• the business use of the home is for the convenience of the employer, and
• no part of the home is rented from the employee by the employer

If the business use of the home is merely appropriate or helpful, no deduction may be taken. To qualify for exclusive use, you must use a specific area of your home only for your trade or business. The area used for business can be a room or other separately identifiable space. You do not meet the requirements of the “exclusive use test” if you use the area in question both for business and for personal purposes. You do not need to meet the exclusive use test if you use part of your home for the storage of inventory or product samples, but to take a deduction for such use you must meet all the following tests:

• The sale of products is your trade or business.
• You keep the inventory or product samples in your home for use in your trade or business.
• Your home is the only fixed location of your trade or business (or, as an employee, it’s your only place of work).
• You use the storage space on a regular basis.
• The space you use is a separately identifiable space suitable for storage.

To qualify under the regular use test, you must use a specific area of your home for business on a regular basis. Incidental or occasional business use is not regular use.

If you use your home for a profit-seeking activity that is not a trade or business, you cannot take a deduction for business use. For example, if you are an investor and you use your home to regularly read financial periodicals and reports, conduct analysis, gather data, make trades, talk on the phone, and carry out similar activities related to your investments, you cannot take a deduction.

You can have more than one business location and still qualify for a home office use deduction as long as your home is your “principal place of business.” To determine whether your home is your principal place of business, you must consider:

• The relative importance of the activities performed at each place where you conduct business, and
• The amount of time spent at each place where you conduct business.

If, after considering your business locations, your home cannot be identified as your principal place of business, you cannot deduct home office expenses.

Figuring the Deduction

To take a home office deduction, you’ll need to figure the percentage of your home used for business. To find the business percentage, compare the size of the part of your home that you use for business to your whole house. Use the resulting percentage to figure the business part of the expenses for operating your entire home. For example, let’s say your home office is 240 square feet and your entire home is 1,200. Your business use percentage is 20%.

Next, identify the deductible expenses. They’ll fall into one of two categories:

1. Direct Expense — Expenses only for the business part of your home, such as paint and repairs to the business-only area of your home. These are 100% deductible.
2. Indirect Expense — Expenses for keeping up and running your entire home, such as insurance, utilities, real estate taxes and general repairs. These are deductible at the business use percentage of the home.

Expenses incurred to improve or enhance the non-business-use parts of your home are not deductible at all.

Depreciation Expense

If you own your home and qualify to deduct expenses for its business use, you can claim a deduction for depreciation. Depreciation is an allowance for the wear and tear on the part of your home used for business. You cannot depreciate the cost or value of the land. You recover its cost when you sell or otherwise dispose of the property. To figure your depreciation deduction, you need to locate the following:

• Month and year you started using your home for business.
• Adjusted basis and fair market value of your home (excluding land) at the time you began using it for business.
• Cost of any improvements before and after you began using the property for business.
• Percentage of your home used for business.

The adjusted basis of your home is generally its cost, plus the cost of any permanent improvements you made to it, minus any casualty losses or depreciation deducted in earlier tax years.

The calculation of the amount you can deduct in any given year is a bit complex. We suggest you give the above-noted data to your accountant and let him or her develop a depreciation schedule for you.

For more information about deductions for business use of a home, search for publication 587 at www.IRS.gov.

Lawmakers have aggressively used the tax code to try to get the economy back on track, and there are now more ways than ever to reduce your tax liability. But all of them take planning. You need to understand your opportunities and leverage the tax breaks available to you and your business. Business owners and managers have more tax concerns to worry about than most people. Don’t act first and think about taxes later. A little foresight can go a long way.

Although the year is winding down, it’s not too late to act. Below are several year-end tax strategies that may help you leverage new incentives or avoid a tax headache. But keep in mind that these strategies won’t work for everyone. Whether or not they help you will depend on your situation. The strategies also involve just a fraction of all the new tax incentives available for businesses and individuals. Make sure you talk to a tax professional to discuss your own situation and to uncover all the tax breaks that can help your business.

