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Tax Planning Guide

It's about that time to do some serious year-end tax planning. We'll deal with your personal return first, then cover business planning.

Don't underestimate the importance of year-end planning. You can save big tax dollars by deferring or shifting income from one year to another. Next year is too late; even the end of December may be too late for some techniques.

Caution--Before taking any tax action, evaluate all the factors surrounding the decision. Don't risk an economic loss for a small tax saving. Even if you're in the highest bracket (figure federal and state), a $1 tax deduction won't save more than about 40 cents in taxes. That means a $100 expenditure will cost you $60 out of pocket; more if you're in a lower bracket.

Note--There have been a number of changes this year as a result of the American Recovery and Reinvestment Act. Some of these changes could result in significant tax savings.

Caution--There has been considerable talk of a hike in tax rates, most likely an added tax bracket at the top end, or, a surcharge on very high income taxpayers. State taxes could also rise for some taxpayers. If you're in the top bracket now, keep these possibilities in mind in your planning.

Other Strategies

Here's a list of other tax saving strategies.

If your estate is substantial consider making gifts to your children or other relatives to use your annual $13,000 exclusion. Better yet, pay medical or tuition bills of a relative directly. That will reduce your estate without cutting into the $13,000 annual exemption. The exclusion stays at $13,000 in 2010.
Analyze the spread between your tax rate and your children's. If they're in a lower bracket gifting appreciated assets to them and letting them sell them can save taxes. If you're in the 35% bracket and they're in the 10% bracket, you can save $250 on $1,000 of short-term gain. On long-term gain property the savings will be less, but could still be significant. Remember, though, if they're not age 18 (24 if a full-time student whose earned income does not exceed half of his or her support) by December 31, and they have unearned income of more than $1,700 it's taxed at your rate.
Make use of that same spread for interest and dividend income. Give your children income producing assets. Won't do much good this year, but will save taxes in the future. See the age rules above.
December 31 is the last day to take gains or losses.
Check your estimated tax payments. Refigure both state and federal taxes to make sure you've paid in enough to avoid a penalty. Generally, it makes sense to pay state taxes before the end of the year to get the deduction this year. If you're underpaid for federal purposes, have additional amounts withheld from your last paychecks. Withholdings are deemed to be spread throughout the year. That's a better approach than making a large estimated payment. It might allow you to avoid a penalty for underpayments earlier in the year.
Can a side business be attacked by the IRS as a hobby? You can generally avoid the hobby loss taint if the business produces profits in any 3 of 5 consecutive years. You might want to defer some expenses to another year if you're close in 2009.
If you incurred a casualty loss related to a Presidentially declared disaster this year, you may file an amended return and take the loss on last year's return.
Shareholder in S corporation? Partner in partnership? Member in an LLC? You can only deduct losses up to your basis. In an S corporation that's your equity investment plus any qualifying loans you made to the corporation, plus accumulated earnings, less distributions and losses. If you don't have enough basis to use the losses, you might want to make an equity investment or loan the corporation funds. You should also check your basis before making any distributions or receiving any loan repayments. In some situations these can generate taxable income. Note. Any unused losses can be carried forward to later years. For partners, many of the rules are similar, but more complicated. Check with your tax advisor. For help in computing your basis and for other information on these entities, see S Corporations, Partnerships, and LLCs--Basics, Misconceptions and Traps--Part I and Part II and our S Corporation Basis and Partnership Basis forms. Remember, losses can generally only be used to offset other income if you materially participate in the business.
Year-end is also a good time to check on your savings bonds. They mature in 30 years. After that time the interest stops accumulating and all past interest is immediately taxable. Chances are you've got some old bonds floating around somewhere.

Other Considerations

Deductible IRA rules. For 2009 you can make the maximum deductible IRA contribution even if both you and your spouse are covered by pension plans if your AGI is $89,000 (phaseout over this amount) or less. Single individuals can deduct the maximum if their AGI is $55,000 or less. Married with spouse covered by plan, you're not? The AGI threshold is $166,000.

You can still convert a regular IRA to a Roth. But remember, the conversion will be taxable. Conversion makes sense if you're in a low bracket this year (e.g., your S corporation or partnership had a bad year). For 2009 your AGI has to be $100,000 or less; for 2010 there is no limit. There are many tax implications. Talk to your advisor.

Collected unemployment? The first $2,400 of benefits is excludable for 2009.

