Personal Tax & Financial Planning Guide 2008

    The Individual Investor’s Guide to Personal Tax Planningfor Tax Year 2009

    The Evolving Tax Landscape

    The federal tax landscape has undergone a series of changes in the past decade. Various legislation has left a complicated array of changing tax rates and benefit phase-out levels—all of which will expire in 2010. More change is likely to occur within the next few years, but the contours of the change are uncertain.

    That leaves taxpayers with considerable uncertainty even before 2010, which makes planning difficult.

    The most recent major tax law changes were passed in the stimulus bill last February, the American Recovery and Reinvestment Act of 2009, which was written in response to last year’s economic crisis. It contained numerous tax provisions that affect individual taxpayers, including:

    • Raising the alternative minimum tax exemption amount in 2009 to $70,950 for married taxpayers filing jointly and $46,700 for single and head of household taxpayers. However, this is a one-year patch only, and unless further legislation is passed, for 2010 the exemption amount will drop back to $45,000 for married taxpayers filing jointly, and to $33,750 for single and head of household taxpayers.
    • A deduction for state and local sales taxes for motor vehicles bought after February 16, 2009.
    • Credits for plug-in electric cars bought or placed in service in 2009.
    • A first-time homebuyer credit of as much as $8,000 for homes bought after April 9, 2009, and before December 1, 2009 (subject to a phase-out for higher income taxpayers).
    • Expanded definition of education expenses for 529 Education Plans now includes computers and computer technology.
    • The $3,500 or $4,500 voucher under the “cash for clunkers” program to buy or lease a new fuel-efficient car is not taxable for federal income tax purposes.
    • You can receive up to $5,000 of U.S. Series I Savings Bonds as part of your income tax refund without setting up a Treasury Direct account in advance.

    This comes on top of last year’s legislation, which included changes for 2009 such as:

    • Suspension of the required minimum distribution rules for retirement plans for the 2009 calendar year.
    • Extending for 2009 the option to use state and local sales taxes instead of state and local income taxes for those who itemize their deductions.
    • Extending through 2009 a new property tax standard deduction ($500 for singles, $1,000 for married filing joint taxpayers) for individuals who don’t itemize.
    • Extending through 2009 the provision allowing taxpayers age 70½ or older to make tax-free distributions from their IRAs to qualified charities.

    For a complete tax guide to the buying and selling of your personal investments, go to our Personal Investments 2009 Tax Guide in the on-line version of this article.

    Known Tax Law Changes

    The current tax landscape has been shaped by an array of tax rate changes and extensions that date back to 2001.

    The Tax Relief Extension Reconciliation Act of 2005, signed into law in 2006, extended through December 31, 2010, the dividend and capital gains tax cuts that were enacted in 2003 and scheduled to expire at the end of 2008. That means that through 2010—barring new legislation—the maximum tax rate for long-term capital gains and qualified dividends is 15%, and taxpayers in the 10% and 15% tax brackets benefit from an even lower 0% maximum tax rate on gains and qualified dividends in 2009 and 2010.

    The extensions provided in the 2005 Tax Reconciliation Act mean that the dividend and capital gains tax cuts expire at the same time as the tax cuts that were passed by the Economic Growth and Tax Relief Reconciliation Act of 2001 and extended by the Working Families Tax Relief Act of 2004. Those tax cuts included lower marginal income tax rates, relief from the marriage penalty and temporary repeal of the federal estate tax.

    Assuming no changes in the tax laws, individuals with substantial investment income can continue to see tax savings through 2010 if they take advantage of the planning opportunities. However, in considering any investment strategy, you should keep in mind that, even if Congress and the administration do not make any tax law changes, after 2010 tax rates are set to revert to earlier levels—with a 39.6% top marginal income tax rate, a 20% top capital gains rate and dividends taxed as ordinary income. In addition, the estate tax and gift tax rates revert to pre-2001 levels.

    The provisions of the 2005 Tax Reconciliation Act and the 2004 Tax Relief Act, combined with the provisions of the 2001 and 2003 Tax Acts, are presented in summary form in Table 1.

