2011 Newsletter for individuals
(Revised November 2011 )

 Compromise of debt  - is it taxable?

If you compromise a debt for less than the face amount, you recognize a type of income generally called "discharge of indebtedness".  Unless there is a specific statutory exception, this income is subject to Federal income tax.  

If you were involved with a "short sale" or a mortgage foreclosure on your principal residence,  you will probably have inocme "due to dischange of indebtedness".  Prior law (through 2009) contained an exclusion of any income from a discharge of debt involving certain types of mortgage debt, 2007 through the end of 2009.  Compromising a credit card debt will alos result in income from "discharge of indebtedness".  If you were able to settle a credit card balance for less than the total balance, you will be receiving a Form 1099 for the amount of the balance that was discharged.   Unless an exception applies, the “discharge of indebtedness” will have to be picked up as taxable type income on your tax return.  If you ignore the Form 1099 that you receive, eventually you will get a bill from the IRS for back taxes, penalties, and interest.

There are a number of exception that mitigate or totally eliminate the amount of taxable income. One of the primary exceptions involves the insolvency exception of IRC Code Section 108.  The actual rules are complicated.  In simple terms, a comparison is made of the extent of your net worth (or lack of it) both before and after the debt compromise.  If you are still not solvent (the fair market value of your assets exceeds the remaining liabilities)  after the debt compromise, the discharge of indebtedness does not have to be included in your income on your tax return.

If you receive a Form 1099 concerning discharge of indebtedness,   you need to talk to your tax professional or you can contact us at (708) 647-1045.  

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Refunds are bad, breaking even is much better

Many employees claim either zero or one allowance on the W-4 turned into their employer, and you may be one of them.  The lower number of allowances will result in more withholdings and probably a larger refund on your tax return.  Most likely you could claim more allowances  based upon the exemptions for children, itemizing, and other factors on your Federal tax return. The reasoning behind claiming either zero or one is usually not wanting to owe any taxes or not being a good saver through out the year.  In this case, I would classify you as a “0/1 allowance filer”.  

A larger refund may feel good, once you have actually received it. However, you could have had the funds this year in the form of higher take home pay.  More than timing is involved. If you are paying monthly finance charges on credit card balances, you are in effect loaning your refund to the government interest free and borrowing the funds from the credit card companies paying interest rates as high as 22%.  If you received your refund now in your paychecks (through lower withholding), you could possibly pay off your credit card charges each month or at least pay down your credit card balances faster and reduce your finance charges.

Furthermore, by reducing your withholding,  you could be building up a savings account for an emergency.  Current economic conditions are challenging.  Many persons feel that job security has disappeared with the new century.  If  you get laid off (or even worse lose your job), a savings account in hand is far more valuable than waiting for your tax refund .........in the following year.

Raising your allowances on your W-4 will probably not help much, this year.  Since 2011 is almost over, the additional allowances will affect your future paychecks.  Changing your withholding allowances now, will affect all of next year’s withholding. I suggest that you deposit the additional take home pay into your savings account.  You can arrange with your employer to have the take home pay increase automatically deposited into your savings account on each payday. You could also set up your own savings account and make your own deposits.  Once you open your savings account and get started, the routine should become almost automatic.

If you are a “0/1 allowance filer” and you claim children as exemptions on your tax return, you will probably saw even bigger tax refunds on your 2000 and 2010 Federal tax returns filed in 2010 and 2011.  If you claimed higher exeptions at work, your take home pay would have been higher due to less  income tax being withheld.  You could have used the additional funds to pay down high interest credit card debt.  Also, when you do finally file your tax returns next year, your Federal and state could be delayed.  For Illinois refunds, there could be a very long delay.

Recent developments, and their effect on withholding, are discussed next.

Federal withholding

There were several changes over the last few years that will probably result in lower Federal income taxes for you.  The lower income taxes will result in a larger refund and the need for less withholding. Two of the changes in particular could affect your withholding.
 

• The child tax credit  for a child dependent under the age of 17 at year end is $1,000.  This credit will probably be extended into future years.
  

• The standard deduction has become fairly generous.  For example, for 2011,  the standard deduction for joint returns will be $11,400. For  head of household filers, the 2011 standard deduction will be $8,400 respectively.  For other filers, the 2011 standard deduction will be $5,700.  For 2012, the standard deduction will be almost $2,000 higher for married filers who are age 65 or older.

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 Illinois income tax withholding (Indiana too)

I suggest that you pay more attention to your Illinois withholding.  The news media is full of articles concerning the financial problems the state is facing.  Possibly, individuals expecting large Illinois income tax retunds next year may get a letter from the state similar to the one I recently received on one of my business clients.  To read this letter, press here.

Illinois tax refunds often exceed $1,000 due to two credits.   If your principal residence is in Illinois, you receive a 5% tax credit of the real estate taxes you pay against your Illinois income taxes.  Also, Illinois allows for a tuition credit of up to $500 per return.  This credit applies primarily to  grammar and high school expenses for tuition and fees.  Both of these credits will reduce your Illinois taxes and probably increase your refund.   However, many persons do not take these credits into consideration when they fill out their Illinois W-4 withholding form.

