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Higher 2011 rates may merit acceleration.

Tax rates are scheduled to be higher next year. It might be time to reverse your usual tax strategy. Instead of deferring tax, it may make sense for some taxpayers to accelerate income into 2010, defer expense into 2011 and pay tax at the current lower rates. The majority of the potential increases are due to the scheduled expiration of cuts enacted in 2001 and 2003 at the end of the year. Particularly:

Capital gain: Top-level rate will increase from 15 percent to 20 percent (18 percent for property held five+ years).

Dividend: Top-level rate will rise from 15 percent to as high as 39.6 percent.

Ordinary Income: Marginal rates will increase at all income levels. The top marginal rate will increase to 39.6 percent (from 35 percent).

Personal Exemption: Phaseout will be reinstated.

Itemized Deductions: "Pease" phaseout reinstated

Child Tax Credit: Reduced from $1,000 to $500

Marriage Penalty Relief: Eliminated

Taxes will be even higher in 2013 when new Medicare taxes enacted as part of the 2010 healthcare bill take effect. Unearned income such as capital gain, dividend and interest that exceeds $200,000 for single filers and $250,000 for joint filers will be subject to a new 3.8 percent tax. The employee share of Medicare tax on earned income above these thresholds will also increase--from 1.45 percent to 2.35 percent. Altogether this means the top rate for capital gains will rise from 15 percent this year (2010) to 23.8 percent in 2013, and the top rates for dividend and interest income will go from 15 percent this year to 43.4 percent in 2013.

Legislation Expected to Temper the Increases

Lawmakers plan to enact legislation that will temper the tax increases. The president and many Democrats have voiced support for extending the tax cuts for income below $200,000 for single filers and $250,000 for joint filers, and for capping the top capital gain and dividend rate at 20 percent. Republicans generally support extending the tax cuts for everyone, at least temporarily. Congress has adjourned for the November 2 elections, so legislation won't be finished until November at the earliest. It could even be delayed until early 2011. If you are considering accelerating tax in 2010, you should begin preparing now so you can act quickly once legislation is enacted.

Things to Think About Before Acting

Accelerating income and deferring deductions can be a powerful strategy, but you need to be careful. There are many reasons when the strategy will NOT make sense. You should make sure the tax increases will apply to you. The tax cuts are likely to be extended for many taxpayers, and could be extended temporarily for everyone.

The time value of money should not be forgotten. You lose the ability to invest any money you spend on taxes now instead of later. If you planned on holding an asset for several years, you might not want to take the bait just to avoid a small bump in capital gains rates. Why not let it continue to appreciate tax-free? And if the asset is something you could pass on to your heirs without ever selling, they may be better off using the step up in basis at death.

Acceleration of tax also might not make sense if it will push you into a higher tax bracket this year than you will be in the future, such as in retirement. And remember to consider the alternative minimum tax. If you're subject to the AMT, you may not benefit from any acceleration of income or capital gains.

Maximize 2010 Taxable Income?

The uncertainty makes tax planning difficult, but there are definitely situations where you may want to increase income and delay deductions to take advantage of the low 2010 rates. Talk to an advisor and make sure you're comfortable with the political and economic analysis. You should prepare your strategies now so you can act once the legislative outlook becomes more clear.

At the personal level, you might be able to accelerate self-employment income, consulting income, retirement plan distributions, the exercising of non-qualified stock options or incentive stock options, and Regular IRA to Roth conversions. The deferral of personal deductions is accomplished in many cases by simply deciding when to make the payment. You may be able to defer deductions for things like charitable contributions; deductible investment expenses such as investment advisory and custodial fees; and professional fees like tax planning and preparation, accounting, and legal fees.

As a business owner, some of your individual income may come from a pass-through business structure such as a partnership or S corporation. You can consider accelerating revenue and deferring the recognition of expense at the entity level. But be careful because accounting method and other depreciation decisions can affect deductions and income recognition for years into the future.

Take Gains Before the New Year?

If you have an appreciated asset or stock with a sizable built-in gain, you may want to consider realizing it before year-end. Come January 1 the top rate is scheduled to rise from 15 percent to 20 percent (18 percent if held at least five years). Even if you want to continue to own the asset or investment, you may be able to trigger the gain and pay tax without changing position. For stock and other securities, you can just sell it and buy it back immediately because there's no wash sale rule for capital gains. Flipping other types of assets may be complicated. If you want to recognize gain but keep some control or use of an asset, you must satisfy rules that determine whether ownership has actually been transferred.

Diversification Opportunity

Do you have a large, appreciated asset that accounts for an inordinate share of your wealth? If you're bearing inherent risk from a lack of diversification because you're avoiding tax on a sizeable capital gain, now might be the time to sell and reinvest the money.

Accelerate Sale Installments

If you sold your business in an installment sale that extends beyond 2010, you may want to recognize the income ahead of schedule. Deferred income on most installment sales made after 1987 can be accelerated by pledging the installment note for a loan.

Converting to a Roth IRA

Now may be the perfect time to consider a rollover from a traditional retirement account such as a 401(k) or Individual Retirement Account (IRA) into a Roth IRA. The $100,000 AGI limit on making a rollover has been eliminated. When you convert, you must pay tax on any realized appreciation, but you don't have to pay tax again if distributions are made correctly. If converting makes sense for you (see "Convert to Roth Before Year-End?" and "Roth Conversion Decision Made Easy," both in the September/October 2010 issue of this publication), it might make sense to do it in 2010 and pay the tax at lower 2010 rates. A special rule this year allows you to recognize the income from 2010 rollovers in 2011 and 2012, so if you want to recognize the income now, you must make that election on your return. The values of the assets in your retirement accounts are now likely depressed, so the gain could be lower now than it might be in future years. Be careful, though, because a large conversion can generate a lot of income, which could affect other tax items tied to AGI (including how much of your Social Security benefits is taxed).

Acceleration of Employee Stock Vesting

If you've granted restricted stock to employees, you might consider accelerating the vesting into 2010. Employees recognize income at the vesting date. You can also accelerate the vesting of non-qualified deferred compensation (NQDC). If vesting is accelerated to a date prior to 2013, employees could avoid the additional 0.9 percent in Medicare taxes that goes into effect in 2013.

C-Corp Strategies

Top dividend rates are scheduled to rise from 15 percent this year to ordinary income treatment in 2011, i.e., with tax as high as 39.6 percent! C-corporations that pay dividends might consider accelerating their dividend schedule so shareholders can enjoy the lower rate. If the corporation isn't ready to distribute cash, it could issue a note to shareholders or have shareholders immediately re-contribute the dividend back to the corporation in the form of a new capital contribution or loan. Keep in mind that mere bookkeeping entries may not be sufficient to accomplish the actual distribution and trigger the tax. Also, distributions of income from the corporation generally will be taxable as a dividend only to the extent they represent earnings and profits (E&P). Distributions exceeding E&P will eliminate basis in capital. This may not make sense because the basis would be more valuable when tax rates are higher. If basis is exhausted, the distribution can be capital gain, but be careful--shareholders may have different bases in their shares.

"Be the change that you want to see in the world."

Mahatma Gandhi

Visit the Business Guidance Tax section for more tax articles.
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Title Annotation:TAXES
Publication:The Business Owner
Article Type:Statistical data
Geographic Code:1USA
Date:Nov 1, 2010
Previous Article:Expanded 1099 obligation: ignore for now.
Next Article:2010 tax information.

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