Financial Abundance

The health care bill, enacted in March, includes two new Medicare taxes on the “wealthy.’  While you may not consider yourself wealthy, there is a reasonable chance that you may have the opportunity to pay one or both of these taxes.  Let’s examine these new Medicare taxes to determine if they might be part of your financial future.

The first tax is a 62% increase (from 1.45% to 2.35%) in Medicare taxes for individuals with earned income over $200K and for couples with earned income over $250K.  While a single person earning over $200K per year is highly compensated, couples need only earn more than $125K each to be engulfed by this new tax.  As usual, the minimum earnings amount is not tied to inflation.  If 1970s style inflation appears in the next few years, earnings of over $125K may become much more common.

The second Medicare tax on the “wealthy” is a 3.8% tax on investment income for singles with an Adjusted Gross Income (AGI) exceeding $200,000 and couples with an AGI exceeding $250,000.   Let’s look at a scenario in which a couple whose earnings are less than $250K could end up paying almost $75K for this new tax.

You and your spouse are 60 years old and owners of a small Sub Chapter S Corporation.  Your joint salaries total $175K.  Through diligent saving over the past 35 years and a small inheritance, you have $1 million dollars in investments to help provide for a reasonable standard of living in your retirement years.

In 2013, the economy finally begins to recover and your business booms, throwing off $75K in dividend income.  At the same time, the stock market finally recovers and you have a 15% return on your investments.

Your AGI from salary and company dividends in 2013 is $250K.  Because of this “wealth,” the $150K in investment income from your savings would be taxed at the then current income tax rate plus you would pay an additional $5,700 in Medicare taxes.

After paying these high taxes in 2013, you decide to sell your business and retire in 2014.  The business sells at the end of 2014 for $1 million.  In 2014 your salaries and dividends from the business total $200K and your investments provide an 8.7% return of $100K .

For 2014, your AGI from salary and company dividends in 2013 is $200K, while your total investment gains (including the sale of your company) are $1.1 million.  The new 3.8% Medicare tax on the “wealthy” would cost you an additional $39,900 above your already high 2014 taxes.

In 2015, you decide to downsize your house, built in 1975 at a cost of $40,000, as well as sell your ski condo that you bought in 1980 for $60K.  Living in Boulder, your house sells for $940K and your condo sells for $460K.  While you have $0 earned income, your investment portfolio increases by approximately 10%, providing $200K in investment income.  Even with the $500K capital gains exclusion for the sale of your home, your total taxable investment income in 2015 is $1 million.  Since $750K of the investment income is taxed at the additional 3.8% rate, the new Medicare tax adds $28,500 to your 2015 tax bill.

The small business owners in the above scenario would hardly be considered “wealthy.”  However, in three years, this couple could pay $74,100 in additional Medicare taxes, thanks to health care reform.

There are several ways that this couple could reduce their taxes, but they did not even know about these new Medicare taxes.  As our government needs more and more tax revenue to sustain its profligate spending, tax planning becomes even more critical.

The good news is that these new taxes do not become effective until 2013.  If you are planning on selling your business or home, tax planning now could save you thousands of dollars in taxes later.  Now, more than ever, it is important to do advanced tax planning with a financial professional who fully understands the tax system.  As our example shows, not understanding the new tax laws can be very expensive.

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In previous articles we have considered the advantages of using indexed Exchange Traded Funds (ETFs) instead of actively managed mutual funds in your portfolio.  In 2010 you may discover another risk associated with owning actively managed mutual funds in your taxable accounts.

If the stock market continues its current sideways to negative movement, by the end of 2010, many equity mutual funds will have less value in December than they did in January.  Even if your actively managed mutual funds lose value in 2010, it is likely that you will owe taxes on these funds when you file your 2010 taxes.  Here’s why:

Before the end of each calendar year, mutual fund companies are required by law to distribute of all of the income and dividends that they received.  With the large stock market gains in the second half of 2009 and early 2010, most actively managed mutual funds will have taken profits in 2010 by selling stocks that have significantly appreciated since they bought them in 2009.  These sales have produced “realized capital gains” for the mutual fund.   If the stock was held less than one year, the gain will be a short term capital gain, treated as ordinary income to the mutual fund owner.  If your mutual fund has a high turnover rate, most of the realized gains will likely be short term capital gains.