Sales tax on motor vehicles. Chances are you've either read or heard about this. Whether you itemize or take the standard deduction, you can increase your deduction by the amount of sales tax on a motor vehicle. There are a number of points to keep in mind:

Only new vehicles qualify.
Sales tax on only the first $49,500 of purchase price qualifies.
Motor vehicle includes motorcycles and motor homes.
If your AGI is more than $250,000 (married, joint) or $125,000 (single), the deduction is phased out over a $10,000 spread.
You can claim the deduction on multiple vehicles (e.g., you and your spouse each purchase new cars).
The vehicle must have been purchased after February 16, 2009.
In states with no sales tax you can deduct document charges or vehicle taxes similar to sales tax.

Clearly, the deduction isn't worth that much, but, if you were going to buy a new car soon, you would save some taxes. For example, an 8% sales tax on a $30,000 vehicle would be $2,400 and result in a tax saving of $600 to someone in the 25% bracket.

Education credits. The Hope Scholarship Credit has been expanded and renamed the American Opportunity Tax Credit. The credit applies to the first four years of a student's college education and is equal to 100% of the first $2,000 of qualified tuition and 25% of the next $2,000 for a maximum of $2,500. Phaseout begins at $80,000 for a single individual and $160,000 for a married couple filing joint. single individual and $160,000 for a married couple filing joint. The credit can be claimed on tuition, fees, and course materials (e.g., books). The credit is available only in 2009 and 2010 for amounts paid in those years for academic instruction in those years. If you think you'll be above the phaseout amount next year, pay your tuition for next , pay your tuition for next semester before the end of the year. If you're above the phase out now, but will be below next year, try to delay payment.

Credits. If you've got a child under age 17 you may be entitled to a $1,000 credit. There isn't much planning involved here.

Energy-saving tax benefits. They're back! And better than ever. The credit percentage for building envelope components (windows, doors) is now 30% and the maximum credit is $1,500. The same percentage applies to furnaces, furnace fans, central air conditioners, and water heaters. Check to make sure the item is certified as complying. There's no phaseout or other restriction, and, since it's a credit it doesn't depend on your tax rate. As a result there's no rush to get the work done this year. The credit will be available in 2010.

Alternative energy credit. The credit caps for solar hot water, wind, and geothermal property have been eliminated. The credit is 30% and applies only to principal residence. The credits won't expire for a number of years, so you have time.

FSA (Flexible Spending Account). The end of the year may be your last chance to deplete your FSA. While some taxpayers will have another 2-1/2 months; that's only if your employer changed his rules.

401(k) election. Now is also the time to make your 401(k) election for next year.

Investment Strategies

The is one of the best areas for tax planning. And, you've generally got till nearly the end of the year to act. There are plenty of good ideas in the discussion below. Just keep in mind that investment objectives should take precedence over tax saving motives.
Assess your positions. The first step is to find out where you stand. That is, list all your positions (stocks, bonds, and any other investments that you might consider selling). Include the date purchased, the purchase price, adjustments (reinvestment of dividends increase your basis, stock dividends and splits affect your basis, etc.), your adjusted cost basis, and the current market value. Then you can determine whether you have a gain or loss and how much. Here's a summary of the rates:

Property held no more than 12 months is taxed at ordinary income rates.
Property held more than 12 months is taxed at no more than 15% (0% if you're in the 10 or 15% bracket.
Collectibles (antiques, etc.) are taxed at no more than 28% if held more than 12 months.
Unrecaptured Section 1250 gain (depreciation) on real property is taxed at 25%.
The rules are more complicated if the property is used in a trade or business (e.g., a backhoe used in your construction business).

Note. If you sold property on an installment basis, the tax rate is based on when the money is received, not when the sale was made. That is, you'll get the benefit of the new rates on property you sold on the installment basis some years ago. Or suffer the higher rates if capital gain rates increase.

Important. If you're in the 10% or 15% bracket in 2009, your long-term capital gains will not be taxed. Caution. Once your taxable income, including any gains, exceeds the 15% bracket any additional gains will be taxed at the 15% long-term capital gain rate. If you know you'll be in a low bracket next year, deferring gains might make sense. As always, investment considerations are paramount.
Check your mutual fund or brokerage statement carefully. Some gain may be taxed at 25% (the unrecaptured depreciation) if you invested in a REIT (real estate investment trust) or you or your S corporation or partnership sold real estate.

Within each rate group, gains and losses are netted to arrive at a net gain or loss. The following additional netting and ordering rules apply. Short-term capital losses (including short-term capital loss carryovers) are applied first to reduce short-term capital gains, if any, otherwise taxable at ordinary income rates. A net short-term loss is then applied to reduce any net long-term gains from the 28% group, then to reduce gain in the 25% group, and finally to reduce net gain from sales taxed at 15% (or 5%).

