Tax Planning for Income

What is tax planning for income?
Tax planning for income usually involves strategies for minimizing your taxable income. In particular, the timing and the method by which your income is reported become paramount. Effective planning begins with an understanding of the various types of income. Next, you'll want to consider tools for creating tax-free income, methods of sheltering earned income from taxes, strategies to defer taxes (and other tax-advantaged strategies), and vehicles for shifting income and tax. For older taxpayers, it's also useful to know how to minimize taxation of your Social Security benefits.

Why is it important for you to understand the concept of income?
As a general rule, you are required to pay tax on your income from whatever source derived, unless a statutory exception applies. Therefore, it's important for you to know which items are included and excluded from the IRS's definition of gross income. Additionally, income can be taxed at different rates, depending on whether the income is ordinary or derived from the sale or exchange of certain classes of property held for certain minimum time periods. Because losses can sometimes be used to offset income, it's also important to understand the concept of active versus passive income.

Why is it important to know how to generate tax-free income?
Although income is usually taxable, there are a number of vehicles that can produce tax-free or nontaxable income. You may be able to enjoy some portion of your income, tax free, by switching some of your investment money to these vehicles. Several useful vehicles exist, including Roth IRAs, tax-exempt bonds, and qualified small business stock.

How can you shelter earned income from taxes?
Sheltering your earned income involves employing one or more tools to generate losses, deductions or credits that will reduce the current federal tax burden on your earned income. Typically, your desired result is income deferral. Several methods exist to shelter earned income from taxes, including traditional deductible IRAs and employer-sponsored retirement plans.

Why should you be aware of strategies to defer taxes?
There are several reasons why deferring the taxation of income is generally desirable. First, deferring taxes will provide you with more money right now to fund various financial plans. Moreover, certain qualified retirement plans allow you not only to defer some of your current taxable income, but also let your retirement savings grow tax-free until a distribution is taken.
As a general rule, when tax rates are stable, it's wise for you to defer the recognition of as much income as possible to a later year and accelerate deductions. This will allow you to minimize your current income tax liability. As a consequence, you will be able to invest money that would otherwise have been used to pay income taxes, keeping that money working for you. When you eventually recognize the income, it's possible that you'll be in a lower tax bracket.

What are some other tax-advantaged strategies?
Many other tax-advantaged strategies exist. For instance, you should be aware of tax shelters and tools for creating passive income in order to take advantage of passive losses. Additional strategies that may help you reduce your overall income tax burden include taking advantage of the tax benefits of generating capital gains, investing in real estate, receiving annuitized payments, and engaging in year-end tax planning.

How can you shift income and tax to others?
Income shifting refers to dividing income among two or more taxpayers in a way that lowers overall taxes. Typically, income is shifted from higher bracket taxpayers to lower ones. If you're interested in income shifting, you should be aware of a number of topics, including the kiddie tax, the tax treatment of below-market and interest-free loans, and the benefits of making gifts of income producing property and employing family members.

What about Social Security benefits?
If you're an older taxpayer, you should probably be concerned with minimizing the taxation of your Social Security retirement benefits. Certain techniques exist to limit the taxation of such benefits, including filing your income tax return jointly and employing tools to reduce your modified adjusted gross income.

This article was provided by Forefield and distributed by Lawrence Sprung.

Qualifying Donations for Haitian Relief Efforts May Be Deducted on 2009 Returns

On January 22, 2010, the President signed into law HR 4462 (Public Law No: 111-126), establishing special rules that apply to charitable donations made for Haitian relief efforts.
An individual who makes a qualified charitable contribution after January 11, 2010 and before March 1, 2010 for relief efforts associated with the January 12, 2010 earthquake in Haiti can treat the deduction as if it were made on December 31, 2009. As a result, individuals who itemize their deductions on Form 1040, Schedule A, can elect to claim the deduction for their Haitian relief contribution on their 2009 federal income tax return. To qualify, the contribution must be made in cash.

Except for the ability to treat the contribution as if it were made in 2009, normal rules and limitations associated with charitable deductions apply. It's important to note that, to qualify for a deduction, donations must be made to a domestic charitable organization.

The legislation also specifies that a telephone bill showing the name of the charitable organization, and the date and amount of the contribution, will satisfy the charitable deduction recordkeeping requirements. This provision was added to facilitate charitable donations made via text messages.