    Table 1. An Overview of Tax Changes in the Coming Years
      2009 2010 2011
    Long-Term Capital Gains Rate
    Tax Bracket Above 15% 15% 15% 20%
    Tax Bracket 15% or Below 0% 0% 10%
    Qualified Dividends Rate
    Tax Bracket Above 15% 15% 15% taxed as income
    Tax Bracket 15% or Below 0% 0% taxed as income
    Marginal Income Tax Rates
    Top Bracket 35% 35% 39.60%
    Fifth Bracket 33% 33% 36%
    Fourth Bracket 28% 28% 31%
    Third Bracket 25% 25% 28%
    Second Bracket 15% 15% 15%
    First Bracket 10% 10% na
    Child Tax Credit $1,000 $1,000 $500
    Marriage Penalty Relief
    Standard Deduction (% of S.D. for singles) 200% 200% na
    15% Tax Bracket (% of bracket for singles) 200% 200% na
    Repeal (%) of Personal Exemptions Phase-outs 66.60% 100% na
    Repeal (%) of Limitation on Itemized Deductions 66.60% 100% na
    AMT Exemption
    Single $46,700 $33,750* $33,750*
    Married Filing Joint $70,950 $45,000* $45,000*
    Head of Household $46,700 $33,750* $33,750*
    * Congress has not yet determined new rules for these years.
    Estate Tax
    Exemption $3.5 million tax repealed $1 million
    Maximum Rate 45% 0% 55%

    What’s New for 2009

    Listed below are tax change highlights for the 2009 tax year, tax changes that are currently set to go into effect in 2010, as well as some old rules you may want to keep in mind when going through your year-end review.

    Alternative Minimum Tax

    The alternative minimum tax exemption amount in 2009 is increased to $70,950 for married taxpayers filing jointly and $46,700 for single and head of household taxpayers. However, this is a one-year patch only and, unless further legislation is passed, for 2010 the exemption amount will drop back to $45,000 for married taxpayers filing jointly and to $33,750 for single taxpayers.

    Standard Deduction

    For 2009, the standard deduction increases to $11,400 for married couples filing a joint return, $5,700 for singles and $8,350 for heads of household.

    In 2010, those amounts will remain at the 2009 levels for married couples filing a joint return and for singles, but will increase to $8,400 for heads of household.

    Personal Exemptions

    For 2009, the personal exemption amount increases to $3,650; in 2010, that amount remains the same.

    Taxpayers with adjusted gross incomes above a certain amount may lose part of the benefit of the exemption, but the amount by which these benefits are reduced in 2009 is only one-third of the reduction that would have applied otherwise. In 2010, those phase-outs do not apply, and all taxpayers receive the full benefit of the personal exemptions.

    In 2009, the adjusted gross income amounts at which phase-outs begin increase to $250,200 for married persons filing jointly, $166,800 for singles, $208,500 for heads of household and $125,100 for married persons filing separately.

    Individual Retirement Accounts and 401(k) Plans

    In 2009, the maximum annual contribution for IRAs remains at $5,000 ($6,000 for any individual who is age 50 or older); in 2010, those amounts remain the same.

    In 2009, the maximum annual contribution limit for 401(k)s increases to $16,500 ($22,000 if you are age 50 or over); in 2010, those amounts remain the same.

    In 2009, the maximum annual contribution for SIMPLE plans increases to $11,500 ($14,000 for those age 50 or over); in 2010, those amounts remain the same.

    Qualified Plan Contributions

    In 2009, the maximum annual contribution for qualified plans, including SEP and Keogh plans, increases to $49,000; in 2010, those amounts remain the same.

    Estate and Gift Tax Limits

    In 2009, the estate tax exemption increases to $3.5 million and the annual gift tax exclusion increases to $13,000. In 2010, as of this writing, the estate tax exemption is repealed (changes are expected) and the annual gift tax exclusion remains at $13,000.

    Required Minimum Distributions

    For calendar year 2009, individuals who would normally be required to take minimum distributions from their IRA and other qualified retirement plans will not be required to do so. Note that if you have already taken a required minimum distribution (RMD) from your IRA for 2009, there is a 60-day period after the withdrawal in which you can roll it back into your IRA, with no taxes due.

    Child Tax Credit

    The child tax credit for dependent children younger than 17 remains at $1,000 through 2010.

    Kiddie Tax

    In 2009, the “kiddie tax” applies to children up to age 18 and could apply to children up to age 24—depending on how much earned income they have and whether or not they are full-time students.

    Under the kiddie tax rules, children with investment income above a certain amount may have part or all of their investment income taxed at the parents’ income tax rate.

    For 2009, the kiddie tax rule applies if the child is 17 or under by the end of the year, and the child’s total investment income for the year was more than $1,900.

    In addition, the kiddie tax can apply to older children, depending on how much earned income they have and whether or not they are full-time students:

    • Starting in the year that your child turns 18, the kiddie tax will apply if your child’s earned income (including salaries and wages, commissions, professional fees and tips) is less than half of the child’s overall support.
    • Starting in the year your child turns 19, the kiddie tax will apply if your child is a full-time student.
    • The kiddie tax will stop applying in the year your child turns 24.
    • The kiddie tax will also not apply if your child is married filing jointly.

