2008 Year-end Tax Planning for Individuals

November 19, 2008 - The end of 2008 is coming up fast. With the year drawing to a close, now is an ideal time to review your tax situation and evaluate strategies that may help minimize your tax bill. Once December 31 passes, your 2008 tax bill is essentially set. Taking certain steps before then can make a difference. How much you can save depends on your individual circumstances, but examination of the following general areas is worth a look -- in addition to considering the tax impact of any special circumstances in which you might find yourself this year.

TRADITIONAL TECHNIQUES

Income shifting. One of the most fundamental year-end tax planning techniques involves accelerating deductible expenses into 2008 and deferring income, if economically feasible, into 2009. With the possibility of changes in the tax brackets following the elections, the deferral/acceleration issue becomes even more complicated. By delaying taxable income you defer taxes. Delaying taxable income may also prevent you from losing lucrative tax breaks that can be reduced or eliminated altogether as your income level rises and propels you into a higher tax bracket.

With less than two months left until the end of the year, you can probably anticipate with reasonable certainty what income and deductions you will be reporting on your 2008 tax return. You may also be able to predict with relative accuracy what your income and expenses for the first few months of 2009 will include. The ability to gauge your income and expenses for 2008 and into 2009 provides a golden opportunity to shift income or expenses into one year or the other depending on what will minimize your overall taxes.

Shifting income, however, is not always a matter of simply delaying receipt of funds. Tax rules may require you to recognize certain types of income when you have earned the right to receive it, even if you arrange for its delayed payment. We can help you recognize and navigate the differences.

Deduction management. Essential year-end tax planning requires determining whether you will take the standard deduction or whether you will itemize your deductions. Consider "bunching" deductible expenses into one or the other year depending upon whether the standard deduction may be taken in one year or whether the adjusted gross income limits for medical (7.5 percent) or miscellaneous itemized deductions (2 percent) may be more easily exceeded.

Even if you know you will itemize deductions, accelerating or deferring them is often a question of determining your probable tax bracket for year end and the next year to maximize their after tax value. Whether or not you will be paying alternative minimum tax is another factor. Sometimes planning is as simple as paying your state estimated tax or real estate taxes in one year or the other; at other times, it's a question of making certain you gather the right proof and follow the proper steps in time to be entitled to a deduction in one year or the other. Again, we can help.

Portfolio timing. The end of the year is the right time to examine your investments (winners and losers over the course of the year) and take the steps necessary to minimize your capital gains income and maximize the benefit of any capital losses. Especially this year, when the stock market took its roller-coaster ride, gathering your portfolio's records for the entire year can make a difference in not only what you might buy or sell in November and December but what estimated tax you will need to pay (or not pay) for the fourth quarter of 2008. Long-term capital losses can be used to fully offset long-term capital gains. Losses taken in excess of gains can also be used to offset up to $3,000 in ordinary income (or $1,500 for a married couple filing separately). The strategy for short-term gains and losses follows a similar game plan, although coordinating the two sometimes takes special care. Unlike excess business losses that can be carried back two years to net an immediate refund in many cases, an individual's net capital losses unfortunately can only be carried forward.

Retirement planning. Year-end planning for 2008 also involves maximizing annual contributions to your retirement plan accounts, since one year's limit cannot be added to the next year's if not taken in time. While contributions to IRAs may be applied retroactively if made before the filing deadline, an individual's elective deferral contribution made as an employee to a qualified plan (such as a 401(k) plan) must be made before the end of the calendar year.

Maximizing contributions to your retirement plan (or plans) before year end also allows you to reduce your adjusted gross income in direct proportion to those contributions. This in turn can give you the benefit of increasing the deductibility of medical and other deductions subject to adjusted gross income floors.

Gift-giving. Slow and steady estate planning through an annual gifting plan can yield dramatic results. Before year-end 2008, you can transfer up to $12,000 per person as an annual exclusion gift. Married couples can gift $24,000 per person by "splitting" their gifts. In 2009, the annual exclusion rises to $13,000 ($26,000 for couples). The caveats are these: (i) the Tennessee gift tax laws are not identical to the federal laws so please seek competent advice if you are giving over $3,000 to any individual who is not your ancestor or a lineal descendent, and (ii) splitting gifts requires filing gift tax returns, so please let your LBMC tax advisor know if giving more than the $12,000 to any individual.

