2009 ends on a far more hopeful note for the economy than it began. And the advent of 2010 presents some unique tax planning opportunities for many individuals. However, here is fair warning. Keep your hands on your wallets. Prospects are strong that Washington will pay for proposed health care reform and attempt to shrink the budget deficit by raising your taxes over the next few years.
Although middle income taxpayers may get a reprieve from these planned tax hikes, it is almost assured that the top income tax rates (paid by couples making more than $250,000, and singles with incomes over $200,000) will revert to Clinton Administration levels. The tax cuts enacted by the Bush Administration are due to expire at the end of 2010. If Congress does not change the law, the top income tax rate in 2011 is scheduled to rise from 36 to 39.6 percent – and – the top 15 percent long-term capital gains rate will hit 20 percent. Also quite noteworthy, after 2010, all dividends will be taxed at ordinary income rates. Yes, that means a potential tax increase from 15% to 39.6%.
Let’s not think tax doom and gloom. This day promises a new year full of opportunity. So as 2009 quickly comes to a close, let’s focus on keeping your future taxes down in 2010 and beyond.
Here are five top tax tips for tax year 2010. The first two are great tax planning opportunities available tomorrow that may never be seen again after 2010. Starting in January, anyone can convert a traditional IRA to a Roth IRA, whose eventual withdrawals will be tax-free. And some homeowners who trade up (or down) may get a $6,500 federal tax credit.
2010 Tax Tip #1. Consider converting your IRA to a Roth IRA
In the past, investors could contribute to a Roth IRA only if their income was under $100,000. But starting in 2010, this income restriction is gone. This is great news, since your Roth IRA earnings come back to you tax-free. And this could be especially smart if you plan to transfer money to heirs someday, since your heirs will get the Roth proceeds tax-free.
So if you have a traditional IRA, whose withdrawals will be taxed, seriously consider converting it into a Roth IRA to escape future taxes. Investors who convert in 2010 can spread the tax impact over a 2 year period for 2011 and 2012. Plans that are converted to Roth IRAs in 2011 or 2012, or any time in the future after 2010, will get taxed on everything in the year of conversion.
Keep in mind that conversion is not right for everyone. For starters, when you convert, you will need to have enough in savings to pay the taxes on the IRA principal plus what your IRA has earned. Also, the younger you are, the bigger the benefit of converting, since your retirement account will have more time to grow tax-free. Do have a long talk with your tax advisor to design the right strategy for you.
2010 Tax Tip #2. Act fast to grab the home-buyer tax credit
Although the $6,500 tax credit for home purchases ($8,000 for first-time buyers) is available through June 30, binding contracts must be signed by April 30. So if you want to get the credit, submit your offer very, very soon.
2010 Tax Tip #3. Fund your tax-deferred plans and elective salary reduction plans to the max.
Exactly how taxes might go up in 2010 and who will owe more may be a mystery, but one thing is certain: taxes are not going down. So you will want to reduce your taxable income as much as possible by funding your retirement plans to the max. That means stuff as much as possible into your 401(k), IRA, or Keogh next year. In 2010, the maximum contribution amounts are unchanged. They are $16,500 for 401(k) and 403(b) plans, $5,000 for IRAs and $6,000 for IRA account holders age 50 and above.
Pile cash into HSAs and FSAs. If your employer offers a pre-tax health savings account — and you are signed up for it — in 2010 you may contribute up to $3,050 for yourself and $6,150 for your family. Flexible spending accounts are capped at $5,000. It is too late to designate FSA money for 2010, but make your open enrollment selections accordingly for 2011.
2010 Tax Tip #4. Consider selling appreciated stocks and funds
Odds are high that the long-term capital gains tax rate will rise in 2011, as planned, for anyone above the 15 percent tax bracket. So if you’re single with an income over $34,000 or you and your spouse make more than $68,000, you should count on a capital gains tax rate increase after 2010. While you should never sell an investment wholly for tax purposes, if you own appreciated stocks or equity funds and were planning to sell them, do it before the end of 2010 and avoid owing higher taxes on their gains. Plan to rebalance your portfolio in 2010. Whatever you do, do not fall victim to procrastination and postpone considerations until 2011. 2010 is the year for action.
2010 Tax Tip #5. Keep an eye on Washington
The abundant tax legislation experienced throughout 2009 is promised to continue well into 2010. Two hot issues remain unresolved and on the front burners. Keep your ears open for developments in Health Care Reform and the ongoing saga about 2010 and the uncertain Estate Tax.
Although our legislators have taken a break for the holidays, heated debates about the vision for and path to Health Care Reform will continue. The only certainty is that Health Care Reform will result in tax increases for businesses and individuals. For that reason, refer to tips 1-4 again.
And, although it is unlikely that the planned estate-tax repeal for 2010 will actually happen, uncertainty still reins.
Wait until the rules get set before making any estate-planning moves. But if Congress, as expected by many experts, reinstates the $3.5 million exclusion with the 45 percent inheritance tax on estates over $3.5 million – and you have an estate worth more than that amount – you should definitely meet with an estate attorney to craft a will with a bypass trust that documents your personal wishes and incorporates wise tax savings strategies.
If you want to start shrinking your estate in 2010, both you and your spouse can give your children, extended family and faithful friends up to $13,000 each tax-free. Hopefully, that will brighten their new year and yours.
Those are our Five Top Tax Tips for 2010.
Best wishes to all for a joyous, healthy and prosperous New Year!
