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As 2010 ends, taxpayers are confronted with the reality that scheduled increases in individual income tax rates, significant reductions in many popular tax incentives and more changes will occur when the calendar reads 2011. One year ago, it appeared highly unlikely that taxpayers would be faced with such uncertainty. Today, that uncertainty is generating many questions and few answers.

As 2010 ends, taxpayers are confronted with the reality that scheduled increases in individual income tax rates, significant reductions in many popular tax incentives and more changes will occur when the calendar reads 2011. One year ago, it appeared highly unlikely that taxpayers would be faced with such uncertainty. Today, that uncertainty is generating many questions and few answers.

Temporary tax cuts

Nearly 10 years ago, Congress enacted the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), which set in motion a gradual reduction in the individual income tax rates. In 2003, Congress passed the Jobs and Growth Tax Relief Act, which gradually reduced capital gains and dividend tax rates. When these laws were enacted, many lawmakers, tax professionals, businesses, and individuals assumed that Congress would either further extend the tax incentives or make them permanent before their expiration after 2010. To date, Congress has not acted; causing great uncertainty for tax planning.

Impact on individuals

The current individual tax rates of 10, 15, 25, 28, 33, and 35 percent are scheduled to expire after December 31, 2010. In their place, the pre-EGTRRA individual tax rates of 15, 28, 31, 36, and 39.6 percent will apply to tax years beginning after December 31, 2010, unless Congress acts to change this result that is otherwise required under the Tax Code. On top of these increases, the Making Work Pay credit, which further reduced income tax withholding for wage earners in 2009 and 2010, will expire after 2010. Additionally, the limitation on itemized deductions for higher-income taxpayers and the personal exemption phase-out for higher income taxpayers are scheduled to return after 2010.

Individuals with capital gains and dividend income will also see significant changes after 2010. The maximum rate of tax on the adjusted gain of an individual will revert to 20 percent (except 18 percent for gains on assets held over five years). Qualified dividends received by an individual for tax years beginning after December 31, 2010 will be taxed at ordinary income tax rates. Additionally, the current zero percent rate for capital gains for taxpayers in 10 and 15 percent tax brackets will expire to be replaced with a 10 percent rate (except eight percent for gains on assets held over five years). 

Individuals liable for the alternative minimum tax (AMT) will also be hit with some surprises. Higher exemption amounts as part of an AMT "patch," routinely enacted in past years, have languished in Congress. Under current law, the exemption amounts for 2010 and again for 2011 are $33,750 for unmarried individuals, $45,000 for married couples filing a joint return and surviving spouses, and $22,500 for married individuals filing a separate return. Comparing these amounts to higher exemption amounts for 2009 shows how drastic the reductions are. For 2009, the exemption amounts were $46,700 for single individuals, $70,950 for married couples filing a joint return and surviving spouses, and $33,475 for married couples filing a separate return.

Further down the road, a new 0.9 percent Medicare tax on earned income above $200,000 ($250,000 for married couples filing a joint return) and a 3.8 percent Medicare tax on the lesser of an individual's net investment income for the tax year or modified adjusted gross income in excess of $200,000 ($250,000 for married couples filing a joint return) are effective for tax years beginning after December 31, 2012. All of these events will, unless altered by Congress, will significantly change the dynamic for many taxpayers.

Expiring incentives

After December 31, 2010, many popular but temporary tax breaks for individuals will revert to their pre-EGTRRA levels, unless Congress acts to prevent this result. One of the incentives taking the hardest hit is the child tax credit. For the 2010 tax year, the child tax credit is $1,000 for each eligible child. After December 31, 2010, the child tax credit is scheduled to plummet to $500 per qualified child. Other enhancements to the child tax credit also will expire after 2010.

Along with the child tax credit, individuals should also expect some reductions in the dependent care credit, the earned income credit, Coverdell Education Savings Accounts (ESAs), the student loan interest deduction, and more. Absent Congressional action, many other popular tax incentives, commonly called tax extenders, expired at the end of 2009. These include the state and local sales tax deduction, the higher education tuition deduction and the teachers' classroom expense deduction.

Impact on businesses

Business owners who are taxed on their business income at the individual rates, such as sole proprietors, will also be hit with a tax increase if the scheduled pre-EGTRRA rates return. The top rate will increase from 35 percent to 39.6 percent for tax years beginning after December 31, 2010.

Among the tax extenders are a number of expired business incentives. At the top of the list is the research tax credit, which rewards businesses for investing in research for new products. The research tax credit expired at the end of 2009.

