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Year-End Tax Strategies for Individuals
Written by Bill Bischoff, Smart money
It's not too late to make these tax-saving moves.
Before acting on our recommendations, be sure to gauge your 2012 income expectations. Moves you make this year may affect next year's taxes, detailed in the table below.
Game the Standard Deduction
If your total annual itemized deductions are usually close to the standard deduction amount, consider the strategy of bunching together expenditures for itemized deduction items every other year, starting with this year.
Itemize in alternating years to deduct more than the standard deduction. Then claim the standard deduction in the other years. Over time, this drill can save hundreds or even thousands in taxes by increasing your cumulative write-offs. That's because you'll bag higher itemized deductions in alternating years and relatively generous standard deductions in the other years. So regardless of what happens with tax rates, you'll come out ahead.
For 2011, the standard deduction is $11,600 for married joint-filing couples, $5,800 for singles, and $8,500 for heads of households. For next year, the standard deduction amounts will be $11,900, $5,950, and $8,700 respectively.
Prepay Deductible Expenditures If You Itemize
If you itemize deductions, accelerating some deductible expenditures into this year to produce higher 2011 write-offs makes sense if you expect to be in the same or lower tax bracket next year. (See the table at the end of this article for the 2012 tax brackets.)
Perhaps the easiest deductible expense to prepay is the interest included in house payments due on January 1. Accelerating that payment into this year will give you 13 month's worth of deductible interest in 2011. You can do the same with a vacation home. If you prepay this year, you'll have to continue the policy for next year and beyond. Otherwise, you'll have only 11 month's worth of interest in the first year you stop.
Next up on the prepayment menu are state and local income and property taxes that are not actually due until early next year.
Next, consider prepaying expenses that are subject to limits based on your adjusted gross income (AGI). The two prime candidates are uninsured medical expenses and miscellaneous itemized deductions. Medical costs are deductible only to the extent they exceed 7.5% of AGI. Miscellaneous deductions--for investment expenses, job-hunting expenses, fees for tax preparation and advice, job hunting, and unreimbursed employee business expenses--count only to the extent they exceed 2% of AGI. If you can bunch these kinds of expenditures into a single calendar year (like this year), you'll have a fighting chance of clearing the AGI hurdles and getting some tax-saving write-offs.
Warning: The prepayment drill may be a bad idea if you know you'll owe the dreaded alternative minimum tax (AMT) for this year. That's because write-offs for state and local income and property taxes are completely disallowed under the AMT rules, medical expenses must exceed 10% of AGI to be deductible for AMT purposes, and miscellaneous itemized deductions are completely disallowed under the AMT rules. Therefore, prepaying these expenses may do little or no tax-saving good for AMT victims.
Deduct Sales Taxes on Major Year-end Purchases If You Itemize
If you live in a state with low or no personal income taxes, be aware that Congress extended the federal tax deduction for general state and local sales taxes through 2011. Therefore, you have the option of deducting either state and local sales taxes or state and local income taxes on your 2011 return--but not both.
Most of you will have to use IRS-provided tables to calculate your sales tax deduction. However, if you've hoarded receipts from your 2011 purchases, you can add up your actual sales tax amounts and deduct the total if that gives you a better answer. Even if you're forced to use the IRS table, you can still deduct actual sales taxes from 2011 purchases of vehicles and boats on top of the predetermined amount from the table. So buying a car or boat between now and year-end could give you a bigger sales tax deduction and cut this year's federal income tax bill.
Warning: The sales tax write-off only helps if you itemize. And if you're hit with the AMT, you'll lose some or all of tax-saving benefit.
Prepay College Tuition
If your 2011 adjusted gross income (AGI) allows you to qualify for the American Opportunity college credit (maximum of $2,500) or the Lifetime Learning higher education credit (maximum of $2,000), consider prepaying college tuition bills that are not due until early 2012 if that would result in a bigger credit on this year's Form 1040. Specifically, you can claim a 2011 credit based on prepaying tuition for academic periods that begin in January through March of next year.
If your 2011 AGI is too high to be eligible for the Lifetime credit, you might still qualify to deduct up to $2,000 or $4,000 of college tuition costs. If so, consider prepaying tuition bills that are not due until early 2012 if that would result in a bigger deduction on this year's Form 1040. As with the credits, your 2011 deduction can be based on prepaying tuition for academic periods that begin in the first three months of 2012.
