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While we emphasize the importance of annual tax planning, it’s also important to not let tax avoidance override your other financial goals.  Liz Davidson, of Forbes.com, wrote a nice piece describing how people lose money when they let tax issues dominate their investment decisions. The article does a great job of examining why payments to the IRS can be such a tough pill to swallow and identifies traps most of us fall into in an attempt to shrink our tax bill.

Please contact us if you have questions about appropriate strategies for reducing your tax bill while also staying on track for your long term goals.

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Know Your IRS Numbers

Unfortunately, there’s no rhyme or reason that will help you to remember the different IRS form codes.  But, remembering the following two will assist you greatly if you encounter a situation like we described above.  After you initiate a rollover of a former 401k or 403b, you should expect to receive a Form 1099R.  This form is used to report distributions from IRAs whether they are taxable or not.  The second form, Form 5498, you will need is not as well-known but equally as important.  This form’s purpose is to report the rollover contribution made to your new IRA.  These two forms work from opposite ends in the event of a rollover, conversion or recharacterization.  Be especially vigilant when reviewing this information when a transaction starts at one trustee and ends up at another.

For example, if you completed a direct trustee-to-trustee rollover out of a Fidelity 401k into a Vanguard IRA you should receive a 1099R from Fidelity and a form 5498 from Vanguard.  The Fidelity 1099R should show the total amount in box 1 and a code G in box 7 for the direct rollover.  The Vanguard 5498 should show the same amount in box 2 Rollover contributions.

If you completed the rollover within 60 days, where you received a check from one trustee and then made the rollover contribution within that time frame you’ll want to make sure that the form 5498 is accurately reporting the rollover in box 2.  More than likely the trustee issuing the 1099R for the distribution will report a taxable transaction.  You should indicate “rollover” on your tax return and the IRS will get the form 5498 to back that up.

May 31st Tax Deadline?

The trustee that maintains your individual retirement accounts (IRAs) is required by the IRS to report contributions, required minimum distributions and the fair market value of the account by May 31.  This date may seem like an odd time to receive a tax form since you’ve probably already filed your return.  However, form 5498 reports contributions made to an IRA during the tax year as well as those made after December 31, but before April 15^th for the previous tax year.  Make sure that those contributions match up to what you have reported on your tax return. If not, contact the trustee that sent the form 5498 and request a correction.

RMD’s not WMD’s

Another place to be sure that the information provided by the trustee matches your records is Required Minimum Distributions.  There are some fairly complicated rules regarding RMDs, especially if the account was inherited, so it makes sense to double check the accuracy on form 5498.

Understanding how this form is used by the IRS can help keep your tax headaches to a minimum.

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What if you never again had to prepare your tax return? Or pay someone to do it for you?  The catch is that the IRS would be the ones who prepare it.  Sound a little scary?  The Bipartisan Tax Fairness and Simplification Act of 2010 introduced in the Senate has a provision for just that scenario.

http://www.theatlantic.com/business/archive/2010/02/will-the-new- tax- reform-bill-kill-h-r-block/36605/

The repeal of the federal estate tax is only in effect for 2010.  After this year, the estate tax is scheduled to be reinstated at levels prior to President Bush’s tax cuts becoming law.  So, rather than receiving a $3.5 million exemption per person and a top tax rate of 45% as was available in 2009, 2011 estate tax law will offer only a $1 million exemption and a maximum rate of 55%.  You don’t have to do the math to realize how big of a change this is.

Secondly, there are some unintended consequences that may come into play as a result of this repeal.  A common estate planning strategy is to use something called a “bypass trust” with the intention of taking advantage of the maximum estate tax exemption.  This strategy was used based on the federal estate tax law being in effect.

Since there is no estate tax for 2010, the wording in the legal documents that are the basis for creation of the trust could be problematic.  They might say something like, “Place all of my assets that are not subject to the estate tax into a trust for my children, then leave everything else to my spouse.”  In the worst case scenario, a spouse could be left with nothing as all of the assets are directed into the trust because they aren’t subject to any estate tax.  Most states have some protection afforded the spouse, however, the potential litigation involved could certainly drain the assets being contested.  This could get especially nasty if there were children from a previous marriage involved.

Another consequence of this repeal is the impact on the “step-up in basis” rule.  This rule basically said that whatever valuation an asset had on the owner’s date of death is the value that the heirs could use as their new tax basis.  For example, if Mrs. Smith died in 2009 while owning stock in IBM that she purchased thirty years ago, under the step-up rule, her heirs could use the stock price as of the day of death to calculate basis for any future sales of the stock.

