2010 Year-End Tax Planning Basics

For 2010, year-end tax planning is particularly challenging. That's because a great deal of uncertainty remains for both 2010 and 2011. Despite this, the window of opportunity for many tax-saving moves closes on December 31. So set aside time to evaluate your tax situation now, while there's still time to affect your bottom line for the 2010 tax year,  and stay up to-date on any late-breaking  legislative changes.

Timing is everything

Year-end tax planning is as much about the 2011 tax year as it is about the 2010 tax year. There's an opportunity for tax savings when you can predict that your income tax rate will be lower in one year than in the other. If that's the case, some simple year-end moves can really pay off.  If you think your income tax rate will be lower next year, look for opportunities to defer income to 2011. For example, you may be able to defer a year-end bonus, or delay the collection of business debts, rents, and payments for services. Similarly, you may be able to accelerate deductions into 2010 by paying some deductible expenses such as medical expenses, interest, and state and local taxes before year-end.  If you think you'll be paying tax at a higher rate next year, consider taking the opposite tack--possibly accelerating income into 2010 and postponing deductible expenses until 2011.

AMT uncertainty complicates planning

If you're subject to the alternative minimum tax (AMT), traditional year-end maneuvers, like deferring income and accelerating deductions, can actually hurt you. The AMT—essentially a separate federal income tax system with its own rates and rules--effectively disallows a number of itemized deductions, making it a significant consideration when it comes to year-end  moves. For example,  if you're subject to the AMT in 2010,  prepaying 2011 state and local taxes won't help your 2010 tax situation, but could hurt your 2011 bottom line. Since 2001, a series of temporary AMT "fixes" bumped up AMT exemption amounts, forestalling a dramatic increase in the number of individuals ensnared by the tax. But the last such fix expired at the end of 2009. While it's likely that  additional  legislation will extend the fix to 2010 (and possibly 2011 as well), right now AMT exemption amounts for  2010 are at pre-2001 levels. Bottom  line? If you think you might be subject to AMT in either 2010 or 2011, talk to a tax professional and pay close attention to what Congress does between now and the end of the year.

IRA and retirement plan contributions

Traditional IRAs (assuming that you qualify to make deductible contributions) and employer-sponsored retirement plans such as 401(k) plans allow you to contribute funds pretax,  reducing your 2010 income. Contributions you make to a Roth IRA (assuming that you meet the income requirements) or a Roth 401(k) plan aren't deductible, so there's no tax benefit for 2010, but qualified Roth distributions are completely free from federal income tax--making these retirement savings vehicles very appealing. For 2010, the maximum amount that you can contribute to a 401(k) plan is $16,500, and you can contribute up to $5,000 to an  IRA. If you're age 50 or older, you can contribute up to $22,000 to a 401(k) and up to $6,000 to an IRA. The window to make 2010 contributions to your employer plan closes at the end of the year, but you can generally make 2010 contributions to your IRA until April 15, 2011.

Still time for 2010 Roth conversions

There's still time to take advantage of the special rule that applies to Roth conversions in 2010: if you convert funds in a traditional IRA or an employer plan--like a 401(k)—to a Roth in 2010,  half the income that results from the conversion can be reported on your 2011 federal income tax return and half on your 2012 return (you can instead report all of the resulting income on your 2010 return, if you choose). Whether a Roth conversion makes sense for you depends on a number of factors, including your marginal tax rate for 2010,  2011, and 2012. However, the ability to postpone tax on the resulting income to 2011 and 2012, combined with the flexibility of being able to wait until you file your 2010 federal income tax return to decide whether you want to do so, makes a Roth conversion a strategy worth considering before year-end.

"Bonus" depreciation and expensing

Good news if you're self-employed or a small-business owner: recent legislation extended special depreciation rules that were scheduled to expire at the end of last year, allowing an additional  50% first-year depreciation deduction for qualifying property purchased in 2010 for use in your business. Again, there's a short window of opportunity to take advantage of this, since, to qualify, property has to be acquired and placed in service on or before December 31, 2010.  In  lieu of depreciation, IRC Section 179 deduction rules allow for the deduction, or "expensing," of the cost of qualifying property placed in service during the year. The maximum amount that can be expensed in 2010 and 2011 under Section 179 has been increased to $500,000 (double the maximum that applied in 2009). The $500,000 limit is reduced when the total cost of qualifying property placed in service during the year exceeds $2 million.

Also worth noting

• For 2010, itemized deductions and personal and dependency exemptions are not reduced for higher-income individuals, but (at least for now) that's going to change in 2011: these deductions will once again be subject to a phase-out based on adjusted gross income. This should be taken into account if you're considering timing income and deductions as part of your year-end planning.

• A 30% tax credit for energy-efficient improvements you make to your principal residence, or the cost of certain energy-efficient equipment you install (including furnaces, water heaters, and central air conditioning units) expires at the end of 2010. There's an aggregate credit cap of $1,500 for 2009 and 2010, so if you claimed the full $1,500 in 2009, you're out of  luck for 2010. But if you haven't reached the maximum credit amount yet, consider timing qualifying expenditures to take advantage of the credit.