Expense business investments

In an effort to jumpstart business investment, lawmakers have expanded the ability of taxpayers to immediately deduct the cost of many types of investments in their businesses.

Legislation enacted in 2010 doubles a bonus depreciation tax benefit for property your business places in service before the end of the year. Under this provision, you can fully deduct the cost of eligible equipment on this year’s return if you place it in service by December 31. To qualify for bonus depreciation, the property you place in service must be new and generally have a useful life of 20 years or less under the modified accelerated cost recovery system (MACRS).

This tax benefit is generally only available for property placed in service before the end of the year (there are different rules for certain property with long production periods and most airplanes), but Congress could extend it. If no legislation is enacted, property placed in service in 2012 will qualify for regular bonus depreciation, which allows you to deduct half of the cost of the property while the rest is depreciated using normal rules.

Get your self-employment taxes right

Employees that earn wages generally split payroll taxes with their employers and these taxes are automatically deducted from their paychecks. Self-employed taxpayers instead pay their own payroll taxes as “self-employment tax,” which is levied against self-employment income. Self-employed taxpayers may then deduct half the cost of this tax (what’s normally considered the “employer” half) for income tax purposes.

Lawmakers provided a partial payroll tax holiday in 2011 that reduces the employee share of Social Security taxes from 6.2% to 4.2%. This rate cut also applies to the self-employment tax, lowering the combined rate from 15.3% to 13.3% for 2011 self-employment income under the $106,800 Social Security wage cap. This rate cut is considered to come from the employee’s share of employment taxes, so it does not reduce your above-the-line income tax deduction for self-employment tax. This deduction is still calculated as one-half of 15.3% of self-employment income, or 7.65%.

Become a “qualified small business”

Lawmakers have focused many new tax incentives on small businesses. Legislation enacted in 2010 presents a unique opportunity for companies that are considered a “qualified small business” (QSB) under tax rules. A QSB must be organized as a C corporation for tax purposes (and meet several other tests) and cannot have more than $50 million in assets.

Original issue QSB stock purchased before the end of 2011 will receive a full exclusion from capital gain. That means taxpayers who purchase this stock before the end of the year will never pay tax on any gain on the stock as long as they hold it for five years and follow all the rules. You can normally exclude only half of the gain on QSB stock held. The full exclusion offers an excellent opportunity for eligible enterprises to raise capital at a reasonable rate or provide owners with a tax efficient growth opportunity. And it’s not only for C corporations. Under QSB tax rules, partnerships may perform a conversion into a C corporation in which the converted partnership interests are treated as stock acquisitions that can qualify for the QSB stock gain exclusion. But be careful, because there are lots of other tax implications to consider when deciding on your business structure.

Smartly set your corporate employee-shareholder salary

If you own a corporation and work in the business, you need to think carefully about your salary structure. Your tax treatment will vary depending on how high you set your salary and whether your business is organized as a traditional C corporation, or an S corporation (in which corporation income is “passed through” and taxed at the individual level).

Payroll taxes that are levied against salary income include a 2.9% Medicare tax (1.45% for the employee and 1.45% for the employer). Distributions of corporate income are generally not subject to this tax. That means if your business is an S corporation, you will pay Medicare tax only on business income received as salary, not income received as a distribution. C corporations are different. C corporation distributions also escape Medicare tax, but are subject to a 15% dividend tax rate (even though the income is already taxed at the corporate level). So many C corporation owners will pay less overall tax on income received as salary (which is deducible at the corporate level).

But remember to tread carefully. You must take a reasonable salary to avoid potential back taxes and penalties, and the IRS is cracking down on misclassification of corporate payments to shareholder-employees.

Make up estimated tax shortfall with increased withholding

Although you don’t file your return until after the end of the year, it’s important to remember that you must pay tax throughout the year with estimated tax payments or withholding. People paid in wages generally don’t have to worry as long as their employer is withholding enough. But business owners or executives with other types of income often need to make estimated tax payments. You will be penalized if you haven’t paid enough.

