Last-minute strategies for year-end tax savings

2009 is quickly coming to a close but there is still time to possibly maximize your federal tax savings for the year. Many year-end tax planning techniques can help you save money. Because of the recession, some of the year-end strategies take on added urgency for individuals affected by a job loss or a reduction in income.

Bunching itemized deductions.If quitting smoking is one of your New Year’s resolutions, you might want to stop in December and possibly deduct the cost of participating in a smoking cessation program. Many medical expenses are deductible. However, medical expenses may only be deducted if they exceed 7.5 percent of your adjusted gross income. Our office can review your 2009 medical expenses and if you are close to the threshold for 2009, you may want to accelerate some elective medical expenses into 2009 to jump over the 7.5 percent floor.

Other expenses may only be deducted if they exceed two percent of your adjusted gross income and you itemize your deductions. These are known as miscellaneous itemized deductions and may also be bunched. They include certain unreimbursed employee expenses, tax preparation fees, certain job search expenses, and more.
Individuals who lost a job in 2009 and whose incomes have fallen need to carefully time their deductions. In some cases, it may be more valuable to defer bunching itemized deductions into 2010 rather than accelerating them into 2009. Our office can help you time your deductions for the maximum benefit.

Above-the-line deductions. Above-the-line deductions help minimize your tax bill because they reduce your adjusted gross income. Generally, above-the-line deductions are only available to taxpayers who itemize their deductions.There are also important income limitations.

One of the most valuable deductions for many individuals is the deduction for state and local real property taxes. You may be able to pre-pay state and local taxes for 2010 before the end of 2009 and take a deduction for 2009. Additionally, for 2009, individuals who do not itemize their deductions get a partial state and local property tax deduction. A non-itemizer single individual can deduct up to $500 in state and local property taxes paid in 2009. Married couples filing joint returns who do not itemize their deductions can deduct up to $1,000.

Another valuable deduction will expire at the end of 2009: the deduction for state and local sales tax when you purchase a new vehicle. The special deduction is available whether you take the standard deduction or itemize deductions on your return. Taxpayers who do not itemize will add this additional amount to the standard deduction on their 2009 return. At year-end, new car and truck prices are generally high across the county, especially after dealers emptied their inventories under the cash-for-clunkers program. If you qualify, the state and local sales tax deduction could help bring down the cost of a new vehicle. Generally, the new vehicle must be valued at $49,500 or less. There are important income limitations so contact our office before you make your purchase.>

Charitable contributions.  Year-end charitable giving generally has always been a smart way to reduce current year taxes but tough substantiation requirements cannot be overlooked. Traditionally, charitable contributions (and other itemized deductions) phased out for higher-income individuals. However, that limitation is reduced by two-thirds for 2009 and does not apply at all in 2010, which makes charitable contributions more valuable not only to charities but also donors. Depending on your income, you may want to delay a charitable deduction into 2010 to take full advantage of the phase out of the limitation.

Retirement savings. The economic slowdown has caused many individuals to tap their retirement savings to help pay for everyday expenses. To discourage the use of pension funds and IRAs for purposes other than normal retirement, the Tax Code imposes an additional 10 percent tax on certain early distributions of these funds. Early distributions from a qualified retirement plan are also subject to federal income tax. However, if you are over age 59 ½ and your taxable income has fallen because of a job loss, the income tax you pay on the distribution could be offset by other deductions.

Distributions that you roll over to another qualified retirement plan or IRA are not subject to the 10 percent additional tax. Generally, you must complete the rollover by the 60th day following the day on which you receive the distribution.

Please contact our office if you have taken an early distribution from a qualified retirement plan or IRA. Besides the 60-day rollover window, there are special rules for military reservists, disaster victims and others.

FSAs. The current generous rules for using funds in a health flexible spending arrangement (FSA) may soon be a thing of the past. Congress is considering, as part of health care reform, placing tougher rules on health FSAs. For example, you could only use health FSA dollars for prescription medications with some exceptions and your maximum annual contribution to a health FSA would be limited to $2,500. These changes could be enacted before year-end but would not affect your FSA spending for 2009.

Depending on the terms of your health FSA, you may have to use your remaining health FSA dollars on or before December 31, 2009. This is known as the “use it or lose it” rule. Some plans allow for an extended period into 2010; for example, until March 15, 2010. If you have unused health FSA dollars, you should consider accelerating qualified purchases before year-end.>

Congress. Finally, there is the added uncertainty of what Congress will do about many popular but soon-to-expire tax breaks. In addition to the ones we have mentioned, other incentives that will expire at year-end include the state and local sales tax deduction, the teachers’ classroom expense deduction, the higher education tuition deduction, tax-free distributions from IRAs for charitable purposes for individuals age 70 ½ and older, and national disaster relief. Many of these incentives are expected to be renewed for 2010 before year-end or in early 2010 with Congress making them retroactive to January 1, 2010. Our office will keep you posted of developments.

If and only to the extent that this publication contains contributions from tax professionals who are subject to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, the publisher, on behalf of those contributors, hereby states that any U.S. federal tax advice that is contained in such contributions was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.