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September 28, 2010

Income Tax Strategies for Year End

As year-end rapidly approaches, it's a good time to take a look at your tax situation. You still have time to take action that could reduce your income tax liability for 2010. First, you need to assess where you currently stand on the following issues:

• Estimate your income, deductions, credits, and exemptions for 2010.

• Determine your marginal tax rate, which is the rate that your next dollar of income would be taxed at. This rate helps you evaluate whether it is worthwhile to use certain tax-planning strategies.

• Evaluate your estimated income tax liability for the year.

• Determine whether you will be subject to the alternative minimum tax (AMT) which will have an impact on tax-planning strategies.

Once you have an idea of where you stand for 2010 with your income tax situation, you can evaluate some tax-planning strategies that may reduce your income tax burden in 2010. Here are some tips to consider:

Sell stocks with losses to offset capital gains. If you have capital gains income but are holding stocks with losses, consider selling those stocks to offset the capital gains. Excess losses may be used to offset up to $3,000 of ordinary income, and the unused portion can be carried forward until utilized.

Contribute the maximum amount to your 401(k) plan. Take a look at your financial situation, making sure you are contributing as much as possible to your 401(k) plan. Unless you have a Roth 401(k), contributions are made from pretax dollars. When you invest in a taxable account, you have already paid income taxes on that money, so you will only be investing 65 or 75 cents instead of the dollar that would be going into your 401(k) plan. That difference makes a 401(k) plan tough to beat over the long term. The maximum contribution to a 401(k) plan in 2010 is $16,500, plus individuals age 50 and over can make an additional catch-up contribution of $5,500, if permitted by the plan.

Decide which type of IRA to contribute to and then do so as soon as possible. Find out whether you are eligible to contribute to a traditional deductible or Roth IRA, and then decide which is the better alternative for you. Although you have until April 15, 2011, to make your 2010 contribution, contribute as soon as possible to allow your funds to compound tax deferred or tax free for a longer time. The maximum IRA contribution in 2010 is $5,000, with an additional $1,000 catch-up contribution for individuals age 50 or older.

Replace loans that generate personal interest with mortgage loans or home-equity loans. Personal interest cannot be deducted on your tax return, while mortgage interest and home-equity loan interest can, as long as the mortgage does not exceed $1,000,000 and the home-equity loan does not exceed $100,000.

Determine whether you should bunch income or expenses for 2010. Depending on your overall tax situation, it may make sense to accelerate or defer income and expenses. Some deductions that can be accelerated or deferred include payment of property taxes, estimated state taxes, medical expenses, and charitable contributions. Income that can typically be deferred includes self-employment income and year-end bonuses or commissions.

Donate appreciated stock held over a year to a charitable organization. You can deduct the stock's fair market value as a charitable contribution without paying the capital gains tax on the sale.

Sell assets on the installment basis. You can use this method to sell certain capital assets, particularly real estate, which will typically allow you to recognize the gain as the installments are collected, rather than in total in the year of sale. You may also want to consider a like-kind, or section 1031, exchange, which allows you to defer any tax liability.

Consider transferring appreciated assets to children. If the children are in the 10% or 15% tax bracket, they can sell the asset and pay no capital gains taxes in 2010. These transfers can be made as part of your annual tax-free gifts, with a maximum tax-free transfer of $13,000 in 2010 ($26,000 if the gift is split with your spouse). However, be aware of the "kiddie tax" rules, which apply to all children under age 19 and to students under age 24. If the earned income of an individual over age 17 exceeds half of his/her support, the "kiddie tax" does not apply. The "kiddie tax" refers to the manner in which unearned income is taxed for children. In 2010, the first $950 of unearned income is tax free, the second $950 is taxed at the child's marginal tax rate, and any remaining unearned income is taxed at the parents' marginal tax rate. Once the individual exceeds the age limits, all unearned income is taxed at his/her marginal tax rate.

Familiarize yourself with all types of income tax deductions, exemptions, and credits. There are a wide variety available, and you should be aware of any that apply to you. For example, many tax benefits exist for higher-education expenses, including Coverdell education savings accounts (ESAs), section 529 plans, and the Hope Scholarship and Lifetime Learning credits. Each has different eligibility criteria, so you need to be familiar with all of them to determine which will work best in your situation.

