. Similarly, a taxpayer won’t want to risk increasing the loss on property that he expects will continue to decline in value by deferring the sale of that property until the following year.
Consider effect of marriage penalty (or marriage bonus).
A taxpayer’s marital status for the entire year is determined as of Dec. 31. A taxpayer who gets married (or divorced) on that date is treated as if he were married (or single) all year long.
One of the tax consequences of marriage may be the payment of the so-called “marriage penalty.” This is likely to happen where the husband and wife each have substantial and relatively equal amounts of taxable income.
One reason for the marriage penalty is that the tax brackets above 15% cover a larger total amount of income for two single taxpayers. For example, in 2011 two unmarried taxpayers can have a total of $167,200 in taxable income without being subject to the 28% rate. If they’re married, the 28% bracket applies to amounts in excess of $139,350. Also, the 33% rate begins at $212,300 on a joint return. On the other hand, two unmarried taxpayers can have as much as $348,800 before hitting the 33% bracket. Finally, single taxpayers can each have up to $379,150 of taxable income taxed below the maximum (35%) tax rate in 2011, while married couples can only have combined taxable income of $379,150 taxed below the maximum rate.
When C corporations should defer or accelerate income.
C corporations, like individuals, must also decide when and how to shift income and deductions between 2011 and 2012. C corporations will, as a general rule, benefit from the deferral of income and the acceleration of deductions in the same way as individuals.
However, acceleration of income may be advisable in some cases. Take, for example, a corporation subject to the 39% “bubble.” Corporate taxable income between $100,000 and $335,000 is taxed at the rate of 39% to phase out the benefits of the 15% and 25% brackets that cover a corporation’s first $75,000 of taxable income.
Taxable income between $75,000 and $100,000, and between $335,000 and $10 million, is taxed at 34%. Taxable income over $10 million is taxed at 35%, except that there is also a 38% “bubble” that applies to corporate taxable income between $15 million and $18,333,333 to eliminate the benefit of the 34% rate.
Taking S corporation losses.
A shareholder can deduct his pro-rata share of S corporation losses only to the extent of the total of his basis in (a) the S corporation stock, and (b) debt owed him by the S corporation. This determination is made as of the end of the S corporation tax year in which the loss occurs. Any loss or deduction that can’t be used on account of this limitation can be carried forward indefinitely. If a shareholder wants to claim a 2011 S corporation loss on his own 2011 return, but the loss exceeds the basis for his S corporation stock and debt, he can still claim the loss in full by lending the S corporation more money or by making a capital contribution by the end of the S corporation’s tax year
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David Dennis • The Tax Court has held that a taxpayer couldn’t deduct purported management fees, in amounts greater than IRS allowed, that his single-member limited liability company (LLC) paid to his wholly owned C corporation.
Background on business deductions. Under Code Sec. 162(a) , a taxpayer can deduct all ordinary and necessary expenses paid or incurred during the tax year in carrying on any trade or business. A trade or business expense is ordinary if it is normal or customary within a particular trade, business, or industry. It is necessary if it is appropriate and helpful for the development of the business.
Courts have held that for expenses to be deductible as ordinary and necessary, they must be reasonable, because the element of reasonableness is inherent in the phrase “ordinary and necessary.” The reasonableness concept has particular significance in determining whether payments between related parties, such as commonly controlled business entities, represent ordinary and necessary expenses.
The Tax Court has held that a taxpayer wasn’t entitled to deduct consulting fees it paid to its subsidiary where the taxpayer failed to establish how the fees were determined, there was no written contract, the invoices provided almost no detail, and there was no evidence of the service provider’s skills that might warrant the consulting fees. (ASAT, Inc., (1997) 108 TC 147 ) The Tax Court has also held that a taxpayer’s wholly owned S corporation was not entitled to deduct management fees paid to another of his wholly owned S corporations where the evidence did not adequately establish the specific services performed and who performed them.
David Dennis • Time for executors to make portability election for 2011 decedents. In a new notice and accompanying news release, the IRS reminded executors of the estates of married decedents dying after 2010 that they must file an estate tax return in order to pass along the unused estate and gift tax exclusion amount, available for the first time this year, to their surviving spouse. The first estate tax returns for estates eligible to make the portability election started becoming due on Oct. 3, 2011 (i.e., nine months after a post-2010 date of death). Because the IRS believes that most married couples will want the surviving spouse to be able to take advantage of the unused exclusion amount of the first spouse to die, the election is deemed made if a Form 706 (estate tax return) is properly and timely filed. No affirmative statement or other indication is necessary. Even if the estate isn’t required to file a Form 706 (e.g., because the value of the gross estate is less than the exclusion amount), the Form 706 must be filed in ordered to make the election. For estates that choose not to make a portability election, if that estate is otherwise required to file a Form 706, the executor must follow the instructions for Form 706 describing the necessary steps to avoid making the election. For estates that aren’t required to file a Form 706, simply not filing the form will effectively prevent the making of the election.
David Dennis • Deferring Income – the “Accrual Basis Tax Payer”
The mere fact that the receipt of cash is delayed doesn’t defer taxable income for an accrual-basis taxpayer. As soon as an accrual-basis taxpayer’s right to the income is fixed, and its amount can be determined with reasonable accuracy, it’s taxable. (In the case of certain tax shelters, C corporations and partnerships having a C corporation as a partner, use of the accrual method is obligatory. Certain taxpayers with inventories also must use the accrual method.
Because of this, generally the only way an accrual-basis taxpayer can postpone income (other than by using the installment sale method) is to defer the actual right to payment for the services or merchandise delivered.
One way to do that would be to postpone completion of a job until 2012 so as to have the right to income arise only in 2012, even though most of the actual work is done in 2011. (Note, however, that some special rules apply to certain long-term contracts for the manufacture, building or construction of property, which often require the recognition of income on a percentage-of-completion basis.
Another way would be to hold up deliveries where that would defer accrual.
This would be the case where the seller’s right to payment is contingent on delivery of the property to the buyer. In fact, delaying delivery until 2012 can defer accrual even where an advance payment for the merchandise is received in 2011. Advance payments against the sale of merchandise generally don’t give rise to income until the payments are otherwise properly accruable under the taxpayer’s own method of accounting.
Other ways to defer income are by postponing the closing of a sale, or by delaying the settlement of a pending dispute over an item of income.