Your Year-End Tax Planning Guide

NEW YORK (MainStreet) — While the average taxpayer tends to avoid thinking about income taxes until the April deadline forces him to, once the ball drops in Times Square at midnight on Dec. 31 and the New Year is rung in there is very little that can be done to cut your 2011 tax bill.

Luckily, during the last two months of the year you can do a great deal to reduce your liability.

First off, sit down with paper and pencil and make a list of your anticipated income for 2011 and all allowable deductions you plan to claim. Using your 2010 return as a guide, prepare a projected 2011 tax return.

Only when this is done can you decide what steps to take to make sure you pay the absolute least amount of federal, state and local income tax for 2011 and 2012. But before discussing those basic year-end tax planning strategies, let me first list some important rules to keep in mind.

  • There are no year-end tax planning actions that apply to all taxpayers in all cases. Year-end strategies must be evaluated in the context of the facts and circumstances of your individual situation.
  • Consider the state and local tax consequences of your actions. And also beware of the dreaded Alternative Minimum Tax (AMT). While a year-end strategy may reduce your “regular” income tax for 2011, it may end up costing you if you fall victim to the AMT.
  • Your first criteria for evaluating any financial transaction you are considering should always be economic. Tax considerations should come second.
  • Be sure to review your year-end situation with your tax professional before taking any actions with your income or assets.

1. Managing Income

Traditional year-end planning calls for postponing the receipt of taxable income until 2012 and accelerating allowable deductions to be claimed in 2011. This strategy will generally apply if you expect to be in the same tax bracket for both 2011 and 2012, or if you expect to be in a lower bracket in 2012.

If you anticipate a substantial jump in income in 2012, which may push you into a higher bracket, you should do the reverse and accelerate the receipt of taxable income for 2011 and postpone deductible expenses until next year. Income will be taxed at a lower rate in 2011, and deductions claimed in 2012 will yield a greater tax savings.

Not sure what your 2012 income will be? When in doubt, defer. Postpone income and accelerate expenses.

As of this writing, except for the annual COLA adjustments, the tax rates and brackets for 2012 will be basically the same as those for 2011 – so while Democrats continually talk about raising taxes on those with the highest incomes, I doubt that there will be any change in the rates or brackets this year.

2. Managing Deductions

It does not pay to itemize your deductions unless the total of your Schedule A deductions exceeds the Standard Deduction that applies to your filing status, plus any additions for age or blindness. For 2011 the Standard Deduction amounts are $5,800 for single filers, $11,600 for married couples filing jointly and qualifying widow(er)s, $8,500 for head of household and $5,800 for married couples filing separately.

The additional Standard Deduction amounts for age 65 or older and/or blind are $1,450 for single and head of household filers and $1,150 for married (joint and separate) filers and qualifying widow(er)s.

If you usually do not have enough deductions to itemize, but after preparing your projected 2011 return discover you will be able to itemize this year, you should incur, and pay for, as many deductible expenses as possible during these last two months of the year.

But if your projected return indicates that you don’t have anywhere near enough deductions to make it worthwhile to itemize, postpone making any deductible payments until 2012. Making these payments in 2011 would not produce any tax savings, but it is possible that by deferring them until next year you may be able to itemize in 2012.

3. Managing Investments

When preparing your projected return you should review the performance of your investment portfolio for the year. Add up all of your realized gains and losses from actual sales for the first 10 months of the year, with separate net totals for short-term (held one year or less) and long-term (held more than one year) activity. Gains and losses from the sale of inherited property are considered long-term, as are any “capital gain distributions” from mutual funds.

Do a similar calculation for unrealized “paper” gains and losses on the investments you still hold. You may want to sell something before the end of the year at a loss to wipe out year-to-date gains, or at a profit to offset year-to-date losses in excess of the $3,000 maximum you are allowed to claim.

Finally, be aware of the wash sale rule. You cannot claim a current loss for the sale of an investment if you purchase the same, or “substantially identical,” investment within 30 days before or after the date of the sale. This rule does not apply if the sale results in a gain.

4. Timing Is Everything

The timing of deductions is especially important when it comes to medical expenses and miscellaneous job-related and investment expenses. You are allowed to deduct medical expenses only if they exceed 7.5% of your Adjusted Gross Income (AGI) and most miscellaneous deductions are only deductible when the total exceeds 2% of AGI.

If you anticipate an AGI of $70,000 you must exclude the first $5,250 of medical expenses. If your medical expenses to date are close to or more than $5,250 and you will be able to itemize this year, pay any outstanding medical bills and schedule (and pay for) check-ups, doctor visits and needed dental work in November and December. If your medical payments to date are substantially less than $5,250, put off paying any more medical bills until 2012. The same concept applies for miscellaneous deductions.

If you expect to be able to itemize on your 2011 taxes and you are making quarterly estimated state tax payments, make the 4th-quarter payment in December instead of waiting until the Jan. 16, 2012 due date, so you will be able to deduct the payment on your 2011 Schedule A.

It's important to remember that if you do not have the cash available to pay for deductible items that you have scheduled as part of your year-end tax plan, you can use a credit card and still claim a deduction in 2011. Allowable expenses charged to a credit card are deductible in the year charged, and not in the year that you actually pay for the charge.

—For more tips and tricks on planning your taxes, visit MainStreet’s Tax Center for our latest coverage!

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