How the Bush Tax Cuts Affect Tax-Saving Strategies

Each November, we like to look at the steps you can take to reduce your tax bill. This year, it's a little ambiguous, because the Bush tax cuts and credits are set to expire at the end of 2010. If they do expire, a lot of folks will experience a significant adjustment to their tax situation.

The "Bush tax cuts" refers to legislation enacted in 2001 and 2003. The cuts lowered tax rates on income, dividends, and capital gains; eliminated the estate tax; lowered burdens on married couples, parents, and the working poor; and increased tax credits for education and retirement savings.

Both Republicans and Democrats favor an extension of the tax cuts for the middle class. Where they differ is whether to extend the cuts for Americans in the top 2% of taxpayers.

With this in mind, we're looking at year-end measures separately for these two groups: the middle class - those making less than $200,000 for singles / $250,000 for married filers - and the higher income taxpayers - those making more than $200,000 / $250,000.

But first, let's take a quick look at what's at stake.

If All the Bush Tax Cuts Expire...

Among other things, if the Bush tax cuts were allowed to expire, the following would take place:

1. Tax brackets would change, from 10%, 15%, 25%, 28%, 33%, and 35% to 15%, 28%, 31%, 36%, and 39.6%.
2. Long-term capital gain tax rates would rise from 15% to a maximum of 20%.
3. The child tax credit would be lowered.
4. The alternative minimum tax would cease to be indexed for inflation.
5. The marriage penalty would be reinstated.

Middle-Income Taxpayers

We don't expect Congress to allow the tax cuts to expire for this group. That means middle-income taxpayers can take the same measures this year they have in previous years to reduce their tax burden for 2010.

We recommend the following steps to save on taxes this year: defer income, accelerate your deductions, and plan out your capital gains.

Defer Income

• If you are planning to sell an investment on which you have a gain, it may be best to wait until the new year. This will defer payment of the taxes for another year (subject to estimated tax requirements).
• If you are due a bonus at year-end, you may be able to defer receipt of these funds until January. Again, this can defer the payment of taxes (other than the portion withheld) for another year. (Note that deferral of tax generally won't work where the bonus is contractually due in 2010.)
• If your company grants stock options, it may be wise to wait until next year to exercise the option or sell stock acquired by the exercise of an option. (Exercise of the option is often a taxable event; sale of the stock is almost always a taxable event.)
• If you're self-employed, and you can afford the delay in cash inflow, defer sending invoices to clients until the end of December.

Accelerate Deductions

• Pay a state estimated tax installment in December instead of at the January due date. Just make sure the payment is based on a reasonable estimate of your state tax.
• Pay your entire property tax bill, including installments due in 2011, by year-end. (This is not applicable to mortgage escrow accounts.)
• Try to bunch threshold expenses, such as medical expenses and miscellaneous itemized deductions. (Threshold expenses are deductible only to the extent they exceed a certain percentage of adjusted gross income.) By bunching these expenses into one year, rather than spreading them out over two years, you have a better chance of exceeding the thresholds, thereby maximizing your deduction. For example, you might pay medical bills and dues and subscriptions in whichever year they would do you the most tax good.

Caution: In most cases, credit card charges are considered paid in the year of the charge regardless of when you pay on the card. But this does not apply to store revolving credit cards. If you charge expenses on a Wal-Mart store credit card, for example, the deduction cannot be claimed until the bill is paid.

 

Some tax benefits are phased out if you have more than a certain level of adjusted gross income. In these cases, a strategy of deferring income and accelerating deductions may also allow you to claim larger deductions, credits, and other tax breaks for 2010.

Tip: Deferring income into 2011 is an especially good idea for taxpayers who anticipate being in a lower tax bracket next year, either because of much-reduced income or much-increased deductible expenses.

Minimize Taxes on Investments

Judiciously match your capital gains and losses to reduce your tax burden for 2010. Where appropriate, try to avoid short-term gains, which are usually taxed at a much higher tax rate (up to 35%) than long-term gains (15%). You might consider, where feasible, trying to reduce all capital gains and generate short-term capital losses of up to $3,000.