If you own actively managed mutual funds in a taxable account, near the end of 2010 the mutual fund will make a distribution that will include all of these taxable gains.  You will be required to pay taxes on these gains, even if the fund has decreased in value since you bought it.  You may also be subject to a significant amount of short term capital gains, even if you have owned the mutual fund for over a year.

Due to the large recent gains in the stock market, many actively managed mutual funds will pay large distributions to the fund owners by the end of 2010. One way to avoid paying taxes on this distribution is to sell the mutual fund before the fund’s distribution date.

Many mutual funds already have large realized capital gains for 2010.  It is wise to avoid buying these funds in a taxable account between now and year end.  If you buy these funds between now and year end, you will pay taxes for 2010 on investments that may have been sold before you even bought the mutual fund.

There are two types of mutual funds that are safer to buy between now and the end of 2010.   The first type of fund is an indexed mutual fund, which is tied to stock market indexes, such as the S&P 500.  These mutual funds typically don’t “turn over” their stocks except when changes are made to the index that they track or when they have a significant number of people selling the mutual fund .  The other type of “safe” actively managed mutual fund is a tax-advantaged mutual fund.  The managers of tax-advantaged mutual funds carefully watch their buys and their sells to minimize the funds realized capital gains.  This approach helps to minimize the annual taxable distributions from these funds.

If you are unsure of whether your actively managed mutual fund is tax-advantaged, you may call the mutual fund company before their published distribution date to determine the approximate amount of their capital gain distribution, as well as the percentages of the distribution that will be short-term and long-term capital gains.

Actively managed equity mutual funds can be a good investment if the manager has the capability of consistently beating his target index.  However, not only must you consider operating fees, 12-b1 fess and other fees associated with mutual funds, for funds held in taxable accounts, it is important to discover the tax consequences of short and long term capital gain distributions associated with the mutual funds that you own or are considering purchasing.

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The Congressional Budget Office recently projected the federate deficit for fiscal year 2010 to be $1.6 trillion.  Many economists and financial experts in our federal government have told us that a $1.6 trillion deficit is required to re-stimulate our economy.  They claim that this deficit is not a problem that should concern us.

I cannot fathom the number 16 with eleven zeros behind it.  To put the deficit in a more understandable perspective, let’s determine the average US tax payer’s portion of a $1.6 trillion yearly deficit.

According the Bureau of Labor Statistics, in March 2010 there were 138 million workers in the US labor force,.  The average weekly salary for these 138 million US employees was $764.00 per week or $39,728 per year.

At the IRS website, you can discover that the total amount of personal federal income taxes, projected to be paid in 2010, is $1.05 trillion.   By dividing $1.05 trillion by 138 million, we determine that the “average” income tax paid per worker is $7,619,.  Since the “average” pay is $39,728, federal income taxes of $7,619 represents 19% of average income.

Most workers pay at least half of their Social Security and Medicare (FICA) taxes, which, at a rate of 7.65 % of income, is $3,039 of total average income.  If we assume that the average state tax is approximately 5%, an additional $1,986 of the average income is paid in state taxes.  Thus, the current tax burden for the “average” person earning $39,728 is $12,644 or approximately 32% of their income.

If our worker is one of the 20% of US workers who are now self employed, the FICA taxes are increased to 15.3%, for a total tax burden of $15,683 or 39.5% of income.

Now that we have determined the “average” tax burden in 2010, let’s calculate the average US workers share of the 2010 $1.6 trillion budget deficit.  When we divide $1.6 trillion by 138 million US workers, we find that the “average” portion of the 2010 deficit is $11,594 per US worker.  This number represents 29% of the income for all US workers.

Combining the $1.6 trillion deficit burden with the 2010 tax burden, the total burden of US taxes and the 2010 budget deficit is equal to 61% of the total income from all 138 million workers.

Of course, we will not pay the $1.6 trillion deficit out of our current income.  However, this debt is added to our current US debt and must eventually be paid by us or our children.