One tax rate that is not scheduled to change after 2010 is the corporate tax rate. The top corporate tax rate is 35 percent for 2010 and will remain 35 percent in 2011 and beyond, unless changed by Congress. Some unincorporated businesses may be eyeing corporate status as a way to reduce their taxes. However, changing status is a complex endeavor and has some special tax rules.

What's ahead?

Congress returned to work on November 15 for a lame duck session. The first week of the lame duck session was spent electing leaders and making other organizational changes for the new Congress that meets in January. Congress took a week long Thanksgiving break and is now back at work. Legislation to extend the individual tax cuts, renew the tax extenders and pass an AMT patch and more has yet to be introduced. There are many proposals, ranging from making permanent all of the reduced rates to making permanent just the 10, 15, 25, and 28 percent rates. Increasingly, lawmakers from both parties are talking about a two or three year extension of the individual rate cuts. Few observers expect Congress to continue working past mid-December (unlike 2009 when lawmakers worked right up to year-end) so taxpayers may enter 2011 faced with continuing uncertainty. Our office will keep you posted on developments.

With the end of the 2010 tax year rapidly approaching, there is only a limited amount of time for individuals to take advantage of certain tax savings techniques. This article highlights some last-minute tax planning tips before the end of the year.

With the end of the 2010 tax year rapidly approaching, there is only a limited amount of time for individuals to take advantage of certain tax savings techniques. This article highlights some last-minute tax planning tips before the end of the year.

Make a charitable contribution by cash or credit card. Charitable contributions can be made at any time, in cash or in property. Taxpayers may also want to accelerate dues and fees for church or synagogue memberships. While a pledge is not deductible, an actual payment will qualify when the payment is made, not when it is received. Thus, putting a check in the mail qualifies as a payment when the payer gives up control of the check (assuming there are sufficient funds and the check is eventually honored), not when the check is received, deposited, or honored.

Charging a contribution is another means of accelerating payment. Payment by credit card is in effect a loan to the payer and is deductible when the charge is made, not when the bill is paid or the charge is honored. Thus, if you make the charge in 2010 but it is not honored until 2011, you can still take the charitable deduction on your 2010 return. Payment by debit card again is a payment when the transaction occurs, even if the amount is not debited until the following day.

Note: special rules may apply to contributions of property, especially motor vehicles.

Adjust withholding. State and local income taxes are deductible when withheld, paid as estimated taxes or paid with a return. If you anticipate owing taxes for 2010, you can increase withholding or make an additional payment to cover the expected liability. The payment must be made in good faith and be based on a reasonable estimate of your tax liability. Taxpayers paying estimated taxes can make the final payment before the end of 2010.

Itemized deductions. In past years, there have been limits on itemized deductions taken by higher-income taxpayers. These limits do not apply in 2010, so taxpayers should not feel constrained to limit their payments and contributions. For higher-income taxpayers, this is especially beneficial.

Deduction for health insurance costs. If you are self-employed, you can take a deduction for your health insurance costs when computing self-employment tax and the self-employment tax deduction.

Small business stock. If you sell qualified small business stock before January 1, 2011, and are eligible for the increased exclusion from income, you may be able to exclude 100 percent of the gains from the sale of stock. Speak with your tax professional before selling such stock, however, since the rules on eligibility and holding periods can be complex. For a majority of taxpayers, the traditional rules for accelerating/deferring income and/or maximizing or deferring deductions to lower your tax bill may still apply in 2010, despite the threat of higher income tax rates next year still possible. Depending on your situation, you may want to:

- Accelerate income if possible, including bonuses, into 2010;
- Defer selling capital assets at a loss until 2011 and later years;
- Sell capital assets that have appreciated in 2010 to take advantage of the lower capital gains rates (the maximum capital gains rate is 15 percent for 2010);
- Move some assets into tax-free instruments, like municipal bonds, that are not subject to federal tax;
- Accelerate billings and/or provide incentives for clients or customers to make payments in 2010 (if you are a self-employed and/or cash-basis taxpayer);
- Take taxable retirement plan distributions before 2011 (for taxpayers over age 59 1/2); and
- Bunch itemized or business deductions into the 2011 tax year.

Maximize "above-the-line" deductions. Above-the-line deductions are especially valuable because they reduce your adjusted gross income (AGI). Many tax benefits may be limited for taxpayers whose AGI is too high. Common above-the-line deductions include contributions to traditional Individual Retirement Account (IRA) and Health Savings Account (HSA), moving expenses, self-employed health insurance costs, and alimony payments.