If your adjusted gross income is over $150,000 in 2011, you generally can avoid penalties by paying at least 90% of your 2011 tax liability or 110% of your 2010 liability through withholding and estimated taxes. If you’re in danger of being penalized for not paying enough tax throughout the year, try to make up the shortfall through increased withholding on your salary or bonuses.

Paying the shortfall through an increase in your last quarterly estimated tax payment can still leave you exposed to penalties for underpayments in previous quarters. But withholding is considered to have been paid ratably throughout the year. So a big bump in withholding on high year-end wages can save you in penalties when a similar increase in an estimated tax payment might not.

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taxconsulting@gt.com PERSONAL EXEMPTION $3,700 per person (none if filling as a dependent) EXEMPTION PHASEOUT There is no phaseout for exemptions in 2011. 

(Phaseout scheduled to return in 2013.) MAXIMUM SALARY DEFERRALS $16,500 for 401(k), 501(c) and 403(b) plans. 

($22,000 if over 50)

$11,500 for Simple, $14,000 if 50 or older. MAX. RETIREMENT PLAN CONTRIBUTIONS IRA (Regular¹ and Roth²): $5,000; $6,000 if 50 or older 

Defined Contribution Plans: $49,000

Defined Benefit Plans: $195,000

¹Phaseout of deductibility of IRA contributions begins at $90,000 (MFJ); $56,000 (S, HH, MFS)

²Roth phaseout begins at $107,000 AGI (S); $169,000 (MFJ); $0 (MFS) STANDARD MILEAGE RATES

	Jan-Jun	Jul-Dec
Business	51 cents	55.5 cents
Charity	14 cents	14 cents
Medical/Moving	19 cents	23.5 cents

ITEMIZED DEDUCTION PHASEOUT There is no phaseout for itemized deductions in 2011.
(Phaseout scheduled to return in 2013.) PAYROLL TAXES 4.2 % Social Security tax levied on first $106,800 in wages. 

1.45 % Medicare tax levied on all wages

Household help: SS tax levied only after $1,700 paid. KIDDIE TAX (Children under 19) First $950 not taxed; 950 to $1,900 at childs’ rate; over $1,900 at parents’ rate. 

(Kiddie tax also applies to college students under the age of 24 who do not provide over 1/2 of their own support.) FOREIGN INCOME EXCLUSION $92,900 SECTION 179 LIMIT $500,000 

(This is reduced by amount of sec 179 property that exceeds $2 million.) CAPITAL GAINS RATES* 

^{* There are special rates for many items, including collectibles, qualified small business stock and real property gain attributable to depreciation.} Assets held 1 year or less: taxed at ordinary income rates 

Assets held more than 1 year: taxed at 15% (zero for taxpayers in 10% or 15% brackets) CHILD TAX CREDIT $1,000 for each child under age 17.
Phaseout begins at $75,000 AGI (S); $110,000 (MFJ), and $55,000 (MFS). AMT RATES 26% of income up to $175,000 

($87,500 (MFS)); 28% thereafter AMT EXEMPTION $48,450 (S, HH); $74,450 (MFJ); $37,225 (MFS) Phaseout of exemption begins at $150,000; $112,000 and $75,000, respectively. QUALIFIED DIVIDEND INCOME Taxed at 15%
(zero for taxpayers in 10% or 15% brackets) ANNUAL GIFT EXCLUSION $13,000 ESTATE TAX EXCLUSION $5 million. RETIREMENT PLAN WITHDRAWALS MANDATORY Age 70 ½ HOME SALE EXCLUSION $250,000(S), $ 500,000 (MFJ) 

(You must include gain on a pro-rata basis for any years after 2009 that your home was not used as your principal residence.)