    Charitable Donations

    Note that in recent years, the rules for certain charitable contributions tightened. No deduction is allowed for most contributions of clothing and household items unless the donated property is in good used condition or better. In addition, charitable contributions of cash (regardless of the amount) to any qualified charity must be supported by a dated bank record (such as a cancelled check) or a dated receipt from the charity that must include the name of the charity, date and the amount of the contribution.

    Congress also extended through 2009 the provision allowing tax-free distributions from IRAs to qualified charities for individuals over age 70½. The maximum contribution limit remains at $100,000.

    Medicare Part D

    Taxpayers who itemize deductions can deduct (as a medical expense) the premiums they pay for the Medicare Part D prescription drug insurance program.

    Itemized Deduction Phase-Outs

    Taxpayers with adjusted gross income above a certain amount may lose part of the benefit of their itemized deductions, but the amount by which these benefits are reduced in 2009 is only one-third of the reduction that would have applied otherwise.

    In 2009, the adjusted gross income amounts at which phase-outs begin increase to $166,800 for married persons filing jointly, singles and heads of household. In 2010, the phase-outs are repealed, and all taxpayers will enjoy the full benefit of their itemized deductions.

    Planning Considerations: Married taxpayers filing jointly will need to calculate whether taking the increased standard deduction or itemizing deductions will generate the most tax savings overall. In doing so, make sure to consider whether state law restricts the ability to itemize to only those who itemize for federal purposes. The higher deductions may also require more couples to pay alternative minimum tax (AMT).

    Sales Tax Deduction

    Congress extended through 2009 the provision allowing taxpayers who itemize deductions the option of choosing between a deduction of sales taxes or income taxes when claiming a state and local tax deduction. In 2010, the state sales tax option will not be allowed.

    Tax-Exempt Interest Reporting

    State and local governments are required to report interest paid on tax-exempt state and local bonds on Form 1099-INT, Interest Income. This amount must be shown on your tax return and is for information only.

    Health Savings Accounts

       Health Savings Accounts
    You may be able to deduct contributions to a Health Savings Account (HSA). These tax-free savings accounts were established under the Medicare Act of 2003, and can be used to pay for medical expenses incurred by you, your spouse or dependents. They are used in conjunction with high-deductible health plans, where your basic health insurance does not cover first-dollar medical expenses.

    HSAs may be established by anyone who is covered by an HSA-qualified “high-deductible health plan,” is not covered by any other health insurance and is not enrolled in Medicare. Qualified high-deductible health plans must have an annual deductible of at least $1,150 for self-coverage and $2,300 for family coverage in 2009; these minimum deductibles increase to $1,200 for self-coverage and $2,400 for family coverage in 2010.

    Tax-deductible contributions can be made to the health savings account for the full amount of the annual deductible each year, up to a maximum of $3,000 for self-coverage and $5,950 for families in 2009. In 2010, these amounts increase to $3,050 for self-coverage and $6,150 for families. If you are over age 55, you can make extra contributions to your account ($1,000 in 2009 and thereafter) and still enjoy the same tax advantages.

    Individuals can also make a one-time transfer from their IRA to an HSA, subject to the contribution limits applicable for the year of the transfer.

    Contributions to HSAs can be made by you, your employer, or both. You can fully deduct your own contributions to an HSA, even if you do not itemize, and contributions made by your employer are not included in your taxable income. The interest and investment earnings generated by the account are also not taxable while in the HSA.

    Amounts distributed from the HSA are not taxable as long as they are used to pay for qualified medical expenses. They can be used to:

    • Cover the health insurance deductible and any co-payments for medical services, prescriptions, or products;
    • Purchase over-the-counter drugs and long-term care insurance and expenses; and
    • Pay health insurance premiums or medical expenses during any period of unemployment.

    Amounts distributed that are not used to pay for qualified medical expenses will be taxable, plus a 10% penalty will be applied.

    HSAs are similar to IRAs in that they are owned by individuals—you are not dependent on a particular employer to enjoy the advantages of an HSA. And if you change jobs, the HSA goes with you. What if you already have an existing medical savings account (MSA)? In that case, you can either retain it or roll the amount over into a new HSA.

    For more information on HSAs, go to the U.S. Treasury’s Web site at and click on Health Savings Accounts.

    You may be able to take a deduction if you contributed to a Health Savings Account (see box above).

    Education Savings

    The 2009 stimulus bill expanded the Hope education credit into a new American Opportunity education credit. The maximum credit is $2,500 per year for the first four years of post-secondary education for tuition and related expenses (including books). However, the credit phases out for higher income taxpayers.