Another way to look at the $1.6 trillion dollar budget deficit is that you are making “unfunded” federal government purchases, equal to 29% of your before tax income, and putting these purchases onto our nation’s credit card.  As with a real credit card, these “purchases” must someday be paid by you, your children or your grand-children.

A politically popular approach to reducing the deficit is to raise taxes on “the rich,” commonly defined as individuals earning over $200K annually.   Under our current tax code, the top 5% of US wage earners (which starts at annual income levels of approximately $170K) will pay 60% of all personal income taxes.  If tax rates increased by 50% on the top 5%, the maximum amount of additional taxes collected would be approximately $300 billion, reducing the deficit to $1.3 trillion from $1.6 trillion.  Obviously, this approach alone will not solve the budget deficit problems

There are two simple facts about government spending. The first is that 100% of the money that our government spends comes from taxes and revenues collected plus borrowed money.  The second fact is that there are only three ways to reduce our federal deficits 1) reduce federal government spending 2) increase taxes 3) implement a combination of reduced spending and increased taxes.

As the numbers demonstrate, a deficit exceeding $1 trillion annually is not sustainable.  We must decide whether our politicians should increase taxes, decrease spending or do both.  Budget deficits must be dramatically and quickly reduced before our total national debt as a country becomes unsustainable for us and our children.

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It is expected that taxes will soon rise.  It is also fairly certain that the cost of a college education for our children or grandchildren will continue to rise faster than the annual rate of inflation.  Let’s look at some of the ways that you can save taxes while saving for your children’s or grandchildren’s college education.

You may be aware of the Qualified State Tuition Program, commonly called a Section 529 College Savings Plan.  With the 529 College Savings Plan you can provide a fund for each child.  Contributions are treated as gifts to the person for whom the plan is established and receive the annual gift tax exclusion of $13,000.  A couple may double this gift amount to $26,000.  A unique attribute of the 529 College Savings Plan is the ability to provide up to five times the annual federal gift tax exclusion amount in a single year.  This allows a single gift of up to $130,000 for each child.

529 College Savings Plan contributions are not tax deductible.  However, all interest and appreciation of the plan’s assets grow tax free until withdrawn.   As long as funds are withdrawn to pay for qualified higher education expenses, the withdrawals are also tax free.  If a designated beneficiary does not use their 529 funds, the donor you may change the beneficiary to a different person, including themselves.  However, if withdrawn funds are not used for higher education expenses, a ten percent penalty plus taxes on all of the funds growth and income will be applied to the withdrawal.

The Coverdell Education Savings Account (ESA) is a less know college savings plan.  Tax-wise, the Coverdell ESA behaves the same as a 529 plan.  However, Coverdell ESAs allow only a $2,000 annual contribution for each beneficiary.  On the positive side, a Coverdell ESA can be set up similar to a Roth IRA providing the “responsible party” with virtually unlimited investment options.  As long as the beneficiary has not reached age 30, the “responsible party” for the Coverdell ESA may change the beneficiary to another person under age 30.

When you purchase EE and I Savings Bonds, they may be redeemed tax free when the bond owner, their spouse or other dependents use these funds to pay for college tuition and fees.  However, due to income phase outs restrictions, full deductibility is lost when a couple has taxable earning above $104,900.

You may also withdraw funds from an individual retirement account, before age of 59 ½, to pay for any family member’s qualified post-secondary education expenses.  The proceeds will be treated as a normal IRA withdrawal with the 10% early withdrawal penalty waived.  .

The Hope Scholarship Credit, now called the American Opportunity Tax Credit (AOC), allows a parent to claim up to a $2,500 annual tax credit for a dependent’s college tuition and mandatory fees.  This tax credit will “phase out” for couples earning above $160,000 per year.  Since this is a tax credit, the full amount (up to $2,500) can be deducted from taxes owed.

The Lifetime Learning Credit can help pay for your own, your spouse, or your children’s education.  You may claim a tax credit of twenty percent of up to $10,000 in combined tuition and mandatory fees for anyone (and everyone) in your family.  Like the AOC, the Lifetime Learning Credit is a tax credit, lowering taxes owed up to $2,000.

