It’s Always Tax Time!

As I write this article, we are approximately one month away from when the Federal government expects our beloved 1040s.  In fact, this year we are graced with an extra three days because returns aren’t technically due until April 18, in observance of Emancipation Day in the District of Columbia.  Procrastinators, rejoice! You have an extra three days this year!

This time of year is always busy at Moneta as we work with our clients and the tax preparers to make sure tax season goes as smoothly as possible.  It is also a time to reflect on all the tax planning we put in place during the prior yearthis is when we see the realities of those planning ideas come to life.  Too many people think of tax planning as something they do in the month of December as they race to implement tax reduction strategies before the clock strikes 12/31.  However, I believe that tax planning is an ongoing processsomething best done throughout the calendar year.  As we put our 2010 tax returns to bed, here are 10 tax-planning ideas to keep on the checklist as we forge ahead in 2011:

  1. Know your tax position.  Having a good understanding of your tax position is a basic, yet important step when managing your tax situation. Do you have a capital loss carryover from your prior year’s tax return?  Are there opportunities to harvest additional losses in the portfolio this year?  Depending on the tax environment and your tax bracket, are you better served to realize capital gains today, while things may be favorable than in the future?  Many clients have been able to bank losses over the past few years, which serves as a nice cushion in offsetting future capital gains.  Also, to the extent that your losses exceed your gains at the end of the year, the IRS allows you to take up to $3,000 of those losses to offset your ordinary income (i.e. such as wage income).  Additionally, having excess capital losses can provide a nice buffer in future years, as they can be carried over indefinitely.
  2. Estimate your federal and state income taxes.  I am fairly comfortable saying that the majority of us do not get very excited about paying taxes.  Even worse is owing penalties to the government for failing to make timely tax payments.  For those who have significant fluctuations in your income stream and/or for those who find themselves either woefully under withheld or with large refunds coming, consider sitting down with your Moneta advisor and/or tax preparer to review your annual tax withholding.  Perhaps you need to make an adjustment to your W-4 withholding form or maybe you need to be making a quarterly estimated tax payment to stay on track.  Regardless, keeping a finger on this pulse is important because you want to avoid unnecessary penalties, yet there’s no need to provide an interest-free loan to the government.
  3. Contribute more to your 401(k) or 403(b).  Contributions made to your work place retirement program provide an additional tax deduction in the current year.  Plus, any growth that accrues in the account is tax deferred until you take out the dollars (generally at retirement).  The IRS has kept the annual contribution limits the same for 2011, which allows an individual to defer up to $16,500 of their compensation into a retirement plan.  Those over 50 have the opportunity to defer an additional $5,500 into their retirement plan in the form of a “catch-up” contribution.  It is worth noting that more plans are beginning to offer a “Roth” feature to their 401(k) or 403(b).  If your plan offers this option, this is a good topic for you and your Moneta advisor to discuss to determine if this is something you should take advantage of (keeping in mind that income limits don’t apply here like they do with Roth IRAs).
  4. Donate appreciated stock.  The last two years have seen a nice recovery from the doldrums of the markets in 2008 and early 2009.  As such, many clients have stocks and mutual funds that have experienced significant appreciation since that time.  To the extent you have large charitable intentions for 2011, consider gifting appreciated securities instead of cash.  As long as you have held the position for at least one year, the IRS allows you to give away the position and take a full charitable deduction for the amount of the gift.  The good news is that you don’t have to pay taxes on the gain in the investment, nor does the entity receiving the gift.  Whatever cash you were going to donate, deposit those dollars back into the portfolio for reinvestment.  In doing so, you haven’t depleted the portfolio, but you have increased your basis in your account (which equals paying less in taxes in the future).
  5. Time your charitable donations appropriately.  Most of us give to our charities of choice not because of a tax break, but because we believe in and have compassion for the organizations’ mission.  However, there are times where it can make sense to accelerate large gifts that may sync up with a year where you find yourself with significant additional income from a bonus, stock option payout, severance package, etc.  Also, you may want to talk to your Moneta advisor about using a charitable gift trust fund from Fidelity or Charles Schwab to help with the process.
  6. Convert to a Roth IRA?  Last year there was a lot of hype around converting traditional IRAs to Roth IRAs.  There were several reasons for the hoopla.  First, many taxpayers were precluded from even considering a conversion in prior years due to income threshold limitationshowever, beginning January 1, 2010, those restrictions were lifted.  Secondly, the IRS allowed taxpayers to take advantage of a two-year spread of the income, meaning that instead of having to recognize the taxable income from the conversion on the 2010 tax return, taxpayers could elect to recognize 50 percent of the conversion amount on their 2011 return and the remaining 50 percent on the their 2012 return.  Finally, I think many saw an opportunity to convert, given the fact that IRA values had become so depleted following the stock market drop.  The thinking was that if you planned to convert, you might as well do it sooner rather than later (while the asset value is lower, thus producing a lower tax liability at conversion).  As we embark on a new year, there still may be good rationale for discussing the Roth conversion option.  One example is a client who recently retired and will see a significant income drop in 2011 but who still has many deductions (i.e., mortgage interest, real estate taxes, investment advisory fees, etc.).  In order to take advantage of the available deductions, some level of income needs to be generated.  Thus, a Roth conversion may serve an ideal tool to accomplish this.
  7. Make 529 plan contributions.  For those saving for college, consider a 529 plan as part of your planning process—a wonderful tool when saving for those college years. Missouri taxpayers are allowed to deduct up to $8,000 per year ($16,000 if  married filing jointly) on your Missouri return, as long as the contribution is made by December 31 of the tax year.  In addition, any growth in the account is not only tax deferred, but can be withdrawn Federal and state tax free if those dollars are used for qualified higher education expenses.  It seems like many choose to make these contributions at year end, but I would encourage you to knock your contributions out early in the year to take advantage of additional tax-free growth and to make sure those contributions don’t get overlooked during the hectic year end!
  8. Take advantage and utilize your workplace Flexible Spending Account.  If used appropriately, Flexible Spending Accounts (FSA) can be great tools to pay for medial and/or dependent care related costs with pre-tax dollars.  The key is understanding what expenses qualify and being able to estimate your calendar-year needs accurately, because FSA dollars are a “use it or lose it” proposition.  If you don’t spend the dollars you allocated to the account, you risk losing any unused balance remaining at year end (some employer’s plans may allow you to put off claiming reimbursements until the following March 15 to address any unused expenses, but you should check with your plan manager to be sure).  Be sure to keep tidy records of all of your reimbursable expenses throughout the year to avoid the end of year scramble!
  9. Consider family gifting.   If you have intentions of giving money to family members and loved ones, take advantage of the yearly gift tax exclusion of $13,000 per person.  If you give more than that to any one individual, you will find yourself subject to gift tax and filing an extra tax return.  However, if making larger annual gifts is an appropriate strategy for you and your estate, this is an important topic to discuss with your Moneta advisor, particularly in light of the new estate tax law changes.  The new legislation reunified the estate and gift tax rules to permit the use of the entire $5 million exemption to make lifetime gifts.
  10. Seek wise counsel.  The U.S. tax code is complex and often difficult to navigate.  My experience both in preparing and reviewing tax returns has always been an eye-opener! It’s amazing to me how often I find errors and/or missed opportunities when reviewing a tax return some of those discoveries have been significant in nature! Partnering with your Moneta advisor and a good CPA is a smart investment you won’t regret.

Matthew D. Ring, CPA, CFP®

Matt is the professional consultant for Tom O’Meara.

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