For long-term gains and losses, a net loss from the 28% group (including long-term capital loss carryovers) is used first to reduce gain from the 25% group, then to reduce gain from the 15% group. A net loss from the 15% group is used first to reduce net gain from the 28% group, then to reduce gain from the 25% group. Any resulting net capital gain that's attributable to a particular rate group is taxed at that group's marginal tax rate.

Fortunately, you're likely to only have to worry about short-term gains and losses (ordinary income treatment) and long-term ones (15% and 0% rate categories), not those in the 28% and 25% group. That will make planning easier.

Careful timing of your capital gains could produce some permanent tax savings. For example, you've got some stock with potentially (you haven't sold it yet) $3,000 of long-term (15%) gains. You've already sold stock that generated $3,000 in short-term losses. You don't think you can generate any short-term profits to offset the loss. It might make sense to hold off on taking the long-term gain. You can use the $3,000 loss to offset ordinary income this year. Then take the long-term gain next year and pay taxes at only 15%. In other words, you're taking a deduction at, say 35%, and paying taxes at 15%.
Unfortunately, the market may not cooperate. You don't want to risk holding onto a stock that could decline in price, just to save some tax dollars. On the other hand, if you're selling real estate, it may be easy to postpone the sale into the following year. If you sell or sold property using an installment sale, you may also have some options in recognizing the income. Minimizing your tax bite isn't as easy as before. You'll have to work through the numbers. If the gains are substantial, consult your financial or tax adviser.

You may have very few gains. But no matter what you do, investment considerations should come first. No tax deduction or gain avoidance technique will offset a poor investment decision. And keep in mind that capital losses can be carried forward indefinitely, capital gains not used to offset losses can't be carried forward; they're taxable immediately.

Even if you can't play the rate game described above, some approaches still work:

Sell capital gain property. If you've already realized some losses during the year, you might want to take enough in capital gains to offset the losses. If unused, the losses can be carried forward indefinitely and used to offset gains or up to $3,000 in ordinary income in any one year. That may be small comfort if you've got a substantial loss carryforward. (A $100,000 in losses at $3,000 a year will take over 33 years to use.) Analyze your positions to decide if you'll continue to have substantial gains in the future. If not, consider selling stock at a gain now to use the loss.

Generate losses to offset gains. If you've realized gains during the year, consider selling positions where you have a loss, but only after assessing the investment's potential. Don't forget that any mutual fund holdings (other than those in an IRA, Keogh, etc.) will probably generate some long-term capital gains through distributions before the end of the year.

Converting short-term into long-term gains. Gains on property held more than 12 months are taxed at no more than 15% now; stock or other investments held 12 months or less produce short-term gains taxed at ordinary income rates, up to 35%.

If you're near the critical 12-month mark, you might want to consider holding on for just a little longer to take advantage of the lower rates. You've got to balance that against the chance that the price could fall. Generally, the closer you are to the 12-month threshold, the more you should consider holding out. The extra return could be substantial. For a formula to see how much you can lose and still break even by waiting, use the formula Breakeven Holding Period for Long-Term Capital Gains on our Formulas page.

Selling different lots. If you purchased shares at different times you can specify (do it in writing) to your broker which lot to sell. If you don't, the IRS assumes a FIFO (first-in, first-out rule applies). Selling the right lots can save considerable tax dollars.

Example--You bought 100 shares of Madison in 1990 for $4,000 and 100 shares in 1995 for $21,000. Madison's now trading at $100 a share so 100 shares are worth $10,000. You want to sell only 100 shares. If you tell your broker to sell the 1995 shares you'll have an $11,000 loss. If you don't specify which lot to sell, the shares bought for $4,000 in 1990 are the ones assumed sold and you'll have a reportable gain of $6,000.

In the example above you could sell half your investment, take a loss, and still have a position in Madison, should a move to higher ground seem possible. The same rules apply to determine the length of the holding period. Sell one lot and you might have a short-term gain (or loss); sell a lot you held longer and you could have a long-term gain (or loss).

Another point. Even if both positions showed a gain, selling the one with the higher cost basis could reduce your position with the minimum amount of tax liability and end up generating more after-tax cash. Of course, if you've got substantial losses with scant hope of using them in the near future, selling the low-cost basis shares may make more sense.

Getting on in years? If you're older or in poor health, you should discuss your options with your tax adviser. The gain built into low-cost-basis shares might escape tax entirely because your heirs will receive a stepped-up basis in the shares. For example, you purchased 100 shares of Madison Software Inc. in the 80's for $1,000--it's now worth $100,000. If you hold the stock on your death your heirs could sell it the next day for $100,000 and pay no capital gains tax. But there are other issues to consider when planning for transferring property on death.