2012 Federal Tax Parameters | |||
Bracket | Single | Joint | Head of Household |
10% | $0-8,700 | $0-17,400 | $0-12,400 |
Beginning of 15% | $8,701 | $17,410 | $12,401 |
Beginning of 25% | $35,351 | $70,701 | $47,351 |
Beginning of 28% | $85,651 | $142,701 | $112,301 |
Beginning of 33% | $178,651 | $217,451 | $198,051 |
Beginning of 35% | $388,351 | $388,351 | $388,351 |
Standard deduction
Single: $5,950
Joint: $11,900
HOH: $8,700
Personal exemption
Single: $3,800
Joint: $3,800
HOH: $3,800
Retirement Account Contribution Limits
Maximum IRA contribution (traditional or Roth): $5,000
Maximum IRA contribution if age 50 or older: $6,000
Maximum 401(k) salary-deferral contribution: $17,000
Maximum 401(k) contribution if age 50 or older: $22,500
Maximum 403(b) salary deferral contribution: $17,000
Maximum 403(b) contribution if age 50 or older: $22,500
Maximum SEP account contribution: $50,000
Maximum profit-sharing account contribution: $50,000
Maximum SIMPLE IRA salary-deferral contribution: $11,500
Maximum SIMPLE contribution if age 50 or older: $14,000
Other Key Tax Figures
Cap on Social Security tax (based on wages or self-employment income): $110,100
Federal gift tax exclusion: $13,000
Federal estate tax exemption probably: $5,120,000
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Thanks to two recent changes in the tax code, investors with huge 401k accounts now have a way to turn them into completely tax-free income for their grandchildren's lifetimes.
This is by far the biggest estate-planning break on record, created even as lawmakers debate over which tax giveaways should be killed to help shore up the federal budget.
"I call this tax break the government's going-out-of-business sale," says individual retirement account guru Ed Slott, who travels the country teaching advisers and accountants how to squeeze benefits out of the Roth IRA. "This is a tax break you could drive 10 Mack trucks through. It's an incredible opportunity to do a totally tax-free transfer of wealth."
This massive estate-tax break was created last year in two steps. First, Congress lifted a $100,000 income restriction on who can convert a 401k or IRA to a Roth IRA, allowing even the wealthiest investors to convert. Then, late in the year, it raised the generation-skipping transfer tax exemption to $5 million until 2013. The GST exemption was previously $3.5 million and was scheduled to drop to $1 million this year before Congress stepped in.
Both of these provisions on their own create possibilities for significant tax savings, upon conversion. But used in combination, the results are exponentially greater.
The Roth IRA has always been on a different playing field compared with alternatives, because it allows gains to be withdrawn tax-free. Money taken out of a 401k, regular IRA or other retirement accounts is subject to income tax rates. Also, the Roth doesn't require that minimum distributions be taken after you turn 70½, as other plans do. So if you don't need retirement plan assets to live on, the Roth preserves it best for heirs.
Not everyone jumps at the chance to convert to a Roth IRA, because you have to pay income taxes on the assets moved into the account. So if you plan to live off of retirement account assets, a conversion may not make sense. But from an estate-planning
perspective, when there are decades of gains ahead, the tax bill can be a small price to pay for big benefits down the road.
With the new GST exemption, the estate-planning benefits that can be wrung out of a Roth are eye-popping. Consider an extreme case: A wealthy individual converts a large 401k account to a Roth IRA and names a grandchild as the beneficiary. The grandchild, at age 1, inherits the Roth, whose assets have grown to $5 million. Because of the new $5 million GST exemption, the Roth assets would not be subject to estate tax or generation-skipping transfer tax.
Under Roth rules, an heir must take required minimum distributions, but the distributions can be stretched over a lifetime, and assets left in the Roth can continue to grow tax-free. Based on a 1-year-old's 81.6-year life expectancy and assuming an average annual return of 8%, Slott calculates that the grandchild's lifetime income from the Roth would be $408 million -- "completely free of estate, gift, income and capital gains taxes," he says.
If both grandparents left a big Roth account to the same grandchild, the tax-free inheritance would be almost twice that amount, depending on the age of the grandchild when the second Roth is inherited.
You don't have to have stratospheric wealth to get in on these great estate-planning benefits. With the same assumptions about life span and returns, a modest $100,000 Roth inheritance would let a grandchild pocket more than $8 million, tax-free. This would have been possible even under the old GST tax exclusion, but the old Roth rules, which prohibited conversions from IRAs and 401k's for those with incomes above $100,000, would have prevented many from taking advantage of the opportunity.
With a new $5 million estate-tax exemption, passed along with the GST exemption last year, the Roth has become a turbocharged tax-favored inheritance tool for any generation. But the benefits are even more pronounced when the Roth income is spread over the long expected lifetime of a grandchild.
Grace Allison, a senior vice president and tax strategist at Northern Trust, cautions that the upfront tax bill on Roth conversions can take the shine off of this strategy, so it's critical to crunch the numbers. If you convert $5 million, at the highest tax rate of 35%, you'll have to hand over about $1.7 million.
That kind of tax bill is mind-numbing for most people, but in the universe where ultra-wealthy people are trying to preserve their multimillions, $1.7 million may seem like a small amount to pay, considering how much will be saved in taxes in the long run. In the extreme example above, the total tax savings would be in the neighborhood of $100 million over the grandchild's lifetime, probably much more.
Did Congress intend for this big generational benefit? While the government could surely use wealthy taxpayers to pay big upfront tax bills on Roth conversions right now, the amount it would forgo in taxes on inherited money over decades would be staggering.
