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Why wait until 2010? Make smart tax moves now

By Walt Mozdzer, CFP®
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Much of the financial services industry is gearing up for Roth IRA conversions in 2010 because the income cap of $100,000 Modified Adjusted Gross Income (MAGI) on Roth IRA conversions is lifted. But before we look too far down the road, we may want to consider actions we can take this year to trim that tax bill.

Background

In order to keep the U.S. economy from slipping into a deep recession or even a depression, our lawmakers in Washington have spent unprecedented amounts of money on stimulus measures. As a result, this country faces the highest budget deficit since World War II. While proponents of the spending spree point to an avoidance of systemic failure across financial institutions and a further rise in unemployment and bankruptcies, lower spending and higher revenues are required to shrink the resulting deficit.

Looking a little further down the road, a reasonable person might conclude that tax hikes are inevitable to help close the gap between tax revenue and spending. Some moves that are likely include the following:

• States instituting tax hikes for both sales and income tax (many already have)
  
  
• Non-tax surcharges (such as a fine for not having health insurance) may become law
  
  
• Other tax breaks such as educators’ deduction, tuition and fees deduction, limits on farm loss deductions and the sales-tax deduction for new vehicles are set to go away
  
  
• Proposals for a Federal 4.5% surtax on the wealthiest taxpayers, a value-added tax, and others
  
  
• Federal income tax for the top brackets is scheduled to rise from 33% and 35% to 36% and 39.6%, respectively, in 2011. Capital gains will rise from 15% to 20%. These hikes could come sooner

What To Do:

Neutralizing Capital Gains Tax

If your investment adviser captured capital losses last year during the stock market turmoil, you may still have losses that went unused and were carried forward to future years. There is no expiration on the loss carry-forwards, but they do end when the investor dies. Given that the S&P 500 index has risen about 53% since the low point, by selling your appreciated securities this year you can use up those carried-over losses and repurchase the same securities right away at the higher cost basis. Remember that there is no 30-day waiting period to repurchase stocks after selling for a gain. This strategy does not work in an IRA or other retirement plan, but only for personal investment holdings.

Review your accounts for worthless securities, particularly stocks of companies that have filed for bankruptcy since the market meltdown in 2008-9. Names that come to mind are Lehman Brothers and Circuit City, among others. Worthless securities can be sold for a loss, but they need to be “wholly” worthless to claim the complete tax loss. The security must be deemed worthless (trading at $0) on December 31 to be claimed as truly worthless on a tax return. See IRS Publication 550 for more information.

For some taxpayers, paying taxes on gains now before tax rates increase may make sense. For example, if you know you are going to sell appreciated property in the next year or so, and you suspect the capital gains tax could rise, taking the gain in 2009 at current rates might be a good move, especially if you’re considering a large transaction.

Even better, taking the capital gain on appreciated property and offsetting the tax with a donation of some of the property or proceeds to a charity could end up producing a zero-tax outcome, while simultaneously satisfying a desire to give back to the community.

If you have purchased stock options in the form of calls or puts and those options expired worthless, you can declare the cost of those options as a capital loss to offset other capital gains. Admittedly, this is not a common strategy for most casual investors.

IRA Moves

If you make less than $100,000 MAGI, you could convert all or part of a traditional IRA to a Roth IRA in 2009. If you consider the possibility of higher ordinary tax rates next year, it might make sense to convert this year. Higher income earners can still convert in 2010 and even spread the resulting tax liability over 2011 and 2012. Roth conversions in 2009 do not have the same ability to spread the tax over two years.

Here are a few more thoughts on IRAs:

• Note: Income restrictions for new contributions have not been lifted for Roth IRAs, only the conversion income limit for 201 will be lifted
  
  
• Small-balance IRAs are good prospects for conversion — the tax bite is small
  
  
• Don’t forget IRA catch-up contributions; $1,000 more for those turning 50 or older in 2009; for 401k participants the catch-up amount is $5,500

Defer Income

For small businesses, self-employed individuals, landlords and farmers, any time you can defer income into next year and/or accelerate expenses into the current year, it’s a tax-lowering strategy. For example, deferring billing at year-end will result in more income being received and taxed in the following year. Also, year-end bonuses might be able to be deferred into 2010 depending on the organization’s legal structure and accounting method. Check with your tax preparer for advice specific to your situation.

Of course, there are also actions available after the year end and before the tax filing deadline, such as funding traditional IRAs and reducing taxable income, but a web of rules apply as to whether such contributions are tax deductible. In the end, one of your best tax moves could very well be to hire a professional adviser to guide you towards a well-deserved strong finish.

Walt Mozdzer, CFP® is a shareholder at Syverson Strege & Company and prepares comprehensive financial and investment plans on a fee-only basis. He is a member of The National Association of Personal Financial Advisors (NAPFA) and The Financial Planning Association (FPA). Walt works well with a wide variety of clients and has been spotlighted in a number of publications.

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