Today is the last day for most 2008 tax deductions. If you use your credit card to pay for a deductible expense today, you can deduct it in 2008 even though you won't pay the credit card bill until 2009.
If you are charitably inclined, some excellent places to take your credit cards include:
Scan through all of our 2008 year-end planning posts to get other deduction ideas. The Tax Grrrl has year-end roundups for businesses and individuals, and Kay Bell also has some last-minute tax planning ideas. Even the IRS has a year-end deduction roundup. So get your deductions in order, and we'll see you in 2009.
If there is a silver lining to this year's cloudy stock market, it's that capital gains taxes will be optional for many of us this year. How can a capital gain tax be optional? You are likely to have capital losses available in your portfolio that you can use to offset your gains. Now's not the time to be proud. Take your medicine by selling enough losers to offset your taxable capital gains, if you can.
Ah, you ask, but why would I have capital gains this year?
- First, the market didn't tank until well into the year. It's entirely possible that you sold stock at a gain before everything went south.
- If you own mutual fund shares, it's likely that they had to liquidate old positions to redeem panicky owners, incurring capital gains on ancient positions that they had to distribute to you. Your mutual fund company website probably can tell you how much that will be for 2008.
- Maybe you sold a business, or some other non-traded asset.
So how do you take your losses? If you own publicly-traded securities, and they're not from short sales (not bloody likely this year), all you have to do is sell them today or tomorrow; the tax law considers the trade date to be the date of the sale, even if the settlement occurs in 2009.
Mind the "Wash Sale" rules. If you bought other shares of the stocks you are selling today or tomorrow in the 30 days preceding the sale, or if you buy back the stock in the 30 days after the sale, your loss is disallowed - even if the purchases are in an IRA.
Remember, you only get to deduct losses in a taxable account. Sales in an IRA or a 401(k) don't offset capital gains on your 1040. And you can only deduct capital losses to the extent of your capital gains, plus $3,000, so you don't need to overdo it. If you do take more losses than you need, capital losses carry over indefinitely until you use them all at the rate of $3,000 per year, or until you incur enough capital gains to absorb them.
Tune in tomorrow for the final installment of our 2008 year-end tax planning series.
Flickr image from Aussiegall
You have three days left to get a letter postmarked in 2008. That means that if you are a cash-basis taxpayer, like most walking, talking humans, you have three days to write a check for a deductible 2008 expense.
For purposes of timing an income tax deduction, having a check in the mail is usually good enough for cash-basis taxpayers You can still write a check to charity and deduct it on your 2008 return if it is postmarked no later than Wednesday this week. The same goes for a deductible mortgage interest payment, a property tax payment, or any other deductible personal or cash-basis business expense.
It wouldn't be the tax law without exceptions. The expense needs to be deductible in the first place, for starters. If it is to a related party, it won't be deductible in 2008 unless the related party picks it up in income this year. And many expenses that are technically deductible, like real estate taxes and income taxes, do no good for taxpayers subject to alternative minimum tax.
Also, while "the check in the mail" may be good enough to claim a deduction, it isn't good enough to achieve a completed gift for gift tax purposes. If you want to claim the $12,000 annual gift tax exclusion for 2008, the donee needs to cash the check no later than Wednesday at 11:59:59 p.m.
If you are writing a check for an amount that's large enough to worry about, you should spring for a certified mail postmark so you can prove timely mailing to the IRS.
To review our 2008 year-end planning posts, click here.
December 26 might not be the best time to say this, but it may be a good idea for you to do some more giving.
This may seem like an odd statement. After all, estates valued up to $3.5 million will be exempt from estate tax in 2009. You may have heard that the Obama administration will propose continuing this exemption amount indefinitely. If a couple can die with $7 million tax-free, why give away anything now? Unless, of course, you are worth that much.
For starters, the current tax law provides that the estate tax goes away in 2010, only to return in 2011 with a $1 million exemption and a top rate of 50%. A lot more folks are worth $1 million than $7 million, and with inflation there will be many more. There's no guarantee that the new Congress and the new President will be any more successful than the last bunch; they've been unable to resolve the issue in 7 years of wrangling.
Also, given the current bailout fever, there will likely be tremendous pressure to raise tax revenues. Rich dead people only vote in a few major cities, so they are an easy target for tax hikes.