For Single, Head of Household, Married Filing Joint/Surviving Spouse, and Married Filing Separate Returns: If you can be claimed as a dependent by another taxpayer, your standard deduction cannot exceed the greater of $950 or earned income plus $300. (G1)  (G1) Applies to all filing statuses (G2) These do not get adjusted for inflation.
SINGLE	HEAD OF HOUSEHOLD
Taxable Income Tax Rate $0 — $8,500 10% $8,500 — $34,500 15% $34,501 — $83,600 25% $83,601 — $174,400 28% $174,401 — $379,150 33% Over $379,150 35% * Standard deduction $ 5,700 (+$1,400 for each spouse age 65+ or blind, $2,800 for each spouse age 65+ and blind.)	Taxable Income Tax Rate $0 — $12,150 10% $12,151 — $46,250 15% $46,251 — $119,400 25% $ 119,401 – 193,350 28% $193,351 – 379,150 33% Over $379,150 35% * Standard deduction $8,400 (+$1,400 for each spouse age 65+ or blind, $2,900 for each spouse age 65+ and blind.)
MARRIED FILING JOINT/SURVIVING SPOUSE	MARRIED FILING SEPARATE RETURNS
Taxable Income Tax Rate $0 — $17,000 10% $17,001 — $69,000 15% $69,001 — $139,350 25% $139,351 — $212,300 28% $212,301 — $379,150 33% Over $373,650 35% * Standard deduction $11,600 (+ $1,500 for each spouse age 65+ or blind, $2,300 for each spouse age 65+and blind.)	Taxable Income Tax Rate $0 — $8,500 10% $8,501 — $34,500 15% $34,501 — $69,675 25% $69,676 — $106,150 28% $106,151 — $189,575 33% Over $189,575 35% * Standard deduction $ 5,800 (+ $1,150 for each spouse age 65+ or blind, $2,300 for each spouse age 65+and blind.)  If you can be claimed as a dependent by another taxpayer, your standard deduction cannot exceed the greater of $950 or earned income plus $300. (G1)
CORPORATE TAX RATES	INCOME TAXES FOR ESTATES AND TRUSTS
Taxable Income Tax Rate $0 — $50,000 15% $51,001 — $75,000 25% $75,001 — $100,000 34% $100,001 — $335,000 39% $335,001 — $10,000,000 34% $10,000,001 — $15,000,000 35% $15,000,001 — $18,333,333 38% Over $18,333,333 35%	Taxable Income Tax Rate $0 — $2,300 15% $2,301 — $5,450 25% $5,451 — $8,300 28% $8,301 — $11,350 33% Over $11,350 35%

Well, the Internal Revenue Services (IRS) actually wants you to remain solvent — so you can continue to pay taxes, of course! And so, there is the Installment Sale election. The election entails breaking up the transaction into a series of smaller transactions that “occur” when each payment is made. For example, if an asset is sold for $100,000, to be paid in five equal annual installments of $20,000, it’s like selling one-fifth of the asset in five consecutive tax years. So, if the seller’s basis in the asset is $50,000, the gain to be recognized with each payment is $10,000 or 50 percent. If your tax rate is 20 percent, then you’ll owe $2,000 in tax with each $20,000 payment received.

The above is a simplified example. Talk to your tax professional before selling any high-value asset. To be sure, every seller wants cash at closing, but in the real world it sometimes takes seller financing to get a deal closed. In the sale of a business, seller financing occurs more often than not.

The Fine Print

Taxes are paid only on “gains.” That is, the difference between your cost basis and sale price for any asset. Expenses associated with the sale are added to basis. Installment payments do not have to be equal dollar amounts, and not even fixed amounts (see Contingent Payments below). But tax due on depreciation recapture is not deferrable, so depreciation recapture tax is calculated at closing for the entire transaction. Only the capital gains portion of a sale may be “amortized” or deferred with the installment method election.

Interest Income

Capital gains tax rates are currently lower than ordinary income rates. Interest income is taxed as ordinary income. Interest paid to the seller on amounts financed by the seller is taxed in the year the payments are received. If the stated interest rate on an installment sale note is not “fair market” in the eyes of the IRS, the IRS may input a fair interest rate.