    You can make non-deductible contributions to qualified tuition plans, also known as section 529 plans. These accounts, offered by states or their designee, are maintained solely for the qualified higher education expenses of a beneficiary. Distributions are tax-free, provided that the distributions are used to pay qualified expenses. Note that for 2009 and for 2010, the definition of “qualified education expense” has been expanded to include computers, computer technology and Internet service.

    In 2009, the contribution limit for an education IRA, now known as a Coverdell Education Savings Account, remains at $2,000 per beneficiary. The contributions are not deductible, but they grow tax-free in the IRA. Coverdell accounts may be used to fund qualified elementary, secondary, and higher education expenses. However, the amount that can be contributed is limited for higher-income taxpayers.

    Investment Strategies: 2009 and Beyond

    Given the nature of the changing tax rates in the past few years, and the likelihood that changes will be made in the near future, tax planning opportunities are difficult to assess.

    Listed below are traditional tax planning strategies that can help keep your tax bill down under various tax scenarios. It is important, however, to keep in mind that your goals and risk tolerance should drive your investment decisions, not just the income tax impact of an investment.

    Consider Roth IRA Conversion Opportunities

    Starting in 2010, you will have the option of converting all or part of your traditional IRA into a Roth IRA regardless of your adjusted gross incomes. Roth IRAs can provide certain advantages, including: the converted assets can be withdrawn tax-free at any time; future earnings are also tax-free (with some limitations); and Roth IRA owners are not required to take any minimum distributions in retirement. The downside, however, is that the conversion amount is subject to current taxation.

    While the benefits of a Roth IRA conversion could be considerable, taxpayers must carefully weigh the upfront tax costs against the long-term tax advantages. For more on this, see “Retirement Plans: Evaluating the New Roth IRA Conversion Opportunity,” by Christine Fahlund in the November 2009 AAII Journal [available at]. You may also want to consult a tax advisor for the best strategy.

    Take Advantage of Lower Marginal Rates

    Deferring income that is taxed at higher ordinary tax rates makes sense. However, currently qualified dividends and long-term capital gains are taxed at the same rate—and this year the rates are at a rock bottom 0% for taxpayers in the 15% or below marginal tax brackets. These rates will expire at the end of 2010, and the outlook for extending these advantageous rates beyond 2010 is uncertain at best.

    Sell Low-Basis Stock

    The current tax environment continues to present the opportunity to sell low-basis stock held for more than one year, because long-term capital gains rates may never be lower—currently, they are taxed at a maximum rate of 15%, and 0% for the two lowest income brackets. Indeed, capital gains rates will revert to previous higher levels—a 20% maximum rate, and 10% for the two lowest brackets—starting in 2011, if not sooner. If you have large positions in either gifted or inherited stocks, or stocks received from a sale of a business, consider using the proceeds from selling the stock to diversify your portfolio.

    Use Losses Carefully

    While tax considerations should not drive your investment decision, you can take advantage of losses in holdings in which you would prefer to either sell or reduce from an investment standpoint.

    Capital losses first reduce capital gains: Long-term losses reduce long-term gains first, and short-term losses reduce short-term gains first. Any long-term losses left over reduce short-term gains and vice versa. If you still have losses remaining after offsetting capital gains, you can reduce your “ordinary” income by up to $3,000. Losses not used this year can be carried forward to future years until they are used up.

    When planning, make sure you don’t run afoul of the wash-sale rules. If you sell an investment at a loss and then acquire substantially identical securities during the 30-day period before or 30-day period after the sale, the loss will be disallowed.

       What You Can Keep From Selling Your Home
    You may be able to exclude up to $250,000 of gain ($500,000 for married taxpayers filing jointly) when you sell your main home. The exclusion is allowed each time you sell your main home, but no more than once every two years.

    To exclude the gain, you must have owned the home and used it as your principal residence for at least two out of the five years before its sale. Periods of use include short absences (such as summer vacations), but longer breaks (such as one-year sabbaticals) do not. You also must not have excluded the gain on another home sale during the two years before the current sale.

    Married taxpayers filing a joint return can exclude gains if either qualifies for the year of the sale, but both spouses must meet the use test to claim the $500,000 maximum exclusion.

    If you do not meet the ownership and use tests, you may be allowed to exclude a reduced amount if the sale was due to health, a change in employment or certain unforeseen circumstances.