In late 2005, Illinois revised the interest rates for both assessments and refunds for periods starting next year. Unless overall interest rates rise dramatically, the interest rate for Illinois refunds on 2011 and 2012 returns will probably be only 2% to 3%.  Also, based up late 2009 correspondence, you could be waiting a long time for your Illinois refund next year; click here. If you mail your Illinois tax return to the state instead of using electronic filing, you will probably experience a very long delay on receiving your refund.  Based upon past history, the state does not start processing mailed in tax returns until the spring or summer. If you choose electronic filing, you will probably get your refund in less than two weeks. Over the last few years, Illinois tax refunds were very prompt on tax returns filed electronically.  Hopefully, this performance will continue.

The real estate and tuition tax credits I discussed above could be treated the same as additional exemptions for purposes of withholding allowances on your Illinois W-4.  While an increase of your withholding allowances on your Illinois W-4 won’t have much effect for this year,  it could dramatically change next year’s income tax withholding.  

Risk of penalties

There are risks of penalties and interest if you claim too many allowances on your Federal or Illinois W-4.  You could even end up owing taxes you can’t afford.  However, if you deposit the increase in your take home pay (through lower withholding)  into a savings account,  you should not have any problem paying any taxes due. The likelihood of owing any significant  taxes is very remote.  If this is one of your concerns, you can go halfway. The following is an example:

Owing taxes at year-end does not mean that you will automatically be subjected to underpayment penalties. There are a number of exceptions to the underpayment penalties.  Press here for this topic.

If you are interested in reducing your withholding, you should contact your tax advisor before making any changes to your withholding.  If you are one of my clients, I will review your withholding when you come in for tax preparation.  If you wish to use my W-4 calculators now, you can discuss the results with me by calling me at 708-647-1045.

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Charitable contributions over specific amounts are not deductible unless strict substantiation requirements are met.  For yours 2011 Federal tax return, the IRS requires some type of written proof of all  charitable contributions.  

All charitable contributions - regardless of the amount

For all contributions, you will need some type of external written document proving that you made this contribution.  An estimate or self made diary can no longer be used as evidence to support a charitable deduction.  The external proof could be your cancelled check or a written receipt from the charity.   

For example, cash donations dropped into the Salvation Army kettles at Christmas time, cannot be deducted since no receipts are given.  The same result applies to anonymous cash donations dropped into the basket at church services.

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Any single charitable contributions - $250 or more

For any single contributions that is over $250, you will also need a written statement  from the charity stating that you did not receive anything of commercial value.   For a copy of a form that can be used for this purpose, press here.

If you make charitable contributions through payroll deductions at work, total annual contributions of $250 or more (even if each payroll deduction is less that $250) will need the written statement discussed above. (IRS Notice 2006-110)

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Non-cash contribution exceeding $500

If you take a deduction for more than $500 on your tax return for non-cash contributions, your reporting requirements increase.  In addition to the above requirements, you will have to attach to your Federal income tax return Form 8283, Non-Cash Contributions.  On this form, you need to provide details including a description of the items contributed and the method of valuation used.

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Donations of autos, boats, and (ofcourse) airplanes 

If you are planning on donating a car (boat or airplane) to a charity, don't expect any large tax deduction regardless of the radio and TV advertisements.  The rules for claiming deductions for vehicle donations was severely tightened starting with 2005 tax returns.   In most cases, your tax deduction will be limited to the actual selling price received by the charity when it sold your donation.  These new rules affecting vehicle donations also apply to boats and airplanes.  To read about the post 2004 rules on vehicle donations press here.  If you are planning on taking a tax deduction of $500 or more, concerning  a donation of a vehicle, boat or airplane, you will need to attach to  your income tax return the Form 1098-C sent to you by the charity.  For a copy of Form 1098-C, press here.

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Non-cash contribution exceeding $5,000

For any contribution of property exceeding $5,000 you will probably need an appraisal from a qualified appraiser.  If you are planning (or have already donated) property with a value that exceeds $5,000, you need to talk to your tax advisor.  Donations of marketable securities (securities traded on national exchanges) are exempt from this requirement.

If you are one of our clients, call one of us at  (708) 647-1045.

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Does this look like the toaster in your basement?

The time is now to clean out your closets, basement, and garage of unneeded clothing and household items.

Take all of these goodies down to Goodwill, Salvation Army, Amvets, or a local resale shop run by a charity. Also, many charities will come to your home and pick up the items.

If you itemize your deductions on your federal income tax return, those donations can be real tax dollar savers. The fair market value of the donated items should qualify for a charitable deduction.

To help you determine the value of your non-cash donations for your tax return, here are some helpful hints:

1. Make a list of the donated property, being sure to make a separate detailed list for each bag or box of items that is donated.

