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Friday, July 09, 2010

Tax Strategies for 2011

2011 is around the corner and a reader asked me, in regards to my previous post:

SL: Assuming that Congress is too fractured to do anything about restoring some of the tax cuts, at least for the middle class and below, are there any particular tax strategies that you think make sense - i.e. sell stocks that have appreciated to get the lower capital gains tax, defer charitable contributions? accelerate charitable contributions? etc.

Getting ready for 2011 will probably be an ongoing subject here at Orthonomics, so consider this installment one. Tax professionals are only starting to figure out what strategies make sense. Or, as one journal writes "new taxes requires us to think outside of the box when it comes to tax planning. In many cases, this means considering strategies that would be contrary to conventional planning practices."

Here are a few strategies to consider:

Accelerate income and defer deductions: normally we try to defer income and accelerate deductions. Hence, a small business owner or landlord might expense equipment in full, a family will try to lower their capital gains taxes by selling loosing stock offset gains, those who pay estimated payments will make sure to send their estimated payment to their state before the close of the year, and in December of the Fiscal Year a family will write out some checks for last minute tax deductions.

When impending tax rates are significantly higher, due to increased marginal rates and the elimination of the 10% bracket, individuals should consider the following (I'm including advice for those who file a Schedule C or Schedule E):

Be aggressive with collecting accounts receivable: If you can collect in 2010, it is worth more than in 2011. Start bothering your customers, subject to whatever halachic restrictions there are of course. (I think I am going to bother a client right now). If you are a second income earner teetering on the next marginal rate, the motivate to collect now is high. Likewise, it makes sense to push off expenses/acquisitions, but only in a way that is yashar. I'm not recommending forgoing payment of bills to vendors, only holding off purchases or changing payment schedules where possible.

Defer Itemized deductions from 2010 to 2011: So long as it is yashar and halachically proper (it wouldn't be proper to withhold a pledge due imo), holding off a voluntary donations from December 2010 to January 2011 makes sense, as does sending estimated tax payments to your respective state in 2011, rather than at the end of 2010 as you might be accustomed to doing.

If you depreciate equipment and have normally either used a double-declining method or fully expensed under Section 179, consider a straight-line or other approach. Of course, you will need the cash flow to be able to pay the tax bill.

If you have a NOL (non-operating loss), you should consider carrying it forward (a one time non-revocable election) rather than carrying back, as is often done.

Capital Gains If you are thinking of selling appreciate assets, 2010 might be the right year to do just that. If you are experienced with stock dealings, you are probably accustomed to selling your losers to offset the gains. For 2010, you might want to defer the losses until 2011, to offset higher future capital gains or just take the up to $3000 loss allowable by tax code.

Retirement Savings
Convert IRAs to ROTH IRAs/Invest in ROTH IRAs. The advice to convert IRAs to ROTH IRAs seems to be popular advice, and in many cases it is good advice. But you have to be very careful here. 1. You need to have the cash in hand to pay the tax bill (actually the rules have changed an you can defer 1/2 of your bill, but I don't recommend playing this type of game) and 2. Conversions can threaten your child tax credits where you are on the verge of being phased out. Taking at $800 hit on your tax credit in the here and now, e.g., might not be the wisest idea. For that reason, while the advice does make sense, it is so important to run the numbers in order to understand the full impact and make an informed decision.

That is it for now. More to come as the strategies develop. Now back to reminding a client that is long overdue with funds that although I've been flexible due to the situation and trust relationship, I need that money before 2011.


JS said...

I look forward to more of these posts. We get slammed by the AMT and would LOVE to know what, if anything, we can do. Our accountant basically shrugs his shoulders and says we can't really do anything since we're not self-employed - our income is what it is and we can't control when and how we earn it. Would love to hear tax tips that don't involve being self-employed.

Other than maxing out my and my wife's 401(k) is there anything else that can be done?


tesyaa said...

