Tax planning: 2009 tips and traps, and 2010 changes

Tax law changes for 2009 will require you to submit more information to your tax preparer to ensure that you get the most of tax credits and deductions. If the person working on your tax returns does not have all the proper information, you could pay too much or your return could be rejected.

Here is an overview of tax changes to consider when gathering your information:

* Making Work Pay Credit (“MWPC”), is a $400 credit to offset a reduction in withholdings enacted early in 2009. It is phased out for higher income and offset by the Economic Recovery Payment, described below. You could end up owing taxes if the credit does fully offset the reduction in withholdings (affects 2009 and 2010).
* Economic Recovery Payment (“ERP”) is a payment received as part of your social security benefits (for 2009 only), and affects the MWPC so that failing to report it could result in your tax return being rejected. The payment itself is not taxable.
* Government Retiree Credit (“GRC”) is for those not receiving social security, but affects the MWPC (2009 only). The new Schedule M reconciles the MWPC, ERP and GRC so you need all the information.
* First Time Home Buyer’s Credit is a $8,000 credit that applies to first time buyers purchasing between certain dates and requires a paper filing (electronic filings will not get the credit). If you buy the home in 2010, you have the option of amending your 2009 taxes for the credit. Note that this credit gets repaid over time on future tax returns beginning in 2010.
* Tax credit for long term home owners buying a new home, between certain dates, also requires a paper filing to avoid being rejected.
* American Opportunity Tax Credit (an expanded Hope Credit) allows use of the credit for two year more years than the Hope Credit, covering junior and senior years of college when the Hope Credit was not available.
* New Vehicle Purchase sales tax deduction (2009 only) is an additional Schedule A item, so long as your are not taking the general sales tax deduction.
* Energy Credit for solar power, fuel cells and certain energy efficient improvements are Schedule A deductions. There are two types of credit depending on what improvements were made to your home and taking the deductions requires you to have documentation.
* The Cash for Clunkers voucher is not considered income (2009 only).
* A tax refund can be used to buy U.S. Series I bonds.
* There is an AMT patch which helps for 2009, but falls back for 2010.
* There is an increased casualty and theft loss limit that helps for 2009.
* Note that a dependent child’s income is taxed when it exceeds $1,900.
* The Tuition and Fees Deduction applies to 2009.
* Unemployment Compensation has $2,400 excluded from taxable income (2009 only).
* Educator’s Expense enhanced for 2009.

Note that not all states accept the IRS changes, so the information and outcome could be different.

For 2010, some old provisions return and some new changes require action now:

* 2010 conversion to a Roth IRA has no income limit and two years to pay the taxes (please see To convert or not traditional IRA to Roth IRA).
* Certain changes lost for 2010 worth repeating (see What to watch out for in 2010 – investing, taxes and more):
* AMT patch falls back;
* Casualty and theft loss limits fall back;
* Educator and tuition and fees deductions against adjusted gross income are not available;
* Deduction of state and local sales taxes ends;
* Exclusion of $2,400 of unemployment income ends; and
* Exclusion of income from qualified distributions from IRAs to charities ends.
* The estate tax still has not been enacted retroactively, as expected (see Estate Planning – will we have a new tax law in time).

As we said before, tax planning involves a multi-year view to optimize what you end up paying (please see More Strategies – Three Year Planning…., Tax Credits and all Continued, and What to watch out for in 2010 – investing, taxes and more)

Let us know if you have questions or comments. Thanks,


What to watch out for in 2010 – investing, taxes and more

With a new year begun, now is a good time to take stock of your finances. Below are a series of areas to address. If you have questions or comments, please let me know Contact Us


The markets were up in 2009, some by over 70%, especially low grade stocks and bonds or what some have called a “junk rally”. Should you expect the same for 2010? Is there “a new normal” to which you need to respond?

If you have read any of my Newsletters, you know my response: last year’s winners usually perform poorly in the following years; many individual investors buy these investments anyway, making it more difficult for fund managers to produce results (it is harder to find good investments when you have a great deal more to invest); individual investors also often sell investments that historically go up; any thesis about a “new normal” tends to either ignore long-term lessons of history or be a flashy way of pitching a tactical move that could make sense, but only if you know when to sell as well as when to buy; and what is out of favor usually returns to favor, so that the more stable stocks and bonds that seem too boring to buy could be the right investment to be making now, as so often investment returns track back to the norm over time.

Studies show that, on average, mutual funds over decades fared slightly worse than their respective indices but individual investors did far worse. On the last point, there is a good article entitled “Stop Listening to Jim Cramer” found at Stop Listening to Jim Cramer. The point of this and some other authors worth noting is that prudent investing requires a long-term strategy, and with it the urge to resist trying to pick winners based on a fad, their most recent performance or some other short-term gauge (see The Biggest Mistake Investors Make). Investing in index funds is very boring, but the fees are low and these funds often do well over time.