2. At the top of this list, write the name and address of the charity along with the date the donation was made.

3. Lastly, divide your list into several columns as completely and as accurately as possible

I suggest that the columns in your list include the following information:

1. description of item

2. quantity (number of shirts, slacks, sweaters, etc)

3. approximate purchase date and cost

4. condition of item (e.g.. new or good). If the item is in poor condition, throw it away.  The used item must be in good condition or better for a tax deduction

5. resale shop value (there is a lot more on this later)

Finally, get a letter from the charity acknowledging your charitable contribution.  If you plan on taking a tax deduction of $250 or more, you need to get a letter from the charity that states that you did not receive anything of commercial value from the charity. For a form letter that meets the IRS requirements, press here.  If you plan on taking a tax deduction exceeding $5,000, you may need a written appraisal. You need to talk to your tax professional or if you are one of my clients, either call me or send me a secure email by pressing here.

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If you itemize, make your charitable contributions in the form of publicly traded stock that has gone up in value instead of contributing cash.

a) As long as you held the stock for more than twelve months, you can take a charitable deduction for the stock's fair market value on the date of the gift.

b) You also escape paying any income tax on the paper gain

The only disadvantage with gifts of stock are the service charges in splitting up the stock.

Never use stocks that have gone down in value for charitable contributions. Your tax deduction will be limited to the smaller fair market value, and you will not get any tax deduction for the drop in the stock's value. If the value of the gift is over $250, you need to obtain a letter from the charity. This letter must acknowledge your contribution and that you did not receive anything in return that has any commercial value. For an example of this letter, press here

If you plan on making any large non-cash contributions (whether the donated items are stock or other assets) talk to your tax advisor.  If you are one of my clients, press here for secure email.

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If your current income is much higher due to a non-recurring item (e.g.. a ROTH IRA conversion), you could benefit from compressing the next 2 to 5 (or even 10) years worth of contributions into the current year. With the higher income comes higher tax brackets. The deductible contribution this year will produce higher tax savings. The deductions reduce the amount of income subject to tax at the highest tax brackets. When your income drops back to the normal levels, your marginal tax bracket will be lower. Therefore, the same contribution will produce lower benefits, because the tax bracket is lower.

Loading up in one year on charitable contributions has a major drawback. Once you make the contribution, you generally lose control over how the funds are spent. One solution to the problem is to set up a private foundation. This solution works when you are considering contributions exceeding $100,000. The major drawback to setting up a private foundation is the cost, which starts at $2,500.

Enter a second solution (with a much lower cost) -- the "donor advised" fund. A "donor advised" fund is a charitable trust that is generally operated by a mutual fund or a charity. First, your charitable contribution to the fund is tax deductible. Second, you are able to keep control over future charitable contributions. Third, your contribution continues to earn investment income tax-free until all of the funds are distributed. The fund holds and invests your charitable contribution. Furthermore, the fund makes charitable contributions (upon your direction) after verifying that the recipient qualifies as a charity.

You can use appreciated publicly traded stock as your charitable contribution to a "donor advised" fund. As long as the stock was held for over one year, you should receive a tax deduction for the stock's fair market value.

There are a number of investment houses (e.g.. Charles Schwab, Fidelity and Vanguard) that have "donor advised" funds. The initial minimum contribution to their funds ranges from $5,000 to $25,000. Annual fees are low; some of them are less than 1% of total assets.

If this topic interest you, talk to your tax advisor. If you are one of our clients,call us at (708) 647-1045 .

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Now is the time to compare your estimated 2011 Federal and state tax liabilities to your credits for withholding and any estimated tax payments made for this year.  There are usually 3 possible scenarios:

• You will either get a small refund or you will owe a small balance.

• You expect to receive a large refund.

• You will have a large tax balance (say over $500).

Getting a small refund or owing a small balance
is probably  the best situation to be in.

Over withholding to get a large tax refund is rarely recommended.  You could have had the funds in your paycheck all year, if your withholdings were less.  Also, if you are expecting a large state income tax refund, you could experience a very long delay.  Over withholding is discussed in more detail in another section; press here  to go to that topic now.

Owing a large tax balance could have some serious financial consequences.  However, assuming that you have the funds available to pay this balance, the only disadvantage is the underpayment penalties. Generally, you could be subject to both Federal and State underpayment penalties.  The actual rules are very complicated and beyond the scope of this page. The following discussion is a very simplified version of the rules.

In computing the underpayment penalties, the year is broken down into 4 quarters, which represents three months. The withholding and estimated tax payments for each quarter are compared to the prorated tax liability of each quarter.  If the quarter's tax payments are less than 90% of the prorated tax liability for the quarter,  you are subject to a potential underpayment penalty. For year 2011, the Federal underpayment penalty approximates a simple interest rate of 5.5%. The Illinois underpayment penalty ranges from 15% down to 2%, depending upon the time period involved.  Illinois also imposes a minimum $150 late payment penalty in certain circumstances.