The Lifetime Learning Credit’s “phase out” begins at $100,000 per year for joint filers.  Since you cannot claim both the AOC and the Lifetime Learning Credit in the same year, if you qualify for the full AOC, you cannot use this credit.  However, the Lifetime Learning Credit can be used for part time students and for courses to improve your job skill, while the AOC only applies to full time college students.

College expenses will continue to rise.  It is more critical than ever for families to begin early planning to meet these high expenses.  As taxes rise, the tax savings from these programs will become an ever more important piece of your child’s or grandchild’s college education planning.

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A recent Wall Street Journal article stated that, with unemployment hovering at 10 percent, approximately 20-23 percent of all US workers are now self-employed.  If you have self-employment income or own a small company, it is important to be aware of the tax saving options available through retirement plans.

We will consider four retirement plan options available for the self-employed and small business owner.  Each of the plans provides immediate tax savings on the retirement funds contributed.  The retirement funds also receive tax deferred growth until the funds are withdrawn.

The simplest retirement plan is the IRA.  If you have no company retirement plan and are under age 70 ½ , you may contribute up to $5,000 ($6,000 if you are over age 50) annually to a traditional IRA.  If your taxable income is below $166,000, your spouse may contribute the same amount, if they have no company retirement plan.  This contribution may occur even if your spouse receives no income.  There are no requirements to file any company paperwork with an IRA.  As long as your earned income exceeds your IRA contributions, you may continue IRA contributions until age 70 ½ .

The easiest company retirement plan, for a self employed individual, is the SEP IRA.  Your annual contribution to a SEP IRA is limited to the lesser of 25 percent of your W2 compensation or $49,000 annually.  SEP IRA contributions are tax deductible for the employer and excluded from the employee’s income.  These plans are immediately vested and must apply equally to all employees over age 20, who have been employed for at least three of the past five years.

For high-income, self-employed individuals, a SEP IRA is often the best choice for a company retirement plan.  If your income is below $50,000 or if you expect to have employees, the SEP IRA may not be your best option, as a SEP IRA requires that you provide the same percentage salary contribution for all of your qualified employees.

If your self-employment income is less than $50,000 or if you have employees, the SIMPLE-IRA is worth consideration.  SIMPLE stands for Savings Incentive Match Plan for Employees.  While these plans allow for up to 100 employees, most SIMPLE-IRA plans are used in smaller companies, including single employee companies.

With a SIMPLE-IRA you may contribute $11,500 ($14,000 if age 50 or over) annually.  Additionally, the company pays an employee matching amount of up to 3% for each employee that makes a SIMPLE IRA contribution.  If you are over age 50 and make $100,000 per year, your total contribution could be $17,000.  A SIMPLE-IRA requires that your company submits a (simple) application to the custodial firm.  Employees typically have the same investment options as they would with an IRA or a SEP IRA.

If you are self-employed and earn $100,000 per year or more, you can maximize your tax deferred contributions to with a Solo 401(k) retirement plan.  Solo 401(k) plans are typically established through mutual fund companies, insurance companies and discount brokerage houses.  These plans will have a set up fee, an annual administration fee, and other fees associated with investments and trading.

With a Solo 401(k) plan, you may contribute $16,500 of your W2 income ($22,000 if age 50 or older) plus twenty percent of your net corporate profits, up to a maximum of $49,000 ($54,500 if over age 50).  As an example, if you are over age 50 and your company produces annual income of $120,000, you may contribute $22,000 plus twenty percent of your net income, for a total of approximately $40,000 in contributions, to a Solo 401(k) plan.

For the self-employed or small business owner, there is no “on size fits all” solution to retirement plans.  The best plan will depend upon your annual income as well as the amount of tax deferred savings you desire to contribute each year.  If it is unclear which plan will be the best for you, feel free to contact me or call your financial advisor to determine which retirement plan best fits your requirements.  Regardless of which plan you choose, it is important to start saving now for your retirement, to help insure that you will have financial abundance throughout your retirement.