NEW OPPORTUNITIES

AMT patch. The Emergency Economic Stabilization Act of 2008 (EESA) included among its many provisions a so-called alternative minimum tax (AMT) "patch." For the 2008 tax year, the AMT exemption amounts were raised to once again in an attempt to insulate most middle-income taxpayers from the reach of the AMT. Whether or not you will be paying AMT can only be determined through a year-end tax projection.

Income for forgiveness of mortgage indebtedness. Those principal-residence homeowners who have part of their mortgage debt forgiven as part of a workout or foreclosure have been spared having to pay income tax on that forgiven income. This treatment has been extended through 2012. State and local sales tax deduction. Despite being one of the more popular tax breaks, the deduction for state and local sales taxes is not permanent and had been set to expire at the end of 2007. Under this deduction, taxpayers who itemize deductions the option of claiming either state and local income taxes or state and local general sales taxes. The Emergency Economic Stabilization Act of 2008 (EESA) extended this deduction for 2008 and 2009. Care is required to maximize this deduction in 2008.

Tuition and fees deduction. Taxpayers may continue to deduct qualifying tuition and fees paid in 2008 that are required for the student's enrollment or attendance at a post-secondary school. The tuition and fees deduction is an above-the-line write-off that, depending on adjusted gross income, can reduce taxable income by as much as $4,000. An above-the-line deduction is frequently more valuable than taking a Hope or Lifetime learning education credit. Since this deduction also has been extended for 2009, deciding in which tax year an upcoming tuition payment will be made can help maximize your overall education deductions and credits.

Tax-free IRA charitable contributions. The EESA extends through December 31, 2009, the opportunity for certain taxpayers age 70 1/2 or older to make tax-free distributions from IRAs for charitable purposes. This contribution can include any required minimum distribution that the taxpayer would otherwise be required to take.

Prior Sale of Demutualized Insurance Stock. If you sold shares of an insurance company that you received due to the demutualization of that company, you may be eligible for a partial tax refund under a recently decided tax case. Though the IRS may appeal the decision against it, your ability to claim a refund depends on your timely assertion of your right to a refund. If you have sold demutualized stock since January 1, 2005, please contact us to determine what you need to do to preserve your claim.

Residential energy property. The high cost of energy is encouraging many people to make energy efficient improvements to their homes. If you are contemplating installing energy-efficient doors and windows, water heaters or other items in 2008, you may want to wait until 2009.

Several years ago, Congress created a residential tax credit for installing energy efficient doors and windows, water heaters and similar items. The nonrefundable lifetime credit could reach as high as $500. However, the credit expired at the end of 2007. Surprisingly, the EESA reinstates the credit but not for 2008. The new law reinstates the credit for 2009 through 2016. The EESA also expands the credit to include certain stoves that use renewable plant-derived fuel along with other enhancements; so while the credit is not available for 2008, the expanded credit for 2009 may be worth waiting for.

Another incentive is available in 2008 for certain energy efficient improvements. Solar electric property, small wind energy property and some heat pump property may qualify for the residential alternative energy tax credit. Additionally, you can use the residential alternative energy credit against AMT liability in 2008.

Vacation home conversions. Gain from the sale of a principal residence that is allocable to periods of "nonqualified use" can no longer be excluded from the taxpayer's gain realized on its sale. A technique that has been used by many vacation home owners is to eventually convert that second home into a principal residence before its sale and claim a full $250,000 principal residence exclusion ($500,000 for joint filers) on the gain. Due to a loophole closing provision in the 2008 Housing Assistance Tax Act, any conversion made after December 31, 2008, cannot shelter the portion of that gain allocable to post-2008 appreciation.

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With the complexity of the tax law, understanding which tax planning provisions to incorporate into your year-end tax planning strategy can be a daunting task. While this communication hopefully gives you a heads up on several strategies that you might like to utilize before year end, there are many more techniques that can be used depending upon a taxpayer's individual circumstances. For a more detailed plan that can be customized to your particular circumstances, please don't hesitate to give your LBMC tax advisor a call.