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Written by: Sidney Kess, CPA, J.D., LL.M.

Published: 28 September 2010

Traditionally, tax planning is done before the end of the year to minimize taxes for the current year and optimize savings opportunities for the future. This year, however, income tax planning is a challenge because of the many unknowns about federal income tax rules. Still, it is helpful to understand these unknowns and planning strategies that can be used amid this uncertainty.

Uncertainty Persists

There are a number of areas of uncertainty because of prior laws, the state of the economy, the federal deficit, and Congress' inaction on a number of fronts.

Expired provisions. More than two dozen favorable tax rules expired at the end of 2009, many of which applied to individuals. Congress is working on a variety of measures that could extend, at least for 2010, some of these provisions (retroactive extensions of favorable tax rules have been done before). The House passed an "extender bill" (American Jobs and Closing Tax Loopholes Act, H.R. 4213) before the Memorial Day recess; the Senate failed three times to pass a similar measure before the July 4th recess but could take up the matter again — before or after the November election (the extenders themselves are not controversial but the way in which to pay for them is still uncertain). Key provisions in the extender bill for individuals include:

• The option to itemize state and local sales taxes in lieu of state and local income taxes.
• Additional standard deduction for real estate taxes up to $500 ($1,000 for joint filers).
• Above-the-line deductions for tuition and fees, and educator expenses up to $250.
• Transfers of IRA funds up to $100,000 by those age 70½ and older to public charities.

Expiring provisions. A number of provisions created by the American Recovery and Reinvestment Act of 2009 were set to run only for 2009 and 2010. With concerns about the deficit, there is little action underway in Congress to extend them. Provisions that will not run beyond this year unless Congress extends them include:

• Making work pay credit of up to $400 ($800 for joint filers (Code Sec. 36A).
• American Opportunity credit, which expands and replaces the Hope credit (Code Sec. 25A(i)).
• Tax credit of up to $1,500 over 2009 and 2010 for certain home-energy improvements (e.g., insulation, storm windows) (Code Sec. 25C).
• Using 529 funds tax-free for technology (e.g., computer equipment, Internet access) (Code Sec. 529(e)(3)(A)(iii)).

Most of the provisions under the so-called "Bush tax cuts" created by the Economic Growth and Tax Relief Reconciliation Act of 2001 (P.L. 107-16) and the Jobs Growth and Tax Relief Reconciliation Act of 2003 (P.L. 108-27) are scheduled to sunset at the end of 2010. Again, deficit concerns make some extensions unlikely, even though the Administration had promised to retain the breaks for all but higher-income taxpayers. Tax breaks scheduled to sunset include:

• Lower income tax rates. Currently, the top tax rate for individuals is 35%; starting in 2011 they are scheduled to revert to 36% and 39.6%.
• Reduced capital gains rates. Currently, the top rate is 15%; starting in 2011 the top rate will revert to 20%.
• Special treatment for qualified dividends. Now they are taxed the same as capital gains (i.e., at no more than 15%); starting in 2011, they will be taxed as ordinary income up to 39.6%.
• Phaseout of personal exemptions and itemized deductions for high-income taxpayers.

Alternative minimum tax (AMT). For the past nine years, Congress has provided a "patch" (an increase in the exemption amount) to keep millions of taxpayers from owing AMT. The exemption amounts for 2009 were $70,950 for 2009 joint filers; $46,700 for unmarried persons; and $35,475 for those married filing separately. There has been no such patch created for 2010, which means that the exemption amounts are set to decline to pre-2001 levels ($45,000 for joint filers; $33,750 for unmarried persons; and $22,500 for those married filing separately). Congress likely will again create a temporary fix to AMT, but this could be delayed until late in 2010 or even early in 2011 and made retroactive.

Planning in the Current Tax Environment

While uncertainty about many tax rules prevails, there are some actions that can be taken now to benefit from what is certain.