Claim "green" credits. You may be able to claim tax credits for purchasing particular property. Certain hybrid cars, such as the Nissan Altima, qualify for an energy credit under Code Sec. 30B. It may be necessary to consult with an auto dealer or check IRS rulings to see what credits are in effect, because the credit for a qualifying "green" vehicle phases out over time and eventually is reduced to zero.

Another credit available for "green" taxpayers is the residential energy credit. The credit is 30 percent, up to a total of $1,500, of certain energy-efficient improvements made by a homeowner to his or her principal residence during 2009 and 2010. For example, the credit can be claimed by installing energy efficient windows and doors.

Make a tax-free gift. You can gift, tax-free, up to $13,000 per donee in 2010. A married couple can apply a combined exclusion of $26,000 to a gift of property for one person. Further amounts to any one taxpayer will be offset by the donor's lifetime exclusion before gift tax is owed. The exclusion applies per year. If it is not used, it is lost; it does not carry over to the succeeding year.

Use an installment sale. If you may be selling property at a gain, you can avoid recognizing the entire gain by using an installment sale. An installment sale has at least one payment after the year of sale. The payment is taxed when it is made, not at the time of the sale. Thus, income can be postponed. The installment method is not available for stocks and bonds, however.

There can be competing considerations, however. Tax rates may increase in 2011 and future years, although perhaps only for the highest-income taxpayers. Still, the amount of gain included in a future payment could be taxed at a higher rate. The 3.8 percent Medicare tax imposed on certain income starting in 2013 also is a factor.

Take your required minimum distributions (RMDs). RMDs have returned for 2010. Although Congress temporarily suspended the RMD requirements for distributions from IRAs and other retirement accounts in 2009, it did not extend this benefit into 2010. Therefore, taxpayers who are age 70 or older must take their RMD from a traditional IRA (Roth IRAs are not subject to the RMD rules), 401(k) or other retirement accounts by December 31. Failure to do so will subject you to a stiff penalty of 50 percent of the amount you were required to withdraw but failed to. However, for taxpayers who turned age 70 in 2010, you have until April 1, 2011 to take your first RMD.

These are just a few last-minute tax planning strategies you may want to consider as year-end approaches. As always, please contact our office if you have any questions.

A preliminary report by the National Commission on Fiscal Responsibility and Reform has sparked debate over the preservation of many popular tax credits and deductions. The preliminary report generally proposes to eliminate a host of tax credits and deductions, both for individuals and businesses, in exchange for lower individual and corporate tax rates. The Commission is expected to send a final report to Congress on December 1, 2010, where it is almost certain to receive a controversial welcome. Nevertheless, the alarm sounded by the Commission will certainly give tax reform a platform it may not otherwise have had. The Commission's report may also provide the "potential cover" necessary for Washington to act on some of the recommendations.

A preliminary report by the National Commission on Fiscal Responsibility and Reform has sparked debate over the preservation of many popular tax credits and deductions. The preliminary report generally proposes to eliminate a host of tax credits and deductions, both for individuals and businesses, in exchange for lower individual and corporate tax rates. The Commission is expected to send a final report to Congress on December 1, 2010, where it is almost certain to receive a controversial welcome. Nevertheless, the alarm sounded by the Commission will certainly give tax reform a platform it may not otherwise have had. The Commission's report may also provide the "potential cover" necessary for Washington to act on some of the recommendations.

Reducing the national debt

President Obama created the Commission to look at ways to stabilize and reduce the nation's $13 trillion debt. The Commission is composed of 10 Democrats and eight Republicans. In mid-November, the co-chairs of the Commission released a preliminary report outlining some of the approaches the Commission may take in its final report.

"We must stabilize then reduce the national debt or we could spend $1 trillion a year in interest alone by 2020," the co-chairs cautioned. To reduce the debt, the co-chairs outlined a five-part plan: (1) Enact spending caps; (2) Pass tax reform; (3) Address health care and Medicare costs; (4) Achieve cost savings in government staffing and farm subsidies; (5) Reform Social Security.

Deductions and credits

The Tax Code includes numerous deductions and credits for all types of taxpayers. Among the most popular for individuals are the home mortgage interest deduction, the state and local tax deduction, the medical expense deduction, the child tax credit, and a variety of energy tax credits. The preliminary report would jettison nearly all of these tax incentives from the Tax Code. The revenue recovered from these tax incentives would go to reducing the national debt and lowering the individual tax rates.