• When you reach age 70½, you're generally required to start taking required minimum distributions (RMDs) from any traditional IRAs or employer-sponsored retirement plans you own. RMD requirements, however, were suspended for 2009, so you may not have taken a withdrawal  last year. RMD requirements are back for 2010, though, and the penalty is steep (50%) for failing to take an RMD by the date required--the end of the year for most individuals.

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Disclosure Information -- Important -- Please Review

The opinions voiced in this material are for general information only and are not intended to provide specific advice or

recommendations for any individual.

To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.

All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

The tax information provided is not intended to be a substitute for specific individualized tax planning advice. We suggest that you consult with a qualified tax advisor.

Securities offered through LPL Financial, Member FINRA/SIPC

Prepared by Forefield Inc, Copyright 2010

November 03, 2010

Conversion Confusion (Roth IRAs in 2010 and beyond…)

Where we were, and where we are

For background, it is important to understand that until 2010, if an individual or couple wanted to convert all or a portion of their traditional IRA balance(s) to a Roth IRA (basically a choice between current taxation and future taxation), they had to have a Modified Adjusted Gross Income (MAGI) of under $100,000.  As part of the Tax Increase Prevention and Reconciliation Act of 2006, congress made a modification to this rule eliminating the income ceiling for conversions after 2009. This means that anyone who wants to can convert to a Roth IRA, no matter their income, age or size of the account being converted. Basically, if you want to convert in 2010, and are willing to pay the taxes now, you can.  Additionally, for conversions made in 2010, you have more than one option for paying the resulting tax liability. You can pay it all in 2010 (by the tax filing deadline) or defer and pay ½ in 2011 and ½ in 2012.

Why is congress making this change?

It would be nice to think that the members of congress have decided out of the goodness of their collective hearts to help us average working folks out a bit.  However, as with most things in life that seem too good to be true, there is a catch.  As previously noted, if you convert from a traditional IRA to a Roth IRA, you are required report 100% of the conversion amount as current ordinary income.  In other words, the government gets their much needed tax revenue now as opposed to waiting until you turn 59 ½ (or older) and begin drawing down your IRA account.   Clearly Uncle Sam is a firm believer in the old adage “A bird in the hand is worth two in the bush” (note that we refrained from inserting a George Bush joke here). What we are left to ponder (knowing full well that congress is unlikely to leave huge tax receipts on the table despite their eagerness to get their hands on this money quickly) is: Is this really a good deal for us? The answer to this question is a resounding ‘Maybe’.  To clarify, we need to take a look at the arguments for conversion.

Why would I convert?

Of course the big question is, why convert?  Why pay taxes now for the right not to pay taxes later?  If you do some research you will see there is no shortage of possible answers. The two most common reasons being thrown about are, first, that tax rates will likely be much higher in the future than they are now, and second, that you may not need to spend these funds in your lifetime so converting to a Roth IRA now could well save your heirs a substantial amount in taxes down the line. While these are both valid points, we would argue that, regarding first point, predicting future tax rates is a tricky business and it is not at all a foregone conclusion that rates will be substantially higher in the future. As to the second point, while some who are still a ways off from retirement are already

primarily concerned with effective generational asset transfer, most people we talk to consider asset transfer a secondary concern after knowing they have carefully planned and saved for their own retirement.

While we may take issue with some of the more trendy reasoning for conversion as outlined above, we believe there may be a more compelling argument for converting at least a portion of your traditional IRAs to Roth IRAs, which boils down to one thing; Flexibility.

Our recommendation

For those of you who have worked with us for any length of time, you are familiar with our mantra about the importance of diversification.   We firmly believe diversification and flexibility are the cornerstones to a healthy financial profile. Essentially, what the Roth conversion allows for is flexibility or ‘tax diversification’ as a hedge against future legislative maneuvers and tax law changes.

If you could tell us today what the tax code will look like and what tax rates will be when you start taking money from your IRAs in 5, 10, 20, or even 30+ years, this conversion question would be as easy to answer as so many have made it out to be.  The truth is, particularly in today’s political climate, it is impossible to determine what legislative changes will be made and what tax rates will be in effect in 3 months, let alone many years down the line.  That is why flexibility is so vital.

It is always our recommendation to have a good mix of non-qualified and qualified assets available at retirement so clients have more options available for their portfolio withdrawals.  By having some money available at capital gains rates (non-qualified), some available at ordinary income tax rates (qualified), and some available tax-free (Roth IRAs¹, etc.), clients are better able to manage their total tax obligation regardless of the tax-structure in effect at the time of their distributions. It may be necessary to give up a few dollars along the way to hedge your bets (in the form of taxes upon conversion), so that regardless of what the political or tax-rate structure is in the future, you will be able to take advantage.  Basically, this is another strategy for the unknown and unforeseeable future, something we think everyone should consider.

As nice as it would be, there is no one-size-fits-all solution to the issue of Roth IRA conversions. The correct answer depends on many factors and should be carefully considered from all angles prior to any action. Remember, if you want the option of deferring taxes on a 2010 Roth IRA conversion until 2011 and 2012, you will need to talk to your financial professional(s) and act soon.

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¹The Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions apply. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.