Assuming that your tax return indicates a balance due does not mean that you will be assessed underpayment penalties.  There are a number of exceptions to avoiding these penalties.  If you meet the requirements of any of these exceptions, you will not be liable for an estimated tax penalty.  Furthermore, the exceptions are applied to each quarter.  Therefore, if you may not meet any of the exceptions for a particular quarter, you could use one of the exceptions for the other quarters. These exceptions are the following:

The threshold exception

There is no Federal underpayment penalty, if you owe less than $1,000.  The Illinois and Indiana thresholds are $500 and $400 respectively.

90% exception

There is no Federal underpayment penalty, if the withholding and estimated tax payments are at least 90% of the current year's tax liability.

Illinois and Indiana follow the same rule.

This exception is applied on a quarterly basis.  For example, for the first quarter (January through March 31st) ,  the taxes are annualized based upon the actual income and deductions for the quarter.  The amount equal to 22.5% or the the annualized taxes is compared to the following  amount, the sum of:

• the estimated tax payments made by April 15th (the due date for the first quarter's estimate) plus
  

• 25% of the total for income tax withholding during the frist 3 months

For the second quarter 45% of the annualized taxes (baased upon the first 6 months of actual income and deductions) is compared to the following amount, the sum of:

• the sum of the estimated tax payments made by June 15th (the due date for the 2nd quarter's estimate) plus
  

• 50% of the total for income tax withholding during the frst 6 months

The third and fourth quarters use the same formula substituting the longer timespan.

If you believe that this tax could affect you, you need to talk to your tax professional.  Clients can contact me at (708) 647-1045.  

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Last year's tax exception

There is no Federal underpayment penalty, if withholding and estimated tax payments equal to or exceed the tax liability on last year's tax return.  This exception also applies to Illinois and Indiana returns;  assuming that resident or non-resident returns were filed for both years.

This exception is computed on a quarterly bases.  Similar to the 90% test discussed above, for the second, third and fourth quarters, the test is applied to the aggregate tax liability (based upon last year's tax) and the withholding and estimated tax payments from the beginning of the year to the end of the quarter being tested.  Year end estimated tax payments do not count for earlier quarters.

There are two special rules involved with "last year's exception":

1. If your 2011 income was more than $150,000 ($75,000 for married filing separately status), your witthholding and estimated tax payments on a quarterly basis need to exceed 110% of your 2010 tax. The same rules will apply to estimates for 2012.
    

2. If you own a small business, and more than half llast year's total income is from that business, and lasst year's total income does not exceed $500,000, you only need to pay in (through quarterly withholding and estimated tax payments) 90% of last year's tax.
    

Illinois has a special rule for individuals who are relying on "last year's tax" to avoid an estimted tax penalty on their Illinios individual income tax return.  Press here to go to this discussion.

If you believe that this tax could affect you, you need to talk to your tax professional.  Clients can contact me at (708) 647-1045.  

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Annualized exception

There is no Federal underpayment penalty, if your withholding and estimated tax payments through the end of the quarter are at least 90% of your actual tax liability through the quarter.  This exception is complicated and beyond the scope of this webpage.   

Generally, this exception is useful when income and deductions fluctuate during the year.   For example, large dividend distributions from mutual funds could be the cause of your tax liability.   Mutual fund distributions usually occur (for tax purposes) in the month of December.   If your tax liability is due to your mutual fund income, an estimated tax payment in the fourth quarter could eliminate any penalty.  For the prior three quarters, the penalty would probably be eliminated using this "annualized exception.

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Fourth quarter state estimated tax payments

If you need to make a fourth quarter estimated payment to the state, you may want to make it before the end of the year, even though the 4^th quarter installment is due in January of the following year. Making the payment this year will result in a deduction on your 2011 Federal tax return, assuming that you itemize deductions.  If you are not planning on itemizing this year, you should defer payment of the 4^th quarter estimated tax payment until next year. Your tax situation may change next year, and itemizing (along with the additional state income tax deduction) may be beneficial. Finally, if you could be subject to the "alternative minimum tax", you need to contact your tax advisor. Press here for a discussion of this topic.

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Special rule for Illinois estimated tax payments

For year 2011 estimated tax penalties on Illinois individual income tax returns,  the prior year's tax exception has been modified.   To use this exception, you need to recompute your "prior year's tax" using a 5% tax rate, instead of the 3% tax rate that was in effect for
2010.  

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-Look at investments that lower taxes 

Except where noted, the following rules involve Federal income taxes, not state income taxes.

Equity investments

There are two general classes of equity investments, dividend paying stock and growth stocks, that historically pay little or no dividend.  Both types of equity investments have strong tax advantages.