Consider your long-term planning needs. In addition to lowering income taxes for 2010, you also want to find strategies to lower taxes in future years. Thus, it is a good time to review your entire tax situation to see if other changes are warranted. For instance, you may want to invest more in municipal bonds, whose interest income is generally exempt from federal, and sometimes state and local, income taxes. Or, you may need to reposition assets between your taxable and tax-deferred accounts to minimize taxes once you start taking withdrawals.

September 22, 2010

Estate Planning Trusts

There are a wide variety of trusts used for estate planning purposes. However, three trusts are typically used in estate plans for married couples. Those trusts are:

A revocable living trust -- With a revocable living trust, ownership of assets is transferred to the trust while you are alive. You can keep any or all of the income, act as trustee, change the trust's provisions, or terminate the trust. You can provide for a successor trustee to take over if you become mentally or physically disabled. Assets in the trust are controlled by the trust agreement and are not subject to probate proceedings, which is considered one of its major advantages.

A bypass or credit shelter trust -- This trust is generally used to ensure both spouses take advantage of their estate tax exclusion amount, without directly transferring assets to other heirs until both spouses have died. Generally, assets equal to the estate tax exclusion amount are placed in trust after your death, but you can place less than that in the trust. Keep in mind that there is no estate tax in 2010, but the estate tax exclusion amount will revert to $1,000,000 in 2011. Once the assets are placed in trust, your spouse can use the income and perhaps some of the principal, with the remaining assets transferred to your heirs after your spouse's death.

A qualified terminable interest property (QTIP) trust -- If you have assets in excess of those going into the bypass trust, you can bequeath them directly to your spouse with no estate tax liability, due to the unlimited marital deduction. However, some spouses want to control how their spouse disposes of those remaining assets, placing assets in excess of those in the bypass trust in the QTIP trust. Income from the trust is distributed to the surviving spouse during his/her lifetime. This qualifies for the unlimited marital deduction, so estate taxes won't be paid after the first spouse's death. After the surviving spouse's death, the principal is distributed to heirs designated by the first spouse.

September 15, 2010

Teaching College Students to Handle Credit Cards

Although the recently enacted Credit Card Accountability, Responsibility and Disclosure Act of 2009 imposed credit card restrictions, credit cards continue to be a great convenience for both college students and their parents. Under the Credit Card Accountability, Responsibility and Disclosure Act, if you are under age 21, you will need to show that you have the income to make required payments or get a co-signer age 21 or older who has the ability to make such payments. The advantages of credit cards are many: it reduces the need to carry cash; enables students to purchase books, clothing, and other incidentals; and provides a ready source for emergency funds. There is also another advantage -- students who handle their credit cards responsibly have a head start on establishing a good credit history that can help them gain access to lower-interest credit after graduation.

However, young adults can't always be counted on to exercise caution when it comes to spending money. And a virtual blank check, in the form of a student's own credit card or authorized use on your card, can often be an irresistible temptation. For a student using a parent's card, the risk may come in the form of a hefty unexpected bill that cuts into monthly cash flow or reserves. But for a student with his/her own card, the risks are even more far reaching: over-limit fees, late fees, and missed payments that can damage the student's credit rating.

So what's a parent to do? While you may not be able to stop your college student from getting a credit card, you can help teach him or her to use that card responsibly. Consider the following tips to help your student manage credit responsibly:

Assist your student in selecting a credit card. Try to convince your student to use a debit card instead of a credit card, so he/she won't get into debt. If your student insists on using a credit card, go through several offers with him/her, comparing interest rates, annual fees, grace periods, and penalties.

Explain the basics of credit card debt. Make sure your student understands that not paying the balance in full every month can result in a significant amount of interest. Low minimum payments mean it may take years to pay off credit card balances. Try to instill the concept of paying credit card balances in full every month.

Urge your student to only use credit cards for necessities, not to fund luxuries. Credit cards can be used for items such as book purchases and car repairs, but they should be avoided for clothing, dining out, and entertainment, unless your child can pay the balance in full each month.

Go over your student's credit card statement together every month. Show your student how to compare receipts to credit card statements. Go over all purchases and explain how credit cards can increase impulse purchases.

To see a broad selection of student credit cards currently available, visit the ManagingMoney.com Student Credit Card Center.