    Starting last year, a new tax rule will help surviving spouses who sell their primary residences. Under prior law, in order to take advantage of the $500,000 exclusion available to joint filers, a surviving spouse had to sell the home in the year of the spouse’s death when a joint return was filed. The new rule now allows a surviving spouse up to two years after the death of the spouse to sell the home and still claim the $500,000 exclusion, as long as the survivor has not remarried and the sale would otherwise meet the requirements.

    Be aware that under new rules, starting in 2009, if you convert a second home into your main home, you may not be able to exclude all of your gain on the subsequent sale of that home even if you meet the ownership and use requirements. The portion of the gain that is no longer excludable is based on the ratio of the time after 2008 that it was a second home relative to the total time you owned it.

    Excluded gains are not reported on your federal tax report; unexcluded gains are reported on Schedule D, Capital Gains or Losses.

    For a complete description of the rules, see IRS Publication 523, Selling Your Home.

    Consider the Impact of Taxes on Mutual Fund Investments

    Selecting tax-aware managers of mutual funds may be important to maximizing your aftertax rate of return in your taxable investment portfolio—and this will become even more important when the advantageous rates that apply to long-term capital gains and qualified dividends expire.

    You may choose when to sell shares of the fund and may, therefore, create long-term versus short-term capital gains. But you don’t control the investments within the fund. Should an equity manager fail to extend the holding period on a stock, it could cost you 20% of your gain (35% ordinary rate for short-term capital gains versus 15% long-term capital gains rate).

    Some mutual fund dividends will qualify for the 15% rate, while others will not. Dividends paid by stocks held by the fund and passed through to the shareholder will qualify for the dividend tax rate. However, capital distributions and bond interest will not. These payments are reported on Form 1099, which specifies the type of distribution. However, the special dividend rate is set to expire after 2010, at which time all dividends will be taxed as ordinary income.

    For more on mutual fund distributions, see the box below.

    Reconsider Taxable vs. Tax-Free Bonds

    Interest from tax-free municipal bonds is generally exempt from federal income taxes, unlike the interest from taxable bonds, which is taxed as income. However, changing tax rates, as well as changes in the yields of taxable bonds relative to tax-free municipals, can alter the aftertax yield advantage for certain taxpayers, making tax-free bonds less attractive.

    Additionally, private-activity bonds (a type of tax-free bond) could increase your exposure to the alternative minimum tax since their interest income is taxable for purposes of the alternative minimum tax (although the 2009 stimulus bill waived this for bonds issued in 2009 and 2010, and 2009 and 2010 refundings of bonds issued after December 31, 2003, through January 1, 2009.

    You should review your bond and money market accounts to make sure that you are earning the highest aftertax return. But don’t forget to consider the state tax implications of switching from tax-free to taxable bonds before making any final portfolio decisions.

    Consider Increasing Retirement Savings

    You may want to use any additional cash flows you receive this year to increase the amount invested in an IRA or 401(k) plan. The main advantage of retirement accounts—tax deferral—continues to make them a good investment vehicle.

    Review the Tax Implications of Taxable vs. Tax-Deferred Accounts

    The spread between capital gains and ordinary income rates has important implications regarding your asset allocation between taxable and tax-deferred (retirement) accounts. For example, from a tax perspective holding individual stocks in tax-deferred accounts and bonds in taxable accounts could be expensive, because gains resulting from stocks held in tax-deferred plans such as IRAs or 401(k) plans will be taxed at ordinary rates when taken as a distribution. By reversing that structure, taxable bonds and other tax-inefficient assets will be shielded from tax in the deferred accounts, while equities will enjoy the reduced rates for dividends and capital gains in personal accounts. Tax-free municipal bonds should, of course, remain outside of retirement accounts. Individuals should also consider the cost of commissions and taxes, as well as current cash flow needs, before making any investment moves between taxable and tax-deferred accounts.

    Protect Social Security Benefits

    If you are receiving Social Security benefits, you may have to pay taxes on them if your “modified” adjusted gross income (primarily your taxable income plus any tax-exempt interest income plus half of your Social Security benefits) exceeds certain levels. To protect your benefits, watch the amount of interest you receive from municipal bonds, since this amount is included in your modified adjusted gross income when determining the Social Security benefit taxability. In addition, you may want to delay taxable distributions from a retirement plan or IRA.


    It is important to remember that taxes are not the key to investment planning. And the temporary duration of the current tax law provisions should motivate individuals to reconsider existing strategies in the coming years. However, one thing is certain: There will be more tax changes coming, and everyone should consider how the changes directly affect their overall tax and investment strategies.