Tip: If you have a large capital gain this year, consider selling an investment on which you have an accumulated loss. Capital losses are deductible up to the amount of your capital gains plus $3,000.

High-Income Taxpayers

Depending on what Congress decides in this legislative session, individuals making more than $200,000 filing singly or $250,000 filing married in 2010 will owe more tax than they have since the 2001 Bush tax cuts were passed. What does this mean for end-of-year tax planning?

Don't Defer Income

If tax cuts for the richest Americans are allowed to expire at the end of the year, then many in the current 33% tax bracket will find themselves in the 36% bracket, and those currently taxed at the 36% rate will be taxed at 39.6%.

For these taxpayers, it makes sense to bump up 2010 income, to take advantage of the current lower rates. Grab that year-end bonus; sell stock acquired by the exercise of a company stock option; bill clients for as much work as possible if you're self-employed.

Take Capital Gains Now

Capital gains and qualified dividends for those in the higher tax brackets would be affected if the tax cuts are allowed to expire for the richest Americans. The capital gains rate would revert to a maximum of 20% for higher income filers (from 15% currently), and qualified dividends would resume being taxed at the regular tax rate of the filer, or as high as 39.6%.

This indicates that now is a good time to take any capital gains or qualified dividends. Selling assets now as opposed to 2011 could have positive tax consequences for higher income filers.

Let Us Help You

As you can see, this is a complicated year for tax planning. Please don't hesitate to come in and meet with us about your situation. There's still a lot we can do to minimize your tax burden for 2010.

Year-End Tax Planning for Businesses

Businesses can take several measures at the end of the year to reduce their tax burden in 2010. Here's a rundown of best options.

Purchase New Business Equipment

Expensing. The Section 179 deduction for equipment purchases was increased again in 2010 under the recent passage of the Small Business Jobs Act of 2010. Businesses can elect to expense (deduct immediately) the cost of most new equipment up to $500,000 (subject to a dollar-for-dollar reduction in that $500,000 for purchases over $2,000,000).

Further, a business can take bonus depreciation of 50% on the amount of capital expenditures in excess of $2,000,000, and then take normal depreciation on the rest.

Note: Many states have not matched these amounts and, therefore, state tax may not allow for the maximum federal deduction. In this case, two sets of depreciation records will be needed to track the federal and state tax impact.

Timing. If you plan to purchase business equipment this year, consider the timing. You might be able to increase your tax benefit if you buy equipment at the right time. Here's a simplified explanation:

Conventions. The tax rules for depreciation include "conventions" (rules) for determining how many months of depreciation you can claim. The conventions that come into play with equipment are...

Example: You buy a $40,000 piece of machinery on December 15. If the half-year convention applies, you get one-half year of depreciation on that machine.

1. The half-year convention: When the half-year convention applies, all property that you begin using during the year is treated as "placed in service" at the midpoint of the year. This means that no matter when you begin using the property, you treat it as if you began using it in the middle of the year.

2. The mid-quarter convention: The mid-quarter convention must be used if the cost of equipment placed in service during the last three months of the tax year is more than 40% of the total cost of all property placed in service for the entire year. If the mid-quarter convention applies, the half-year rule is out the window, and you treat all equipment placed in service during the year as if it were placed in service at the midpoint of the quarter in which you began using it.

Tip: Don't forget to tell us about any equipment purchases you're planning. We can examine the timing of these purchases so you take full advantage of these tax rules.

Other Year-End Moves

Partnership or S Corporation Basis. Partners or S corporation shareholders in entities that have a loss for 2010 can deduct that loss only up to their basis in the entity. However, they can take steps to increase their basis to allow a larger deduction. Basis in the entity can be increased by lending the entity money or making a capital contribution by the end of the entity's tax year.

Caution: Remember that by increasing basis, you're putting more of your funds at risk. Consider whether the loss signals further troubles ahead.

Retirement Plans. Self-employeds who have not yet done so should set up self-employed retirement plans before the end of 2010.