Caution--The rules are more complicated when it comes to mutual funds. There are several methods of computing cost basis. That topic is beyond the scope of this article. Mutual fund companies now provide cost basis information on year-end statements or will give you that information if requested by phone. But that's only one of your options. And it may not be the best one.

Take the loss, regardless. If there's no chance of a comeback for the investment, consider taking at least some of the loss, even if you have no offsetting gains. Up to $3,000 of losses can be used against ordinary income. Additional losses can be carried forward to use against future gains or up to $3,000 a year can offset ordinary income. On the other hand, gains are fully taxable in the year of sale.
Collect bad debts. You cannot take a bad debt deduction for nonbusiness bad debts unless the debt is totally worthless. We can't go into details here, but most debts held by individuals are considered nonbusiness. You must be able to show you tried to collect the debt, but were unable to. This could take some time. Don't wait till the last minute.

Worthless stock. You can't just claim the stock is worthless. You have to be able to prove it. Even if the stock isn't quoted and the company is in bankruptcy, the IRS will claim it could recover. Sell the stock through your broker. If you can't, sell it to a colleague (not a relative; and get documentation).

Installment sale. An installment sale can spread a gain over several years. That may keep you out of a higher tax bracket and/or allow you to defer the gain to years when you might be in a lower bracket. In addition, that capital gain may be useful in later years to offset any capital losses. All that's necessary is that at least one payment is received in the next tax year. Should tax rates drop or for any other reason you can use the gain at little tax cost in a future year, there are ways to recognize the gain immediately. Talk to your tax adviser. Capital gain rates could go up in the future.

Three cautions. You can't use the installment method for publicly traded stock and you've got be careful if you're selling tangible property. In the latter situation, any depreciation recapture is fully taxable in the year of the sale. It can't be deferred. Finally, you can't use the installment method if you're a dealer in that property. For example, you can sell a machine tool used in your business on the installment basis. On the other hand, if you're a dealer that sells such tools, you can't use the installment method.

Charitable contribution of appreciated stock. This is an old technique, but it works so well it's always worth mentioning. If you make a charitable contribution of stock (you've held more than 12 months) that's appreciated in value you get to deduct the full fair market value as a charitable contribution. That's better than selling the stock and contributing the cash since you avoid paying capital gains tax and you also avoid increasing your adjusted gross income by the amount of the gain. The latter is important since many exemptions (e.g., the $25,000 rental real estate exemption) and thresholds are based on your AGI. Caution. There are some special rules. The most important is that your deduction is limited to 30% of your AGI. Any excess can be carried forward, but only for 5 years. So don't overdo it. Consider a charitable lead or remainder trust.

Bond swaps. The idea is to sell bonds where you've got an unrealized loss, take the money and invest in bonds or other securities with a higher yield. This approach generally only makes sense if you can use the loss to offset other gains. The tax savings can be added back to the proceeds of the bond sale to provide additional capital.

Wash sales. You may have a loss in a position and want to take the loss this year, but like the stock and want to hold on. If you sell the stock (or bond) and purchase the identical security within 30 days before or after, the loss will be disallowed. For example, you sell 100 shares of Madison Inc. at a loss on November 28, 2009. If you bought 100 shares of Madison Inc. within the 30-day window, say on November 10, 2009 or December 20, 2009, the loss would not be allowed for tax purposes. It's not lost. Your basis is adjusted and you get the benefit when the new stock is sold.

The easiest way out of this situation is to wait 31 days before repurchasing the same securities. The second approach is to buy stock of another company in the same industry that is expected to perform similarly. Later you can buy back into your original holding. And one emerging growth mutual fund is not the same as another emerging growth mutual fund. CAUTION. A S&P 500 Index fund run by Madison Investments is the same as a S&P 500 Index fund run by Chatham Investments. Index funds can be identical.

Selling short against the box. In the past this technique could be used to effectively sell the stock (you got the cash and locked in the gain), without paying the tax. Moreover, you could defer the tax virtually indefinitely. That won't work any more. You can use the approach to postpone a gain for 30 days into the following year. However, after you close the position you'll have to hold the stock for 60 days. That can expose you to substantial risk. Talk to your broker or financial adviser before considering this approach.

Passive activities. Do you own an interest in a partnership or S corporation that is a passive activity in your hands? The general rule is that passive losses can only be used to offset passive income, or deducted in full when the passive activity is disposed of completely.

