Higher Anticipated Taxes Prompt Aggressive Planning

John Kammerer

CPA

HLB Tautges Redpath

jkammerer@hlbtr.com

hlbtr.com

Topic: Accounting

Absent Congressional action, the 2011 tax year will result in higher taxes for nearly every individual taxpayer.  The most significant changes set to take place in 2011 are a result of the scheduled sunset of tax cuts from the Bush administration and are highlighted below.  As a result, the 2010 tax year provides many taxpayers a unique opportunity to save taxes through a variety of tax planning techniques including opportunities to accelerate taxable income and take advantage of current preferential tax rates.    

Individual Income Tax Brackets

The changes likely to affect the largest number of taxpayers will be changes to the individual income tax brackets.  As a result of the 2001 and 2003 Bush administration tax cuts, the individual brackets gradually changed during the past decade to establish a 10% bracket and to lower the top bracket from 39.6% to 35%.  The tax brackets were also adjusted to eliminate the "marriage penalty", whereby married taxpayers could end up paying higher income taxes than two single taxpayers earning the same amount.  

At the end of the year, unless Congress intervenes, the tax cuts are set to expire resulting in an increase in the top tax bracket to 39.6%, the elimination of the 10% bracket and an increase in the remaining tax brackets.  The increase provides taxpayers an incentive to shift income from the 2011 to the 2010 tax year by accelerating income and deferring deductions.   

Long-term capital gains/dividend rates

Tax law changes affecting investment income include an increase to the long-term capital gain and qualified dividend tax rates.  The top long-term capital gain rate is currently 15% and is scheduled to increase to 20% in 2011.  The upcoming 5% increase in the tax rate provides taxpayers an incentive to have capital gains taxed in 2010 rather than 2011.  One option taxpayers may consider to accomplish this goal is electing out of the installment sale method if the taxpayer will be receiving payments over multiple years.  Generally, with sales eligible for the installment sale method of accounting, taxpayers are taxed on the gain from the sale of property over the period in which the payments are received.  By electing out of this treatment the entire gain will be taxed in the year of the sale which allows taxpayers to take advantage of the 15% tax rate.  Taxpayers should carefully consider cash flow implications of this decision as it could result in a large amount of taxable income before the cash flow is available to pay the tax.  The second option is to accelerate the sale of gain stocks to 2010 and defer the sale of loss stocks to 2011.  However, the decision to sell stocks should not be made solely for tax purposes but should be part of an overall investment strategy.  It may make sense to repurchase the asset sold at a gain in 2010 to preserve the investment and still take advantage of the historically low tax rates. 

The qualified dividend rate is currently tied to the long-term capital gain rate (15%), but it is set to expire and return to the ordinary income rate in 2011.  This could result in the dividend rate increasing from 15% to 39.6% for some taxpayers.  As a result, it may make sense to accelerate dividend income to avoid a nearly 25% increase in the tax rate. 

Cancellation of Debt Income

As a result of the American Recovery and Reinvestment Tax Act of 2009, taxpayers were given the opportunity to defer recognition of cancellation of debt income until 2014 and to spread the recognition of the income over 5 years.  This election was available to taxpayers with qualified debt repurchased by the debtor during 2009 and 2010.  There are a variety of factors to consider in determining whether this election makes sense.  If it is a beneficial transaction, working with lenders to have the event conclude during 2010 could provide an opportunity to benefit from this long-deferral period.  

Estate Taxes

The estate tax is set to expire in 2010 and, without congressional action, will be reinstated at a 55% tax rate.  Planning is important since there is no single method of estate planning that makes sense for each taxpayer.  It is typical to use a variety of different planning techniques depending on the particular assets owned. 

We do not have the ability to predict Congressional action that may affect tax laws, however, it’s important for taxpayers to consider implications on future taxes and look for opportunities through planning.