Year end tax planning in uncertain times

In today’s uncertain economic times, with potential tax law changes on the horizon, tax planning can be a challenge. Between now and year end, it’s important to monitor your financial situation closely, keep an eye on congressional developments and work with your tax advisor to devise a tax plan based on your best guess as to what the future holds. With that in mind, let’s look at strategies that may work for your financial situation.

Revisit your portfolio

Like most people, you probably have some investments that have taken a beating lately. But even if an investment’s value has declined, it may still reflect unrealized gains if its value exceeds your cost basis. If you plan to sell any of these assets or if you’ve already recognized some capital gains this year, it may make sense to sell some losing investments to offset those gains.

If you have both unrealized gains and unrealized losses in your portfolio, and you plan to unload some of these assets, here are a few rules of thumb to keep in mind:

• Generally, it’s preferable to sell long-term gain assets (those held more than a year) first because they qualify for a lower tax rate.

• On the losing side, it usually makes sense to sell assets that generate short-term losses first because you can use them to offset higher-taxed short-term gains (with any leftover losses used to offset long-term gains).

• If you have a net capital loss for the year, you can use it to offset up to $3,000 of ordinary income (such as from salary or interest). You can carry forward the excess to future tax years, but a better strategy might be to sell some investments at a gain to take advantage of those nondeductible losses this year.

• If you’re not selling all of your shares in an investment, use the specific identification method to designate which shares you want to sell. For example, if your objective is to minimize your gain or maximize your loss, instruct your broker to sell the highest-cost shares first.

As you implement your plan, watch out for the wash-sale rule, which prohibits you from deducting a loss on an investment if you acquire a substantially identical investment within 30 days before or after the sale.

Weigh your “alternatives”

This year’s alternative minimum tax (AMT) “patch” boosted the AMT exemption, for 2009 only, to $70,950 for joint filers and $46,700 for individuals and heads of households. Unless Congress enacts another patch for next year, the exemptions will roll back to $45,000 and $33,750, respectively, resulting in AMT liability for many taxpayers.

If you expect significant AMT liability in 2010, consider shifting some AMT income into 2009 to take advantage of this year’s exemption amounts. Keep in mind that there are other strategies you may be able to implement to reduce the AMT tax bite.

Buy a home

If you haven’t owned a principal residence during the previous three years and buy a home before Dec. 1, 2009, you may qualify for the “first-time homebuyer” tax credit. For qualifying purchases after Dec. 31, 2008, generally the credit is equal to 10% of the purchase price, up to $8,000, and you won’t be subject to the repayment obligation that applied to the credit last year. But the credit phases out beginning when adjusted gross income (AGI) reaches $75,000 ($150,000 for joint filers).

Buy a car

If you buy a new car, light truck, motorcycle or motor home before year end, you can take an above-the-line deduction for state and local sales or excise taxes. The deduction is limited to the tax on the first $49,500 of a vehicle’s purchase price and phases out beginning when AGI reaches $125,000 ($250,000 for joint filers).

Buy your college student a computer

If you’re paying for college expenses with a 529 plan, you can take tax-free withdrawals to pay for the student’s computer and Internet access. This benefit is available for 2009 and 2010.

Dust off your crystal ball

These are just a few of the many moves you can make before year end to reduce your tax bill. To start the process, estimate your income, deductions and tax liabilities for both this year and next. Then you and your tax advisor can look for opportunities to shift income and expenses between 2009 and 2010 to produce the best tax result. (For a few business tips, see “Mind your own business”.) •