Making Roth IRA conversions. Starting in 2010, there are no income limits barring individuals from converting traditional IRAs to Roth IRAs. While tax is due on the income that results from the conversion (i.e., if the IRA was funded entirely by tax-deductible contributions, then all of the conversion amount is taxable), there is an opportunity to build up tax-free income in the Roth IRA. If higher tax rates persist after 2010, then the value of the tax-free income will be even greater than it is now. There is a safety value for converters: If the value of the account drops significantly after the conversion, the account can be recharacterized to avoid taxation on the higher value; another conversion can be made at a later time.

Note: Income from conversions made in 2010 only are reported 50% in 2011 and 50% in 2012, providing helpful tax deferral (Code Sec. 408A(d)(3)(E)). Alternatively, an individual can opt to include all of the income in 2010. The election will depend upon what the tax rates will be after 2010.

Taking advantage now of expiring provisions. With extensions uncertain, act now to utilize existing tax breaks. Examples:

• Homeowners may want to make certain energy improvements so they can claim a 30% tax credit of up to $1,500 (Code Sec. 25C).
• Students with 529 plans may want to purchase new computers with funds from their plans so the withdrawals will be tax-free (Code Sec. 529(e)(3)(A)(iii)).
• Buy a new hybrid vehicle. The tax credit for such a purchase is set to expire at the end of 2010 (Code Sec. 30B(a)(3)). Caution: Only certain vehicles continue to qualify for the credit, so check www.fueleconomy.gov.

Reviewing investments. Given the favorable tax rate on capital gains, now may be a good time to take gains. If an investor wants to maintain the investment position, the security can be purchased; the wash sale rule that bars recognition of losses if substantially identical securities are acquired within 30 days of the sale only applies to losses and not to gains (Code Sec. 1091).

Investors may also want to consider the advisability of holding dividend-paying stock. Advisors have been touting these investments because of their yield. However, the after-tax yield starting in 2011 will likely be lower than today because of the end to favorable treatment for qualified dividends.

Accelerating or deferring deductions. Some tax deductions, such as charitable contributions and certain elective medical procedures, are within the control of an individual. The decision on whether to take actions this year or wait until next year can result in tax savings. High-income taxpayers may benefit from accelerating certain itemized deductions because they are not subject to any phase-out of those deductions in 2010; the phase-out is set to return in 2011.

Thus, for example, charitable-minded individuals might contribute appreciated securities (to get a deduction at fair market value and avoid capital gains tax) but sell securities that have declined in value (to create a capital loss) and then donate the cash.

The same strategy — accelerating deductions — also applies to accelerating state and local tax payments (e.g., paying real estate taxes and state and/or local income taxes that would otherwise be due in 2011 before the end of 2010). However, the decision for preparing state taxes is impacted by the alternative minimum tax (AMT); deductions for these taxes are not allowable for AMT purposes (Code Secs. 55-59).

Accelerating or deferring income. Conventional wisdom has suggested that deferral is generally the best strategy for income wherever possible because there is at least an additional year in which the taxes must be paid. However, given the possible rise in tax rates in 2011, deferral may mean higher taxes on income that is deferred. For example, someone in the top tax bracket who earns $10,000 as a year-end bonus for 2010 would pay $3,500 in taxes on this amount if the bonus is received this year. If the bonus is deferred to 2011, the income tax bite would likely rise to $3,960, or $460 more.

Adjusting withholding and estimated taxes. While tax refunds are nice (and some taxpayers use them as forced savings to pay for vacations, etc.), they amount to interest-free loans to the government. Those who overpaid 2009 taxes should review withholding and estimated taxes to ensure they don't needlessly overpay in advance. Similarly, those who underpaid taxes (perhaps because of the making work pay credit) should also revise tax payments to avoid underpayment penalties. Situations likely to require adjustments in withholding and estimated taxes include:

• Changes in family situations, such as marriages, divorces, births of a child.
• Substantial investment gains, such as gains from the sale of a business interest.
• Roth IRA conversions that will be reported in 2010.