Required Minimum Distributions 2010

If you are turning 70½ in 2010, you will need to take a Required Minimum Distribution (RMD) from your Individual Retirement Account (IRA). Pursuant to IRS Regulations all RMDs must be withdrawn by December 31 each year. However, since this is the first year you must take an RMD, you may defer the 2010 distribution until April 1, 2011. Failure to withdraw the RMD by the required deadline may result in a 50% penalty on the amount not distributed as required by the applicable IRS Regulations. If you choose to defer your 2010 RMD until April 1, 2011, your 2011 annual RMD still must be withdrawn by December 31, 2011.

If you are already 70½, you will need to satisfy an RMD from your IRA for 2010. Your RMD must be withdrawn prior to December 31, 2010. Again, failure to withdraw the RMD by the required deadline may result in a 50% penalty on the amount not distributed as required by law. As you may know, there was a one-year suspension for RMDs in 2009. Notwithstanding, your 2010 RMD must be withdrawn by December 31, 2010, regardless of whether you took advantage of the 2009 suspension. You may not defer your 2010 RMD until April 1, 2011.

Can You Afford to Have One Spouse Stay at Home?

For many families, this is an important question. Unfortunately, most dual income couples feel that both of them have to work in order to meet their expenses and maintain their lifestyle. If you evaluate your situation financially--factoring in the cost of working and the amount of taxes that you pay while both of you are working--you may find that you have a choice. One of you may be able to stay at home without seriously affecting your cash flow. This evaluation will at least enable you to make a more informed decision.

When one spouse stays at home, you will not have to incur several work-related expenses, especially if you have young children and are paying for child care. Most people are aware of child-care expenses because they are so obvious, but you need to take into account many other hidden expenses when you consider staying home. In many cases, not only do you save money by not incurring those expenses, but you may be able to save a great deal of money by making some small changes in your lifestyle. Here is what you need to consider:

  • Impact of the loss of second income
  • Cost of earning the second income
  • Hidden benefits
  • Long-term cost of not working
  • Lifestyle changes

Impact of the loss of second income
Frequently, the real impact of the second income is not as much as the income itself. In fact, it can be much less. It is easy to think that if you are making $70,000 a year, your loss would be $70,000. However, if you calculate the taxes, the extra cost of working, and other expenses, the real impact may be far less, depending upon where and how you live.

Cost of earning the second income
Here is a list of some typical expenses that you need to consider before making that decision. Look at your spending diary and identify how many expenses are related to both of you working. Make a list of how much you can save by not incurring those expenses.

Child care
For most working couples with young children, child care is the expense with the most impact on your decision. Depending upon how young your children are, the kind of child-care arrangement you prefer, and the number of children, the cost of child care will vary. When you calculate child-care expenses, make sure that you add related expenses, such as driving to and from the child-care center or any payroll taxes that you may be paying for your nanny.

The reduced commuting expenses also add up, not only in terms of gasoline and oil changes, but also wear and tear on your car and auto insurance.

Lunches out
When you are working outside the home, the seemingly small expense of lunches adds up. When considering whether you or your spouse should stay home, you should take into account the amount spent on office lunches.

Depending upon where you both work, you may be spending a sizable portion of your income to buy work clothes. When one of you stops working, you will not be spending this money on clothes.

Dry cleaning
The same holds true for your dry cleaning expenses. Add them up to find out how much you would save if dry cleaning became unnecessary for one of you.

Take-out dinners
With two of you working, you are probably spending a sizable amount of money on take-out dinners. If you are able to have your dinners at home, you reduce the need for expensive take-out meals. You may also save on groceries, since you will have more time to shop carefully, and may find many items on sale.

Housecleaning services
When both of you work, you may be paying to have your house cleaned. Add up those expenses.

Hidden benefits
There may be some hidden savings when you switch from a two-income to a one-income household. For example, you may be able to save on taxes. Often, your joint income puts you into a higher tax bracket and you wind up paying a good portion of one spouse's income on taxes. If you are filing a joint return, calculate the impact of the second income on your taxes.

Long-term cost of not working
Although the picture in the short-term may look promising for one spouse to stay at home, you need to consider some long-term implications of that decision.

Consider the long-term effect on your 401(k) plan. If you or your spouse remain in the workforce, 401(k) plans not only give you an immediate tax break, but also grow to make a larger retirement nest egg. Your 401(k) is funded more when you are working because you are contributing (and your employer may also make contributions).

Consider when, if at all, you or your spouse is planning to reenter the workforce and the effect on future earnings. When one of you reenters the workforce, your earning power is likely to be diminished. Some individuals who reenter the workforce find that they are not getting paid their former salary while doing a similar job. Also, you may have to climb the career ladder once again since there may not be the opportunity to start where you left off.