Business Sale

Most businesses sell with the “asset method” in which the buyer purchases all the assets of the business — inventory, tools, equipment, receivables, websites, company name, phone numbers, customer lists, files, etc. — for a single price. For IRS purposes, whether or not seller elects the Installment Sale method, the parties must agree on the allocation of purchase price among the various types of assets, using fair market value (FMV) as the guide. Once this is done, the seller can determine whether the installment sale method is available — and desirable — for any asset or group of assets.

Example: You sold your business September 1 for $220,000. The terms were $100,000 down and a note for $120,000. The note payments are $15,000 each plus 10 percent interest due every July 1 and January 1. Your selling expenses are $11,000.

To analyze the application of the installment sale method to this transaction, the first step is to calculate the percentage of your gross selling price taken up by your selling expenses. In this case, it’s 5 percent ($11,000/$220,000).

The FMV, adjusted basis and depreciation claimed on each asset sold are as follows:

Under the residual method, you allocate the selling price to each of the assets based on its FMV ($201,500). The remaining $18,500 ($220,000 – $201,500) is allocated to goodwill (section 197 intangible).

The assets included in the sale, their selling prices based on their FMVs, the selling expense allocated to each asset, the adjusted basis and the gain for each asset are shown in the following chart.

The building was acquired in 2002, the year the business began, and it is Section 1250 property. There is no depreciation recapture income because the building was depreciated using the straight-line method.

All gain on the truck, Machine A and Machine B is depreciation recapture income since it is the lesser of the depreciation claimed or the gain on the sale. The total depreciation recapture income is $5,209: $3,650 on Machine A, $799 on the truck and $760 on Machine B. As mentioned earlier, these gains are reported in full in the year of sale and are not included in the installment sale computation. Similarly, the $10,000 for inventory assets cannot be reported using the installment method. Inventory is simply excluded from the installment method.

The contract price for the installment sale totals $108,500. The assets included in the installment sale, their selling price and their installment sale bases are shown in the following chart.

The gross profit percentage (gross profit ÷ contract price) for the installment sale is 48 percent ($52,075 ÷ $108,500). The gross profit percentage for each asset is figured as follows:

The sale includes assets sold on the installment method and assets for which the gain is reported in full in the year of sale, so payments must be allocated between the installment part of the sale and the part reported in the year of sale. The selling price for the installment sale is $108,500. This is 49.3 percent of the total selling price of $220,000 ($108,500 ÷ $220,000). The selling price of assets not reported on the installment method is $111,500. This is 50.7 percent ($111,500 ÷ $220,000) of the total selling price.

Multiply principal payments by 49.3 percent to determine the part of the payment for the installment sale. The balance, 50.7 percent, is for the part reported in the year of the sale. When you receive principal payments in later years, no part of the payment for the sale of these assets is included in gross income. Only the part for the installment sale (49.3 percent) is used in the installment sale computation.

The only payment received in Year 1 is the down payment of $100,000. The part of the payment for the installment sale is $49,300 ($100,000 × 49.3 percent). This amount is used in the installment sale computation.

Installment income for Year 1. Your installment income for each asset is the gross profit percentage for that asset times $49,300, the installment income received in year 1.

Installment income after Year 1. You figure installment income for years after Year 1 by applying the same gross profit percentages to 49.3 percent of the total payments you receive on the buyer’s note during the year.

Contingent Payments

A contingent payment sale is one in which the total selling price cannot be determined by the end of the tax year of sale. This happens, for example, if you sell your business and the selling price includes a percentage of its profits in future years. If the selling price cannot be determined by the end of the tax year, you must use different rules to figure the contract price and the gross profit percentage than those you use for an installment sale with a fixed selling price. For rules on using the installment method for a contingent payment sale, see Regulations section 15a.453-1(c).

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Selling an asset with terms? Don’t pay the entire tax bill now. Pay it as you receive the payments. The methodology may appear complex, but it’s simple in its essence. Turn the details over to your accountant.