Final Word

Individuals should consult with their tax advisors to help determine which strategies would be beneficial to them. Also watch for actions in Congress that can impact mid-year planning strategies.

Sidney Kess, CPA, J.D., LL.M., has authored hundreds of books on tax-related topics. He probably is best-known for lecturing to more than 700,000 practitioners on tax and estate planning.

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Written by: Sidney Kess, CPA, J.D., LL.M.

Published: 05 September 2010

By: Sidney Kess, CPA, J.D., LL.M.

The U.S. Tax Court is the court to use when the amount of federal taxes is in dispute and the taxpayer has not yet paid the bill. Several recent decisions from the Tax Court provide guidance for individuals and businesses in planning for future transactions.

Corporate services at cost

It is common practice for a business owner to use the services of his or her company for personal matters. The question that can arise is the extent to which this results in income to the owner.

In one recent case, the sole shareholder of a corporation in the construction business had his company build a lakefront vacation home for him. He had the corporation maintain a “cost plus” job account on its books to keep track of the materials for his home. He reimbursed the corporation for all of the materials, labor, and overhead costs related to his job. He acted as the general contractor, dealing with all of the subcontractors himself.

The IRS said that the profit that corporation would otherwise have made on its building activities for him of more than $48,000 was a constructive dividend. The Tax Court said that at-cost services do not result in a constructive dividend to an owner (Welle, 140 TC No. 19 (2013)). Normally the shareholder’s corporation would have charged customers a profit margin of 6% to 7%. However, the foregone profit was not a constructive dividend because it did not result in a distribution of current or accumulated earnings and profits (Code Sec. 316(a)). While an economic benefit received can amount to a constructive dividend, it only becomes a dividend if it is a distribution from earnings and profits without expectation of repayment. There is no automatic connection between a corporation’s decision not to make a profit on services provided to a shareholder and a corporation’s distribution of earnings and profits. A dividend results only when corporate assets are diverted to or for the benefit of a shareholder.

Planning pointer: A shareholder can have his or her corporation provide services for the owner’s benefit without triggering a constructive dividend as long as the corporation is reimbursed for its outlays.

IRAs and Personal Guarantees

An IRA can be a flexible investment vehicle, allowing for tax deferral of income and gains until distributions are taken. However, tax deferral is thwarted if the IRA is misused by engaging in a prohibited transaction. This causes the IRA to lose its exempt (tax-deferred) status, resulting in immediate taxation of all of the funds in the account (assuming the IRA was created with tax-deductible contributions).

One individual set up a corporation (Corporation A) and had his IRA buy its shares. Then Corporation A purchased another corporation (Corporation B) with cash and a note. The IRA owner personally guaranteed the note issued by Corporation A. After B’s stock had appreciated, he converted his IRA to a Roth IRA. Then B’s stock was sold for a considerable gain.

The IRS said that all of the gain was taxable to him and the Tax Court agreed (Peek, 140 TC No. 12 (2013)). His personal guarantee of the note issued by the corporation whose stock was in his IRA was an indirect extension of credit to the IRA, which is a prohibited transaction. This caused the IRA to lose its exempt status as of the date that the note was made (well before the conversion to a Roth IRA and well before the sale of B’s stock) (Code Secs. 408(e) and 4975(c)(1)(B)).

Planning pointer: Self-directed IRAs offer considerable opportunities for investment growth by savvy individuals. However, exercise care when using self-directed IRAs. Only certain types of investments are permissible. What’s more, any self-dealing can be viewed as a prohibited transaction.

Dependency exemptions for noncustodial parents

When parents get divorced, only one can claim a dependency exemption for their child. Under federal tax law, the exemption belongs to the custodial parent unless that parent waives the right to claim it. A waiver must be made in writing; Form 8332, Release of Claim to Exemption for Child of Divorced or Separated Parents, is used for this purpose.