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Typically, financial advisors and tax consultants advise their clients to defer all income possible into future years to avoid paying taxes on earnings for as long as possible.  However, 2010 should be looked at as a “tax waterfall” year, in which this advice may get turned on its head.  Let’s examine why you might consider having as much income as possible taxed in 2010.

The press has been full of the fact that the “Bush tax cuts” will expire at the end of 2010.  We have been led to believe that this event will only effect the wealthy, currently being defined as couples earning over $250,000 per year.  While I could make the case that working couples with total income of $250K per year are not always “wealthy”, let’s explore how the expiration of these tax cuts will affect all tax payers, rich and poor alike.

In 2011, when the tax cuts passed in 2001 expire, everyone’s taxes will increase.  What is not commonly known is that, on a percentage basis, the largest increases will be on taxpayers who earn the least.  Here’s why:

In 2010 a couple with taxable earnings of only $25,000 per year pays 10% taxes on the first $16,750 and then 15% on each additional dollar that they earn, up to $68,000.  The total 2010 federal tax bill on $25,000 of taxable income is approximately $2,900.

Since 2011 tax brackets have yet to be published, we will assume no inflation, leaving the 2011 tax brackets the same as in 2010.  In 2011, the 10% tax bracket disappears.  The couple earning $25,000 now pays 15% taxes on every taxable dollar that they earn.  When their tax bill comes due, instead of owing $2,900 to the federal government, they will owe $3,750.  This represents a 30% increase in federal taxes owed.

Now let’s look at a “wealthy” couple, with taxable earnings of $250,000 per year.  In 2010, they are in the 33% marginal tax bracket with a federal tax bill of approximately $60,300.  In 2011, if this couple again has $250K in taxable income, they are now in the 36% marginal tax bracket, with a federal tax bill of approximately $66,600.   The additional $6,300 represents a 10% increase in federal taxes owed..

When the 2001 tax cuts expire, every tax payer will be negatively impacted.   Tax payers with the least income will be hit with the greatest percentage federal tax increase.   Regardless of what the politicians say, the expiration of the 2001 tax cuts will hurt every tax payer, not just the wealthy.

The 2011 tax impact will be even more onerous for Americans who have saved and invested their income. Currently, if you are lucky enough to have long term investments that have increased in value, the government receives a maximum of 15% of your (capital) gain when you sell the investment.   In 2011, the taxes on investment gains will increase by at least 33%, as the long term capital tax rate rises to (at least) 20%.

If you are receiving stock dividends, you currently pay a maximum of 15% federal tax on all of your qualified dividends.  In 2011, these same dividends will be taxed at your ordinary income tax rate, which could be as high as 39.6%.  Thus your dividends will receive tax increases that could be a great as 164% of their current rate.

These tax increases require no action by congress.  Our politicians are also considering numerous new tax increases.  One increase being considered is a European style Value Added Tax (VAT), similar to a sales tax but on a national scale.  However, without any legislative action, the expiration of the 2001 tax cuts will result in a significant tax increase on every tax-paying American.

2010 will be a very important year to pay close attention to your taxes.  If you are planning on retiring, selling a vacation home or any other activity that might have significant tax consequences, visit with you financial and/or tax advisor early in 2010.  Together, you can determine the lowest cost approach, on an after tax basis, to the important decisions that you face in 2010.

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In recent newsletters, I have explained why it is often wise to convert traditional IRA account assets to a Roth IRA.  However, for many people this was not allowed.  In 2010, the $100,000 income ceiling has been removed, allowing everyone to convert IRA funds to a Roth IRA.  2010 also provides the added benefit of being able to spread the income taxes owed on the conversion over two tax years.

What many people are unaware of is that the IRS also offers an “insurance policy” on your Roth conversions.  This insurance can be especially important if you pay taxes on a large amount of converted funds that then proceed to fall dramatically in value, as did the stock market in 2008  This IRS “insurance policy”  is called “Recharacterization.”

Recharacterization allows you undo an IRA to Roth IRA conversion.  If you make the IRA to Roth IRA conversion in January of 2010, you will typically have until October 15, 2011 to undo this conversion through a recharacterization.   Over this 21 month period, if your converted funds fall substantially in value, you would have been better off leaving these funds in the IRA and converting them at their lower value  Recharacterization is the IRS “insurance policy” that allows this.