Remember that now you are more exposed to the risks of the economy because you are dependent on one income. You are more vulnerable to economic downturns and company downsizing. So, if the working spouse loses a job, it will have a more devastating effect on the family's finances. Keep in mind that as your children grow, your child-care expenses--one of the biggest expenses in a young family's budget--will decrease considerably. As a result, you will save less from having one of you stay home.

Lifestyle changes
When one spouse stays home, you may need to make some lifestyle changes. In fact, making some changes in your present lifestyle might allow one of you to stay home. Here is how you can do it.

Make two lists: need list and want list

In your need list, include all the bills that you have to pay, whether you stay home or work outside. In your want list, include entertainment, travel, music and dance lessons, books, toys, and gifts. For many, the need list is probably all you can handle with one income. Don't panic. You can take steps to have at least some items from your want list.

Reduce expenses
You can make both big and small changes that will reduce your expenses. For more information and specific ideas, see How to Cut Costs.

Remember that little things add up

By making small changes, such as turning off lights when not needed or drying clothes on racks instead of using the dryer, you not only save money, but also instill in your children the value of such things.

Make things instead of buying them

Frequently, your creativity gets a big boost when you have a little more time to yourself. You can save a considerable amount of money by making small things such as birthday cards and holiday gifts. The added advantage can be the personalized attention given to each item, and the feeling of joy when you have created something yourself.

Find alternatives

If you work out at a health club, find out if you can join a nearby YMCA or a less expensive health club instead. Instead of renting a hotel room at a fancy resort, find out if you can rent a cabin in a national park.

Find out if you can make money working at home

You may not realize that you can also make money by staying home. Find alternative employment such as a part-time, evening, temporary, or a work-at-home job to fill the shortage.

Turn your hobby into a part-time business

If you like to write, find out if you can write for your local newspaper. This will not only give you extra income, but also some recognition, and may be a way to voice your opinions. For other ideas, see How to Increase Cash Flow.

Plan ahead

Do not quit your job without planning. If you plan ahead, you can pay off a loan to save monthly installments, secure a part-time or at-home job, or start implementing other lifestyle changes to reduce the impact when your second income stops.

This article was provided by Forefield and distributed by Lawrence Sprung.

Estate Tax Update

The federal estate tax is dead--at least for now.

It's 2010, and the temporary, one-year repeal of the federal estate tax is in effect. The failure of Congress to either extend the 2009 estate tax rules into 2010 or enact a permanent estate tax law has created several unfortunate consequences. Here are some things you need to know to protect your family and your assets.

Both the federal estate tax and the federal generation-skipping transfer tax (a separate tax on property given to grandchildren, great-grandchildren, etc.) are repealed for 2010 (unless Congress enacts legislation to reinstate them, retroactive to January 1, 2010 or otherwise).
Both taxes are scheduled to return in 2011 at levels that applied prior to 2001; that means a $1 million exemption and a top tax rate of 55% (in 2009, the exemption was $3.5 million and the top rate was 45%).

The federal gift tax remains in effect with a $1 million lifetime exemption, and the top tax rate is 35%.

The step-up in basis rule that allowed heirs to inherit property with a fair market value as of the date of death of the decedent has been modified. For 2010, the basis for inherited property is the lesser of the decedent's basis (carryover basis) or its fair market value on the date of death. But, $1.3 million of estate property is afforded a step-up in basis, and up to $3 million of property passing to a surviving spouse receives a step-up as well.

What's next?
It's anyone's guess what Congress will do next. Some believe quick action will reinstate the taxes at 2009 levels (see above). Others believe Congress will proceed cautiously in an attempt to enact serious reform. In either case, any reinstated tax may or may not be made retroactive to January 1, 2010. Needless to say, planning under these circumstances is challenging, at best.

The fallout
If your estate plan assumed that an estate tax would be imposed in 2010, it may no longer carry out your intentions; it may not provide adequately for your spouse, and it may not meet your overall tax objectives. Here are some steps you may want to take.

See your estate planning attorney about the possible need to revise your will, trust, and other estate planning documents, especially if they include formula clauses. A formula clause expresses certain bequests in terms of fractions or percentages in order to eliminate or reduce estate taxes. You may also need to see your estate planning attorney about these documents if you live in a state that imposes its own estate and/or inheritance tax, or if your documents include multi-generational planning.

Organize your records and get your parents/grandparents to organize theirs. The modified carryover basis rules impose strict reporting requirements, including supporting documentation and penalties for noncompliance.

This article was provided by Forefield and distributed by Lawrence Sprung.

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