Spring Forward, Fall Back into Tax Planning

By: Bernadette Smith, Fifth Third Private Bank

Planning now could help prevent potential pitfalls near the end of the year.

While you are getting ready for the end of the year, now would be a good time to begin your tax planning. With all of the expected federal tax law changes failing to be enacted over the past year, it is hard to keep up with what tax provisions are in – and which are not. Thus, beginning your tax planning now is more important than ever.
With so many possibilities of tax breaks and other provisions yet to be renewed, viewing all your options early can benefit you as things change closer to the end of the 2010 year. Starting your tax planning now provides you time to find ways to accelerate income and determine if you should defer or accelerate deductions.  Typically, you would defer deductions since income tax rates are increasing in 2011, however, it may be more beneficial to accelerate deductions into 2010 since they are not phased out based on income.
Last year’s federal income tax return can be a good starting point for your 2010 year-end planning. You can use your 2009 1040 Form to assess your current tax situation and identify potential strategies for lowering your 2010 taxes.
As part of your year-end planning, consider ways you can time income and/or deductions and credits to produce the best tax results. Here are some points to note when considering your year-end tax planning:
Income timing: In past years, the common method of timing your income, if economically feasible, was to delay taxable income until after the end of the year. By delaying income, you defer your taxes on that income. However, in 2010, effective planning will focus on accelerating income.  The reason – some of the biggest tax increases in decades are scheduled to take place next year. It has yet to be seen if Congress will intervene. Some of the most common means to accelerate income are security sales (which have the added benefit of historically low tax rates on long-term capital gains), IRA distributions, exercising stock options and earning or receiving bonuses.
Deduction timing: At the federal income tax level, the deductions that are most commonly used in year-end tax planning are those available to taxpayers who itemize their deductions. These would include charitable contributions, estimated state and local tax payments, real property taxes for which the due date is early in the succeeding year, and, for those who are able to deduct medical expenses, timing the performance of elective procedures. For those who operate a cash-basis business as a sole proprietor or manage rental properties, there may be opportunities to accelerate or defer expenditures. In most of these areas, payment by credit card before year-end pulls the deduction back into that year. In the investment arena, there may be depreciated securities for which loss harvesting provides deduction opportunities.
Avoid Alternative Minimum Tax (AMT): This system has recently become a problem for many more than just the wealthy. The AMT was originally a system designed to ensure anyone benefitting from special deductions and credits for certain expenses pays a minimum amount of tax. The tax, initially considered to be for the wealthy, has hit many in the middle-class due to inflation in the marketplace. The AMT patch to increase exemption levels has yet to be approved for the 2010 tax year, so plan accordingly.
Social Security: If you receive Social Security retirement benefits, a portion of your benefits could be taxable in 2010 if your provisional income – adjusted gross income plus one-half of your social security benefits and tax-exempt interest income – exceeds certain levels. Timing income from other sources may help you avoid or minimize income taxes on your benefits.
Also, remember tax credits. Tax credits can be more effective than deductions in reducing taxes because, while deductions offset income, credits offset taxes dollar-for-dollar, and in some cases, are either partially or fully refundable.
There are many things to consider this year, but starting early can help you navigate through those potential pitfalls. Talk to a tax professional to review your situation. Reviewing your specific tax situation can help you determine whether a particular planning strategy is right for you.

Bernadette Smith, CFP, is Senior Portfolio Manager at Fifth Third Private Bank. She serves on multiple boards, including the Women & Girls Foundation.  Recently, she was appointed by Gov. Rendell as a member of the Inter-branch Commission for Gender, Racial and Ethnic Fairness,  received the YWCA “A Tribute to Women Leadership Award and the Athena Award.