2010 New Tax Law Changes

Kevin Huang, CPA was interviewed by KTSF 26 to share the 2010 new tax law changes.

Is it Best to Maximize or Minimize Deductions?

As the end of the year approaches, it’s a good time to review your potential tax deductions and develop a strategy that maximizes the benefits. Most taxpayers may deduct the higher of two amounts from adjusted gross income when figuring their taxable income. These amounts are either a fixed amount set by law (the “standard deduction”) or a listing of the expenses the taxpayer paid during the year that the government allows (known as “itemized deductions”).

The basic federal standard deductions for 2010 are: $11,400 for joint filers, $8,400 for head of household, and $5,700 for others. Add-ons to the standard deduction are allowed for taxpayers (and their spouses, if filing jointly) who are blind and/or age 65 or older. In some years, other add-ons—such as a limited amount of real property tax—are also allowed.

 It would seem to be a simple choice—use the larger of the standard or itemized deductions. However, strategies may be used to maximize the benefits that add complexity. For example:

• Bunching Strategy – If your itemized deductions and your standard deduction are about the same, it may be possible to maximize your itemized deductions every other year and take the standard deduction in alternate years. Methods of doing this are discussed below.
• The Alternative Minimum Tax (AMT) Effect - If you are subject to the AMT, the standard deduction is not allowed at all, but some itemized deductions are. Therefore, if you are subject to the AMT, you should always itemize your deductions.

 Here are some tips on maximizing your itemized deductions:

• Medical – Medical deductions for regular tax purposes are deductible only to the extent that they exceed 7.5% of your Adjusted Gross Income (AGI). That percentage increases to 10% for the AMT. Where possible, consider prepaying or deferring medical expenses to match your deduction strategy. In addition to the normal medical deductions, don’t overlook the costs of fertility procedures, learning disability expenses, nursing home expenses, pregnancy tests, certain special education, prescribed smoking-cessation programs, certain weight-loss program expenses, and certain impairment-related expenses.

A child’s medical expenses paid for by divorced parents are generally deductible by the parent who pays the expense. You can also deduct medical expenses for an adult “medical dependent.” Generally, one who would qualify as your dependent except for gross income limitations.

• Taxes – Deductible taxes include real and personal property taxes as well as state and local income taxes. Generally, real property taxes are paid in two or more installments during the year. This gives you the opportunity to “bunch” tax payments by paying an entire year’s tax bill plus one or more installments from the prior year all in one tax year.

If you are paying state estimated taxes, the fourth quarter’s payment is due by January 18, 2011 in most states. However, you have the option to pay it before the end of the year and move the deduction into 2010. Keep in mind that taxes are not deductible for AMT purposes.

• Charitable Contributions – Charitable contributions are deductible for both the regular tax and the AMT. Because they are discretionary, a taxpayer can choose when to make a payment. For example, you could prepay your 2011 tithes in 2010, thereby doubling up deductions in 2010.

Don’t overlook year-end non-cash contributions of items lying around the house that are never used. As long as they are in good or better condition and are contributed to a charity before the close of the year, the contribution will count as a deduction for 2010 (provided you have proper documentation).

• Miscellaneous Deductions – This is a catch-all category that generally includes investment and employee business expenses. These deductions are only allowed to the extent that they exceed 2% of your AGI—but not at all for AMT purposes. Don’t overlook potential losses from IRA and variable annuity accounts that have declined in value during the recession. However, utilizing these losses requires special action, so please call for details.

Because of the 2% of AGI limitation, certain otherwise-deductible expenses might be handled differently, such as working out a reimbursement plan from your employer for employee business expenses. Doing so may mean reducing your salary, but you will be converting taxable income to non-taxable reimbursement—always a desirable outcome. If your miscellaneous deductions are less than 2% of your AGI, consider paying IRA fees from the IRA account instead of making a separate payment.

If you believe you are a candidate for deduction planning, please call this office for an appointment.

Maximizing Credits to Reduce Taxes

There are a number of credits that can help reduce your tax bite for 2010. Unlike a deduction (which reduces your taxable income and thus provides a benefit equal only to the deduction amount times your tax rate), a tax credit is a dollar-for-dollar reduction of your tax. For some credits―such as the Earned Income Tax Credit, Child Tax Credit, Child and Dependent Care Credit, and others―there’s not much you can do to change the outcome. However, there are some credits, described below, that offer year-end tax planning opportunities.

Maximize Education Credits – If you have a child in college for whom you claim a dependent exemption and you or someone else is paying the tuition for that child, you probably qualify for either the American Opportunity Credit or the Lifetime Learning Credit. The credits begin to phase out for higher-income taxpayers whose modified adjusted gross income is $80,000 or more ($160,000 for married couples filing a joint return).

• American Opportunity Credit - Maximum credit is obtained from $4,000 of tuition and qualified expenses that provides a credit up to $2,500 (100% of the first $2,000 and 25% of the balance). Under normal circumstances, education credits are non-refundable; that is, they offset only a taxpayer’s tax liability. However, for this credit, up to 40% can be refundable.
• Lifetime Learning Credit - Maximum credit is obtained from $10,000 of tuition and qualified expenses that provide a 20% credit up to $2,000.

 If you have not already paid the maximum expenses for the year, it may be appropriate for you to prepay certain expenses that apply to the first quarter of 2011. The laws generally allow you to prepay tuition for an academic period that begins during the first three months of the next tax year, and then you can claim the prepaid amount for the current year’s credit. Please contact this office for additional information on this tax strategy or other issues relating to education tax benefits and credits.

Take Advantage of the Home Energy Property Tax Credit – 2010 is the final year to take advantage of the “Home Energy Property Credit” that provides a tax credit for energy-saving improvements made to a taxpayer’s principal residence. The credit is limited to $1,500 (30% of up to $5,000 of qualified expenditures) for improvements made in 2009 and 2010. So, if you claimed this credit in 2009, the most you can claim for energy property improvements for 2010 is the $1,500 maximum less any amount claimed in 2009.

Qualified improvements (those certified by the manufacturer to qualify for this credit), the use of which must originate with the taxpayer, must have a reasonable expected life of at least five years, and include:

o Energy-efficient Exterior Windows and Skylights,
o Energy-efficient Exterior Doors,
o Energy-efficient Metal Roofs with appropriate pigmented coatings,
o Energy-efficient Asphalt Roofing with appropriate cooling granules,
o Energy-efficient Heating Systems,
o Energy-efficient Air Conditioning Systems and
o Insulation Materials or Systems designed to reduce heat loss or gain.

Credit is not allowed for onsite preparation, assembly, or installation of the component. It is a non-refundable personal credit; thus, the credit can be used only to bring your tax (including the alternative minimum tax) down to zero. Any excess is not refundable and cannot be carried over to a subsequent year.

Pick a Hybrid or Lean-Burn Vehicle – If you are planning to purchase a new automobile before the end of the year, it might be appropriate to purchase either a hybrid or lean-burn vehicle. Credits for these types of vehicles range from $900 to $2,350. However, this credit has phased out for most manufacturers and is currently available only on qualified vehicles manufactured by General Motors, Chrysler, Nissan, Mazda, BMW, and Mercedes for hybrid vehicles, and by Volkswagen, Audi, and Mercedes for qualifying lean-burn vehicles.

This credit is a non-refundable personal credit, which means it can reduce your tax only to zero, and any balance is lost. However, if the vehicle is used partially for business, the portion of the credit attributable to business use becomes a general business credit, and any amount not used in 2010 carries back one year and forward for 20 years until used up.

If you have questions about how any of these credits will impact your specific circumstances or would like to schedule a year-end planning appointment, please call this office.