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VOLUME 3 ISSUE 7 - July 2010
Planning for the inevitable - Tax savings opportunities for 2010
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 By Joseph Kirgesner, CPA, CVA, CFF
Principal
Unlike most years, individual tax planning for 2010 requires a substantial change in the conventional wisdom typically applied. The primary cause of this change in mindset involves the expiration of the so-called “Bush tax cuts” at the end of the year.
Enacted in 2001, these tax cuts reduced the marginal tax rates for virtually all taxpayers, and lessened the impact of certain tax benefit phase-outs, such as itemized deductions and personal exemptions. Furthermore, the alternative minimum tax (AMT) exemption will be lowered to 2001 levels, possibly subjecting over 26 million taxpayers to this tax in 2010 compared to fewer than 5 million taxpayers who were subject to AMT in 2009.
Exacerbating this situation is the looming additional 3.8% Medicare tax on net investment income (i.e. interest, dividends, capital gains, and rents inter alia) which will become a reality in 2013. Although proper tax planning involves a comprehensive review of current and future tax legislation, this article will focus on two specific tactics which may prove beneficial for this year.
ACCELERATE RECOGNITION OF LONG-TERM CAPITAL GAINS
Tax planning usually involves three general strategies – maximizing tax deductions, conversion of taxable income to a more favorable type of income, and/or deferral of the recognition of taxable income to a later year. For 2010 however, acceleration of the recognition of long-term capital gains may prove beneficial.
For any capital asset sold during 2010 which was held more than one year, a maximum tax rate of 15% applies. For tax years 2011 and later, this favorable rate increases to 20%, with many experts predicting Congress to raise this rate to 25% or higher. Even without a tax increase, the tax on long term capital gains may approach 24% for 2013 and later, or a 60% increase in the taxes paid on the gain.
As a result, it may be beneficial to sell capital assets such as stock, real estate, or other highly appreciated assets in 2010, even if you wish to maintain your holdings. Unlike sales of capital assets at a loss, the gain from such a sale is fully taxable even if the same asset is purchased within thirty (30) days. The “wash sale” rules which prevent harvesting of capital losses if the identical position is re-acquired do not apply in this case.
For example, if you hold a position in XYZ Inc. with an unrealized capital gain of $100,000, sale during 2010 will result in federal tax of $15,000 (slightly higher for certain circumstances). If sold in 2011 or later, the tax will increase to $20,000, or even higher. By selling during 2010, the tax on that portion of the gain will be locked in at 15%, and the asset basis will be higher in the future when the taxpayer fully disposes of the position in XYZ. By selling, and then immediately re-acquiring the asset, there is no market risk, however, transaction costs of the sale and re-purchase must be considered, especially in the case of real estate.
The sooner that ultimate liquidation of the asset is anticipated, the more likely it is that this strategy will be beneficial. A major risk, however, is that the asset may depreciate or devalue after re-acquisition, resulting in unnecessarily paying taxes in 2010, with less beneficial capital losses in the future. Nevertheless, informed tax planning will consider this investment risk as well as possible tax benefits.
PAY DIVIDENDS FROM C CORPORATIONS
Also expiring at the end of 2010 is favorable tax treatment of qualified dividends from C corporations. Currently taxed at a maximum of 15%, these qualified dividends may be taxed in 2011 at a rate of over 41.5%, possibly increasing to over 45% by 2013 when the Medicare tax commences.
Accordingly, if a C Corporation has accumulated earnings and profits which may be available to distribution to shareholders if prudent use of working capital would allow, we recommend that the maximum distribution be made during 2010. If cash flow is not currently available, the dividends may be declared and paid, with the shareholder(s) loaning the cash back to the C corporation.
The tax on $100,000 of qualified dividend income in 2010 may approximate $15,000, while it may increase to over $41,000 for 2011, or a 250% increase in the taxes paid.
These tax strategies are provided for information only and do not constitute a specific recommendation for your own circumstance. However, if you believe that such tax planning strategies may benefit you, please contact your Apple Growth Partners contact to assist in the plan design.
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