You can gift up to $12,000 per donor, per donee, each year without eating away at your $1 million lifetime gift exemption (yes, the gift tax exemption is much lower than the estate tax exemption). That means a couple with two kids and four grandkids can reduce their ultimate estate with $144,000 of gifts each year. Do that every years for 10 years and you've effectively increased your lifetime estate tax exemption by just shy of $1.5 million. But once you let an annual exclusion lapse, it's gone forever. Sure, you can do annual gifting in 2009 (at an increased $13,000 annual exclusion amount), but you can do that anyway; the 2008 opportunity never returns.
With your portfolio likely somewhat smaller than it might be, you can give away stocks and other assets at values unthinkable only last year, squeezing a lot more shares into the same $12,000 annual gift. So maybe you shouldn't stop giving just yet.
Iowa's state sponsored Section 529 plan, College Savings Iowa, provides an addtional benefit to Iowa taxpayers: a deduction on your Iowa return for up to $2,685 per donor, per donee. That means parents with two children can deduct $10,740 in 2008 contributions (though additional non-deductible contributions are allowed). For a top-bracket Iowa taxpayer, this is like a 6% negative load on your investment.
Some other states also provide deductions for investments in their plan; you can look up your state at the College Savings Plan Network site. There is no Section 529 deduction on the federal return. Section 529 plan contributions do count against your annual $12,000 gift tax exclusion.
If you want a 2008 CSI deduction, you need to pay in by December 31.
Congress has been taking a lot of the zip out of donations of property to charity in recent years. Even so, a property donation can still be the most tax-efficient way to fulfill a charitable pledge before year-end.
When you donate appreciated long-term capital gain property to charity, you get to deduct the entire fair value of the donation without ever including the gain in income. That works out better than selling the property for a gain, paying the tax, and donating the remaining cash.
Aside from the obvious problem here -- who has capital gain property right now anyway? -- Congress has made it more difficult over the years to claim deductions for property gifts.
First they trimmed back the fun of used car donations. Unless the charity uses the car in its operations, you only get to deduct the amount the charity gets for the car when it sells it.
Then they shut down the big-game safari loophole - you don't get a fair market value deduction for stuffed game animals anymore.
Finally, they cut back the deduction for any donations of tangible personal property that the charity won't be using for its tax-exempt purpose; such gifts can only be deducted at their cost basis. For example, if you donate a painting to a museum for their collection, you get a fair market value deduction. If you donate it for them to sell, you can only deduct your cost. This restriction doesn't apply to marketable securities or real estate.
Unless you are donating marketable securities, the tax law requires you to get a qualified appraisal from a qualified appraiser to take any deduction - whether at cost or fair market value - if the claimed value exceeds $5,000. The appraiser will have to sign a Form 8283 that will be attached to the donor's tax return. No appraisal, no deduction.
What does this all mean?
- If you want to make a property donation, it's easiest to use marketable securities.
- If you are donating other property, and you plan to take a deduction over $5,000, get the appraisal done first; if you've already made the donation, arrange the appraisal now.
- If you are donating something like artwork, make sure the donee won't be selling it within three years if you plan to claim a fair-market value donation.
Check back every business day through 12/31 for another year-end tax planning post.
Forbes reports that there will be no waiver for 2008 of the rules requiring minimum distributions from IRAs and retirement plans (via Kay Bell). There have been calls to waive the 2008 RMD requirement because of the stock market decline during the year; the distribution is based on account values at the end of 2007, and is mandatory for taxpayers who reach age 70 1/2 by the end of 2008. Forbes bases its report on a letter from the Treasury to Congresscritters who have called for a 2008 waiver.
This means if you haven't taken your distribution yet, you need to get it done. The tax law imposes a 50% excise tax on RMD shortfalls. If you just turned 70 1/2 this year, you have until April 1 to take the distribution; older taxpayers have to take it by December 31.
Congress has waived the RMD rules for 2009, but the waiver does not apply to the distributions that can be taken by April 1 for taxpayers reaching age 70 1/2 this year.
S corporation shareholders can only deduct losses if they have basis in either:
-Their stock, or
-Loans they have made (not guaranteed!) to the S corporation.
A big part of year-end planning for S corporation shareholders is making sure they have some basis. When you have multiple shareholders, loans are often preferred because each shareholder can choose whether or not to make the loan without disrupting the ownership percentages.