Dividend Planning. Dividends you cause your corporation to pay qualify for the reduced 15% (or 5%) rate in the hands of stockholders, including you as a stockholder. Such a dividend may reduce the risk of a tax on accumulated corporate earnings.

Budgets. The need for a business budget may seem obvious - but many companies overlook this critical business planning tool. A budget is extremely effective in making sure a business has adequate cash flow and, thus, in ensuring a business's financial success.

That's why every business, from the smallest to the largest, should have a budget. Once the budget has been created, then monthly actual revenue amounts can be compared to monthly budgeted amounts. If actual revenues fall short of budgeted revenues, expenses must generally be cut.

For more on this topic, see the article below about common budgeting errors.

Tip: Each year-end, business owners should get together with their accountants to budget revenues and expenses for the coming year.

Consult Us First

These are just a few of the year-end planning tax moves that could make a substantial difference in your tax bill for 2010. But be careful about acting on these suggestions without consulting us first. They are general in nature, and your specific tax or financial situation may require special planning.

Small Business Jobs Act - A Look at the Benefits

On September 27, 2010, President Obama signed the Small Business Jobs Act of 2010 into law - a $42 billion bill in tax cuts, increased loans, and other measures. The bill is designed to prop up small businesses so they can create more jobs.

Many of the Act's provisions have already kicked in - which means it's time to learn how they benefit you.

More Loan Money Available

The main focus of the Small Business Jobs Act is to help small businesses get loans. Here are the three major ways the Act makes loan money available to small business owners.

SBA Recovery Loans. The American Recovery and Reinvestment Act of 2009 (the Recovery Act) was last year's attempt by Congress to aid struggling small businesses. The Jobs Act of 2010 extends some of the Recovery money. With the passage of the Jobs Act, the Small Business Administration began funding new Recovery loans within a few days of the president's signature.

7(a) and 504 Loans. These are the two largest SBA loan programs, and under the Jobs Act, they got a huge boost.

The bill increased the maximum 7(a) and 504 loans from $2 million to $5 million, and the maximum 504 manufacturing-related loan from $4 million to $5.5 million.

Increased Capital to Community Banks. The Jobs Act established a $30 billion fund, run by the Treasury Department, that extends ultra-cheap capital to community banks with incentives to lend to small businesses. This means higher loans - with better guarantees - are now available at your local bank.

Tip: Now is an excellent time to explore your borrowing options - whether it's through a national organization like the Small Business Administration or your hometown lending institution.

Don't miss out on the chance to use some of this capital for your business. Give us a call to talk over your needs.

Tax Cuts, Credits, and Breaks

The Small Business Jobs Act includes $12 billion in tax incentives. Take a look at the top six:

1. The elimination of capital gains tax on certain small business investments if they're held for five years.
2. Higher limits on the amount of investments small business owners can write off for 2010 and 2011.
3. The extension of a Recovery Act provision that allows for a 50% bonus depreciation. This means small businesses can deduct capital expenditures on certain investments.
4. The ability to deduct all of your health insurance payments for you and your family when figuring your self-employment tax.
5. An increase in the amount entrepreneurs can deduct for start-up expenses for this year.
6. The ability to offset tax liabilities for five years by carrying back general business credits.

Less Red Tape

Some of the Act's benefits reside in reduced paperwork and clearer regulations, which allow you to take advantage of tax breaks much more easily.

Deduct Your Cell Phone Simply. Previous policies required lots of documentation to deduct charges from an employer-provided cell phone. With onerous and confusing paperwork, you had to prove you used the mobile device for business purposes more than 50% of the time.

The Small Business Jobs Act addresses this headache. The legislation removes cell phones from the Internal Revenue Code's definition of "listed property."

What does this mean for the small business owner? It's now much less complicated to deduct the use of your mobile phone on your taxes.

Tip: Other telecommunications devices have also been removed from "listed property," including Blackberries and PDAs.

Limited Penalties. The bill limits the penalty for failing to report a transaction that the IRS has formally identified as an abusive tax shelter. The penalty is set at 75% of the tax benefit and capped at $200,000 for corporations and $100,000 for individuals.

Questions?