For 2010, things are a little bit different.  Heirs are only able to use the step-up rule for $1.3 million worth of asset appreciation.  Spouses get an addition $3 million in appreciation.  If Mrs. Smith dies in 2010, depending on the size of her estate, her heirs would need to know what amount Mrs. Smith purchased the IBM stock for, any dividends that were reinvested, and stock splits received in order to assign tax basis.  Not only is this a costly change for heirs, but also a documentation nightmare for tax preparers.  Like the estate tax, the unlimited step-up is scheduled to return in 2011.

Many observers of this mess think that Congress will retroactively impose a fix to undo the estate tax repeal.  However, that is certainly not a given and even if it does happen, what new, unintended consequences will be inflicted on otherwise well-laid plans?

If you have not yet made the maximum contribution, you still have time!  Tax payers have until April 15^th of 2010 to make their Roth contributions for the 2009 tax year.  If you are within the income limitations to make contributions, a Roth IRA is an excellent investment account as investment growth is tax deferred and withdrawals in retirement can be tax free.  For 2009, single filers are able to fund their Roth IRAs with 100% of the contribution limits if their income is below $105,000.  Their amount of contribution availability drops if they are above the $105,000 and are phased out completely at $120,000.  For Married Filing Joint taxpayers, income restraints begin at $166,000 and end at $176,000.

Looking forward for 2010 contributions, contribution limits for this year have stayed the same.  This includes the limits for the Roth and Traditional IRAs and the majority of employer sponsored plans such as 401ks and 403bs. A very good practice is to contribute enough of your salary to receive at least the employer match.  Also, pay raises often present an easy opportunity to increase your deferral, while reducing your adjusted gross income.

The contribution limits for nearly all types of retirement plans are listed in the following chart:

Our wealth management service monitors your income and determines every year how much you should be contributing to each of these investment accounts.  It also reviews your income tax and estate picture, which may provide opportunities for tax savings.  If you are interested in this service, please contact us.

• Should you take losses or pull in capital gains?  It depends on your likely tax bracket…Take a look at your 2008 tax return. The IRS will allow taxpayers to deduct a maximum of $3000 in investment losses against ordinary income.  Many investors had a lot more than $3000 in realized losses in 2008 and, as a result, have a carry forward of the unused losses to 2009.  The opportunity now is that the IRS allows an unlimited amount of realized investment gains to be offset by realized investment losses.  So if you held on to an investment that has recovered much of its value this year, now may be a good time to sell.  If you don’t have any losses from 2008 to use consider selling something at a loss now.  Like we said above, the IRS allows $3000 of realized investment losses to be used as a deduction against ordinary income.  If you are in a higher tax bracket, that can be a valuable tax savings.

• If you are in the 10 and 15 percent tax brackets you can realize capital gains on investments held for more than a year at a zero percent tax rate in 2009.

• Watch out for the social security bubble – Up to 85% of your benefits could be subject to income taxation depending on other sources of income.

• Taxpayers normally subject to required minimum distributions from tax deferred accounts have been granted a waiver for 2009. It may make sense, however, to take some amount from those accounts depending on tax bracket.  Also, remember that you have sixty days from the distribution date to rollover into an IRA if you change your mind.

• Look at making a Roth conversion.  Because of the tax-free nature of the withdrawals, you need to consider your current tax bracket vs. your future tax bracket.

• Consider donating appreciated stock rather than writing a check.

• Make your property tax and estimated state income tax payments by December 31 if you want the write off for federal tax purposes.  Make sure that you consider the implications for alternative minimum tax.

• Weigh 2009 and 2010 together.  For example, you might want to wait until January to make property tax and state estimated tax payments if you think you will be in a higher tax bracket in 2010.

• If you are in the position to do so, you can gift to as many individuals as you wish up to $13,000 as the allowed gift tax exclusion.  If you are married, your spouse can gift $13,000 to those same individuals.

• The Hope Education Credit was renamed the “American Opportunity Tax Credit” for 2009.  This maximum credit for the first four years of postsecondary education is now increased to $2500.  This includes course materials costs in addition to tuition and fees.

Will discussed tax-loss harvesting, an important but often over-looked tax strategy.  Click here to read the article, “Taking the Sting Out of Investment Loses” by Russell Wild, MBA.

Distributions from your retirement accounts are not required by the IRS for 2009 but does that mean that they aren’t necessary?  Congress determined that the 2009 waiver of Required Minimum Distributions was a way for retirees to shore up their retirement savings by keeping them invested rather than liquidating at depressed prices.  This makes sense except for a few minor details like making sure that bills are paid and having food on the table.  Many folks simply are not in the position to afford doing without their distributions from pre-tax retirement accounts.  For those who have other sources of cash flow, this waiver does present opportunities for tax planning purposes.

