Money Matters / Tax uncertainty abounds
A substantial number of the tax cuts introduced under the last presidential administration are heading toward expiration at year end.
But that doesn't necessarily mean they're going to expire. Congress could extend them. So, though you may not usually start thinking about tax planning this early in the year, it's an important time to do so. A good tax-minimization strategy could save you a lot of money.
Marginal income tax rates
The maximum marginal tax rate for 2010 sits at 35 percent but, unless legislative action is taken, it will rise to 39.6 percent for 2011. That could drive up your 2011 tax bill if you don't plan carefully.
To reduce the impact of higher rates, think about the timing of your income and expenses. Consider doing the opposite of normal tax planning and accelerating income into 2010, when it could be taxed at a lower rate, and deferring deductible expenses into 2011, when they could be more valuable.
Your income may be more controllable than you think. Look for items such as bonuses, consulting or other self-employment income, U.S. Treasury bill income, real estate or other non-publicly traded property sales and retirement plan distributions (if not required).
Some of your expenses may be within your power to control as well. Check with your tax advisor about your state and local income taxes, real estate taxes, mortgage interest, margin interest and charitable contributions. Just be forewarned that some prepaid expenses can be deducted only in the year to which they apply.
Note: Check with your tax advisor about your AMT risk before executing any of the tips mentioned here.
Capital gains rates
Also in flux are the tax rates on long-term capital gains (as well as the maximum qualified dividend tax rate). The top rate stands at 15 percent but, unless Congress takes action, it will rise to 20 percent for the 2011 tax year. The dividends rate, also 15 percent, will go up to as high as 39.6 percent if nothing is done legislatively.
When it comes to investments, time is generally your friend because it allows more opportunity for assets to grow and any losses to be recovered. But with the tax rates in flux, timing becomes just as important as it does when considering your marginal tax liability.
To this end, consider selling some of your appreciated assets to trigger capital gains, which will enable you to make use of the potentially lower 2010 rates. In addition, you may, if possible, want to defer recognition of capital losses until 2011 so you can put these losses to use offsetting 2011 gains potentially subject to a higher tax rate.
Another idea: Look into purposely conducting some related-party transactions that will accelerate unrealized income or gains into 2010. A related party may be a relative or a related business or investment entity. There are many rules regarding related-party transactions, but most are designed to prevent the acceleration of deductions, so doing the opposite won't typically violate the rules.
What we do know
Although tax uncertainty abounds, what we do know is that it's more important than ever to start tax planning early this year. This information is general and not intended as advice to anyone. Always discuss your particular tax situation with your financial advisor before taking any actions.
Norm Grill is the managing partner of Grill & Partners LLC, certified public accountants and consultants to closely held companies and high-net-worth individuals, with offices in Fairfield and Greenwich. He can be reached at 203-254-3880 or N.Grill@GRILL1.com