You've got several options. The first is to do nothing. Any unused losses can be carried forward. That may be small comfort since the losses are worth less and less each year because of the time value of money.

You might try selling the investment. There is a market for some old tax shelter partnerships. That may be a smart move if it's unlikely the prospects for the investment will improve. Make sure you understand the basis rules when calculating your gain or loss. Those losses you took on your tax return in prior years reduced your basis. You could have a gain, or much less of a loss.

Try to generate offsetting passive income. This is a longer-term strategy. The income could come from rental properties, a regular business partnership or S corporation where you don't materially participate, etc.

Investment interest. As an individual, your interest deduction is generally limited to interest on a home mortgage, a home equity loan, and investment interest. Investment interest is interest incurred to buy investment property--usually stocks, bonds, etc. (But not tax-exempt bonds. You can't deduct any interest associated with them.) The rule is that any investment interest is limited to your investment income for the year. Any excess can be carried forward. Investment income includes interest, nonqualifying dividends (dividends that don't qualify for the lower, capital gain tax rate), short-term gains, and, if a special election is made, long-term capital gains and qualifying dividends.

Example--You had $2,000 of margin interest during 2009. You had $1,200 of interest income from bank accounts and $200 of short-term gains and $100 of nonqualifying dividend income from REITs. That's a total of $1,500 of investment income. You can deduct $1,500 of the margin interest. The unused $500 of interest expense can be carried forward and deducted next year, if you have sufficient investment income.

It may be too late in the year to generate interest or dividend income, but you could create some net short-term capital gains by selling stock or bonds at a profit. Remember, investment considerations come first. Long-term capital gains and qualifying dividends can also be considered investment income, but only if you make an election to have them taxed at ordinary income rates. In some cases this election works, but you've got to run the numbers.

Investment interest doesn't have to come from a margin account, but you must be able to show the interest expense applies to the investments.

If you're a small business owner that operates through a regular corporation you may find yourself concerned about this trap if you borrowed money to purchase stock in the corporation, advanced equity capital, or loaned it additional funds.

Example--You borrowed $150,000 to purchase stock in Madison Inc. a regular corporation in which you have a 50% interest. You borrowed another $50,000 which you loaned to the corporation at 6%. During the year the corporation paid you $3,000 of interest on the loan. You paid interest of $18,000 on the $200,000 you borrowed. You have no other interest, dividend, or capital gain income. Since you only have $3,000 of investment income (the interest the corporation paid you) you can only deduct $3,000 of the interest. The remaining $15,000 can be carried forward.

Often the situation described in the example above won't reverse for several years. If the interest rate on the loan to the corporation were higher, you'd be able to deduct more of your investment interest. In some situations it might even make sense to pay a taxable dividend. There's no general rule here. Work through the numbers with your tax advisor.
S corporations, partnerships, LLCs etc. don't have this problem. Any such interest expense is deductible on Schedule E.

Getting Started

Estimating your income. This is the first step. You can't take action if you don't know where you stand now. Assemble your records for the first 10 months of the year. If you record income and expenses on a regular basis, this should be a snap. If not, doing it now is vital for tax planning and will make tax filing easier next spring.