The danger with loans is that the losses reduce the shareholder-lender's basis in the loan; if it is repaid before enough S corporation income is earned to restore the loan's basis, the lender has a taxable gain. This is especially a problem under the new regulations that restrict "open account" S corporation loans. This problem snared S corporation owners with income on $1,622,050 in loan payments yesterday in Tax Court.
The Taxpayers, brothers Sheldon and Ira Nathan, loaned the funds to their S corporations, enabling them to deduct losses. In a series of transactions, they made capital contributions of over $1.4 million to the corporations and repaid the loans. The IRS said they had ordinary income on the loan repayment. The taxpayers tried to convince the court to allow them to increase the loan basis by treating the capital contributions as income, but the judge didn't go for it (my emphasis; copious citations omitted):
By attempting to treat petitioners' capital contributions to G&D and W&N CAL as income to G&D and W&N CAL, petitioners in effect seek to undermine three cardinal and longstanding principles of the tax law: First, that a shareholder's contributions to the capital of a corporation increase the basis of the shareholder's stock in the corporation; second, that equity (i.e., a shareholder's contribution to the capital of a corporation) and debt (i.e., a shareholder's loan to the corporation) are distinguishable and are treated differently by both the Code and the courts; and third, that contributions to the capital of a corporation do not constitute income to the corporation.
As you go about S corporation year-end planning, a few things to keep in mind:
- If you are looking at a loss, determine whether you have enough basis to deduct it. You need to take into account any current year loans and distributions to date.
- If you are considering year-end loans or contributions to capital, remember that basis is necessary to deduct losses, but it isn't sufficient; your basis has to be "at-risk" and you have to clear the maze of the "passive loss" rules.
- If you make a year-end loan to the S corporation to take losses, remember that the loan needs to stay in place until S corporation income has restored your loan basis; otherwise you will trigger income when you repay the loan.
- If you have repaid a loan already and now are facing taxable income as a result, don't count on restoring your basis with another loan or a capital contribution.
- Be extremely careful in using funds from another wholly-owned entity to finance a loan to the S corporation; if you circle the funds back to where they started, the IRS may strike down the loan as lacking substance.
Cite: Nathel, 131 T.C. No. 17.
The Section 409A rules may be the worst single piece of tax legislation passed in the Bush era. A response to the WorldCom and Enron scandals, it imposes extremely complex rules with ridiculously high penalties on every employer. Even the NFL:
NFL agents were sent an urgent memo this week from the NFLPA, requiring immediate attention to § 409A. This provision, originally aimed at bloated executive compensation packages, potentially calls for a full tax burden on signing bonuses and future guaranteed money in the year the package is negotiated, even if the money is deferred over several years. This would have dramatic ramifications. ... 409A becomes a major concern if enforced, meaning the full value of these deferred payments could be brought to taxation in the year negotiated, not earned, potentially affecting tens, even hundreds of thousands of dollars depending on the size of the contracts.
Transition rules for 409A expire at the end of the year. The rules take full force next year, including written plan requirements and full compliance with regulations. If you haven't done so, you should make sure you are ready for the new rules.
In general, if you are a cash-basis taxpayer, you have to pay your business expenses by the last day of the year to deduct them. If you are an accrual-basis taxpayer, you have to clear the "all-events test." That is, all events to determine the liability must have taken place by year-end, and the liability must be determinable with reasonable accuracy.
Of course, it's more complicated than that, so go there and check it out.
Retirement plans are a tricky problem for income and estate tax planning. If you die with a retirement plan balance, it can be subject to estate tax, and your beneficiaries also have to pay income tax. These two taxes help explain the popularity of the provision that allows taxpayers to use their IRAs to make charitable gifts.
Taxpayers who will reach age 70 1/2 by year-end can have their IRA trustees contribute up to $100,000 per year to charities without the donation going through the tax return. By avoiding both the income tax and the estate tax, it provides an efficient way to fund a charitable pledge. To qualify, the IRA trustee must transfer the donation directly to the charity. While the donation doesn't appear on the IRA owner's return, there is also no deduction. But by keeping the IRA out of "above the line" income, it avoids AGI-based deduction phaseouts. It also is a tax-efficient way for non-itemizers to fund charity.
The IRS has more on IRA donations to charity here.