JS - for the past couple of years I've wondered about whether it would be worth paying an accountant to see if we could avoid being slammed by the AMT. I'm glad you hired someone so we didn't have to :)

Dave said...

I would expect some form of modification of the AMT, as it is an election year. (If you fell under AMT last year, I would assume you will absolutely fall under it this year)

However, the strong "revenue neutral" political rhetoric is going to make how the AMT is adjusted... interesting.

If you live in a high-tax state, with a large family, you are always going to be in AMT territory (or at least at risk for it).

Anonymous said...

There are some strategies you can implement if you are being hit by the AMT. It all depends on your exact situation but sometimes it might actually be worth it to increase your taxable income instead of reducing it such making your 401(k) contributions to a Roth 401(k) instead of a traditional 401(k) (assuming your 401(k) offers the Roth option. Once again you do have to run the numbers very carefully to see if this would help in your situation but it is possible that this would move you out of the AMT and this way your retirement account would be tax free when you make withdrawals in retirement.

JS said...


Can you explain that? My understanding was that 401(k)'s are one of the few things you can deduct even on the AMT. Given our high marginal rate, it makes sense to take the deduction now since our marginal rate will almost definitely be lower in the future.


Anytime. :)

All I have ever found online doing my own research is for those who are self-employed: delay income, speed up expenses. Doesn't help those who get a biweekly paycheck.

Also, someone correct me if I'm wrong, but I heard that under the AMT you can't deduct for children at all either.

Anonymous said...

If you fall under the AMT, and have an AGI over 160k or so (filing jointly), you will be phased out or cannot take the child tax credit at all. Additionally, itemized deductions may be graduated as well.

We have an AGI around 180-220 the past couple years.

I have done my own taxes since I graduated, first by hand now by taxcut. I have checked with an accountant every 4-5 years, and have found that they have not identified any missed opportunities.

Offwinger said...


I think what you're demonstrating is the difference between an accountant and a financial planner.

Some accountants act as financial planners, but many do not. You want financial planning - strategies for how to reduce your tax bill in the upcoming years while meeting family goals for saving, investment, retirement, providing for kids, etc. For people with salaried incomes and no stock bonuses/options, it might seem "simple" but it still requires a careful look at marginal tax rates now & estimated versus savings mechanisms that put money out of reach for now.

Miami Al said...


There is also a difference in going to an accountant with actually training in accounting, or a Tax Prep service that basically adds things up and fills out the forms. They might be able to run some scenarios for you, but it's going to be backwards looking.

Also, your accountant may have the ability to help you figure things out, but you are paying $150-$300/hour for their time, and most people don't want to pay for hours of work to prepare.

That said, if you are on a W-2, it's pretty hard, since you can't control your income side, just the expenses/deductions.

Simple example, certain expenses might be deductible for a W-2 earner on Schedule A, subject to a 2% threshold. If you run a business, you can deduct them on Schedule C, which reduces income. If your business files its own return, you can take the deductions right there.

For wealthy and middle-class and lower people, the tax system is pretty simple:
Income - Deductions = Taxable Income * Tax Rate = Taxes - Credit = Taxes owed

For people in the upper middle class, it's more complicated, because as Income goes up, deductions/credits get phased out, etc. As a result, reducing income by $1 may have more of an impact that increasing deductions by $1. Also, if you earn $1, pay $1 in expenses, you still owe FICA on it, but if you are running a small business, you don't have to pay FICA on business expenses.

JLan said...

"Can you explain that? My understanding was that 401(k)'s are one of the few things you can deduct even on the AMT. Given our high marginal rate, it makes sense to take the deduction now since our marginal rate will almost definitely be lower in the future."

It has to do with the way the AMT works, and it's not necessarily applicable to your situation.

