Before your clients file those 1040s, consider post-year-end planning opportunities. Although most tax planning opportunities expired in 2010, some post year-end techniques are still available.
Individual Retirement Accounts. 1) The deadline to make a 2010 deductible contribution to a traditional IRA is the client's tax filing deadline with no extensions—usually April 15, 2011. The 2010 contribution limit is $5,000, plus a $1,000 catch-up for those ages 50 and over during the tax year. Even if an individual can make the maximum contribution, deductibility may be limited or eliminated for those who are active participants in an employer-sponsored retirement plan, or who are married to someone who is. See IRS Publication 590 (2010), Table 1-2 on page 14, or at irs.gov.
2) Early filers may be able to fund a 2010 IRA contribution with a 2010 tax refund-deductible or not. Accommodating custodians will accept direct deposits from the IRS of tax refunds into traditional IRAs, Roth IRAs or SEP IRAs. If the refund is intended to be a 2010 contribution, it must be deposited with the IRA custodian by the client's 2010 tax filing deadline. You may want to verify that client refund deposits come in a timely manner and are coded as 2010 contributions.
3) Use a 2010 deductible IRA contribution to offset a taxable IRA or 401(k) distribution taken in 2010.
4)Make contributions to a minor's own IRA. Minors employed in a family business and those with documented income from mowing lawns or baby-sitting may make IRA contributions of their own. If the minor has already spent his earnings, the contribution may be funded by a gift. The contribution may be fully deductible and may be used to offset some kiddie tax. Children age 18, and full-time students age 19 through 23 are not subject to the kiddie tax if their earned income exceeds one-half their support expense for the year. All other children under the age of 23 will see their investment income over $1,900 (2010 and 2011) taxed at their parents' rate.
Recharacterization. 1) For a 2010 Roth IRA conversion, your client may choose to pay 100% of the tax due with his 2010 tax filing or spread the tax 50/50 over 2011 and 2012. But if the converted amount has dropped a lot in value or otherwise become unattractive, clients may recharacterize to eliminate the conversion tax obligation and perhaps later reconvert with a lower conversion tax obligation.
2) Recharacterize the converted amount, plus earnings or minus losses, by client's tax filing deadline plus extensions, which can be as late as Oct. 17, 2011. Even if a client files his 1040 by April 18, 2011, pays the conversion tax and then thinks better of it; he has until Oct. 17, 2011 to recharacterize, file an amended return and request a refund. The client may not reconvert before the later of the beginning of the tax year after the tax year of the conversion or the end of the 30-day period beginning on the day the recharacterized amount was transferred back to a traditional IRA.
SEP IRA. Employer sponsored retirement plans such as a pension plan or 401(k) must be adopted during the tax year. A Simplified Employee Pension (SEP) IRA plan may be adopted and funded as late as the employer's tax filing deadline, plus extensions. The SEP is a streamlined employer plan built on an IRA chassis. It involves minimal IRS reporting and is inexpensive to operate.
Implementing a SEP post-year-end could allow your small business owner client to make tax-deductible contributions up to 25% of eligible participants' qualified compensation and is favored by self-employed individuals and micro-business owners.
Healthcare Expenses. Clients covered by high-deductible health plans (HDHPs) should consider implementing a Health Savings Account or HSA—a sponsoring employer is not required. An HDHP has an annual deductible of at least $1,200 for self-only coverage, with annual out-of-pocket expenses not to exceed $5,950 ($2,400 and $11,900 for family coverage). 2010 contributions may be made as late as a client's tax filing deadline with no extension and generate above-the-line deductions of up to $3,050 for self-only coverage ($6,150 for family coverage), plus $1,000 (a catch-up) for individuals age 55 and older who, on the last day of the year, were not in Medicare.
A new tax provision—available for 2010 only—allows self-employed individuals to deduct 100% of their health insurance costs—from earned income for purposes of calculating self-employment tax, and from adjusted gross income (AGI) as a medical expense not subject to the 7.5% of AGI medical expense limit.
Deductions and Education Credits. Lower AGI and thereby the income tax obligation. Maximize itemized and standardized deductions (standard deduction not available under the AMT). One less familiar strategy is to have the client not claim a working college student as a dependent.
Education credits are not available to high-income clients. If the client waives his right to the dependency deduction, a working college student may file his own return and claim the credit. He won't be entitled to a personal exemption deduction. But deductions only reduce taxable income, while credits create a dollar-for-dollar tax savings. Thus salvaging the credit may provide the greater family tax benefit.
Information Returns (includes 1099, K-1, 5498). Assume clients will receive corrected or late information returns on their investment account activity and plan accordingly. Most information returns must be received no later than Jan. 31. Others such as the Partnership Schedule K-1 are not required to be provided until the day the partnership return is filed. Often the REIT, partnership, IRA custodian, brokerage or other issuer may not have all the information to prepare the forms the first time around. Clients generally know when to expect a corrected 5498 (reports IRA contributions, rollovers and the fair market value of the account). Anticipate corrected 1099s or K-1s restating taxable earnings, passive income or return of principal to avoid amending 1040s.
Be familiar with tax provisions still in play for 2011 and 2012. New tax law extends or creates many favorable tax provisions for 2011 and 2012.
• 2010 Ordinary Income Tax Rates Retained (2011 and 2012).
• Itemized Deductions Still Not Subject to Overall Phase-Out.
• AMT Preemptively Patched (2011).
• 2% Social Security Payroll Tax Cut for Employees and Self-Employed (2011).
• IRA Qualified Charitable Distributions or QCDs Extended (2011). IRA owners 701/2 or over may make a tax-free distribution of up to $100,000 if paid directly to a qualified charity.
• $5,000,000 Exemption Amount and 35% Rate (2011 and 2012). Lifetime transfers of wealth, including generation-skipping transfers made in 2011 and 2012; and clients dying in 2011 and 2012 are allowed a $5 million exemption amount and a low 35% tax rate on amounts in excess of that exemption.
Susan Hartman, JD, CFP, is a tax and estate planning consultant in Raymond James' Wealth Solutions Group, a resource for RJ advisors across the country. She is based in St. Petersburg, Fla.