Do you have questions about how to take advantage of the Jobs Act's provisions? Make an appointment to meet with us. We're eager to help you claim the capital you need for your business.

Avoid Three Common Errors in Budgeting

When it comes to budgeting, it's absolutely essential to estimate your spending as realistically as possible. Here are three budget-related errors commonly made by small businesses, and some tips for avoiding them. These errors tend to throw budget estimates out of line with reality, thereby taking away from a budget's usefulness.

1. Not Setting Goals. It's almost impossible to set spending priorities without clear goals for the coming year. It's important to know, in detail, what you want or need to achieve in your business.

2. Cost Underestimation. Every business has ancillary or incidental costs that often don't get budgeted. For example, each time you buy a new piece of equipment or software, you must budget for staff training and for maintenance of the equipment, as well as the actual cost of the equipment.

3. Lack of Flexibility. Don't be afraid to update your forecasted expenditures either several times per year or whenever new circumstances affect your business. Compare estimates to what you actually pay out, and then adjust your budget figures.

We can help you set up and maintain a budget. Call our office to discuss.

Income from Foreign Sources

Many U.S. citizens earn money from foreign sources. But not all these taxpayers remember that they have to report all such income on their tax return, unless it is exempt under federal law.

U.S. citizens are taxed on their worldwide income. This applies whether a person lives inside or outside the United States. The foreign income rule also applies regardless of whether the person receives a Form W-2, Wage and Tax Statement, or a Form 1099 (information return).

Foreign source income includes earned and unearned income, such as:

• Wages and tips
• Interest
• Dividends
• Capital gains
• Pensions
• Rents
• Royalties

There is good news. Citizens living outside the United States may be able to exclude up to $91,500 of their 2010 foreign source income if they meet certain requirements.

If you're married and you both work abroad and meet either the bona fide residence test or the physical presence test, each of you can choose the foreign earned income exclusion. Together, you can exclude as much as $183,000 for the 2010 tax year.

Caution: The exclusion does not apply to payments made to U.S. government employees or folks in the military living outside the United States.

If you earn income from outside the country, please be sure to meet with us about it. We need to address all the tax implications of this situation.

Check Your Withholdings

With less than two months remaining in the calendar year, it's a great time to double check your federal withholding to make sure enough taxes are being taken out of your pay.

The average refund for 2009 was $2,887, up 8 percent from 2008. Even though the Making Work Pay Tax Credit lowered tax withholding rates in 2009 and 2010 for millions of American households, some workers and retirees still need to take steps to be sure enough tax is being taken out of their checks.

Certain folks should pay particular attention to their withholding. These include:

• Married couples with two incomes

• Individuals with multiple jobs

• Dependents

• Some Social Security recipients who work

• Workers who do not have valid Social Security numbers

• Retirees who receive pension payments

As was the case in 2009, taxpayers who wind up owing tax because too little was taken out of their paychecks during 2010 may qualify for special relief on a penalty that sometimes applies. Depending on their personal situation, some people could have less withheld from their paychecks than they need or want.

Failure to adjust withholding could result in potentially smaller refunds or, in limited instances, a taxpayer may owe tax rather than receive a refund next year.

An easy way to check how much you'll owe this year is to use the 1040 Tax Calculator on our website. Or just give us a call and we'll figure it out with you.

Expanded Adoption Credit

The Affordable Care Act raises the maximum adoption credit to $13,170 per child in 2010, up from $12,150 in 2009. It also makes the credit refundable, meaning that eligible taxpayers can get it even if they owe no tax for that year. In general, the credit is based on the reasonable and necessary expenses related to a legal adoption, including adoption fees, court costs, attorney's fees, and travel expenses. Income limits and other special rules apply.

If you adopted a child this year, you may be eligible for this credit. Make sure you contact us early, though. To claim this tax relief, we must file a paper return, which means your refund will be slower than if you could file electronically.

Is It Time to Adjust Your Pricing? How QuickBooks Can Help

Changing the prices of your company's services and inventory items can solve one of two problems, depending on why you're looking for a solution. Say your materials suppliers have upped their prices. You may choose to increase your affected products to maintain your profit margin. Or maybe an item or service has not been moving well. A drop in price might trigger improved sales.