Tax rates

Under current law (effective through the end of 2010), the individual tax rates are 10, 15, 25, 28, 33, and 35 percent. The preliminary report proposed to consolidate the individual rates into three brackets: eight, 14, and 23 percent. However, consolidation would require elimination of all deductions and credits. Keeping one or more tax incentive would require an upward adjustment in the rates. For example, retaining the popular home mortgage interest deduction would result in a consolidated rate schedule of 13, 21 and 28 percent.

AMT and more reforms

The co-chairs also proposed to eliminate the alternative minimum tax (AMT). Abolishing the AMT would cost the federal government a projected $1 trillion in lost revenues over 10 years. The co-chairs did not say where the lost revenues would be recovered.

The preliminary report also briefly described some other reforms. These include raising the federal gasoline tax by 15 cents, treating capital gains and dividends as ordinary income, and capping the income tax exclusion for employer-provided health care at an unspecified amount.

Business taxes

Businesses would also be significantly impacted by proposed reforms. The co-chairs discussed abolishing the Code Sec. 199 domestic production activities deduction, the LIFO method of accounting, and tax incentives for the oil and gas industry. Revenues recovered from the elimination of these incentives would go to reducing the national debt and lowering the corporate tax rate.

Outlook

At least 14 members of the Commission must agree on the language of the final report to send it to Congress for an up or down vote. It is unclear if 14 members will agree with the final recommendations. Several Commission members have said the preliminary proposals cut too much; others claim they fall short of cutting enough.

If you have any questions about the Commission's proposals, please contact our office.

If you make energy-efficient improvements to your home in 2010, you may be eligible for a federal tax credit that can help lower your tax bill. Two of the main credits for "green" improvements made to a home are the nonbusiness energy property credit and the residential energy efficient property credit. If you qualify for a tax credit, you will need to retain documentation that your energy efficient improvements are eligible for the tax credits you claim. You will need to certify that the property you purchase to improve your home qualifies for the credit - you don't want to purchase items with the intention of claiming a credit only to find out later that the items do not qualify.

If you make energy-efficient improvements to your home in 2010, you may be eligible for a federal tax credit that can help lower your tax bill. Two of the main credits for "green" improvements made to a home are the nonbusiness energy property credit and the residential energy efficient property credit. If you qualify for a tax credit, you will need to retain documentation that your energy efficient improvements are eligible for the tax credits you claim. You will need to certify that the property you purchase to improve your home qualifies for the credit - you don't want to purchase items with the intention of claiming a credit only to find out later that the items do not qualify.

Energy credits

The Code Sec. 25C nonbusiness energy property credit is a nonrefundable tax credit for qualified nonbusiness (residential) energy property. The credit amount is 30 percent of the sum of expenses for qualified energy efficiency improvements and qualified energy property for 2009 and 2010 property. The credit is limited to a lifetime maximum credit of $1,500 for 2009 and 2010 property.

The credit is available for a variety of energy property. Among the residential energy property that may qualify for the credit are:

- Furnaces and boilers;
- Water heaters (non-solar);
- Central air conditioning;
- Insulation;
- Exterior windows, doors and skylights; and
- Certain roofing.

There are also a number of household items that are not covered by the tax credit, including:

- Ceiling fans;
- Washers & dryers;
- Refrigerators;
- TVs;
- Toilets;
- Dehumidifiers;
- Dishwashers;
- Lighting (for example, light fixtures, compact fluorescent light bulbs, and LEDs) ;
- Ovens / Ranges; and - Programmable thermostats.

A related credit - the Code Sec. 25D residential energy efficient property credit - provides a nonrefundable tax credit for qualified residential energy efficiency property placed in service before 2017. Generally, the credit is 30 percent of the cost of qualified residential energy efficiency property with no upper limit except for qualified fuel cell property.

The residential energy efficient property credit is also available for a variety of energy property. They include solar electric property, solar water heating property, geothermal heat pumps, small wind energy systems, and fuel cell property. The credit generally encompasses labor costs applicable to on-site preparation.

Certifying your purchases

 Not all energy efficient improvements are eligible for a tax credit. For example, ENERGY STAR distinguishes energy efficient products which may be eligible for a tax credit; but, many individuals may not be aware that not all ENERGY STAR products qualify for a tax credit. Therefore, you should check the manufacturer's tax credit certification statement (discussed further below) before purchasing or installing any products in your home.