Whether intentional or not, opportunities to combine the Roth with the GST exemption are limited. The exemption is scheduled to drop to $1 million in 2013.
And it's always possible that tax reform will rescind these tax breaks before that. Roberton Williams, a senior fellow at the Urban Institute, says that if any drastic changes are made, it will be Congress' problem to figure out how to honor previous tax breaks in Roth accounts. In the meantime, get 'em while you can.
This article was reported by Karen Hube for The Fiscal Times.
Tax law could make grandkids rich
Congress last year enacted temporary changes that allow for a massive estate-tax break through a Roth IRA. As a result, a grandchild could pocket millions, tax-free, over a lifetime.
Sometimes Congress hands out a break that is so generous it seems it must be a mistake. This one's a doozy: The ability to receive a totally tax-free inheritance of $400 million or more.Thanks to two recent changes in the tax code, investors with huge 401k accounts now have a way to turn them into completely tax-free income for their grandchildren's lifetimes.
This is by far the biggest estate-planning break on record, created even as lawmakers debate over which tax giveaways should be killed to help shore up the federal budget.
"I call this tax break the government's going-out-of-business sale," says individual retirement account guru Ed Slott, who travels the country teaching advisers and accountants how to squeeze benefits out of the Roth IRA. "This is a tax break you could drive 10 Mack trucks through. It's an incredible opportunity to do a totally tax-free transfer of wealth."
This massive estate-tax break was created last year in two steps. First, Congress lifted a $100,000 income restriction on who can convert a 401k or IRA to a Roth IRA, allowing even the wealthiest investors to convert. Then, late in the year, it raised the generation-skipping transfer tax exemption to $5 million until 2013. The GST exemption was previously $3.5 million and was scheduled to drop to $1 million this year before Congress stepped in.
The Roth IRA has always been on a different playing field compared with alternatives, because it allows gains to be withdrawn tax-free. Money taken out of a 401k, regular IRA or other retirement accounts is subject to income tax rates. Also, the Roth doesn't require that minimum distributions be taken after you turn 70½, as other plans do. So if you don't need retirement plan assets to live on, the Roth preserves it best for heirs.
Not everyone jumps at the chance to convert to a Roth IRA, because you have to pay income taxes on the assets moved into the account. So if you plan to live off of retirement account assets, a conversion may not make sense. But from an estate-planning
perspective, when there are decades of gains ahead, the tax bill can be a small price to pay for big benefits down the road.
With the new GST exemption, the estate-planning benefits that can be wrung out of a Roth are eye-popping. Consider an extreme case: A wealthy individual converts a large 401k account to a Roth IRA and names a grandchild as the beneficiary. The grandchild, at age 1, inherits the Roth, whose assets have grown to $5 million. Because of the new $5 million GST exemption, the Roth assets would not be subject to estate tax or generation-skipping transfer tax.
Under Roth rules, an heir must take required minimum distributions, but the distributions can be stretched over a lifetime, and assets left in the Roth can continue to grow tax-free. Based on a 1-year-old's 81.6-year life expectancy and assuming an average annual return of 8%, Slott calculates that the grandchild's lifetime income from the Roth would be $408 million -- "completely free of estate, gift, income and capital gains taxes," he says.
If both grandparents left a big Roth account to the same grandchild, the tax-free inheritance would be almost twice that amount, depending on the age of the grandchild when the second Roth is inherited.
You don't have to have stratospheric wealth to get in on these great estate-planning benefits. With the same assumptions about life span and returns, a modest $100,000 Roth inheritance would let a grandchild pocket more than $8 million, tax-free. This would have been possible even under the old GST tax exclusion, but the old Roth rules, which prohibited conversions from IRAs and 401k's for those with incomes above $100,000, would have prevented many from taking advantage of the opportunity.
With a new $5 million estate-tax exemption, passed along with the GST exemption last year, the Roth has become a turbocharged tax-favored inheritance tool for any generation. But the benefits are even more pronounced when the Roth income is spread over the long expected lifetime of a grandchild.
Grace Allison, a senior vice president and tax strategist at Northern Trust, cautions that the upfront tax bill on Roth conversions can take the shine off of this strategy, so it's critical to crunch the numbers. If you convert $5 million, at the highest tax rate of 35%, you'll have to hand over about $1.7 million.
Did Congress intend for this big generational benefit? While the government could surely use wealthy taxpayers to pay big upfront tax bills on Roth conversions right now, the amount it would forgo in taxes on inherited money over decades would be staggering.
Whether intentional or not, opportunities to combine the Roth with the GST exemption are limited. The exemption is scheduled to drop to $1 million in 2013.
And it's always possible that tax reform will rescind these tax breaks before that. Roberton Williams, a senior fellow at the Urban Institute, says that if any drastic changes are made, it will be Congress' problem to figure out how to honor previous tax breaks in Roth accounts. In the meantime, get 'em while you can.
This article was reported by Karen Hube for The Fiscal Times.
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