Often, divorce courts specify which parent is the one to claim a dependency exemption. This direction may not align with federal tax law, as one parent found out. A divorce decree awarded physical custody of the couple’s three children to the mother. The dependency exemptions were to be divided between the parents, but the divorce decree did not require the mother to execute Form 8332 to release the claim to the exemptions. The father claimed a dependency exemption for two of the children, consistent with his understanding of the divorce decree, but he did not get his ex-wife to sign Form 8332. She claimed a dependency exemption for two children, so that each parent claimed the same child as a dependent on their returns.

The Tax Court concluded that tax law trumps state law on divorce matters when it comes to the dependency exemption (Shenk, 140 TC No. 10 (2013)). Simply put, because the mother did not sign a release of her right as custodial parent to claim the dependency exemptions, the father could not claim them despite the language in the divorce decree.

Planning pointer: A parent going through a divorce should make sure that an experienced tax advisor review documents related to settlements so he or she understands the consequences of the provisions in the documents.

Easements with strings

An individual who owns a building or land may be able to obtain a current tax deduction without losing the right to use the property. This is accomplished through a conservation easement (or a façade easement with respect to a certified historic structure) granted in perpetuity. To qualify, there must be a legally enforceable restriction on the use of the property so that it is exclusively for (Code Sec. 170(h)):

- Preservation of land areas for outdoor recreation by, or the education of, the general public.

- Protection of a relatively natural habitat of fish, wildlife, or plants, or similar ecosystem.

- Preservation of open space (including farmland and forest land).

- Preservation of a historically important land area or a certified historic structure.

The problem arises in how the donation of an easement is structured. In a recent decision, donors made gifts of cash and a façade easement of their property located in a historic preservation district in New York City to the National Architectural Trust (NAT) and claimed a charitable deduction. The easement was appraised at $990,000 (the easement apparently reduced the appraised value of the $9 million property by 11%); they also donated cash equal to 10% of the appraised easement value ($99,000). The IRS disallowed the deduction, maintaining that the gifts were “conditional.” Under the terms of a side letter with NAT (referred to by the donors as a “comfort letter”), the property would be returned to the donors if the IRS disallowed the deduction.

The Tax Court agreed with the IRS that the gift was conditional and not deductible (Graev, 140 TC No. 17 (2013)). The donors argued that the possibility that the condition would be triggered (i.e., that their donation would be disallowed) was so remote as to be negligible (Reg. Secs. 1.170A-1(e), 1.170A-7(a)(3)), and 1.170A-14(g)(3)). They said that under state law (New York in this case), the side letter was unenforceable because it was not part of the recorded deed, making it a nullity.

The court rejected the donors’ arguments. The facts showed that NAT was ready and willing to honor the letter. NAT kept the donors informed about Congressional developments concerning easements and gave them an opportunity to back out of the donation before the deed was recorded. Thus, the donors effectively reserved the right to have their easement and cash returned if certain events occurred, making the gift conditional and nondeductible.

Planning pointer: Donors making conservation easements should follow the rules carefully to avoid a disallowance of the deduction for their charitable donation. Retaining any rights or conditions can disqualify the donation. For more details, review the IRS’ Audit Technique Guide on Conservation Easements at www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Conservation-Easement-Audit-Techniques-Guide#_Toc113.

Conclusion

Tax Court decisions offer important guidance on key points in tax laws that serve to help in planning transactions in the future.

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Written by: Sidney Kess, CPA, J.D., LL.M.

Published: 25 August 2010

Tax credits are more valuable to taxpayers than deductions because they reduce tax payments dollar for dollar; their value is not dependent on the taxpayer's tax bracket. In the past several years, Congress has used tax credits to effectuate administration policies, such as encouraging the purchase of homes to stimulate the poor housing market, and for businesses, hiring new employees and paying for employee health care. Moreover, an ever-growing number of credits are now fully or partially refundable so that they form a "negative income tax" (payments are made to taxpayers in excess of the taxes they owe).

There are now dozens of tax credits for individuals and businesses. Many of the credits for individuals have income limitations that bar their use by high-income taxpayers. Here are some of the new credits for 2010, as well as those that represent "last chance" opportunities because they are set to expire this year.