Starting with year 2003, dividends from publicly traded  corporations have been taxed at the same tax rates as long term capital gains. Therefore, if your marginal tax bracket exceeds 15% (e.g. 28%), the tax rate on your qualifying dividend income for this year will be 15%. If your marginal tax bracket for the year is 15% or less, the tax rate on your qualifying dividend income for the year will be only 5%.  These tax rates were extended through year 2012.  The term "marginal tax bracket" is the highest tax rate that any part of your income is taxed on.  For example if you are a single filer and your 2011 taxable income is $83,601,  $1 is taxed at the 28% bracket (your "marginal tax bracket").  The remaining taxable income is tax at the lower 10%, 15% and 25%  tax brackets. 

You may be getting an unpleasant surprise if your dividend paying stocks are held in a margin brokerage account.  All or part of your dividend income may not qualify for the lower tax rates. In many margin accounts, the stock is not actually owned by the account holder.  Instead, the brokerage firm "loans" the stock to the account holder.  In that situation, the dividend income credited to your margin account actually belongs to a different person.  The special lower dividend tax rates only apply to stock actually owned by the account holder.

Equity investments and municipal securities have a major non-tax drawback. They can and many times do go down in value.  A good example was the market reaction to Italy's financial problems.   If you are retired or near retirement, I feel that you should be concentrating on keeping your capital or net worth intact.   In that situation, low yielding savings accounts or short term FDIC insured CDs may be your best option.  The interest rates are terribly low right now, but you won't lose your principal.

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Series E bonds

Series E bonds have a number of tax advantages. The interest on Series E bonds is generally taxable in the year that the bonds are redeemed rather than in the years earned.  When the bonds are ultimately cashed in, the interest is exempt state income taxes also.  

Series E bonds may be attractive to you if you are retired, receiving security benefits, and part of your social security benefits are being taxed. You could live off of the principal of your other investments while the Series E bonds build up interest, free of any current tax. Eventually, the Series E bonds will become part of your estate, and subject to possibly lower taxes when the bonds are redeemed.

Series E bonds are suitable, if you are saving for your child's college education. You can buy the bonds in your child's name rather than yours. When your child redeems the bonds, the interest income will be taxed. However, your child will probably be in a lower tax bracket than you.  Unfortunately, buying the bonds in your child's name (rather than your name) may be counter productive if he or she applies for college financial aid. 

Finally, in some cases Series E bond interest in exempt from Federal tax if a family member has tuition expenses for year.  For information on this topic, press here.

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Tax deferred annuities

Tax deferred annuities also offer tax advantages. Unfortunately, many times the commissions and other load charges outweigh their tax advantages. Many times, the brokers touting this type of product are more interested in their financial future than in your financial future.  You need to ask the broker for an analysis of expected yields after taking into account all commissions and other load charges.  If the broker is unwilling to give you this information, go someplace else.

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 Municipal bonds

Municipal bond interest is generally totally exempt from Federal income taxation.  I generally do not recommend investments in municipal bonds.  This is because yields, credit quality and maturities of your municipal bonds are generally related.  Therefore, the better the interest rate, either the longer the maturity and/or the lower the credit worthiness of the borrower.  If interest rates in general go up or the borrower runs into financial problems, you will lose money on your municipal securities.  Additionally, municipal bond interest is usually subject to state income taxes.

Before making any major changes in your investments you should consult with an investment counselor that you trust such as a certified financial planner or your CPA.  Also,  be extra cautions when you follow the advice of  financial advisors who work on a commission basis. They may be making recommendations based upon the potential commissions they will earn,  if you buy.  They may be more interested in their retirement,  than your  retirement.  Nme I sell stocks, securities, insurance,  or receive commissions.

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Many mutual funds distribute all of their annual investment income and trading gains during either November or December of each year, even though the gains and investment income were earned throughout the entire year. If you buy the mutual fund late in the year, you will become the owner of record for purposes of the entire year's dividend and capital gains distributions.

Even though your tax return income will increase due to these year end distributions, your economic income won't change (other than the additional taxes you will pay). Generally, the mutual fund's value will decrease an amount equal to the dividend payout. Disregarding any other market fluctuation, you would probably end up with the same number of shares if you purchased the shares the day after the "dividend date". The dividend date is the date used to determine "owner of record" for purposes of the year end dividend distributions.

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Don't count on Social Security; it may be "broke" when you retire. Maximum contributions to your traditional IRA make sense even if you or your spouse are covered by an employer retirement plan, and you are not entitled to any deduction for the contribution.

First, the income accumulation is free from all income taxes until you receive the income in the form of IRA distributions. Second, if the contribution is deductible, Uncle Sam is in effect subsidizing part of your contribution in the form of the tax savings from the contribution.

The ROTH IRA

You have a choice of contributing to a traditional IRA or a ROTH IRA. If you are able to contribute to a ROTH IRA instead of a traditional IRA, your contributions will not be deductible. However, there could be a real rainbow when you start taking distributions. All of your distributions could be totally tax-free.

ROTH IRAs are not available to everyone. Above certain income levels ROTH IRA contributions are either only partially allowed or not allowed at all. A comparison of income levels for year 20110 and 2012 are listed below:
 

ROTH IRA CONTRIBUTIONS are not allowed if your income exceeds the above described upper ranges. If your income falls within the above described income ranges, the allowable contribution into a ROTH IRA has to be reduced by twenty-five cents for each dollar that your income exceeds the beginning of the income levels. If your 2011 income exceeds the above described income levels, no contribution to a ROTH IRA is allowed.  