    How Much of Your Social Security Is Taxed?
    Income Level Percent of
    SS Benefits
    Below $25,000 Single & Head of Household
    Below $32,000 Married Filing Jointly
    $25,000 to $34,000 Single & Head of Household
    $32,000 to $44,000 Married Filing Jointly
    Above $34,000 Single & Head of Household
    Above $44,000 Married Filing Jointly

       AMT: An Unpleasant Surprise
    Are you subject to the alternative minimum tax? This tax comes as a surprise to many taxpayers. You may be subject to this tax, especially if any of the following criteria apply to your situation:

    • You have large itemized deductions for state and local taxes, including property and state income tax, or from state sales tax;
    • You have exercised incentive stock options;
    • You have significant deductions for accelerated depreciation;
    • You have large miscellaneous itemized deductions or a large deduction for unreimbursed employee business expenses;
    • You have tax-exempt income from private-activity bonds (although, for private activity bonds issued or, in certain cases reissued, in 2009 and 2010, interest is not considered an AMT preference item);
    • You have a large capital gain.

    The alternative minimum tax is calculated by first determining the tentative minimum tax. The tentative minimum tax is 26% of the first $175,000 ($87,500 married filing separately) of alternative minimum taxable income in excess of the exemption amount, plus 28% of any additional alternative minimum taxable income. However, for alternative minimum tax purposes, dividends and capital gains will be taxed under the same rules as for regular tax calculations. The alternative minimum tax is the excess of the tentative minimum tax above the regular tax calculated.

    Alternative minimum taxable income adds back certain preference items to regular taxable income—including state income taxes, real estate taxes and miscellaneous itemized deductions—and can cause the alternative minimum tax to be larger than the regular tax.

    In addition, although the tax rate on capital gains and dividend income is the same for both regular tax and alternative minimum tax, the disparity in rates between the alternative minimum tax and the regular tax may result in a higher effective rate on all income, including capital gains and dividends.

    The IRS offers the AMT Assistant, an electronic version of the AMT Worksheet in the 1040 Instructions. By filling in a few simple questions, you can determine whether or not you owe the alternative minimum tax. Go to the AMT Assistant at (found in the Online Services section).

    Year-End Tax Planning

    All Taxpayers: Determine Where You Are Now

    Year-end planning gives you the opportunity to shift certain items around, should that be beneficial in terms of your tax liability. Taking a few initial steps now and using year-end planning strategies can result in significant tax savings.

    How can you effectively plan?

    Here are the basic steps you should take to help start your personal tax planning:

    • First, estimate your income, deductions, credits, and exemptions for 2009 and 2010 using the Tax Forecasting Worksheet (page 18);
    • Identify items that you can shift from 2009 into 2010 and beyond (or vice versa);
    • Determine your marginal tax rate—the rate at which your next dollar of income will be taxed—for 2009 and 2010;
    • Determine how much tax you owe and when you must pay it to avoid underpayment penalties;
    • Determine whether you are subject to the alternative minimum tax (AMT);
    • Consult with your tax advisor, and then take the actions needed to make the best of your tax situation.

    To minimize your taxes, consider both short-term and long-term tax planning issues and strategies. Starting early will give you extra time to obtain additional information about items that concern you and to investigate additional ideas for tax savings or deferral. The Tax Forecasting Worksheet on page 18 will help you to view the current year and next year together and will provide a starting point for evaluating the tax effects of various strategies.

    Avoiding Tax Underpayment Penalties

    Make sure you determine your 2010 tax liability and the due dates for paying those taxes (including self-employment tax and the alternative minimum tax [AMT]), so that you avoid underpayment penalties. Federal tax law requires the payment of income taxes throughout the year as you earn your income. This obligation may be met through withholding, quarterly estimated tax payments, or both. If you do not meet this obligation, you may be assessed an underpayment penalty.

    For the 2009 tax year, if your total tax due minus the amount you had withheld is less than 10% of your total tax due, you will not be assessed an underpayment penalty. The disadvantage of overpaying throughout the year, though, is that you are in effect making an interest-free loan to the government. However, the underpayment penalty can be high, and it is calculated as interest on the underpaid balance until it is paid, or until April 15, 2010, whichever is earlier.

    You can avoid underpayment tax penalties by adopting one of the safe harbor rules. The basic rule is to pay the required amount by the end of the year through withholding and quarterly estimated payments. The required amount will be one of the following, depending on your individual situation:

    • 90% of the current year’s tax liability;
    • 100% of the prior year’s tax liability (increases to 110% for taxpayers who had adjusted gross income in excess of $150,000); or
    • 90% of the tax liability based on a quarterly annualization of current year-to-date income.