The reason: A tax dollar saved is a full dollar retained in the business. Federal and state taxes take a bite out of every other business dollar. Here’s the proof.

Tax Savings vs. Sales Increase.

The following formula yields the sales necessary to match any amount of tax dollar savings.

Example: Company A has a 10 percent pretax profit margin (pretax profit divided by revenue) and is in an overall 35 percent tax bracket (federal and state). Tax planning saved $10,000 in taxes. The tax savings is equivalent to the profit on $153,846 in additional sales, computed as follows:

The $10,000 tax savings provided Company A with The after-tax equivalent of $153,846 in additional sales. Any tax dollar saved would yield the after-tax equivalent of $15 in increased sales ($154,000/$10,000).

Tax Saving vs. Cost Cutting.

Now let’s compare the value of a $1,000 tax savings with that of a $1,000 cost reduction. Use the table below, which again assumes an overall 35 percent tax rate.

As shown, if your profit margin is 15 percent, a $1,000 savings in taxes is equivalent to additional sales of $10,256 — about 1.5 times the $6,667 amount you would realize from cutting costs by $1,000. And the lower your pretax profit margin, the more valuable tax savings are to you. For example, if your profit margin is only 5 percent, a $1,000 tax savings is equal to $38,462 in sales!

When the goal is after-tax cash in your pocket, adding revenue and lowering expenses is paramount. But tax reduction is critical as well. Dollar for dollar, the value of a tax dollar saved is unmatched.

Answer: You have to meet two tests to deduct interest on another individual’s loan: (a) You have to be directly legally liable for the loan, and (b) you have to make the payments. From a tax point of view, your arrangement for the loan repayment is benefiting neither you nor your daughter. She can’t claim the interest deduction because she isn’t making the payments, and you can’t deduct them because you’re not legally obligated for the loan payments. You might be better off giving your daughter the money to repay her own mortgage loan. At least then she could claim the interest deduction.

——–

Editor’s note: If you co-signed the original note as guarantor, you may be allowed to take the interest deduction.

Example 1: Assume that you’ve had a good year of income. You are married, file jointly, and determine your taxable income for 2010 to be $205,000 currently – the total of interest income ($10,000), salary ($80,000), commissions ($40,000) and pass-through earnings from your company ($75,000). It is near year-end and you are close to completing a sale that will add $50,000 to your company’s net income (and to your pass-through income). Should you push to get it done before year-end or let it slip into 2011?

If we look at the federal tax rate tables, we see that married couples filing jointly pay a 28 percent income tax rate for income between $137,301 and $209,250. Income over $209,250 to $373,650 is taxed at 33 percent. If the sale closes this year, you will owe a total federal tax of $16,288 on the additional $50,000 of income, computed by applying the 28 percent rate to the $4,250 left in the 28 percent tax bracket and applying the 33 percent tax rate to the remaining portion of the commission income. But if you delay closing until next year, when you expect your overall income to be lower, the income could be taxed at the 25 percent and/or 28 percent levels, saving you at least $2,288 in federal tax (assuming the $50,000 is all taxed at the 28 percent rate), and even more when you include state tax. A nice return, considering how little effort is required.

Example 2: Joe Roe has calculated his taxable income, after regular and itemized deductions, at $77,000 for 2010. It has been a great year, but he expects his income to be more its typical $40,000 next year. Using the federal income tax tables for married filing jointly, he sees that he is in the 25 percent tax bracket for all income over $68,000. As such, he is paying 25 percent tax on $9,000 of his income. He checks his personal payables for deductible expenses and sees that he is holding a real estate tax bill due March 15, 2011 for $7,000. Because many real estate taxes are deductible in the year they are paid, and this one is, he could go ahead and pay the bill before year-end and reduce his 2010 taxable income by $7,000. To the extent that next year’s income will all be taxed at the 15 percent bracket, Mr. Roe would save $700 in taxes, calculating the savings as the difference between the 25 percent and 15 percent tax rates multiplied by the $7,000 of income that would have otherwise been taxed at 25 percent.