Making Work Pay Credit

This tax credit, created under the American Recovery and Reinvestment Act of 2009 (P.L. 111-5), was designed to help jump-start the economy by putting more money in the hands of workers by increasing their take-home pay. The making work pay credit began in 2009 and applies to both employees and self-employed individuals but will only run through 2010 unless Congress extends it (Code Sec. 36A). The credit is up to $400 for single taxpayers and $800 on a joint return; it is refundable.

The credit phases out for singles with modified adjusted gross income (MAGI) between $75,000 and $95,000, and for joint filers with MAGI between $150,000 and $190,000. Higher-income taxpayers do not qualify for the credit.

In 2009, some employees found that they owed federal income taxes because they were under withheld due to the making work pay credit (www.irs.gov/newsroom/article/0,,id=204447,00.html). Such workers should adjust withholding and estimated taxes for 2010 to avoid this problem for 2010.

Home Energy Credits

To encourage "green" homes, there are two types of tax credits for making certain energy improvements to a principal residence:

• Nonbusiness energy property credit for adding insulation, storm windows or doors, as well as energy-efficient central air conditioning, boilers, heaters and furnaces (Code Sec. 25C): The credit is 30% of the cost of the improvement, with a cap of $1,500 for aggregate expenditures made in 2009 and 2010. The credit does not apply after 2010 unless Congress extends it.
• Residential energy-efficient property credit for adding renewable energy property such as solar panels, thermal heat pumps, wind energy property, and fuel cells (Code Sec. 25D): The credit is 30% of the cost, without any dollar cap, and will continue through 2016.

Adoption Credit

To help adoptive parents defray the cost of adopting a child, there is a tax credit. The Patient Protection Act of 2010 increased the dollar limit on the credit for adoption expenses in 2010 to $13,170 (Code Sec. 23). Those who adopt a child with special needs can claim the credit without regard to their out-of-pocket adoption costs.

There continues to be an income cap on eligibility to claim the credit; the cap for 2010 is slightly higher than it was in 2009. The phase-out is MAGI between $182,520 and $222,520.

The credit had been scheduled to sunset at the end of 2010 but has been extended through 2011. The dollar limit may be indexed for inflation for 2011.

American Opportunity Credit

To help families pay for higher education, the American Recovery and Reinvestment Act of 2009 created a new and improved credit to replace temporarily the Hope credit for education. The American opportunity credit, which is set to run only through 2010 unless Congress extends it, can apply for the first four years of higher education (Code Sec. 25A(i)).

The credit is 100% of the first $2,000 of tuition, plus 25% of the next $2,000 of tuition, for a total credit of $2,500. Of this amount, 40% is refundable.

The credit is subject to an income limitation. The credit phases out for MAGI between $80,000 and $90,000 for singles and $160,000 to $180,000 for joint filers.

Retirement Savers Credit

The tax law wants to encourage retirement savings through IRAs and participation in qualified retirement plans. Toward this end, taxpayers with modest income can claim a tax credit for their contributions (Code Sec. 25B). In effect, they can "double dip" by benefiting from the contribution (e.g., a tax deduction for a contribution to a traditional IRA or a salary reduction for a contribution to a 401(k) plan) as well as claiming the tax credit.

Some of the income limits on eligibility for the tax credit in 2010 have been increased, allowing more taxpayers to qualify. 

Home Buyer Credit

There had been a tax credit designed to encourage the purchase of a residence. The credit for a first-time homebuyer was up to $8,000, and the credit for a long-term resident was up to $6,500 (Code Sec. 36). The credit, created in the midst of the housing market crisis, expired at the end of April 2010. However, those who were in contract on April 30, 2010, have until June 30, 2010, to close in order to claim the credit.

The credit is refundable. A credit for a home purchased during the eligibility period in 2010 can be claimed on a 2009 tax return (those who are on extension for 2009 returns can claim the credit when they file; those who have already filed will need to submit an amended return).

