Year End Financial & Tax Planning Tips

A take-off on the old adage “significant savings can often be had to those who ‘don't wait’” states the case with year-end tax planning. A few smart moves prior to Dec. 31st can make a significant difference in your April tax bill. The key for most of us will be to defer income and accelerate deductions.

Some common income deferrals include:

1. Delay year-end bonus, compensation, payments for service, and rents;

2. Postpone retirement plan distributions that are not required;

3. Hold off on the sale of capital gain property until after January 1st, or opt for installment payments instead of lump sum.

Typical deduction acceleration methods are:

1. Pre-pay deductible interest as well as state payments for property and estimated income taxes;

2. Make charitable contributions prior to year-end. Where gains exist, consider gifting appreciated investments rather than cash so to get a deduction for the entire market value without having to realize the taxable gain.

3. Be sure to maximize deductible IRA ($5,000 plus an additional $1,000 for those over 50 for 2011; indexed to inflation in subsequent years) and SEP ($49,000 based on eligible compensation) & 401K retirement plan employee salary deferral contributions ($16,500 plus an additional $5,500 for those over 50). Remember an unemployed spouse may also be eligible for the IRA.

Investors want to be mindful of a few points as well:

1. New mutual fund investments may be best delayed until after year-end distributions have been made. This is because distributions are blindly made to an owner on a given date of record without regard to how long the investment was owned. For example, a 10% capital gain distribution for record owners of December 13th; a December 12th investment of $10,000 could result in a $1,000 taxable capital gain with no mitigating advantage.

2. Offsetting realized gains with losses can help as well, so long as the sales do not cause adverse investment results. Keep in mind the 30-day “wash sale” rules, and up to $3,000 of investment tax loss can be applied against income from other sources.

3. Charitable IRA’s: Those over age 70½, who are faced with taking Required Minimum Distributions (RMD) from their IRA, can opt to have up to $100,000 of the balance contributed to the charities of their choice directly. By doing so, they can satisfy their RMD and may come out ahead tax-wise.

4. Roth IRA Conversion: In select situations, it can be beneficial to have some or all of a traditional IRA converted to a Roth. When considering this, the upfront tax cost must be weighed carefully against the longer term benefit that a “tax-free” Roth can provide.

For self-employed professionals and small business owners, recent legislation makes it advisable to re-evaluate your retirement plan structure. As an example, a self-employed individual with $100,000 of net profit could only fund $18,587 to her SEP IRA, but was able to fund $35,087 ($40,587 if over 50) to a one person 401K. The difference could result in an additional tax savings of almost $10,000.

For some, it may be even more advantageous to consider a defined benefit pension plan. Another self-employed client in his late 50’s, who was able to make a $220,000 deductible contribution based on his $400,000 salary. This is expected to generate a tax savings of $100,000. Certainly, much depends on the circumstances, such as the owner’s age, income history and whether other employees were involved.

Many semi-retired clients, for example, are compensated as independent contractors for consulting and for serving on corporate boards. Depending on the situation, they may be able to establish a pension plan that might allow a substantial contribution to offset the majority of this income. The trick is that these plans generally need to be established prior to year-end.

If you are one of the over 3 million taxpayers subject to the Alternative Minimum Tax, it may be better to accelerate income and defer deductions. That is because the AMT, with its own system of rates and rules, will disallow many itemized deductions. For example, AMT taxpayers could hurt themselves by pre-paying their state taxes in the current year. They may also find portions of their mortgage interest expense disallowed.

There are a myriad of other year-end tax savings tips. Don't forget; for those in the higher tax brackets, $1,000 in additional tax deduction may result in almost $400 in actual tax savings. Awareness and acting prior to year-end are the keys to effective tax planning. Meet with your tax or financial professional soon. It may well be the best investment you make all year!

Note: Any information contained herein is not a complete summary or statement of all available data necessary for buying or selling any investment and does not constitute a recommendation.

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