Strategies for lowering the rate at which income is taxed include the rationalization of taxable income between tax years in light of marginal tax rates, moving income to persons or entities that are taxed at lower levels, moving income into accounts that are nontaxable or tax deferred, and conducting transactions in a manner that qualifies for lower rates (such as long-term vs. short-term capital gain rates).

Allocate Income Among Years to Avoid Higher Tax Brackets.

This technique, known as Marginal Tax Rate Analysis, is explained in more detail in the accompanying article titled “Managing Marginal Tax Rates: A Basic Tax Reduction Tool.”

Hold Appreciated Investments Long Enough to Qualify for Long-Term Gains Treatment.

Investments held for less than one year are taxed at ordinary income tax rates, which are higher than capital gains rates. Investments held for more than a year are taxed at long-term capital gain rates, which are lower at all income levels.

Make Charitable Contributions with Appreciated Assets Instead of Cash.

Doing so will save you from owing tax on the capital gain, and you will still be able to deduct the full, appreciated value of the stock (if you have held the investment more than a year).

Gift Money, Assets or Investments to Entities That Enjoy Lower Tax Rates.

Any person can give $13,000 in cash or property per year to any person or persons, with no income tax or gift consequence to either party. This tax code provision is most often used to move assets to children and grandchildren because the amount transferred will not be subject to estate and/or generation-skipping tax. It is an effective tool for moving income-generating assets to persons who enjoy lower tax rates. As long as the gift is $13,000 or under, there is no reporting requirement. Additionally, one spouse may give $26,000 as long as the amount is reported and both spouses consent on their tax return.

Shift Income to Entities Domiciled in Cities, States or Countries with Lower Overall Tax Rates.

City, county, state and federal taxes vary significantly. Businesses that have multiple locations of operation and/or a non-local client base, and even individuals, should consider how taxes could be reduced if income could be attributed to another locale.

• Failure to report income
• Claiming fictitious or improper deductions
• Improper allocation of income to a related taxpayer in a lower tax bracket

Every tax planning strategy is based on structuring a transaction to accomplish one or more of the following often-overlapping goals:

A. Lower Taxable Income

By lowering taxable income, you lower the amount of taxes due. Many strategies to reduce taxable income will simply delay or defer recognition of income. This alone is valuable, of course, given the time value of money. Other tactics include increasing tax-deductible expenses, moving income to entities that enjoy lower tax rates and finding losses to offset investment gains.

B. Claim All Available Tax Credits

Tax credits are dollar-for-dollar reductions to your tax bill. Deductions are dollar-for-dollar reductions of your taxable income. There is a big difference. Tax credits are much more valuable than deductions because a $100 credit reduces your tax bill by $100, regardless of your tax bracket. In contrast, a deduction simply reduces your taxable income by the product of the deduction amount times the applicable tax rate. For example, if you are in the 33 percent tax bracket, a $100 deduction will reduce your taxes by $33.

C. Lower the Applicable Tax Rate

Such strategies include rationalization of taxable income between tax years in light of marginal tax rates; moving income to persons or entities that are taxed at lower rates; moving income into accounts that are non-taxable or tax deferred; or conducting transactions in a way that qualifies for lower rates (such as long-term vs. short-term capital gain rates). See also “Lower Your Applicable Tax Rate“.

D. Control the Effects of the AMT

The AMT was established in 1986 to ensure that higher-income individuals and corporations pay at least a basic level of tax, regardless of the number of tax credits and deductions that they garner. It requires that federal income taxes be calculated by two separate and distinct methods – regular tax laws and AMT laws. You pay the higher of the two. C-corporations with annual revenues under $5 million (and in some cases up to $7.5 million) are exempt. Individual taxpayers who have incomes over $75,000 face heightened risk of triggering AMT taxes. AMT tax rates are lower, such as 26 percent and 28 percent for individuals, but far fewer credits and deductions are allowed.