Regardless of how high your income is for year 2011, you can still contribute to a traditional IRA (assuming that you have some earned income).  Starting with 2010, you can convert your traditional IRA to a ROTH IRA, regardless of your income.  Prior to 2010, you could not generally convert a traditional IRA into a ROTH IRA if your income exceeded $100,000,

The ROTH IRA conversion rules are very complex, and beyond the scope of this webpage.  While it appears that you can contribute to a traditional IRA (no income limitation) and then immediately convert the traditional IRA into a ROTH IRA.  However, if you have other traditional IRAs, there could be a significant amount of income recognized.  The rules are complicated; you will need to discuss this topic with your tax advisor.

In one situation, a Roth IRA contribution may be the only one allowed.  If you or your spouse is over 70½ years old at year end, the only IRA contribution allowed is a ROTH IRA contribution.

For more information on the ROTH IRA, press here.  

MAXIMUM ANNUAL CONTRIBUTIONS

In general, you can contribute a maximum of $5,000 into an IRA for the year 2011. If you are married and you file a joint income tax return, you can also contribute up to $5,000 for your spouse (even if he or she has no earnings).  Also, if you are at least 50 years old at year-end, you are entitled to a maximum contribution of $6,000. The same rule applies to your spouse with no earnings for the year, assuming that you are married and you file a joint tax return However, the total IRA contributions for both you and your spouse cannot exceed your combined earnings.

Finally, on your 2011 return you may be able to take a credit of up to $1,000 against your taxes by claiming a "saver's credit".  If you are married filing a joint tax return, the "saver's credit" could be as high as $2,000.  Press here for information on the saver's credit.

Your 2011 IRA contribution will be due by April 16, 2012 .  However, the earlier you make your 2010 IRA contribution,  the longer the funds will be working to earn you tax deferred income (or in the ROTH IRA's case, tax-free).  If you have college-bound children, and you plan on applying for financial aid, you may want to make your IRA contributions earlier. 

Also, starting on January 1, 2012 you can also fund your 2012  IRA.   The sooner you fund your IRA in the year, the sooner the funds will start earning tax deferred earnings. The maximum contributions for 2012 are the same as for 2011 discussed above.

Many financial institutions assess a service charge for setting up IRAs and other retirement plans and are not particularly customer friendly on explaining the available options. These institutions should be avoided.

If you believe that this topic  could affect you, you need to talk to your tax professional.  Clients can contact me at (708) 647-1045.  

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Stock losses are subject to the capital loss rules. These rules limit such losses to a maximum of $3,000 against other income. However, if you don't sell the stock, the loss is never deductible.  Also, your capital loss deduction can offset your income which is subject to regular tax rates.  For example, if you are in a 28% tax bracket, a $3,000 capital loss deduction could save you more than $900 taking into consideration your tax savings on your Federal and state income tax returns.

With the new lower capital gains tax rates, segregating gains and losses into separate years can result in significant tax savings.  For example, if stocks with offsetting long term capital gains and losses are sold in the same year, the maximum tax savings is only 15%.  The 15% rate is the maximum tax rate on long term capital gains. If your marginal tax rate is lower than 15%, the tax savings rate goes down to only 5%.  However, if the losses are all sold in one year, up to $3,000 of the losses are deducted at your higher marginal tax rate.

Finally, if you feel that the particular stock has long term value, consider selling the stock by year-end, waiting at least 30 days, and then buying it back. Based upon the circumstances, the tax savings may outweigh the double commissions.

For a detailed discussion of the capital gains rules, press here.

If you believe that this topic could affect you, you need to talk to your tax professional.  Clients can contact me at (708) 647-1045.  

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If you are married, both spouses work, and either of you incur employee business expenses; you should be looking at the tax filing status of married filing separately. Employee business expenses that are not reimbursed are included in a category of deductions called "miscellaneous deductions". The "miscellaneous deductions" are subject to a 2% exclusion based on income. In general, the tax deductions that are allowed for this category of expenses must be reduced by 2% of your total income. By filing separate tax returns, the total income is smaller since the other spouse's income is excluded. Therefore, the 2% exclusion is smaller.

If it looks like filing separate returns may be beneficial, the spouse with the employee business expenses should consider paying any unpaid employee expenses, before year end. This spouse should also pay out of his or her own funds other expenses that qualify as "miscellaneous deductions"; such as investment publications and safe deposit boxes. Many times, education courses also qualify for the "miscellaneous deduction" category. Job seeking expenses also qualify.

Another reason to consider the filing status of married filing separately is the new "savers credit".  Press here for information on this topic.

