Tax Planning in Uncertain Times

As another tax year nears closure, WTAS reminds our clients of year-end tax savings strategies.

Most often, the techniques we discuss are some variation on two common themes: (1) the acceleration of deductions and losses into the closing year, and (2) deferral of income and gains beyond the closing year.

Unfortunately, as the 2010 tax year closes, we find ourselves in somewhat unprecedented territory. At the time of this writing, the current Democratic administration has at least agreed in principle with the new House Majority Republican leadership on an extension of the so-called Bush-era tax cuts, though it remains unclear whether Democratic Congressional leaders will agree. In the absence of any legislative action before year-end, we might anticipate: the largest tax increase in more than 15 years, the first increase in capital gains tax rate in more than two decades, and the return of itemized deduction and personal exemption phase-outs. Accordingly, tax strategies in 2010 might focus on income acceleration and loss deferral — the opposite of what we typically advise.

Also on the table is the fate of the gift and estate tax regime. As you may know, no estate tax was imposed in 2010. However, beginning on January 1, 2011, the gift and estate tax structure will revert to what it was in 2001, including a top rate of 55%.

With all the political and economic twists and turns of the past three years, we abandon any realistic hope of prognosticating future tax legislation. In that spirit, we offer a brief look at potential 2010 year-end strategies that include income/gain acceleration and deduction/loss deferral, assuming the Bush-era tax cuts are not extended. We also explore some of the tax provisions expiring in 2010 that — while running counter to deduction deferral — nonetheless should be considered in case Congress does not extend those benefits beyond 2010.

  Individuals Businesses
Income Rates. Projected to increase from the current top rate of 35% to a top rate of 39.6%. Consider accelerating income (i.e., wages, bonuses, stock options, restricted stock, etc.) and reducing the deferral of income (i.e., 401(k) and other retirement and deferred compensation plans) prior to the end of 2010 and reverse accordingly in 2011.  
Long-term Capital Gains. Projected to increase from the current rate of 15% to a top rate of 20%. Consider recognizing gains prior to the end of 2010. If proceeds are to be received in installments, consider making the affirmative election out of installment sale treatment. Preserve losses for future years. Partners, LLC members, and shareholders of S corporations should discuss with management the consummation of any large dispositions prior to the end of 2010. If proceeds are to be received in installments, consider making the affirmative election out of installment sale treatment.
Dividends. Projected to increase from the current rate of 15% to a top rate of 39.6%. Impacted only to corporations in which an individual owns shares and declares a dividend. Closely-held C corporations and S corporations that previously were C corporations should review their accumulated earnings and profits, with an eye toward distributing any remaining earnings and profits in 2010. If sufficient cash is not available, consider the use of consent dividends. Finally, if the corporation needs capital, consider the use of a dividend followed by a loan from the shareholder to the corporation.
Election to Defer COD Income. Taxpayers realizing income from the relief of cancellation of debt (COD) income may elect to spread recognition ratably over a five year period beginning in 2014. This election expires at the end of 2010. Restructure any debt prior to the end of 2010 and analyze whether the election is (1) available and (2) efficient. In some cases, the election can have the effect of making the income presently recognized. Restructure any debt prior to the end of 2010 and analyze whether the election is (1) available and (2) efficient. In some cases, the election can have the effect of making the income presently recognized.
Increased Equipment Expensing and Bonus Depreciation. Currently, taxpayers can expense up to $500,000 of new equipment as well as claim first year 50% bonus depreciation for equipment acquired in 2010. This provision expires at the end of 2010.   Consider accelerating any large equipment purchases into 2010 as this benefit only applies to equipment purchases made in 2010.
Phase-out of Itemized Deductions. Consider “bunching” of medical expenses, unreimbursed business expenses, miscellaneous expenses subject to the 2% adjusted gross income (AGI) limitation, and prepaying real and personal property taxes.  
Energy-Savings Tax Credits. Consider the purchase of alternative motor vehicles, energy efficient appliances and property (e.g., insulation, windows, doors, furnaces, boilers, heaters, pumps, central air conditioners, stoves, dishwashers, clothes washers, refrigerators, etc.) prior to the end of 2010.  

While this table discusses some of the more noticeable expiring provisions, it is far from comprehensive. For a complete list of tax provisions expiring at the end of the year, feel free to contact us.

Given the dynamic nature of taxes and legislation, perhaps it goes without saying that 2010 is not over yet. We could still see legislative action between now and the holiday break, leaving tax practitioners to scramble in the last week of the year. Obviously, it is a difficult environment for proactive tax planning. Any acceleration of income before year-end could prove unnecessary if the Bush-era tax cuts are extended. We typically run multiple scenarios for our clients considering year-end income acceleration transactions, among other things, so that alternative proposals can be considered and discussed. Please do not hesitate to call your WTAS advisor to discuss these matters.