New and of Note

1. Must itemize to deduct real property taxes. Congress did not extend the real property tax deduction that was available in 2008 and 2009 for taxpayers who don’t itemize. The provision had allowed an additional standard deduction of up to $500 for singles and $1,000 for married couples filing jointly. The only way to deduct your 2010 property taxes is to itemize.
2. Phaseouts of itemized deduction and exemption eliminated. Business owners with sizeable incomes have suffered in recent years through phaseouts of their personal exemptions and itemized deductions. The good news there is that they have been eliminated in 2010. Taxpayers at all income levels can use their deductions and exemptions in full.
3. Homebuyer credit. Congress extended a tax credit for homebuyers in 2010 to include purchases made by September 30, 2010 if a binding contract was in place by April 30, 2010. The credit offers up to $6,500 for “long-time residents” who owned a home that was their principal residence for five of the eight years before the purchase, or $8,000 for “first-time homebuyers” who did not own a principal residence in the three years before the purchase. The credit begins to phase out at income levels of $125,000 for singles and $225,000 joint filers, and the house can’t cost more than $800,000.
4. Payroll tax reduction. Lawmakers enacted a one-year reduction in the employee portion of the Social Security tax in 2011 from 6.2 percent to 4.2 percent. The reduction applies all the way up to the Social Security wage limit of $106,800, and reduces self-employment taxes for self-employed business owners from 15.3 percent to 13.3 percent. It does not affect the deduction for self-employment taxes. Business owners with employees must be using the IRS’s updated withholding tables by February 1, 2011 and must credit employees for any overpaid Social Security tax by March 31, 2011.

Moves to Consider Now

5. Your 2010 IRA contribution. If you haven’t already made your IRA contribution for 2010, you have until April 18, 2011 to do so. If you don’t have an IRA account yet, you can set one up. Contribution limits for 2010 are $5,000 ($6,000 if you are 50 years of age or older). Contribution are deductible so long as your 2010 income did not exceed $109,000 for joint filers and $66,000 for singles.
6. Roll over to a Roth. The $100,000 income limit on rollovers from an IRA or 401(k) to a Roth IRA disappeared in 2010. This type of rollover allows you to pay tax on the conversion in exchange for no taxes in the future (if withdrawals are made properly). A special provision allows you to pay the taxes on a 2010 conversion in equal installments in 2011 and 2012.

Other Suggestions

7. Gather proof of your 2010 charitable donations. Donations to individuals, social clubs, political groups or foreign organizations are not deductible. Qualifying charitable contributions must be documented to be deductible. If you claim a charitable deduction of more than $500 in donated property, you must attach Form 8283. If you are claiming a deduction of $250 or more for a car donation, you’ll need a contemporaneous written acknowledgment from the charity that includes a description of the car.
8. Electronic filing. Filing electronically will speed up your refund and can save you from simple mistakes. Before the IRS accepts an electronic return, it checks for several critical errors. The IRS gives you the chance to correct the problems before it accepts and processes your electronic return.
9. Check your numbers twice. Avoid math errors and make sure to get your Social Security numbers right. IRS computers automatically match all Social Security numbers and check for simple math mistakes. If you wrote down the wrong Social Security number for one of your dependents, the IRS will disallow the dependent, recalculate the return and usually send you a brand-new tax bill. Millions of returns also generate math error notices that often come as unwelcome surprises to unsuspecting taxpayers. These problems can be a hassle to unwind.
10. Don’t miss the deadline for filing an extension. Don’t bury your head in the sand if you’re not going to get your return filed on time. Filing for an automatic extension with Form 4868 is painless and will spare you penalties for missing the deadline. But remember, extending the filing deadline does not extend the time for making a contribution to an IRA, and it does not extend the time for payment. By the filing deadline, you must have paid at least 90 percent of your 2010 tax liability through withholding, estimated payments and any payment made with your extension.