Getting married before year-end could cost you more in taxes.  If you are a client, call me and I will go through the computations with you. Possibly, you could hold off on the marriage plans until the first of next year.  Finally, if you are a single parent with children who are college bound, getting married could adversely affect college financial aid.  If you are a client and you have college-bound children, you need to talk to us or your financial advisor.

If you believe that this topic could affect you, you need to talk to your tax professional.  Clients can contact me at (708) 647-1045.

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For 2012, the standard deductions will be much more generous than the rates for 2011, expecially for married couples who are both over age 65.  However, for year 2011, the standard deductions will be a little higher than the rates for 2010. The reason for the big change from 2011 compared to 2012 has to do with the methodology used.    The following table compares the standard deductions for 2010 through 2011.

There are also additional additional standard deductions for both blindness and being age 65 or older.  For 2011 tax returns, this additional standard deduction (for being 65 or older or blindness) will be $1,150 for each qualifying spouse.  For 2012, this additioanl standard deduction goes up to $1,450.  If you are both legally blind and over age 65 by year end, the additional exclusion doubles.

In most cases, itemized deductions include: state and local income and real estate taxes (less the amount discussed above) , mortgage interest on your residence, charitable contributions, and in some cases medical expenses and items such as un-reimbursed employee business expenses, tax preparation costs, and investment expenses. In many cases, The tax rules governing itemized deductions are very complex and are beyond the scope of this discussion. In most cases, if you do not own a residence that has a mortgage, you will be better off taking the standard deduction. There are exceptions including situations involving large deductions for medical expenses, charitable contributions, and employee business expenses.

Assuming that nobody else can claim you, you can elect to take the standard deduction instead of itemizing; taking the standard deduction is more beneficial. If someone else can claim you, you have to itemize. Also, each year stands on its own. Therefore, you can take a standard deduction in one year and then switch to itemizing the following year.

If your itemized deductions are close to the amount you could claim for a standard deduction, consider accelerating itemized deductions into this year.  By accelerating itemized deductions into 2011, you can save taxes now by itemizing. On your 2012 return, you can always take a standard deduction.    Also,  there is a strong possibility that the future tax legislation may eliminate all of the itemized deductions other than charitable contributions and the mortgage interest deduction. Taking (or not taking) a standard deduction is not affected by your choice in an earlier year.

For example, pay some of the charitable contributions you would normally make next year, this year.  Second, assuming that you own a home in either Will or Cook County, you can pay your first installment of next year's real estate tax payment, this year. Your first installment for next year is equal to 50% of the current year's taxes.  This recommendation assumes that you will not be subject to alternative minimum tax;  press here  for a discussion of this topic.

Finally, you may want to look at filing separate returns if you are married, both spouses work, and one spouse incurs employee business expenses and the other spouse does not. Employee business expenses are treated as "miscellaneous deductions" that are subject to a 2% exclusion based on income. There may also be an additional benefit to take a filing status of married filing separately. One of those benefits is the opportunity to take advantage of the "saver's credit". Press here  for information on the "saver's credit".  If you are one of my clients and you meet this criteria, you need to see me before the end of the year for tax planning; there is no charge for this service.

If it looks like filing separate returns may be beneficial, press here.

If you believe that this topic could affect you, you need to talk to your tax professional.  Clients can contact me at (708) 647-1045.  

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Before January 1, 1998, Illinois and Indiana had a reciprocity agreement whereby cross-border residents working in the other state filed only one state income tax return with their resident state. The cross border resident could treat the out of state withholding the same as resident income tax withholding. Illinois residents working in Indiana were not subject to Indiana tax; they were only subject to Illinois tax. Also, they could treat the Indiana withholding as Illinois income tax withholding. The opposite rule applied to Indiana residents working in Illinois. This was how the rule worked until Illinois terminated the reciprocity agreement with Indiana. For 2003, there was still no reciprocity agreement worked out between the two states.

Expect another tax preparation nightmare, if during 2011 you lived in Illinois and worked in Indiana (or vice versa). You will have to prepare both Illinois and Indiana income tax returns.

If you gamble across the border, you are going to lose even if you win.  You will probably have to file multiple state income tax returns.  Both Indiana and Illinois share with the IRS the gambling winnings reported on the W-2G forms.  Also, both states require withholding on winnings as low as $600.  Indiana, in particular, has been very active in taxing Illinois residents on their Indiana gambling winnings.  

For more information on this topic, press here.

While both states are taxing the same income, the resident state will give you a credit for the taxes paid to the non-resident state where you worked. The net result will be two tax returns taxing the same income; however, the resident state gives you at least a partial credit for the income taxes imposed by the other state. Each state has different rules on how the tax credit is computed.

If you work in Illinois and live in Indiana and your only income are your Illinois  wages, you will be paying more in taxes than if the same wages were earned in Indiana.  The Illinois tax rate is higher, 5% versus 3.2% for Indiana.  

What about 2012?  It does not look any more promising than last year. Visit our website periodically for updates on this topic.

If you believe that this topic could affect you, you need to talk to your tax professional.  Clients can contact me at (708) 647-1045.