Interest and dividends. You won't have 1099s, but you should have a good idea of your interest and dividend income. Check your last statements from your broker, mutual fund, etc. and annualize the amount (use the year-to-date amount, divide by the number of months the statement covers, then multiply by 12). Caution. Annualizing may not work for dividend income. It's fine for small dividends, but you may have to do some additional work if you have big holdings in some stocks. Alternatively, use last year's amounts and adjust up or down. Don't forget about any trust income, or passthroughs from S corporations and partnerships.
Salary income. This one is easy. You should have cumulative pay stubs that show gross income and taxes withheld. Annualize them as described above. Adjust for bonuses.
Business income. If you have income from a Schedule C (sole proprietorship), S corporation, or partnership, you'll need those numbers. We'll deal with this in our companion article.
Rental income. If you have rental properties, you'll need to come up with an income estimate. Before annualizing the income or loss for the first 10 or 11 months, be sure there are no unusual factors. For example, if you incurred big repairs earlier in the year, you may have to adjust for that. Not sure of how much depreciation to use? You won't be too far off if you use last year's number (unless 2008 was a partial year or you made significant additions in 2008 or 2009).
Capital gains. For many taxpayers this is an important factor and difficult to predict. And, while going through stock transactions this year could still be painful, it is important since this is where you can do considerable tax planning. Get all your buy/sell tickets and match them up to find your gain or loss on every transaction. Total short-term gains and losses, then long-term gains and losses (property held more than 12 months).
Also check for distributions from mutual funds. Some funds may still have carryforward losses, but there's a good possibility some or all of your funds could distribute income before the end of the year. You may be able to call the fund to see what the year-end distribution will be.
Other income. Did you sell your main or vacation home, win any prizes or awards, settle a lawsuit, receive alimony, etc.? Get a state or local income or real estate tax refund? You could have additional taxable income. Also consider insurance reimbursements you received this year for medical expenses you deducted in an earlier year.
Principal residence sale. If you sold your principal residence, there's a good chance you'll owe no tax on the sale. If you're single, the first $250,000 of gain should be exempt. If you're married, you can exclude the first $500,000. (Caution. The exclusion doesn't apply or is reduced if you sold a principal residence within the last two years.) However, before you go to the next topic, think again. If you're a long-time home owner, you could have broken this threshold. Remember, you'll have to consider gains deferred on prior sales before 1997. The exclusion also contains a number of restrictions. If you used part of the home for business, some of the gain may be taxable. Finally, even if you don't owe any federal taxes, you still could be liable for state income taxes on the sale.
Distributions from pension plans. You may have taken money out of an IRA, Keogh, 401(k), etc. during the year. Chances are it's all taxable income. In addition, if were under age 59-1/2 and don't qualify for one of the exceptions, you'll owe a 10% penalty. CAUTION. This is an important item. Such distributions can raise your final tax bill significantly.
Nontaxable income. Some income escapes taxes. That includes gifts and inheritances (generally, but pensions, annuities, etc. received from an estate are likely to be taxable) interest on most municipal bonds, returns of capital (e.g., principal repayments on a loan), reimbursements from your employer for business expenses, etc. Make sure you don't count any items as income if they're not. But if you're a shareholder in an S corporation or a partner in a partnership or LLC and received distributions in excess of your basis, they may be taxable.
Check last year's return. Many items repeat year after year. You may find some income you hadn't considered.
Estimating your expenses and deductions. You've also got to come up with an estimate of your deductions. The items below are common deductible expenses.
Alimony. If your divorce was structured properly it should be deductible. However, payments that are really part of a property settlement or child support aren't deductible. Conversely, alimony is taxable to the recipient; property settlements and child support aren't.
Contributions to SEP, IRA, Keogh, etc. Some will depend on your income (e.g., SEP contributions may depend on your Schedule C income).
If you're self-employed or a shareholder/employee in an S corporation, you may be entitled to deduct 100% of health insurance premiums you paid. Amounts that may not be deductible because of an income limitation can be taken as an itemized deduction.
• Medical expenses. Add up all your expenses. Include medical insurance premiums not deducted elsewhere, doctors, dentists, hospitals, travel to and from the doctor, etc. Also include medical appliances such as glasses, hearing aids, etc. You may be able to deduct additions to your home if required or prescribed by a doctor. For example, a wheelchair ramp, special sink, etc. This can get tricky. Check with your tax adviser. Of course, reduce the amount by any reimbursement from insurance. Your deduction is limited to the amount that exceeds 7.5% of your adjusted gross income (AGI).
Taxes. Include real estate taxes, state income taxes paid in 2009, and personal property taxes. When adding your taxes be sure to include any payments made when you filed your 2008 state return. For 2009 you can deduct either your state income taxes or your state sales taxes paid, but not both. If you think your sales tax would be higher, now would be a good time to gather your purchase records. Some taxpayers may even want to buy that new boat or car before the end of the year. (See below for more on auto sales tax.)
Interest. You're generally limited to interest on a home mortgage, including a mortgage on a second home. To that you can add a home equity loan with a principal amount of no more than $100,000. Interest to purchase an interest in an S corporation or partnership is also fully deductible (but not on Schedule A). Interest on other investments may or may not be deductible. Compute the total amount; we'll discuss planning later.
Charitable contributions. Go through your receipts and checkbook. You may receive a notice from your church at the end of the year. For now you can use an estimate. Remember the rules on charitable contributions. You'll need a canceled check or receipt.
Education expenses. Amounts paid for your children or yourself may be deductible toward your AGI or qualify for a credit or deduction. More than likely the amount spent will far exceed the amount qualifying for a tax benefit.
Casualty or theft loss. It's got to be a big one. Only losses that exceed 10% of your AGI, plus $500 per casualty are deductible.
Miscellaneous deductions. Include professional or union dues not reimbursed by your employer, tax preparation fees and books or software to help you prepare your return, investment expenses, safe deposit box rental, job-related education, and unreimbursed employee business expenses. If you work out of your home that can include a second telephone line, etc. Remember, only the amount over 2% of your AGI is deductible. If you had gambling winnings, gather all your losing tickets, etc. They can be deducted, but only to the extent of winnings.

