Nine year-end strategies well-worth your time and energy

With the year’s end fast approaching, there’s still time to minimize your tax bill for 2010 and build a strong financial base for 2011. There are three primary ways to reduce your tax bill with just three weeks remaining – investing in yourself, your retirement or your home. Go back to school for a higher education credit of 20% of the cost of attendance up to $2,000, contribute to an IRA or increase 401(k) contributions, and take advantage of up to $1,500 of home energy efficiency upgrades. Here are nine strategies to help guide you through the sometimes-confusing ins and outs of year-end tax planning.

Tax savings strategies for 2010:

1. Estimate your income and deductions.

Comparing this year’s likely income against projected 2011 earnings is the key to making wise decisions at tax time. If it looks like you’ll make more in 2010 than in 2011, you may find that you’re ineligible for important credits and deductions this year. Hence, the wisest course may be to defer as much income as possible into 2011 or postpone incurring certain expenses until next year. If you expect to make more in 2011 than in 2010, you may want to bunch deductions next year in order to minimize the taxes you’ll owe in 2011.

2. Maximize contributions to company-sponsored plans

This is a great place for a tax break. If you have not contributed the maximum to your 401(k), find out if you can increase your contributions for the year. Your contributions are made pre-tax, which reduces your adjusted gross income and overall tax bill. Employer matching can mean even more money in your retirement plan.

3. Save on education

The fate of tax treatment for educational expenses is up in the air as Congress debates tax law changes.  As it stands currently, you could get a credit up to $2,500 based on your eligibility for higher education in 2010 if you pay for tuition for spring semester now. If you, your spouse or your dependents have a college tuition bill for the spring 2011 semester, you might benefit from paying the spring semester tuition before the end of 2010. The education credits are subject to income limits. No American Opportunity credit \ may be taken once your modified adjusted gross income reaches $180,000 for married taxpayers filing a joint return and no Lifetime Learning Credit may be taken once your modified adjusted gross income reaches $120,000. The credits are reduced with modified adjusted gross income exceeds $160,000 or $100,000, respectively. If you expect a raise in 2011 that will bring your income into or over the phaseout range, pay the tuition now.

4. Determine your Alternative Minimum Tax (AMT)

Completing a year-end tax projection can help you determine if you’ll be subject to the AMT. Some itemized deductions are not allowed under the AMT which can result in a higher tax bill. Tactics to minimize the impact of AMT include: deferring capital gains (when appropriate), considering the timing risks associated with exercising incentive stock options and minimizing unreimbursed business expenses.

5. Consider your IRA

If you’re eligible to deduct your IRA contributions, you can make traditional IRA contributions to decrease your 2010 income. And, you can contribute right up until April 18, 2011, to impact your 2010 return.

6. Look at your withholding

Now is the time to ensure that you have enough tax withheld or have paid enough estimated tax to meet your projected obligations and to avoid a penalty for underpayment.

7. “Green” your home

Energy-efficiency improvements to your home get a tax credit rate of 30% of the cost of all qualifying improvements, with a maximum credit limit to $1,500 claimed for 2009 and 2010 combined. This includes home improvements such as adding insulation, energy-efficient exterior windows and doors, energy efficient heating and air conditioning systems, and certain metal and asphalt roofs.

8. Make a hybrid purchase

You can drive away with a tax credit if you buy a qualifying gasoline/electric hybrid or qualifying clean diesel vehicle in 2010. The size of the credit depends on how fuel-stingy your new car is, but the tax savings can range from several hundred to $2,350.

9. Examine your portfolio

If you have a large net capital gain in 2010, you might want to consider reducing your tax liability by selling some stock that will generate a loss before year-end.

This article was contributed by the Tax Pros at H&R Block. H & R Block is not affiliated with LPL Financial.  Please consult a tax professional for your own situation. This information is not intended to be a substitute for specific individualized tax advice.