September 7, 2010

Health Care and Education Reconciliation Act of 2010

On March 30, 2010, the Health Care and Education Reconciliation Act of 2010 was signed into law, representing a massive overhaul of the health care system that will affect almost all taxpayers, many employers, and much of the health care industry. However, the provisions will be implemented over a number of years. Here is a summary of the major provisions by implementation date:


• Medicare beneficiaries will receive a $250 rebate when they reach the gap in coverage for prescription drugs, known as the "doughnut hole." The gap exists when total costs exceed $2,830 until they reach $6,440.

• A national high-risk insurance pool will offer insurance to individuals who have a preexisting condition and have been uninsured for at least six months until 2014.

• All insurance policies must offer dependent coverage to children who have not yet attained age 27.

• Insurance companies must cover certain preventive services. They also can no longer impose lifetime coverage limits, rescind coverage for any reason other than fraud, or exclude preexisting conditions for children.

• Businesses with less than 25 full-time workers who are paid less than $50,000 per year in salary get a tax credit of up to 35% of the health insurance premiums paid for employees. The credit rises to 50% in 2014.


• The costs for over-the-counter drugs not prescribed by a doctor can no longer be reimbursed through a health reimbursement account (HRA) or health flexible spending account (FSA) or be reimbursed on a tax-free basis through a health savings account (HSA) or Archer Medical Savings Account (MSA).

• The tax on distributions from a HSA or an Archer MSA that are not used for qualified medical expenses is increased to 20% of the disbursed amount, up from 10% for HSAs and 15% for Archer MSAs.

• Medicare recipients receive free preventive services and a 50% discount on brand name drugs purchased in the Part D doughnut hole.


• Starting in 2013, single individuals with earned income in excess of $200,000 and married couples with earned income in excess of $250,000 will pay an additional 0.9% Medicare tax on the excess over those base amounts.

• A 3.8% Medicare tax will be imposed on net investment income of single individuals with adjusted gross income over $200,000 and joint filers over $250,000. Net investment income includes interest, dividends, royalties, rents, gross income from a trade or business involving passive activities, and the net gain from the disposition of property (other than property held in a trade or business). This tax applies only to income in excess of the thresholds. Thus, if a couple earns $150,000 in wages and $150,000 in capital gains, $50,000 will be subject to the new tax.

• The threshold for deducting medical expenses on a tax return increases from 7.5% to 10% of AGI. Individuals age 65 and older are exempt from this increase through 2016.

• Allowable flexible spending account contributions are limited to $2,500 per year. The dollar amount will be indexed for inflation after 2013.


• All U.S. citizens and legal residents must have qualifying health insurance or pay a tax penalty. The tax penalty will be the greater of:

-- $95 per year (maximum of three times that amount or $285 per family) or 1% of taxable income in 2014

-- $325 per year (maximum of three times that amount or $975 per family) or 2% of taxable income in 2015

-- $695 per year (maximum of three times that amount or $2,085 per family) or 2.5% of income in 2016

After 2016, the penalty will be increased annually by a cost-of-living adjustment. Exemptions will be granted for financial hardship, religious objections, American Indians, individuals without coverage for less than three months, aliens not lawfully in the United States, incarcerated individuals, individuals who find the lowest cost plan option exceeds 8% of household income, individuals with incomes below the tax filing threshold ($9,350 for singles and $18,700 for couples in 2010), and individuals residing outside the U.S.

• Individuals and small businesses with fewer than 100 workers will be able to purchase health insurance on state-based health insurance exchanges. When insurance is purchased on the exchange, the individual reports his/her income. Low- and middle-income individuals and families may then be eligible for a tax credit based on the income reported. The IRS will pay the premium assistance credit directly to the insurance plan, with the individual paying the difference in premium. The premium assistance credit is available for individuals and families with incomes up to 400% of the federal poverty level ($43,320 for an individual or $88,200 for a family of four, based on 2009 poverty levels) who are not eligible for Medicaid, employer-sponsored insurance, or other coverage.

• Businesses with 50 or more workers will pay an annual penalty if they do not provide health insurance coverage to workers.


• "Cadillac" health insurance plans must pay a 40% tax on the portion of coverage worth more than $10,200 for individuals and $27,500 for families.


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