Finding your tax bracket. If you've got a good handle on your income and expenses you can net the two to arrive at your taxable income. Be sure to also subtract out personal exemptions ($3,650 each for yourself and spouse and dependent children). If your AGI exceeds certain thresholds your personal exemption and itemized deductions may be limited.
If you're pretty confident of your computations, you can find your tax bracket by using the Tax Tables in our Reference File. Keep in mind that long-term capital gains and qualifying dividends are taxed at a lower rate. Go to our Tax Tables for the details.

Also consider your filing status this year and next. If you're going to get married or divorced next year, that can drastically affect your tax bracket. How much can depend on your new (or old) spouse's income. For example, you're a salesman making $175,000 annually. Your new wife is an artist yet to be recognized. You'll save a substantial amount over last year. On the other hand, the closer your incomes are, the less the savings. Whether you're married or single this year depends on your status as of December 31. (If you'll be single with a dependent child you'll be able to file for head of household status.)
If things look too complicated, and you don't want to talk to your tax adviser, get a computer program. Final or planning versions of popular programs should be available soon. In a pinch you can use last year's program. The final tax amounts will be off, but not significantly, and may be good enough for planning purposes.

Delay collections where possible. If you have rental income, don't bill the tenant until it's too late for the check to arrive in 2009. (See below if you rent property to your business.) If you're self-employed you can use the same approach for clients (if you're on the cash basis of accounting).
Defer compensation. If you receive a salary you may be able to defer a year-end bonus to next year. Talk to your employer. Get a written agreement. There's a danger here. Because the arrangement cannot be secured, you could lose if your employer has financial difficulties. And the amount must be paid within 2-1/2 months of yearend. The rules have changed with respect to deferred compensation. Check with your tax adviser.
Avoid taking distributions from your IRA, 401(k), etc.
If you have a stake in the company, it gets trickier. Deferring compensation may not have any effect if you're a shareholder in an S corporation. Deferring $20,000 of bonus will only mean you'll have that much less salary income and the S corporation will have $20,000 less in deductions. The additional net income will be passed through to you. So if you're the only shareholder, it's a wash.
Stock options. If you receive incentive stock options (ISOs), you don't have any taxable income until you sell the stock, so you might consider delaying a sale till next year. CAUTION. The bargain element of the option (the difference between the option price and the market value at the time of exercise) must generally be recognized this year for alternative minimum tax purposes. The alternative minimum tax is likely to be more of an issue this year.
Longer term planning. It's really too late to defer interest and dividend income. However, a commercial annuity will defer tax on any future income. You might also consider Treasury bills or bank certificates of deposit with a term of one year or less as a way to defer interest for a year. (E.g., all the interest on a T-bill purchased on January 15, 2010 that matures January 14, 2011 would be taxable on your 2011 return. You may be able to defer payment of the taxes to 2012.
Accelerating deductions. In addition to deferring income, one way to lower your taxable income in 2009 is to accelerate deductions. Here are some options.
Pay all taxes due in 2009 before the end of the year. For example, you're billed for your real estate taxes in December, 2009. You can pay them as late as January 31, 2010 without penalty. Pay them in 2009.
Pay all deductible interest due before the end of the year. CAUTION. You can't prepay interest that's actually due next year.
Bunching makes even more sense for medical expenses. Here there's a 7.5% threshold. Take that physical before the end of the year, get new glasses, pay off the orthodontia bill early, etc. If you, your spouse or a dependent has a physical handicap, the cost of a wheelchair ramp, lowered cabinets, special bathroom fixtures, etc. may be tax deductible. Check with your tax advisor. The amount can be substantial and could easily put you over the 7.5% floor. When doing your calculations be sure to include any medical insurance premiums (that can't be deducted as a self-employed individual).
Maximize any pension plan contributions. That includes IRA, SEP, Keogh plan. You can wait until tax filing time to make the contribution to a IRA or SEP. Anyone with self-employment income (e.g., a sole proprietorship or single member LLC) can set up an SEP.
If you do business as an S or regular corporation you can set up a regular qualified pension, profit-sharing plan. However, you must act quickly here. This can take time to set up and must be done before yearend.
Home office expenses. If you can claim a deduction for an office in the home fill the oil tank, pay homeowner's insurance premiums, do repairs (capital improvements must be depreciated), pay utility bills on time, etc. CAUTION. For these "indirect" expenses, only the portion allocable to or directly attributable to the home office is deductible. If you have your own business or your employer asked you to work from home, you may qualify.