Those examples, of course, are simplifications of what needs to be a thoughtful, studied process. They're critical business decisions that should be made with the guidance from your trusted ProAdvisor. We're not experts in just QuickBooks - we also understand the flow of profit and loss, and we can be valuable allies in your battle for continued growth.

We'll explore the tools that QuickBooks offers to help simplify price changes once your decisions have been made. They're not overly difficult to use, but we want to ensure your intentions are carried out accurately. And there are related inventory issues that may be impacted by your modifications.

First Steps

First, make sure that QuickBooks is set up to accommodate price levels. Click Edit | Preferences and select Sales & Customers in the left vertical pane. Then click the Company Preferences tab. You'll see the window shown in Figure 1.

Figure 1: Before attempting price level changes, be sure the Use price levels box is checked. If it's not already checked, click on the box next to Use price levels. Then click OK.

Multiple Options

QuickBooks offers options related to item price changes. You can simply alter the cost of one item, or you can modify several at once. Your adjustments can be in the form of either percentages or fixed amounts.

There are two ways to get to the price-changing window. You can click the Customers menu, then Change Item Prices. Or you can select the Items & Services icon from the home page. If you do the latter, simply open the Activities menu at the bottom of the screen and select Change Item Prices to see a window similar to the one shown in Figure 2.

Figure 2: The Change Item Prices window displays lists of your products.

By opening the drop-down list below Item Type, you can select the desired type of product: Service, Inventory Part, Inventory Assembly, Non-Inventory Part, or Other Charges.

Targeting Your Changes

Once you've selected the right type, click in the column next to the item(s) you want to change. A check mark will appear. If you want to increase or decrease the prices of all of them, click next to Mark All at the bottom of the screen, as pictured in Figure 3.

Figure 3: Click the box next to Mark All if you want to change the prices of all entries.

Based on your discussions with us, you should now know how you want to adjust the selected price(s). You may have just decided on a new price, in which case you can simply enter it in the New Price column.

Here's an alternative. In the box to the right of Adjust price of marked items by (amount or %), enter either an individual number to increase by that amount, or a number with a % sign after it to up it by that percentage. To decrease the cost, enter a negative number.

The next step is a little trickier. If you simply want to alter the price of an entry based on its current sales price, leave the Current Price option showing in the next box. But if you want to change it based on its Unit Cost, you'll have to consult us or do some digging to learn what that is.

If you want the resulting numbers to be rounded up, click the arrow next to Round up to nearest. When you're satisfied with your work, click Adjust to see your changes reflected in the New Price column. Make any desired modifications, then click OK.

One Exception

Of course, no existing transactions will be altered. But if any of your newly priced items or services occur in memorized transactions, you'll have to edit them. Go to Lists | Memorized Transaction List. Highlight the affected transaction, then right-click and delete it. Enter a new transaction and memorize it again. If you know only that transaction will be affected, you can select Edit Memorized Transaction instead of deleting it.

Don't know where all of those items occur? Go to Edit | Find to locate them as shown in Figure 4.

Figure 4: You can easily find items in memorized transactions using the Find tool.

Making price changes in QuickBooks - even global ones - isn't terribly difficult, but it involves a business decision that's best made in conjunction with us. It can lead to increased profitability no matter which direction you go, as long as you take into account the issues and potential outcomes involved.

Financial Tips for November 2010

Make Gifts to Minimize Estate Taxes
If your estate planning indicates a potential estate tax liability, consider making gifts before year-end to minimize estate taxes. Example: You can give away $13,000 a year ($26,000 if you are married and your spouse elects to participate) to each of a number of donees free of gift tax, thereby reducing your estate tax liability.

Year-End Tax Review Meeting
Estimate your taxes due for the year, and consult with us on the steps you should take before year-end to minimize negative tax consequences.

Review October's Budget vs. Actuals
Compare October income and expenditures with your budget. Make adjustments as appropriate to your November expenditures. Make sure you have invested your planned savings amount for October.

Tax Due Dates for November 2010

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