When you calculate your taxes, you have to calculate them both ways (the AMT rules and the normal rules), and you ultimately pay whichever amount is higher. Depending on where your income is, the deductions still available to you, credits still available to you, etc., it's possible to be in a range with a low marginal rate, since adding more income will merely raise your normal tax to the same amount as your tentative minimum tax. This is why they talk about the AMT "phasing out" over a certain income level; at that point, your normal tax rate will catch up to your AMT tax rate and everything further will be at the normal tax rate. Thus, it's possible that contributing to a Roth 401k could only minimally raise your taxes.

With that said, there are three caveats to this strategy:

1) It requires you to be aware of exactly what you're going to earn. A capital loss or capital gain, or a bonus, or any other sudden income would mess up your calculations. That makes it particularly hard to carry out if you're spreading your 401k contributions out throughout the year.

2) It's easiest to do this if you're actually calculating your own taxes, or at least using something like Turbotax. An accountant could do the calculations but is likely to charge you as much or more as you'd save.

3) The AMT is in flux every year, and in fact, it still hasn't been patched for this year. Not knowing the exemption amount makes things quite difficult. If Congress decides not to patch the AMT, the exemption this year would be $45k for a couple married and filing jointly (it was $70950 last year). Without knowing this amount, I'm not sure you could calculate the right amount to switch to a Roth 401k, even if that strategy is potentially applicable to you.

Lion of Zion said...

what is AMT (i'm not sure if it's a good thing that i don't know about it)

Dave said...

Alternative Minimum Tax.

It was developed to prevent the wealthy from escaping tax obligations through clever tax sheltering, but was never scaled for inflation automatically.

Essentially, you figure your taxes under both models, and pay the higher.

JLan said...

" Lion of Zion said...
what is AMT (i'm not sure if it's a good thing that i don't know about it)"

Ohhhh dear....

The AMT (Alternative Minimum Tax) is a tax originally designed to require high earners to pay some tax (it was originally developed during the period with a much higher top tax bracket and many more deductions, with the richest few paying almost no tax due to loopholes). It was heavily revised in 1986 (along with the rest of the tax code) and again in 1993. It functions by eliminating both the standard deduction and many common itemized deductions (including state income tax, though charitable contributions and home mortgage deductions are still allowed), granting a much higher than usual exemption (which also gets phased out at higher income levels), and taxing everything at 26-28%. Those required to calculate the AMT pay the higher of the normal income tax or the AMT (if you made $1 million, for example, your normal income tax would be higher and so you'd pay that).

The last two times it was significantly revised (1986 and 1993), the exemption levels were set and then not indexed to inflation. The married filing jointly exemption was $40k in 1986-1992 and $45k starting in 1993; single was $30k/$33,750.

Starting in 2001, Congress has been "patching" the AMT exemption level; first with a 2001-2002 level, then a 2003-2005 level, and then year 2006-2009. These patches must be passed regularly to index the exemptions; if Congress doesn't pass a patch this year, the exemptions will fall back to 1993 levels and nearly everyone married with an come over $100k will be required to pay it and likely owe money on it.

Also of note, the amount at which the exemptions start to phase out ($150k) hasn't been adjusted since 1986.

Miami Al said...


Right, but generally for the "big" decisions, like 401(k) vs. Roth, you just don't know until you fill out your taxes, and by then it is too late.

If by quirk, your marginal rate is around 15% (because as you earn a dollar, you might be paying 28%-35% on it, but if you were in AMT, the AMT "extra tax" amount is being reduced, so you can weirdly get low marginal rates.

But, unless you know where you land, it's hard to tell if you should do one or the other. The easiest deduction to manage is property taxes, ours are due in March, with discounts to pay early all the way back to November, so you can pick which year you get it.

People also don't realize that the mortgage deduction really phases out over time. Since mortgage deduction normally determines whether you itemize or take the standard, the REAL deduction is Mortgage Interest - Standard Deduction. Each year, the amount of your payment that is interest goes down, which people realize, but the Standard Deduction goes up, so the differential gets smaller and smaller.

conservative scifi said...