So what do you do? First, create or update your investment allocation with a long-term view that does not respond to fads. This is essential. Second, rebalance at least annually, selling the excess of your winners to buy your under-performing funds. Historically, this is a way to sell high and buy low. Third, as a tactical move, consider funds investing in large cap US stocks, dividend paying stocks, and adding or increasing your allocation to international stocks. Also, use bond funds that have short-term durations and try to find bond or convertible bond funds that are buying or holding bonds that are discounted. Finally, consider adding commodities as further diversification, with the goal of obtaining gains from either new building, especially in foreign markets, or the chance that we have inflation instead of deflation.

Tax law changes

In my 2009 year-end tax planning Newsletters, I highlighted Roth conversions and other ideas that still apply in 2010. I also pointed out that, with the Bush tax cuts expiring and the need to cover deficits, counting on marginal income tax rates to rise is a safe bet. (Please see Three-year Planning for this year-end and Year-end Tax Planning – Tax Credits – Continued)

This means that you should maximize your contributions to your 401(k), SEP or 403(b) plans, use your HSA or FSA, avail yourself of the first-time home buyer credit and even sell stocks and bonds to reset the basis before the long term capital gains rate rises.

With respect to the Roth conversion, you get two years to pay the taxes for a conversion in 2010. However, the 2011 rate could be higher so this may not be an option worth taking.

In the end, we all need to follow what Congress does to update our strategies during the year.

Estate tax update

Congress is expected to reinstate the estate tax retroactively to January 1. However, instead of the $3.5 million credit and 45% rate, there are some pushing for $5 million and 35% who may win in a compromise. We will update you when we know more.

Also, remember to use your $13,000 annual exclusion for gifting strategies.

Credit – mortgages, cards, etc.

Check your mortgage rate against what you can get on refinancing now. Rates are still low so you may be able to save. Also, if your appraised value is less than the mortgage, there are government programs to help (see Making Home Affordable – refinance eligibility).

If you have not purchased a house, rates are low as are home prices, so this could be a good time to act. First time home buyers have the tax credit as an extra incentive (as mentioned above), if they can act in time.

There are actions to take regarding your credit rating and use of credit cards. Monitoring your credit score will let you know if you can qualify for good loans and credit cards, as well as alerting you to any potential identity theft.

Check to see what accounts are open and use them, reasonably. An account that is not used can be closed under the new banking laws, which has a negative impact on your credit score.

If you do have higher fees or rates imposed, fight to see if you can get your old terms back. Many notices are sent without real scrutiny of your particular situation so, if you have a good history, you may win this fight. Also, opt out of the overdraft fees ($39 per time you go over your credit limit).

If you are looking for a new card, consider credit unions, as their rates are capped, unlike other credit card issuers.

Finally, consider adding a child who is in college to your card, because the new law requires them to prove sufficient income to afford the payments.

Estate plan and life insurance

As noted above, we await action from Congress on the federal estate tax.

However, you still need to make sure that your current will/trust/durable power of attorney/medical directive/etc. work under state laws, have all the people you still want as your fiduciaries and reflect any other changes you have experienced. If not, you should update these documents.

Other financial matters

Do you have an umbrella policy? Did you buy or update your disability policy? Have you checked to see if you can get a better deal on your auto insurance? Would increasing the deductible make sense for your risk tolerance and cash flow?

There are many other items to review. Please check out Finance Health Day – your own financial planning focus


Even if 2010 is not a repeat of 2009 for investments, there are many steps to take to make certain that you are in an optimal position on all your financial fronts.

Let us know if you have questions or comments. Thanks,


Comments on health insurance, tax changes and asset allocation (not even having all investments in cash is safe)

Starting with my reoccurring theme of asset allocation, I post below two comments on investing.

The first short comment from Morningstar reaffirms that you need to diversify by class, as well as in each class, of investment.

The second comment from Merrill Lynch provides a year to date summary of returns, showing that the people who tried to market time, by going to cash last year, missed out on substantial returns by being out of the stock markets in 2009.

Finally, as another example on diversifying, we had some clients invest in Euro bonds. They made over 20% in the last two years, which is much having gone to cash.

So, again, I urge anyone who has not reviewed their allocation to do so now …..

Tax impact of Health Care Reform
On the health care reform and its impact on your taxes, I reprint a section from the Kiplinger’s Tax Letter below.

As with many other sources, they believe a bill will pass and that it will have an impact on taxes.

The impact is likely to be predominately on people with income in excess of $250,000, but not beginning until 2011. When we know more on this, we will give you an update.