    Penalties are based on any underpayment, which is the difference between the lowest amount required to be paid by each quarterly payment date and the amount actually paid by that date. The annual required amount, based on either of the first two alternatives, is paid in equal installments. In the case of the third method, which is based on annualized income, the amount due each quarter is based on actual income received for each installment period. The third method is typically more beneficial if you expect to receive most of your income during the latter part of the year. It allows for lower required payments in the early quarters.

    Payments made through withholding from your paycheck (or from your pension or other payments) are given special treatment. The IRS treats income tax that is withheld as having been paid equally throughout the year (unless you prefer to use actual payment dates). This lets you make up for underpaid amounts retroactively, because amounts withheld late in the year may be used to increase the amounts paid in earlier quarters.

    State and Local Rules: Be aware that many states have underpayment rules that vary from the federal requirements.

    Timing: Income & Deductions for Taxpayers Not Subject to AMT

    You have opportunities to reduce your taxes if you can control the timing of either your income or expenses. However, it is important to make sure you understand whether you may be subject to the alternative minimum tax (AMT) before adopting these strategies (see box above).


    Your income is generally taxed in the year of receipt, so having the ability to control when you receive it affords a strategic tax planning opportunity. Deferring income until a later year will, in most cases, delay the payment of tax. You cannot defer taxation by merely delaying receipt of the income if the funds are available to you and the time of payment is subject to your unrestricted discretion. Any decision to defer income must be weighed with the lost time-value of the money and other risks that could alter or forfeit your right to the income.

    The timing of bonuses, recognition of capital gains from the sale of stocks, and the exercise of non-qualified stock options are all events that can easily be delayed into a subsequent year. You should also consider the deferral of compensation through the use of various retirement plans and deferred-compensation arrangements. If you operate a business or collect rental income and report that income on the cash receipts and disbursements method, you have an opportunity to delay or accelerate the billing to your customers or tenants and determine the timing of the related income.


    You can reduce taxes by controlling the payment of deductible expenses. If paid by December 31, you may deduct certain expenses that are due next year on your 2009 tax return. This strategy helps most when you expect this year’s marginal tax rate to be higher than next year’s. Taking the deduction in a year with a higher rate makes the deduction worth more. Again, you must balance this decision with the time-value of money and other inherent risks.

    For example, if you pay a deductible expense in December 2009 instead of April 2010, you reduce your 2009 tax instead of your 2010 tax, but you also lose the use of your money for three-and-one-half months. Generally, this will be to your advantage, unless you have an alternative use for the funds that will produce a very high return in that three- or four-month period. You must decide whether the cash used to pay the expense early should be used for something more urgent or more valuable than the accelerated tax benefit.

    Another consideration concerning the timing of deductions is that for higher-income taxpayers, the “phase-out” on itemized deductions, while reduced in 2009, is totally repealed in 2010. That means that for these taxpayers, in 2010 less of their income will be taxed and their deductions will count for more.

    For those who will pay 2010 estimated taxes based on their 2009 tax liability, reducing your 2009 taxes has another advantage: Your 2010 estimated tax payments may be smaller.

    State Taxes

    If accelerating deductions makes sense for you and you choose to claim a deduction on your state and local income taxes, you may want to prepay the balance on your estimated state tax liability in December, rather than waiting until 2010. This secures that deduction on your 2009 tax return, even though the payment might not be required by the state until January 15, 2010, or April 15, 2010.

    Charitable Contributions

    If you are planning on making a gift to a charity in 2010, consider making the gift in 2009 to accelerate the tax benefit of the contribution. However, it is important to note that certain limitations exist with respect to deductions for charitable contributions.

    You should also consider the benefits of gifting appreciated stock to a charity. If you donate long-term appreciated stock directly to the charity, you get a deduction for the full fair market value of the stock; whereas, if you sell the stock first and donate cash, you only get a deduction for the aftertax cash donated.

    When making a gift to charity, you must have an appropriate record of the gift in order to properly support the deduction. In addition, cash contributions of any amount must be supported by a written record either in the form of a bank record (for example, a cancelled check) or a written receipt from the charity. The record must include the name of the charity, the date, and the amount of the contribution.

    Prepaid Interest

    A cash basis taxpayer may not deduct prepaid interest before the tax year to which the interest relates. However, there is some flexibility to prepay year-end interest that is due early in the following year. For example, if a mortgage payment is due on January 10, a taxpayer can accelerate the deduction of the portion of the interest relating to the period up to January 1 by mailing the check in December.

    The most significant interest deductions currently available are for home mortgage interest and for investment interest expense to the extent of current-year investment income. Interest paid in relation to investments that earn a tax-free return is not deductible.