One of the things we tend to focus on during the tax planning process is the marginal tax rate; or, the rate at which the last and next dollar of taxable income will be taxed.  A common example of how the marginal rate can be especially severe for retirees is in the area of Social Security benefits.  The tax code allows that below certain income limits Social Security benefits are not subject to income tax.  However, once those limits are exceeded a percentage of Social Security benefits must be added to the taxable calculation.  This inclusion of Social Security benefits can effectively create a hidden, higher marginal tax rate.  An opportunity that the waiver of RMD presents is in managing the amount of income so that the addition of Social Security benefits is mitigated.

Tax planning often requires looking at multiple tax years in order to reduce the overall tax effect.  Care must be taken so that the efforts related to an earlier tax year are not undone by future cash flow needs that push subsequent tax years into unintended marginal tax rates.  If, for instance, a large expenditure (i.e. new car, medical costs, etc.) is looming on the horizon it may make sense to take a 2009 IRA distribution – even though it is not required – if it allows you to stay away from a higher tax bracket in 2010.  There can be many complicating variables involved in the multi-year analysis, including itemized deductions and the alternative minimum tax to name just a few.  However, the cumulative tax savings can certainly make it a worthwhile exercise.

Required Minimum Distributions are not eligible for Roth conversions so the 2009 RMD waiver provides an opportunity for those taxpayers whose adjusted gross income (not counting the amount converted) does not exceed $100,000.  The benefit of a Roth is that its earnings grow tax-free and the assets of the account will not be subject to required minimum distributions during your lifetime.  There will be taxes due on the amount that is converted, however, so it is important to pay close attention to the projected marginal tax rate during the tax planning process.

Tax planning is an often overlooked and underutilized part of the annual cycle of tax compliance.  Too often folks miss out by waiting until after December 31 to start looking at their tax situation.  By then it’s often too late.  The RMD waiver is another opportunity for some taxpayers to get it right.

Please contact us with questions regarding your investment accounts and to ask what the new RMD wavier means for your personal situation.

In the current economic environment employers are evaluating all of their cost cutting options. In many cases this may lead to suspending or reducing their 401k match.

For employees of such companies this should prompt an evaluation of their current savings strategies. One of the golden rules you will hear in financial planning is that you should, at the very minimum, contribute enough to your 401k to receive the employer match because this is “free money.”  However, when the matching program is suspended, this no longer holds true.

Some questions you should ask yourself when deciding if you should continue contributing to your 401k plan are:

• How would I use the additional money in every paycheck?

• What other savings strategies should I utilize?

• What would be the tax implications of discontinuing contributions?

This first question is key because part of the attraction of 401k deferrals is that they make retirement saving automatic, eliminating the opportunity to spend those funds rather than save them. This has become increasingly important in modern society with the reduced availability of traditional pension plans to cover our retirement needs.  Without the automatic deferrals from your pay check, it will be important to establish other savings strategies to continue funding your retirement goals.

This leads us into questions 2 and 3, which are intricately related. The appropriate retirement savings strategies will rely heavily on your income level and tax bracket. You should evaluate what your adjusted gross income would be with and without your current 401k contribution. Before eliminating your deferral altogether you will want to make sure that this will not push you into a higher tax bracket, since traditional 401k contributions are made pre-tax. If you are in a low tax bracket then you may want to consider contributions to a Roth IRA instead of your 401k since withdrawals from that account will be tax free in retirement. As a result of lay offs and pay cuts over the past year, some individuals may now be within the income limitations to make Roth contributions when they were not in the past. This option should be analyzed as well.

For most employees a combination of some level of 401k and IRA (Traditional or Roth) contributions make sense. Seek the guidance of your financial advisor to help you evaluate your options when faced with a 401k match suspension.

IRS form 4868 Application for Automatic Extension of Time must be sent in by the April 15th deadline in order to have a valid six-month extension with the IRS.  Form D-410 does the trick with the N.C. Department of Revenue.

There are many different reasons why you may need to file an extension.  Small business owners, for example, often need to get their business taxes completed before they can do their personal return.

No matter your reason for filing an extension, one rule applies across the board – an extension gives you extra time to file, it doesn’t give you extra time to pay.  In order to qualify for an extension the IRS requires that you “properly estimate your 2008 tax liability”.

You can usually get a pretty good estimate by preparing a preliminary return using the information you know is good – a W-2 for example – and guesstimating the information you need more time to gather.  Then apply the payments you have made through withholdings and/or estimated payments.  For any amount still due a payment should be sent in with the extension.

Some advice for those who don’t have the money to send in with the extension, file the extension anyway.  Remember we said earlier that the extension is extra time to file not extra time to pay?  The IRS can hit you with two separate penalties for not sending in the extension (late filing and late paying) – but only one (late paying) if you send it in.  So sending it in can only help and it certainly won’t hurt.

Whether you file the extension electronically or by mail it allows you six more months to get your act together.

This article was written by Will Holt, a CPA at Financial Symmetry, Inc.