Thanks for the suggestion on the Roth IRA conversion. I just tried a conversion in Turbotax 2009 (we had a $6400 AMT tax above our "regular" tax), and the cost of converting $60,000 was only about $3000 in extra taxes plus a penalty for those over $100,000 AGI, but the penalty won't exist in 2010. I may have to seriously consider doing the Roth conversion, if it really won't cost me very much.

Adam said...

Anybody else putting money in muni bonds? I invest in a NJ Muni Bond fund which is double-tax free and yields the equivalent of around 7%. Not too shabby in my opinion. Since the bond fund owns hundreds of bonds I am not terribly worried should one or two bonds default which is extremely unlikely in any event. (Also, recoveries for bond holders when these types of bonds default is usually very high.) The only real risk in my opinion is interest-rate risk but I really just don't see too much inflation in the coming years due to high unemployment. Also, even if interest rates rise, I expect the spread between T-Notes and Muni Bonds to narrow so that the pain won't be that bad for holders of the latter. Just my opinion. Invest at your own risk.

Orthonomics said...

Adam-Since this post is dealing with tax strategies, I might was well point out that private activity bonds, which could include muni bonds, can trigger the AMT.

JS-I'm really not sure what you can do, but I'm researching and learning.

Adam said...

Good point SL. The bond fund I invest in (VNJTX or (VNJUX if you have over $100k)) doesn't hold any PA bonds so it is truly AMT-Free. I wouldn't have invested in it otherwise. Also, it's management fees are rock-bottom. Since I have over $100k invested, I pay only .12% in fees a year which is downright silly it's so low.

Adam said...

Also, even if you have less than $100k to invest, the fees are really low (.20%) and I think you can invest with as little as $3,000. I'm not saying that a NJ Muni bond fund is for everyone but I think people should know that it is out there and think about whether it is right for them. Vanguard also has similar funds for New York, California, Ohio and perhaps a few other states.

Anonymous said...

You really should do some research and keep up to date on your fund. The Vang. Fund you mention, currently has a dist. yield of a little over 4% and an SEC yield of 3.23%, a far cry from the 7% you mentioned although you might be talking taxable equivalent yield which of course depends on one's tax rate both federal and state. The expenses as you mention are very low and that is a great help in improving your ann. return from the fund but do bear in mind that it is described as a long term fund so when rates do rise as they eventually will, the fund will likely take a hit. Also bear in mind that there are other funds out there from other families doing an equally good job or better such as NJTFX from TR Price. 10 yr. rtns are virtually identical despite the Price funds higher expenses, for the ytd and 1 yr. ending 6/30/10, the Price fund has outperformed, again even with higher exp. ratio and it currently yields slightly better than the Vang. fund.

Adam said...

Anon 10:17,

A few quick comments and then I'll leave this muni bond issue alone.

1) Dist. Yield is the only yield that matters to me right now because that reflects the current yield. The hypothetical forward-looking projection provided by the SEC-yield is of little interest to me for a wide variety of reasons.

2) Taxable equivalent yield for me for the fund is somewhere in the 6.5% neighborhood. It used to be higher but with that kind of yield you are keeping WAY ahead of inflation which is the name of the game in my book. If you are looking to make serious returns then this fund is not for you. Buy some international tech-stock fund or play the lottery. That is not my style.

3) Also, I prefer my Vanguard fund over the T Rowe Price fund you suggest for the simpler reason that the ONLY thing you can control when investing is expenses, and the expenses on the Vanguard Fund are meaningfully lower than on the fund you suggest.

Again, every has their own risk/reward tolerance and everyone has their own unique needs. I don't work for Vanguard and could care less if anyone else invests with them. I only wanted to flag muni bonds for the readers of this blog since it is one of the only legal ways to make tax-free income.

Anonymous said...

Adam: Thanks for your suggestions. I have some money in CDs that are coming due. With CDs now topping out at about 1.5% and being risk averse, I will look into the Vanguard tax free muni fund for my state.