    Medical Expenses

    If the timing of certain medical and dental expenditures is flexible and your overall medical expenses are high in the current year, you may want to accelerate payment of these expenses. Because unreimbursed medical expenses are only deductible to the extent that they exceed 7.5% of adjusted gross income, it is best from a tax standpoint to incur expenses—such as replacement eyeglasses or contact lenses, elective surgery, dental work, and routine physical examinations—in a year in which you have already gone over (or the added expenses would take you over) the 7.5% threshold.

    Miscellaneous Itemized Deductions

    Miscellaneous itemized deductions are only deductible to the extent that they exceed 2% of adjusted gross income. This category is large but includes:

    • Tax preparation fees such as tax preparation software, tax publications and any fee paid for electronic filing; and
    • Investment fees, custodial fees, trust administration fees, and other expenses paid for managing your investments that produce taxable income.

    Accelerating miscellaneous itemized deductions only benefits taxpayers who accumulate expenses sufficient enough to exceed the 2% threshold. If possible, it may be advantageous to pay these types of expenses in one year if, because of the 2% floor, you would not receive a benefit of the deduction in each of the two consecutive years.

    Timing Caution for Taxpayers Subject to AMT

    The alternative minimum tax (AMT) was originally designed to ensure that everyone would pay his or her fair share of income taxes. In 1987, only 140,000 taxpayers were subject to the AMT. Since then, however, it has evolved into a separate tax regime that will affect millions of unsuspecting taxpayers at some time in the future.

    The wisdom of conventional tax planning advice to defer income and accelerate certain types of deductions may not hold true if an individual expects to be subject to the AMT. Accordingly, during the year-end tax planning process, it is critical that you determine if you are subject to the AMT in both the current year and the following year. This analysis is even more complicated because the AMT exemption level for next year is unknown.

    If you are continuously subject to the AMT, avoid investing in private-activity (municipal) bonds. Income from these bonds is taxable for AMT purposes (although the 2009 stimulus bill waived this for certain bonds issued in 2009 and 2010). Furthermore, you should be aware that unusual combinations of income and deductions might require AMT planning that runs contrary to conventional tax-planning advice. Although the exercise of an incentive stock option (ISO) does not give rise to regular taxable income to the employee, the difference between the exercise price and the market price of the stock must be recognized for AMT purposes for the year in which the option is exercised. Accordingly, the exercise of ISOs with a large bargain element often causes a tax liability under the AMT tax regime.

    The AMT area is extremely complex, so generalizations are difficult. If you think you may be subject to the AMT, you should consult with your tax advisor before year-end to determine how to minimize your exposure.

       Where’s My Money? Tracking Your Refund 24/7
    If you are expecting a refund on your 2009 income tax, you can check on its status if it has been at least six weeks from the date you filed your return by mail, or three weeks if you filed electronically. You will need to supply the following information: your Social Security number or IRS Individual Taxpayer Identification number, your filing status, and the exact whole-dollar refund amount as it is shown on your return. You can check the status of your refund in two ways:

    On the Internet, go to and click on “Individuals” and then “Where’s My Refund?”

    By telephone (for automated information), call 800/829-4477.

    If you are unable to get information on your refund through either of these two automated services, you can call the IRS for assistance at 800/829-1954.

    The site also allows you to start a trace for lost or missing refund checks, or to notify the IRS of an address change when refund checks go undelivered. Taxpayers can avoid undelivered refund checks by having refunds deposited directly into a personal checking or savings account. This option is available for both paper and electronically filed returns.

    Year-End Estate and Gift Tax Planning

    Year-end planning from an estate planning perspective typically involves ensuring that “annual exclusion” gifts are completed by the end of the calendar year.

    Under the federal gift tax system, each donor is permitted to make non-taxable gifts of a certain amount each year to any donee. These gifts are called “annual exclusion” gifts and do not count against the donor’s lifetime gifts exemption (currently $1 million). In 2009, the annual gift exclusion level increased to $13,000, where it will remain in 2010. To the extent not used, the annual exclusion evaporates at the end of each calendar year.

    Annual transfers that take advantage of this exclusion can both diminish the donor’s estate tax liability and improve the lives of the recipients. These gifts can take many forms (cash, stocks, real estate, partnership interests) and can be given outright through Uniform Transfers to Minors accounts, and even through a trust—provided it contains special provisions designed to allow the gift to qualify for the annual exclusion.

    Note that, as of this writing, the estate taxes are scheduled to be repealed for 2010 only, but it is expected that this repeal will be changed. Planning that can reduce these taxes remains important, but check with a tax advisor for the latest information.

       2009 Tax Planning

       2010 Tax Planning