To claim a credit for products "placed in service in 2010" (that is, installed), homeowners must complete Form 5695, Residential Energy Efficient Property Credit, and submit the form with their Form 1040 when they file their 2010 taxes by April 17, 2011 (since April 15 falls on a Friday in 2011). Homeowners do not need to provide the IRS with any other documentation when filing their return.

However, you should keep a copy of the Manufacturer's Certification Certificate, any labels from the products you purchased showing they meet certain energy efficient standards, and your sales receipts. A Manufacturer's Certification Statement is a signed statement from the manufacturer certifying that the product or component qualifies for the tax credit. Manufacturers generally provide these certifications on their website or with the product packaging. Homeowners can generally rely on these statements for certification. The certification does not need to be attached to your return, however.

A business can deduct ordinary and necessary expenses paid or incurred in carrying on any trade or business. The expense must be reasonable and must be helpful to the business.

A business can deduct ordinary and necessary expenses paid or incurred in carrying on any trade or business. The expense must be reasonable and must be helpful to the business.

Gifts to a business client, customer or contact can be deductible business expenses. However, the maximum deduction for gifts to any individual is $25 per year (Code Sec. 274(b)). A gift is any item that is excluded from income under Code Sec. 102. Gifts that cost $4.00 or less, as well as promotional items, are not subject to the $25 limitation.

Gifts by individuals to co-workers are normally considered nondeductible personal expenses. However, employee achievement awards ($400 limit) and qualified plan awards are not subject to the $25 limitation.

Substantiation

Taxpayers must be able to substantiate certain business expenses by adequate records or sufficient evidence to take them as a deduction. Substantiation is required for business gifts, as well as traveling, lodging and entertainment expenses, because they are considered more susceptible to abuse (Tax Code Sec. 274(d)).

For business gifts, IRS regulations require that taxpayers substantiate the following elements of the gift:

- Amount (the cost to the taxpayer);
- Time (the date of the gift);
- Description of the gift;
- Business purpose - the business reason for the gift, or the nature of the business benefit derived or expected to be derived as a result of the gift; and
- Business relationship - occupation or other information relating to the recipient, including name, title and other designation, sufficient to establish the business relationship to the taxpayer.

The IRS provides substantiation rules in Treasury Reg. 1.274-5T(c). The taxpayer must maintain and produce, on request, "adequate records" or "sufficient evidence" that corroborate the taxpayer's own statement. Written evidence has "considerably more probative value" than oral evidence alone. While a contemporaneous log is not required, written evidence is more effective the closer in time it relates to the expense. Support by sufficient documentary evidence is highly credible.

Adequate records

Adequate records include an account book, diary, log, statement of expenses or similar records, as well as documentary evidence, which in combination establish each element of the expense. However, it is not necessary to record information that duplicates information on a receipt. The record should be prepared at or near the time of the expenditure, when the taxpayer has full present knowledge of each element. A statement, such as a weekly log, submitted by an employee to his employer in the regular course of good business practice is considered an adequate record.

An adequate record of business purpose generally requires a written statement of business purpose. However, the degree of substantiation will vary depending on the facts and circumstances.

Sufficient evidence

A taxpayer that does not have adequate records may establish an element by other sufficient evidence, such as the taxpayer's written or oral statement with specific, detailed information, and other corroborative evidence. A description of a gift shall be direct evidence, such as a detailed statement by the recipient or documentary evidence otherwise required as an adequate record.

If the taxpayer loses records through circumstances beyond the taxpayer's control, the taxpayer may substantiate the deduction by reasonably reconstructing his expenditures.

As an individual or business, it is your responsibility to be aware of and to meet your tax filing/reporting deadlines. This calendar summarizes important tax reporting and filing data for individuals, businesses and other taxpayers for the month of November 2010.

As an individual or business, it is your responsibility to be aware of and to meet your tax filing/reporting deadlines. This calendar summarizes important tax reporting and filing data for individuals, businesses and other taxpayers for the month of November 2010.

December 1

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates November 24-26.

December 3

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates November 27-30.

December 8

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates December 1-3.

December 10

Employees who work for tips. Employees who received $20 or more in tips during November must report them to their employer using Form 4070.

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates December 4-7.

December 15

Monthly depositors. Monthly depositors must deposit employment taxes for payments in November.

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates December 8-10.

December 17

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates December 11-14.

December 22

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates December 15-17.

December 27

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates December 18-21.

December 29

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates December 22-24.