Charitable contributions. Cash and credit card payments before the end of the year count; pledges don't. You've got considerable opportunity here to accelerate deductions. Cash, check or credit card payments are best. If the contribution is $250 or more, a receipt from the organization is necessary. For lesser amounts you'll still need a receipt or a canceled check.
If you do business as a sole proprietorship or have rental properties, make sure all bills are out early. Talk to your customers; offer a discount for early payment. The same advice applies to S corporations, partnerships, and LLCs since the income is passed through to the owners.
If you do business through a regular corporation and your tax advisor has suggested taking a dividend, this might be a good time. Particularly if you're in the 10% or 15% bracket. The dividend escapes tax if you're in these brackets.
Should you reduce or avoid making contributions to your IRA, Keogh, or other type of qualified plan? Generally, no. Once you pass up on a year, it's gone forever. The exception might be if you're young or can make up for it by making a much larger contribution next year.
While it's pretty drastic, you might want to take money out of your traditional IRA or other qualified plan. That may make sense if you're currently in the 15% or 10% bracket, won't owe the 10% penalty on early withdrawals (e.g., you're over 59-1/2 or qualify under some other exception), will be in a higher bracket in future years, and would be taking money out of the plan soon anyway (e.g., for business needs). However, if you owe the penalty, you might want to consider other options. There are a number of exceptions to the early withdrawal penalty. One is for college tuition payments. Check the rules carefully.
Convert some or all of your regular IRA to a Roth IRA. You'll pay tax on the income, but there's no penalty. Future withdrawals from the Roth will be tax free. Again, the idea makes sense only if you're in a low bracket this year. It'll help if the investments in the IRA aren't doing well but should appreciate in the future. Because you're paying the tax upfront, you want to make sure the investment won't go down. Talk to your advisers before making the switch. You can't do a conversion to a Roth if your AGI is over $100,000.
If you're currently in the 10% or 15% bracket consider selling stock with a gain. If you're in this bracket, capital gains escape tax, if the asset is held more than 12 months. CAUTION. Capital gains may receive favorable treatment from a rate standpoint, but they still affect your AGI. Thus, the income could affect your ability to claim itemized deductions, take education credits, etc.
Take a bonus. If you work for someone else, ask if you can get your bonus early. If you do business as a C corporation, increase your salary. But be careful here. See the discussion below on marginal tax rates.
Stock options and restricted stock. If you received restricted stock you can make an election to be taxed on the amount currently. Get expert advice here. You can't undo the election and it could backfire. If you received incentive stock options, exercise the option and dispose of the stock.
Cash in savings bonds and take the interest. Watch the maturity dates.
Installment notes. If you made a sale on the installment basis in a prior year, you might consider taking more of the deferred gain now. You might be able to take part now and leave a portion deferred.
IRA withdrawals can escape the penalty tax (but they're still taxable income) if the money is used for college tuition. You need the cash early in 2010 but don't want the income next year. Or you need $20,000 and that will put you into a new bracket. Consider taking some of the funds this year, some next. Check the rules with your tax adviser.
You can avoid paying tax on IRA withdrawals if you can replace the money within 60 days. You might be able to extend that by taking money from another account to replace the first.
Distributions from a Roth IRA may escape both income taxes and the 10% penalty, but a number of rules apply. Check with your tax advisor.
Don't forget to take into account early withdrawal penalties associated with the mutual fund, annuity, etc.
Taking a lump sum rather than a payout over your life expectancy from an inherited annuity, IRA, etc. can be tempting, but the tax cost could offset any benefits.
Cashing in a life insurance policy could also be attractive, but it could generate a substantial tax liability.
If you're definitely going to get hit by the tax this year, and will be in a higher bracket for regular taxes next year, you might want to postpone some deductions such as taxes, interest, etc. Save the deductions for when they can be used.
For a similar reason, you might want to accelerate income into this year, when it will be taxed at a lower rate. Careful. If you over do it, you could end up paying tax using the regular system at higher rates. And, it could create a minimum tax problem next year.
If you exercised incentive stock options that will trigger the AMT, consider disposing of them before the end of the year. Evaluate all the pros and cons carefully, however.
Think you'll escape the tax? The most vulnerable taxpayers are those with ordinary income between $200,000 and $500,000. Taxpayers with less ordinary income but substantial capital gains are also targets.
You can get some help at the IRS Web site at Alternative Minimum Tax Assistant for Individuals. As of this writing the 2009 version isn't on the site, but the 2008 version may give you an idea of where you stand.