Here is how recharacterization works:

Let’s assume that you convert $100,000 from your traditional IRA to a Roth IRA in January 2010.  If your marginal tax bracket is 25%, you will be required to pay $25,000 in additional taxes for this conversion.  If the market goes up, the $100,000 grows tax free and you (or your heirs) are never required to pay taxes on this growth.

But what if the market declines, leaving the converted $100,000 with a value of only $50,000 in September, 2011.  You have now paid $25,000 in taxes on an investment that is now worth $50,000.  At this point, your effective tax rate is 50%.  If this happens, you should use the IRS provided “insurance policy” called recharacterization.

Before October 15, 2011, you may put the $50,000 remaining in your Roth IRA back into your traditional IRA account.  You must also file an amended tax return showing this recharacterization.  If done properly, your amended tax return will provide for a refund of the $25,000, in 2010 taxes that was accessed for the Roth conversion.

31 days after you have completed a recharacterization you can once again convert the remaining $50,000 in IRA funds to a Roth IRA.  If you are still in the 25% tax bracket, your tax bill is $12,500 for this new conversion.  If the market skyrockets and the $50,000 grows to $100,000, you will have paid only a 12.5% tax rate on the conversion, based on the new market value.

IRA to Roth IRA conversions have many benefits, as long as you have the financial resources to pay the taxes owed, without having to use IRA funds.  However, the conversion and recharacterization rules are somewhat complex.  If you are exploring a Roth conversion in 2010, be sure to talk to your financial adviser or CPA about the benefits and drawbacks of an IRA to Roth conversion.  After considering all of the facts, if you decide on an IRA to Roth IRA conversion, be sure to re-analyze this decision in September 2011, to see if you should take advantage of the recharacterization insurance policy.

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While it is important to execute year-end tax saving strategies to minimize your taxes in 2009, your greatest opportunity for tax savings comes from advanced tax planning before the start of 2010.  There are several areas where advanced planning will provide a significant amount of tax savings in the year ahead.  Here are just a few:

Purchasing a home – Congress has extended the $8,000 refundable tax credit to anyone who closes a “first home” by the end of June 2010.  This “first home” credit applies also to anyone who has not owned a house for the past three years.  If you have a home that you have owned for at least five years, you are eligible for a refundable tax credit of $6,500, as long as your new home costs less than $800,000.  To qualify for either option, income cannot exceed $225,000 for joint tax filers.

A refundable tax credit provides for a full tax refund of either $8,000 or $6,500, even if the taxes that you owe are less than the refund amount.  As an example, suppose that you owe taxes of $5,000 and are receiving a refundable credit of $8,000.  With a refundable tax credit, you pay no taxes at year end and the treasury will send you a check for $3,000.

If you have not owned a home in three or more years or are thinking about moving after living in your home for at least five years, these subsidies can help you buy a new home.  Just be sure to sign a purchase agreement by April 30 and that closing occurs by June 30.

Health Savings Accounts – If you choose a qualified High Deductible Health Plan (HDHP) for your family’s health insurance in 2010, you will be able to make a tax deductible contribution of $5,950 to your Health Savings Account.  Not only are these funds immediately deductible against 2010 income, when you use these funds for future health care, no taxes are due on these funds or their income.

HSAs combine an immediate tax deduction (like an IRA) with the advantage of never paying taxes on these funds (like a Roth IRA), when the HSA funds are used for health care services.  On an after tax basis, HDHP insurance plans, combined with fully funded HSAs are often the most cost effective approach to providing health insurance.

Sales Tax Deduction – For the past few years, Congress has allowed for taxpayers to choose between deducting their state and local income taxes or their annual sales taxes. In states such as Colorado, most people deduct the income taxes.  However, if you are retired or having a low income year, it may be more advantageous to deduct state and local sales taxes instead of income taxes.