Collect all of our 2008 year-end planning posts!
Self-employed taxpayers can get some great tax-savings opportunities via retirement plans. While SEP-IRAs the easiest type to set up, they aren't for everyone. If you have multiple employees, they provide very little flexibility. Also, a taxpayer with substantial self-employment income and no employees might achieve a much great deduction - up to --- via a "solo" 401(k) profit-sharing arrangement. A self-employed taxpayer who doesn't participate in another 401(k) plan can shelter the first $15,500 of self-employment income via such a plan; the total 2008 contribution might be as large as $46,000. This can provide a nice tax benefit for, in effect, taking money out of one pocket and putting it in another pocket.
Calendar-year taxpayers have until the end of December to formalize a qualified pension or profit-sharing plan for 2008 (SEPs, in contrast, can be put in place as late as the extended due date of the 1040). If you are interested, you should move on this immediately, as even the most accomodating plan provider needs a little time to get the paperwork in order.
Check back daily for more 2008 year-end planning ideas.
For business taxpayers, adding new fixed assets can be one of the easiest ways of controlling taxable income at year end. Section 179 lets taxpayers deduct currently the cost of some assets that would otherwise have to be capitalized and depreciated or amortized over a period of years.
As an anti-recession measure, Congress increased for 2008 the amount of assets for which Section 179 can be elected. For tax years beginning in 2008, taxpayers may deduct up to $250,000 of the cost of assets placed in service that would otherwise be capitalized.
There are some important limits on using Sec. 179:
- The amount of the deduction phases out dollar-for-dollar to the extent asset additions exceed $800,000.
- It doesn't apply to all property. For example, buildings and building components are ineligible, as are most assets used in a real property business.
- It is limited to active business and wage income. Sometimes Section 179 deductions are wasted when they pass through on a K-1 to a company with an operating loss, or to a retired individual with no current active income.
- The asset has to be "placed in service" by year-end. It's not enough to have ordered or paid for the asset.
Charitable giving is a big part of year-end tax planning. The IRS has posted a summary of tax rules governing charitable contributions (via the TaxProf). They have this to say about the always-popular gifts of household goods:
For all donations of property, including clothing and household items, get from the charity, if possible, a receipt that includes the name of the charity, date of the contribution, and a reasonably-detailed description of the donated property. If a donation is left at a charity’s unattended drop site, keep a written record of the donation that includes this information, as well as the fair market value of the property at the time of the donation and the method used to determine that value. Additional rules apply for a contribution of $250 or more.
If you get examined, that written record comes in handy.
One of the oldest tax planning tricks in the book is paying in December state and local taxes that aren't due until next year. That way you get get the benefit of the deduction one year sooner. If it works, you could get a tax benefit on your April 2009 filing, rather than your April 2010 filing.
Does the math work? Not always. I ran a little computation for a hypothetical taxpayer who will face the same marginal tax rate this year and next without owing alternative minimum tax, and without estimated tax underpayment penalties or other side issues taken into account. I take into account the value of the prepayment on the return next April to the foregone interest would have earned on the state and local taxes if you had waited to pay them until the due date, using a 4% discount rate. The results are below; the circumstances where prepaying works are in green, and the due date for the prepaid taxes are on the left side.
In short, unless you are in the top bracket, prepaying your Iowa state income taxes due April 30 doesn't make sense. 28% and 33% bracket taxpayers might benefit from prepaying property taxes due March 1.
Of course, other factors come into play. If you are in AMT both years, you get no benefit of prepaying taxes, because the deduction is worthless. If you are in AMT in one year and not the other, it only makes sense to pay the state and local taxes in the non-amt year. In any case, you have to have a decent two-year tax projection to make the call. If the dollars are big, get your tax advisor involved.
UPDATE: Robert Flach makes a good comment: for taxpayers meeting our simplifying assumptions, it always makes sense to prepay a fourth quarter state estimate otherwise due in January, if you itemize in the first place.
One of the most painful taxes is imposed on income you don't receive. If a taxpayer who has reached age 70 1/2 fails to take the "required minimum distribution" from an Individual Retirement Account, the law slaps a 50% tax on the amount not withdrawn.
The RMD must be taken by December 31. Taxpayers who turned 70 1/2 in 2008 have until April 1, 2009 to take their first required minimum distribution.