You may also be interested in reading, IRS Tax Audits Know No Season

photo credit: eviloars

While regular tax brackets have been adjusted for inflation over the years, the Alternative Minimum Tax has not.  That is why individuals with moderate incomes are likely candidates.  If you’re income is over $75,000, you are considered to be AMT candidate.  What makes you vulnerable are a large number of deductions that can include: several children, interest deductions from a second mortgage, capital gains, high state and local taxes, and ISO’s (Incentive Stock Options).
When first introduced in 1969, the Alternative Minimum Tax (AMT) was widely acknowledged to be a “rich man’s tax” — a fallback tax for those wily taxpayers with big incomes and numerous deductibles. But because the AMT has been adjusted for inflation only twice in 30 years, it is now encroaching upon the middle class.
Computing your AMT can be a complex process.  But having a general understanding can be a great help.

The Other Federal Tax

The AMT truly functions as an “alternative” tax system. It has its own set of rates and rules for deductions, which are more restrictive than the regular rules. It operates in parallel with the regular income tax system in that if you’re already paying at least as much under the “regular” income tax as you would under AMT, you don’t have to pay it. But if your regular tax falls below this minimum, you have to make up the difference by paying the alternative minimum tax.
AMT can be triggered by a number of different variables. Although those with higher incomes are more susceptible to the tax, many other factors such as the amount of your exemptions or deductions can also prompt the tax. Even commonplace items such as a deduction for state income tax or interest on a second mortgage can set off the AMT. To find out if you are subject to the AMT, fill out the worksheets provided with the instructions to Form 1040 or complete Form 6251, Alternative Minimum Tax — Individuals.
AMT rates start at 26%, rising to 28% at higher income levels. This compares with regular federal tax rates, which start at 10% and step up to 35%. Although the AMT rates may appear to cap out at a lower rate than regular taxes, the AMT calculation allows significantly fewer deductions, making for a potentially bigger bottom-line tax bite. Unlike regular taxes, you cannot claim exemptions for yourself or other dependents, nor may you claim the standard deduction. You also cannot deduct state and local tax, property tax, and a number of other itemized deductions, including your home-equity loan interest, if the loan proceeds are not used for home improvements. Accordingly, the more exemptions and deductions you normally claim, the more likely it is that you’ll have an AMT liability.
On the positive side, the AMT does allow you to apply a special AMT exemption — $66,250 for joint filers and $44,350 for singles in 2007 — designed to prevent the AMT from applying to taxpayers with modest incomes.
There’s also an “AMT credit” that allows you to claim a credit on your tax return in future years for some of the extra taxes you paid under the AMT. However, you can only use the AMT credit in a year when you’re not paying the AMT. To apply for the credit, you’ll need to fill in yet another form, Form 8801, to see if you are eligible.

Avoiding the AMT

Because large one-time gains and big deductions that trigger the AMT are sometimes controllable, you may be able to avoid or minimize the impact of the AMT by planning ahead. Here are some practical suggestions.

Time your capital gains.

You may be able to delay an asset sale until after the end of the year, or spread a gain over a number of years by using an installment sale. If you’re looking to liquidate an investment with a long-term gain, you should review your AMT consequences and determine what impact such a sale might have.

Time your deductible expenses.

When possible, time payments of state and local taxes, home-equity loan interest (if the loan proceeds are not used for home improvements), and other miscellaneous itemized deductions to fall in years when you won’t face the AMT. Since they are not AMT deductible, they will go unused in a year when you pay the AMT. The same holds true for medical deductions, which face stricter deduction rules for the AMT.

Look before you exercise.

Exercising ISOs is a red flag for triggering the AMT. The AMT on ISO proceeds can be significant. Because ISO tax issues are complex, you should consult with your tax advisor before exercising ISOs.
AMT situations are where a tax professional really comes handy.  If you feel that you may be subject to them, please seek the guidance of a tax professional to aid in your planning. 

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