Note: Taxpayers who purchased homes prior to 2009 under an older version of the first-time homebuyer credit must start to "recapture" the credit in 2010. Recapture of this credit is taken over 15 years, so that ¹/₁₅ of the credit for a 2008 purchase is reported as income on a 2010 return. If the maximum credit of $7,500 was claimed, then the recapture amount for 2010 is $500.

Credits for Business

• Small employer health credit: As part of the Patient Protection and Affordable Care Act (P.L. 111-148), small employers (those with fewer than 50 employees) may qualify for a tax credit starting in 2010 (Code Sec. 45R). The credit, which is intended to encourage small businesses to pay some or all of employee health care premiums, is highly complex, and depends on the number of employees, what their average income is, the portion of premiums paid by the employer, and the average premium rates for small group markets in the state in which the employer is located. The 2010 state average premium rates for small group markets for purposes of figuring the credit, as set by the Department of Health and Human Services, has been announced by the IRS (Rev. Rul. 2010-13, IRB 2010-21).
• Employee retention credit: As part of the Hiring Incentives to Restore Employment (HIRE) Act of 2010 (P.L. 111-147), employers who hire eligible workers after February 3, 2010, and before January 1, 2011, and keep them on the payroll for 52 consecutive weeks can qualify for a tax credit of up to $1,000 per employee; the credit is given through an increase in the general business credit (Code Sec. 38(b)). There is no limit to the number of employees for whom the credit can be claimed. The credit will be claimed on 2011 tax returns. Eligible employees for this credit are defined as those who have not worked more than 40 hours during the 60-day period prior to starting work with a new employer and for whom employers can qualify for a payroll tax holiday in 2010 (no Social Security taxes are owed by employers on the wages of eligible employees during 2010). When hired, employees must provide an affidavit that they have been unemployed; new Form W-11 is used for this purpose. The IRS has posted questions and answers about the payroll exemption, which impacts eligibility for the employee retention credit (www.irs.gov/newsroom/article/0,,id=221036,00.html).
• Work opportunity credit: To encourage employers to hire individuals who are part of targeted groups, such as welfare recipients and felons, there is a special tax credit (Code Secs. 51-53). In most cases, the credit is 40% of first-year wages up to $6,000, for a top credit of $2,400 per eligible employee. The American Recovery and Reinvestment Act of 2009 created two new targeted groups of workers for whom employers can claim this credit: unemployed veterans and youths between the ages of 16 and 25 who are not in school and lack a sufficient number of basic skills. These two new targeted groups apply only for 2009 and 2010 unless Congress extends this rule. Note: Employers who qualify for a payroll tax holiday with respect to new employees who are from targeted groups must decide between the payroll tax holiday and the work opportunity credit; they cannot claim both tax breaks with respect to the same employee. Opting for the work opportunity credit in lieu of the payroll tax holiday does not prevent an employer from claiming the employee retention credit for those who remain on the payroll.

Sidney Kess, CPA, J.D., LL.M., has authored hundreds of books on tax-related topics. He probably is best-known for lecturing to more than 700,000 practitioners on tax and estate planning.

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Written by: Sidney Kess, CPA, J.D., LL.M.

Published: 20 May 2010

Tax Season 2010

Each year, savvy individuals review their tax pictures and determine the steps they should take before the end of the year to minimize their tax bills. This year is especially challenging for year-end tax planning because of several factors: the economy, the number of tax breaks that are expiring and the potential for adverse tax changes in the future. The sooner that year-end planning begins, the more opportunities for tax savings.

Conventional wisdom suggests that wherever possible, income should be deferred to next year and deductions that might otherwise be taken next year should be accelerated into the current year. This wisdom is based on the belief that a taxpayer's tax rates could be lower next year due to indexing of tax brackets, lower income or a reduction in tax rates. At this time, these assumptions might not apply for the following reasons:

• Tax brackets might not be adjusted for inflation. For example, Social Security benefits will not increase for 2010 because of historically low inflation.
• Taxpayers might already be in low brackets in 2009 because the economy has impacted their incomes; 2010 might see incomes rise, along with taxpayers' tax brackets.
• Tax rates surely will not be reduced; in fact, they could increase in 2010 to pay for government programs and the mushrooming deficit. The current low tax rates on individuals are scheduled to sunset after 2010.