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See me before year end

Make an appointment with me for your year-end tax planning. You will probably save on your taxes next year. There is never a charge, if we prepared your previous year's tax return.

For an appointment, call us at (708) 647-1045.  Either you will immediately talk to a live person, or you will get a message that we are closed or busy with other clients.  If the latter occurs, you will get a prompt call back.  

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Charity and the Older Taxpayer

If you are at least 70 1/2 years old and you have funds in a retirement account, you are most likely subject to the "Required Minimum Distribution Rules".  These complex rules require distributions based up either a single or joint life expectancy.  For more information on these rules, press here.

If you need to take a "Required Minimum Distribution" (RMD) from your IRA this year (2011) and you plan on making year end charitable donations, direct your IRA trustee to cut the checks to the charities directly from your IRA instead of "presonally receiving the RMD.  

By directing the RMD to the charity, you do not have to include the payment to the charity in your gross income.  Effectively, you get an itemized deduction for the payment even if you take a standard deduction.  With the 2011 standard deduction being close to $14,000 for a joint return filers who are over 65; most likely this group will be taking a standard deduction on their income tax return. Finally, if you are a resident of a state that taxes IRA distributions, you will save on state income taxes.  

There is a lifetime limit of $100,000 of direct IRA donations.  Second,  the exclusion only applies to amounts required to be taken as "required miinimum distributions" .  Therefore,  if the amount was not required to be distributed (due to the RMD rules) the exclusion does not apply.

If you plan on making year end charitable donations, and you are subject to the "Required Minimum Distribution Rules; you can probably save on your 2011 taxes by directing your IRA trustee to make the contributions on your behalf.

If you believe that this topic could affect you, you need to talk to your tax professional.  Clients can contact me at (708) 647-1045.

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Residential Energy Property Credits may be ending this year

Back in 2006 and 2007, there was a 10% credit for purchases of certain types of energy efficient products to be used in your primary residence.  This credit was equal to 10% of the cost, and there was a lifetime limit of $500.  This credit was not available for any purchases in 2008.

The energy credit was put back into law for years 2009 and 2010. Also, the credit was raised from 10% to 30% and the lifetime cap was raised to $1,500 from $500.   For year 2011, the energy credit was again extended but the the lifetime cap was rolled back down to $500.  

The following improvements are eligible for the 30% energy tax credit include the following:

•      insulation materials

•      exterior energy efficient windows (including skylights)

•      exterior insulated doors

•     qualified high efficient central air conditioners

•     energy efficient water heaters or furnaces

•     certain insulated metal roofs and

•     advanced high efficiency main air circulating fans.
   

If you are planning a purchase of eligible energy credit items to claim the credit (and you have not claimed already at least $500 of energy credits), want to claim the credit, you need to buy it this year, and also have it installed and operating by the end of the year.

If you believe that this topic could affect you, you need to talk to your tax professional.  Clients can contact me at (708) 647-1045.  

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ROTH IRA Conversions - the pros outweigh the cons

If you have a traditional IRA, year 2010 may be the best year to convert it to a ROTH IRA. There are a number of advantages of a ROTH IRA over a traditional IRA; the main ones are the following:

For a discussion of the advantages of ROTH IRAs, press here.

For a discussion of the rules concerning requried distributions by older individuals, press here.

The main drawback to a conversion of a traditional IRA to a ROTH IRA is the fact that the entire value of the IRA (less you after tax cost in the IRA) account has to be included on your Federal income tax return in the year of the conversion.   The term "after tax cost" refers to any contributions to IRAs that you did not deduct on your tax return,

Assuming that your IRA is composed of common stocks, the timing of a conversion of a traditional IRA into a ROTH IRA is usually a matter of luck. The best time to convert is when the IRA account value is the lowest.  If your IRA account composition mirrors the stock market, then the best date to convert is the date the stock market is at the lowest level of the year.  If I was able to predict this date, I would be retired living on a tropical island!  All you can do is give it your best shot.  

However, if the stock market takes a significant dip between now and year end, and you feel that the market will recover, that is probably the best time to convert your traditional IRA to a ROTH IRA. The lower the value of the traditional IRA, the less income to be included on your tax return, and a lover Federal income tax cost.

If your decision turns out to be a wise one (the value of the account goes up), the gain from the date the IRA was converted will generally be tax free.   

However if your decision turns out otherwise (the value of the IRA account keeps going down), you can essentially unwind the original conversion at no tax cost.  You have until the extended due date of your tax return to recharacterize the ROTH conversion back to a traditional IRA.

In some cases, distributions from 401K and other retirement plan distributions can be directly rolled into a ROTH IRA.  The tax consequences are similar to the rules for converting traditional IRAs to ROTH IRAs discussed above.   Also, you can convert a Simple IRA or a SEP-IRA to a ROTH IRA;  however, at least two years of participation in the plan is requried.

If you believe that this topic could affect you, you need to talk to your tax professional.  Clients can contact me at (708) 647-1045.  

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