While many IRA trustees automatically compute the required distribution, they are not required to. Many others don't. If you have multiple IRAs, you aren't protected just because you have received one or more distributions; you have to take the RMDs based on the total balance of your IRAs. You can, however, take the entire RMD from a single IRA, as long as it's enough to cover your entire required distribution for all of your IRAs.
You compute your 2008 required minimum distribution by consulting the appropriate RMD table (linked here) and dividing your aggregate IRA balance as of December 31, 2007 by your remaining life expectancy; you should use this handy IRS worksheet to make the computation. For most taxpayers, this life expenctancy table applies.
There is no RMD requirement for "Roth" IRAs, so they are not part of the computation.
The bottom line: If you have reached age 70 1/2, it's up to you to make sure you take enough out of your IRAs.
UPDATE: While there has been talk about waiving minimum distribution requirements for 2008 as a result of the decline in the stock markets this year, nothing has happened yet.
UPDATE, 12/19/08: It looks like there will be no RMD waiver for 2008.
Year-end planning isn't just about reducing 2008 taxes. It's also about getting ready for 2009. One looming 2009 item is a new regulation that will require single-member limited liability companies to begin filing their own payroll tax returns.
Single-member LLCs are normally "disregarded" for income tax purposes. If they are owned by a corporation or partnership, they are taxed as a division of that entity; if they are owned by an individual, their income is taxed on the individual's 1040. They don't file their own income tax returns. "Q-subs" -- wholly-owned subsidiaries of S corporations - are also "disregarded entities."
Prior IRS guidance (Notice 99-6) allowed disregarded entities to have their employees reported on their parents' employment tax returns. New regulations (TD 9356) that take effect in January 2009 require disregarded entities to file their own payroll tax returns, including 941s and W-2s, under their own name and taxpayer identification number.
As these rules are mandatory for the first payroll of 2009, now is the time to make sure that your payroll system is ready for the change. If you have employees in a single-member LLC or Q-Sub, but have been reporting the LLC/Q-sub employees on the owner's payroll tax returns, you need to make sure your systems are ready for the change.
One traditional year-end tax blunder is the purchase of a mutual fund share just before it makes its required annual capital gain distributions. When you do this, you buy a year's worth of capital gain taxes for the privilege of owning the shares for as little as one day. This can be especially galling in a year that the fund has lost a lot of value, like this year.
This year's expected capital-gains distributions have been caused mainly by investors leaving stock funds, which forced fund managers to sell some holdings. There was a total of $204 billion in net outflows from all stock funds through October, according to research firm TrimTabs Investment Research. And the problem has been exacerbated by fund rotations, as some investors kept their money in the stock market but moved among types of stock funds. For instance, some shifted from value funds to growth strategies and others dumped small-stock funds for large-stock funds -- all actions that could create capital gains.
The bottom line: check the fund websites for their expected 2008 capital gain distribution dates before you buy.
The end of the year is four weeks away. That means we have four weeks to set right the tax mistakes of the last 48 weeks.
This year has some unusual tax planning features. The uncertain economy makes folks reluctant to defer income out of understandable fear that income deferred a month might be deferred forever. If you need cash to complete a tax planning tactic, loans are more difficult to come by.
But the bad economy also provides some tax planning opportunities. The stock market debacle should make it easy for many of us to avoid any taxable capital gains this year, given the available losses in our portfolios. The widespread decline in asset values lets us move more assets to the next generation tax-free as part of our estate planning.
Where to start? Figure out where your 2008 taxes stand so far. Gather your paystubs and your brokerage and bank statements. Figure out whether you have any bonuses or other unusual year-end items coming up. Look over last year's tax return and identify items that are likely to change since last year. Then visit your tax advisor or dummy up a 2008 tax return to see where you stand. Tomorrow we'll start to do something about it.
This is the first in a series of 2008 year-end tax planning posts. If you can't wait, check out our tax planning for prior years - but remember, the law changes every year, so what worked last year doesn't necessarily work in 2008.
The items included in the Tax Update Blog are informational only and are not meant as tax advice. Consult with your tax advisor to determine how any item applies to your situation.
Joe Kristan writes the Tax Update items, and any opinions expressed or implied are not necessarily shared by anyone else at Roth & Company, P.C. Address questions or comments on Tax Updates to