The bottom line is that it is difficult to determine whether this year or next year will be the lower tax rate year. For those who can confidently make this determination, maximizing deductions and minimizing income in the higher tax rate year is advisable. The following checklist details tax-savings strategies for accomplishing this:

Accelerate Medical Expenses

Have elective medical procedures done before the end of 2009 (assuming that total medical expenses exceed 7.5% of adjusted gross income).

Prepay Income and Property Taxes

Prepay state and local income taxes and property taxes. For example, pay taxes otherwise due in January 2010 before the end of 2009. However, do not prepay these taxes if subject to the alternative minimum tax (AMT). The taxes are not deductible for AMT purposes.

Increase Charitable Contributions

Donations charged to a credit card before the end of the year are deductible this year even though the credit card bill is paid in 2010. Obtain required substantiation for all donations.

Delay Year-End Billing

Self-employed individuals using the cash basis for accounting purposes should delay year-end billing so funds will be received next year (assuming the customers' ability to pay is not a concern).

Take Advantage of Expiring Tax Laws

More than two dozen tax provisions are set to expire in 2009. Some might be extended; others won't be. As of now, there have been no indications from Congress that breaks will be extended. Here are some important ones to use before it is too late.

• Buy a principal residence by Nov. 30, 2009, to take advantage of the first-time homebuyer credit. This credit of up to $8,000 applies only if the purchaser (and spouse) has not owned a home in the past three years and has income below set limits.
•  Buy a new car before the end of the year to deduct the state and local sales and excise taxes on the purchase as an itemized deduction, or as an additional standard deduction if not itemizing.
• Transfer tax free up to $100,000 from an IRA to a public charity if at least age 70½ by the end of 2009. This transfer opportunity can reduce future taxes while benefiting a favorite charity now.

Harvest Capital Losses

Despite some recovery in the stock market, investors might be holding securities that could generate tax losses. Capital losses on the sale of securities can offset capital gains, dollar for dollar. Capital losses in excess of capital gains can offset up to $3,000 of ordinary income ($1,500 for married persons filing separately).

Capital losses in excess of these limits can be carried forward indefinitely to offset gains (and limited ordinary income) in future years. "Banking" capital losses might yield sizable tax savings in the future if capital gains rates increase. The current low rates are set to sunset after 2010, but could be increased before then.

Abandon Worthless Securities

Worthless securities are treated as having been sold on the last day of the year in which they became worthless. Usually worthlessness requires more than the issuer merely filing for bankruptcy. However, investors can treat securities as worthless if they abandon them by giving up any rights in them.

Alternatively, investors might be able to sell nearly worthless securities for pennies through their brokerage firms in "accommodation sales" and take the capital loss.

However, beware of the wash sale rule, which prevents recognition of a capital loss if substantially identical securities are purchased 30 days before or after the sale. The wash sale rule applies even to securities that are sold or acquired in tax-deferred accounts, such as IRAs. For example, if an investor sells stock at a loss in a taxable account and then has his or her IRA purchase the same stock within the wash sale period, no loss on the stock sale can be recognized now.

Take Capital Gains

This might be the last year to enjoy favorable capital gains rates. The 15% and the zero rates for taxpayers in the 10% or 15% tax bracket are set to expire at the end of 2010; the rates could be changed even earlier.

Shift Income to Family Members

Because of the zero tax rate on long-term capital gains and qualified dividends for 2009, consider shifting income to members in the 10% or 15% tax brackets so they can receive this type of income tax-free. For example, an adult child providing support for a parent could gift appreciated securities rather than cash, saving the capital gains tax on the securities and possibly increasing the funds available for the parent's support.

