Many tax provisions that had already expired or were scheduled to expire at the end of the year were extended as part of the Emergency Economic Stabilization Act of 2008, signed into law on October 3, 2008. Included in the list of extended provisions is an additional one year alternative minimum tax (AMT) “patch,” eliminating a level of uncertainty that would otherwise have plagued many individuals as they reviewed their year-end tax situation. As always, year-end presents both an opportunity and a challenge when it comes to tax planning. But keep in mind that the window of opportunity for many taxsaving moves closes on December 31.
The basics: timing is everything
Year-end tax planning is as much about the 2009 tax year as it is about the 2008 tax year. There’s a real opportunity for tax savings when you can predict that you’ll be paying taxes at a lower rate in one year than in the other. If that’s the case, some simple year-end moves can pay off in a big way.
Unless you think you’ll be in a higher bracket next year, look for opportunities to defer income to 2009. For example, you may be able to defer a year-end bonus, or delay the collection of business debts, rents, and payments for services. Similarly, you may be able to accelerate deductions into 2008 by paying some deductible expenses such as medical expenses, interest, and state and local taxes before year end.
Delay income / Accelerate deductions
- Delay collection of business debts, rents, and payments for services (if you use the cash method of accounting)
- Defer compensation/year-end bonus if possible
- Defer sale of capital gain property or take installment payments instead of lump-sum payment
- Postpone retirement plan distributions that aren’t required
- Make next year’s charitable contribution this year instead
- Pay medical expenses that are due in January before the end of the year
- Prepay deductible interest and property tax
- Make first quarter installment payment of state estimated tax in December
- Accelerate alimony payments
AMT: What you don’t know could hurt you
If you’re subject to the alternative minimum tax (AMT), traditional year-end maneuvers, like deferring income and accelerating deductions, can actually hurt you. The AMT–essentially a separate federal income tax system with its own rates and rules–effectively disallows a number of itemized deductions, making it a significant consideration when it comes to year-end moves. For example, if you’re subject to the AMT in 2008, prepaying 2009 state and local taxes won’t help your 2008 tax situation, but could hurt your 2009 bottom line.
The Emergency Economic Stabilization Act brought the latest in a long series of temporary “fixes” for AMT, but this patch (which includes increased AMT exemption amounts), expires at the end of the year. It’s likely that a more permanent solution will be implemented next year, but the specifics of such a permanent solution are uncertain.
There’s also good news for many who have been subject to AMT in prior years, particularly those caught in the AMT web as a result of exercising incentive stock options in the past. The Stabilization Act makes the calculation of the AMT refundable credit amount more taxpayer-friendly (through 2012), and eliminates the phase-out of the refundable credit amount for individuals with higher adjusted gross incomes. The Act also provides for an abatement of outstanding tax balances owed as of October 3, 2008, attributable to the AMT treatment of incentive stock options. The bottom line? Consider carefully your AMT situation for 2008 in light of the recent changes.
IRA and retirement plan opportunities
Traditional IRAs (assuming that you qualify to make deductible contributions) and employer-sponsored retirement plans such as 401(k) plans allow you to contribute funds pretax, reducing your 2008 income. Contributions you make to a Roth IRA (assuming that you meet the income requirements) or a Roth 401(k) aren’t deductible, so there’s no tax benefit for 2008, but qualified Roth distributions are completely free from federal income tax–making these retirement savings vehicles very appealing.
For 2008, the maximum amount that you can contribute to a 401(k) plan is $15,500, and you can contribute up to $5,000 to an IRA. If you’re age 50 or older, you can contribute up to $20,500 to a 401(k) and up to $6,000 to an IRA. The window to make 2008 contributions to your 401(k) closes at the end of the year, while you can generally make 2008 contributions to your IRA until April 15, 2009.
For some, it may make sense to think past 2008 and 2009: If you qualify, consider whether it makes sense to convert some or all of your traditional IRA assets to a Roth IRA. Funds that you convert, to the extent that the funds represent investment earnings and deductible contributions, are considered taxable income. Nevertheless, the potential future tax benefit could outweigh the current tax bill.
New and extended provisions
The Emergency Economic Stabilization Act also extended several popular provisions that had expired or were set to expire. To the extent that they apply to you, be sure to factor these items into your year-end analysis:
- For 2008 and 2009, you’ll continue to have the option to deduct state and local general sales tax (instead of state and local income tax) on your Schedule A.
- The above-the-line deduction (maximum $4,000 deduction) for qualified higher education expenses, and the above-the-line deduction for up to $250 of out-of-pocket classroom expenses paid by education professionals, are also extended through 2009.
- Taxpayers age 70½ or older now have through 2009 to make charitable contributions of up to $100,000 directly from an IRA to a qualified charity, without including the distribution in income.
- Beginning this year (and continuing for 2009 as well), individuals who do not itemize deductions are able to claim an additional standard deduction of up to $500 ($1,000 for married couples filing jointly) for real estate property taxes paid.
Energy efficient home improvements
A credit of up to $500 for the purchase of energy efficient home improvements (e.g., insulation, exterior windows and doors) and energy efficient property (e.g., qualified furnaces) expired at the end of 2007.
The Emergency Economic Stabilization Act reinstated the credit, but only for property placed in service during 2009. While limited in scope–for example, the credit is capped at $200 for windows, and $150 for qualified furnaces–the credit offers an opportunity for savings. If you’re eligible for the credit, and plan on making a qualifying improvement or purchase, waiting until 2009 to do so might make sense in order to qualify for the credit.