My approach is to have a large jar in the pantry into which my wife and I put every receipt with at least $1 in sales taxes.  At the end of the year, you might be surprised to find out how much you pay in sales taxes.  As an example, if you buy $80,000 in taxable items, you pay $6,800 with Colorado’s 8.5% sales tax,.  With Colorado’s 4.64% income tax rate, $145,000 of taxable income is required for the same $6,800 deduction.

IRS provided sales tax tables vastly understate actual sales tax payments.  For the sales tax alternative to succeed, you must save your sales tax receipts.  However, a little effort at the end of the year could save hundreds of dollars in federal income taxes.

Other tax savings approaches include maximizing your retirement plan savings, properly funding your flexible spending account (FSA), gifting strategies, etc.  To get more detail on these and other tax strategies, check out my book, Financial Abundance Guide, which is now available free on my website.

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One of my Seven Steps to Financial Abundance is “minimize your taxes.”  As 2009 draws to a close, there are several ‘to do” list items that can help assure that your 2009 federal and state taxes will be as low as possible. Let’s look at ten actions that could lower your 2009 taxes, if they are performed by December 31.

1.    New Car Purchase – If you were unable to take advantage of “cash for clunkers,” but are still planning on a new car purchase, do it now.  If you buy a new vehicle by December 31st, you can deduct state and local sales taxes from your 2009 federal tax return, regardless of whether you itemize or not.  This deduction applies to the first $49,500 of a new car price and phases out for couples earning over $250,000.
2.    Capital Loss Deduction – Determine if you have realized any 2009 capital gains in your taxable investment accounts.  If so, assuming that the taxable accounts have assets that are valued at less than their purchase price, sell enough of these capital loss assets to have a net realized capital loss of $3,000 in 2009.  This $3,000 capital loss will offset other 2009 income.
3.    401(k) and 403(b) Plans – Maximize your 401(k) and 403(b) contributions before year end.  In 2009, the maximum tax deductible contribution for each plan is $16,500.  If you are over age 50, you may make a “catch up” contribution of $5,500 for a total of $22,000.  If it is too late to increase your allocations for 2009, be sure to sign up for the maximum reduction that you can afford in 2010.
4.    Roth IRA Conversions – If your modified Adjusted Gross Income (AGI) for 2009 is less than $100,000, you may convert IRA holdings into a Roth IRA.  While the AGI limitation will disappear in 2010, if your 2009 income is lower than normal, it may be wise to convert some IRA funds before the end of 2009.
5.    IRA Charitable Contributions – For those over age 70½, 2009 is the last year in which you can make direct charitable donations of up to $100,000 from your IRA.  If you withdrew this money and then gave it to a charity, your AGI would increase, which could trigger future Medicare premium increases.
6.    Charitable Gifts –If you are inclined to help those less fortunate than yourself, charitable giving will help reduce your taxes.  Any tangible items that you donate must be in at least “good” condition.   Keep a detailed list of the items, their condition and the thrift store value of each item.
7.    Set up a Donor Advised Fund – If your charitable gifts are in cash, consider establishing a Donor Advised Fund.  You can donate long-term appreciated capital assets to the Donor Advised Fund and receive a deduction for the full value of the asset.  Not only will you receive a charitable tax deduction, you will never pay taxes on your capital gains.
8.    Defer Income – The self-employed and some small business owners can elect to invoice customers in January, so they don’t have to include this income in 2009.  However, this may only be wise if you will be in the same or lower tax bracket in 2010.
9.    Adjust Medical Deductions – Since medical deductions are limited to expenses exceeding 7½ % of income, if you have already had high 2009 medical expenses, get any tests, eyeglasses, prescriptions or dental work that you may require during 2009.  If your 2009 medical expenses are low, hold off on these expenses (if possible) until 2010.
10.    Prepay mortgages and state income taxes – If your mortgage payment is due January 1, paying it by December 31 will allow you to deduct the interest in 2009.  Prepaying your state income tax by December 31 will also allow the amount paid to be deducted in 2009.

There are other methods of reducing your 2009 taxes, such as IRA and HSA contributions, that do not require action by December 31.  However, the actions listed above must be done by December 31 if you wish them to apply to your 2009 taxes.

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