Time to start your 2010 year-end tax planning

Published 2:11 pm Wednesday, December 1, 2010

As many of you know, the tax landscape will undergo many changes come January 2011. For the 2010 tax year, taxpayers will benefit from relatively favorable federal tax policies that will result in lower taxes when compared with those of even a few years ago. But scheduled increases in income tax rates, elimination of previously allowed deductions and expiring credits — along with a return of the estate tax — will make the 2011 tax year a very different one from 2010.

Recent elections and the resulting divided Congress mean there’s still much we don’t know about future tax policy. As we await further tax news from both the current lame-duck Congress and the upcoming session of the new Congress, now is a good time to review some of the known and potential changes for the 2011 tax year. Discuss these with your CPA adviser as you complete your year-end tax planning — strategic action taken before Dec. 31 can help you reduce your tax burden and focus on your financial goals in 2010 and beyond.

With many tax benefits set to expire, most taxpayers will experience some major form of increased tax liability starting in 2011. All federal income tax and long-term capital gains rates are set to increase. The phase-out for itemized deductions and personal exemptions will return to their pre-2001 levels. And various credits, such as the Residential Energy Credit and the American Opportunity Credit, are set to expire. It’s also likely that the Alternative Minimum Tax will become a surprise tax for tens of millions of taxpayers.

Limits in the tax law preventing higher-income taxpayers from converting traditional IRAs to Roth IRAs are eliminated beginning with the 2010 tax year. The normal rule for 2010 is that taxpayers pay tax on the conversion, with half the income subject to tax in 2011 and the other half subject to tax in 2012. However, an election to tax the conversion income in 2010 is now available, which may help you avoid potentially higher tax rates in 2011. Your adviser can help determine whether a Roth IRA conversion in 2010 is right for you.

Many of the Bush administration’s tax cuts were set to gradually increase over time through 2010. For example, the itemized deduction and dependency exemption phase-outs have slowly decreased over the past few years and are completely eliminated in 2010. However, those cuts, along with many other tax benefits, were temporary and are set to expire in 2011 absent additional legislation from Congress. As a result, 2010 could be a relatively good year to accelerate taxable income for many taxpayers.

In 2001, Congress made changes to the estate and gift tax code, resulting in a gradual increase in the amount of assets not subject to the federal estate tax and a decrease to the gift and estate tax rates. In addition, as part of the legislation, there was a one-year “repeal” of the federal estate tax in 2010, followed by a complete sunset of the law back to 2001 rates and exemption amounts. In other words, while there’s currently no estate tax in 2010, beginning Jan. 1, 2011, the estate tax comes back with a vengeance at a higher rate (up to 55 percent) and with an exemption of only $1 million.

However, Congress may increase the exemption up to at least $3.5 million. Accordingly, estate and gift tax planning becomes even more crucial in 2011, particularly if you reside in a state like Washington that has its own separate inheritance tax.

With all these changes coming, both Democrats and Republicans have outlined strategies for providing various levels of tax relief. The resulting tax legislation will likely be a compromise between the two sides. However, it is nearly impossible to predict the content of new legislation or whether it will be passed before year-end. The best option for taxpayers is to tentatively plan for changes in 2011, but closely monitor the actions of Congress between now and the end of the year.

Ryan Blume is a tax senior manager with Moss Adams LLP in Everett. He primarily serves closely held businesses, high net worth individuals and families. He can be reached at 425-303-3009 or ryan.blume@mossadams.com.