Caution: When gifting to a child subject to the kiddie tax (up to age 23 if a full-time student not providing more than half his or her own support), keep in mind investment income limits applicable to the child. For 2009, investment income over $1,900 is taxed to the child at the parent's highest marginal rate. A child could, for example, have $38,000 in investments yielding a 5% return without exceeding the kiddie tax limit ($47,500 at a 4% return).

Gift Income to Family Members

Income-shifting is aided in 2009 by an increased annual gift tax exclusion of $13,000 per beneficiary ($26,000 if a spouse consents to split the gift). For wealthier individuals, greater gift opportunities include:

• Transferring funds to a child or grandchild's 529 college savings plan: The gift-tax-free limit per child for 2009 is $65,000 (five times $13,000), or $130,000 if the spouse splits the gift.
• Paying for tuition or medical expenses of a family member directly to the service provider: No dollar limit here.
• Making interest-free loans: Because of the current low interest rate climate, the cost of these loans, if any, is low. The first $10,000 of such loans is exempt as a gift loan; loans of up to $100,000 — to enable a child to purchase a home, for example — also are exempt if the child's investment income does not exceed $1,000.

Add Funds to 529 Plans

See aforementioned "Gift Income to Family Members" for the rules for contributions. Withdrawals from 529 plans in 2009 and 2010 can be qualified (i.e., tax-free) for computer technology. This includes the cost of a laptop, Internet access and software (gaming and entertainment software must be primarily for education purposes).

Cash in Savings Bonds for College

Cashing in U.S. savings bonds can help pay for higher education without current income tax cost. The MAGI limits on the exclusion of savings interest redeemed to pay qualified higher education expenses are up in 2009.

Use New Education Credit

The American Opportunity credit, which can be used for the first four years of higher education, applies in 2009 and 2010. There are MAGI limits on eligibility; 40% of the credit is refundable (it can be received even though it exceeds tax liability).

Consider Timing of Tuition Payments

Determine when to pay spring 2010 tuition and fees. Depending on the timing of the payment, it could engender a tax break for 2009 or 2010. Note: The above-the-line deduction for tuition and fees is set to expire at the end of 2009.

Minimize IRA Withdrawals

There are no required minimum distributions from traditional IRAs, 401(k) and similar plans in 2009. This rule applies to account owners and beneficiaries. Individuals are permitted to take some or all of their savings, but usual taxation rules apply (i.e., ordinary income treatment and a 10% early distribution penalty for those younger than 59½ unless an exception to the penalty applies).

Maximize IRA Contributions

Active participants in qualified retirement plans might be able to add to deductible IRAs in 2009 because the income limits have increased. For 2009, fully deductible IRA contributions are allowed as long as modified adjusted gross income (MAGI) does not exceed $55,000 for singles, $89,000 for joint filers and $166,000 for a nonactive participant with an active-participant spouse. Partial deductible contributions are permitted for those with MAGI within a phase-out range.

The MAGI limits for contributing nondeductible amounts to a Roth IRA have increased to $105,000 for singles and $166,000 for joint filers (partial contributions are permitted for those with MAGI within a phase-out range).

Make IRA Contributions Early

IRA contributions for 2009 can be made up to April 15, 2010; however, the sooner contributions are made, the more tax-deferred income in a traditional IRA or tax-free income in a Roth IRA can accrue.

Convert to Roth

For 2009, conversions from traditional IRAs or qualified retirement plans to Roth IRAs are allowed only if MAGI does not exceed $100,000 (married persons must file jointly to convert). Starting in 2010, the conversion restrictions are repealed; anyone can make a conversion of some or all taxable accounts. The cost of the conversion is the tax that results, though there is no early distribution penalty. Individuals who want to make conversions next year should be sure to have sufficient cash (separate from the converted account) to pay the resulting taxes. Note that the tax on conversions in 2010 automatically is payable one-half in 2011 and one-half in 2012. However, taxpayers can elect to report all conversion income in 2010, which might be advisable if income tax rates increase after 2010.