Estate Taxes
Kiplinger’s expects Congress to keep the estate tax much like it is today, rushing to avert the year of no estate tax and the year after or a $1 million credit (we now have a $3.5 million credit)…

Kiplinger’s also has comments on the “cash for clunkers” and changes likely in 401(k) plans…..

Let me know if any of this raises questions or comments please. Thanks,


From Morningstar:
Theoretical and empirical research, as well as long-term data from financial markets, confirms that risk is minimized significantly and performance can be enhanced when a portfolio holds, for long periods of time, different asset classes with dissimilar price movements. This approach, which fulfills the fundamental underlying objective of modern portfolio theory, is also in accord with the standards of modern prudent fiduciary investing.

From Merrill Lynch:
…. In the meantime the S&P 500 Index had its best quarterly return since 1998, rising almost 16%. Most US equities rose sharply in the second quarter as investors regained their appetite for risk; investors bid up stocks beginning in March after it appeared that the financial sector had stabilized and this momentum continued through the second quarter. Investors seized upon indicators such as retail sales, industrial production and ISM survey data that suggested economic growth, although weak, was showing improvement. Indeed, retail sales and durable goods orders were higher than expected and employment figures showed a moderation in worsening trends. After the strong end to the first quarter, analyst estimates for company earnings were on average revised higher as the depression scenario faded into memory. During the quarter, the riskiest assets were bid up the most, with the Russell 2000 Small Cap Index returning more than 20%.
Outside the US, the story was similar: markets improved sharply on the turn in economic data. The MSCI Emerging Markets Index had its best quarter in U.S. dollar terms since it was launched in 1988 – rising almost 35% in the second quarter…..

The Kiplinger Tax Letter (ISSN 0023-1762)
Health care reform may seem stalled for now, with both the House and Senate missing the deadline that Obama set for action on a bill…early August.
But work still goes on behind the scenes, so Democratic leaders can make a final push this fall.
Readers are asking what’s going to happen to the legislation and what it will mean for taxes.
We’ll share our answers to those questions.
What are the chances that no bill will pass?
Very unlikely, given all the political capital that the president has spent on this issue. He’s sure to insist Congress keep at it.
But if gridlock continues, Obama may have to accept a scaled down bill… a lesser expansion of the government’s role in providing coverage to the uninsured.
A smaller bill would lower the price tag, reducing the need for tax hikes. The odds of a big-ticket tax increase such as an income surtax would go way down. It wouldn’t be needed to offset higher federal spending from revamping health care.
Does a smaller bill mean no employer mandate? No, although the number of small businesses that would be covered by the mandate and the tax penalties for failing to provide coverage to employees would be smaller than originally thought. The tax would be somewhat less than the $750 per worker proposed in the Senate, and would be phased in for those businesses with payrolls that exceed $500,000. As first proposed, the tax would have covered firms with payrolls over $250,000.
Would a mandate apply beyond the private sector? Yes. The coverage rule and tax penalty are sure to cover nonprofit groups and state and local governments.
Could employers avoid the mandate by classifying workers as contractors?
Theoretically. However, it’s a risky move. Tax pros predict that a mandate would spur many firms to consider reclassifying employees to avoid covering them, forcing them to buy their own coverage. But you can expect that angry workers will squawk to the IRS, giving the agency lots of leads for employment tax exams.
Are middle incomers likely to see higher taxes to fund the overhaul?
Don’t rule it out. Lawmakers are considering, for example, a new tax on gold plated insurance plans. Those policies aren’t owned just by upper incomers. They are included in the contracts of many union members…police, firefighters, etc.
Would Congress consider making tax hikes start in 2010? Definitely not. Figure that 2011 would still be the earliest year that hikes would become effective.
Will continuing delays on health care push estate tax changes into 2010?
Not very likely. Lawmakers still intend to act before the end of the year to prevent the estate tax rate from dropping to zero in 2010. The exemption amount for 2010 will be kept at $3.5 million and the rate will stay at 45% for another year. The estate tax bill is sure to include extensions beyond 2009 of popular tax breaks, such as tax free IRA payouts to charity and the deductions for tuition and sales tax.

The “cash for clunkers” program has tax angles for people and businesses. Vouchers are tax free for individuals. Therefore, if you trade in a vehicle for a more fuel efficient one and get a $3,500 or $4,500 dealer credit on the trade-in, you owe no tax, even if the amount of the credit far exceeds the trade-in’s value. And if you purchase a qualifying hybrid or a lean diesel vehicle as a replacement, you still can claim the hybrid or diesel credit, even though the voucher isn’t taxed.
But car dealerships don’t benefit from the tax break, IRS officials say. The voucher amount is included in the gross receipts from the sale of the vehicle.

Many 401(k) plans will have a different look a couple of years from now. The economic downturn is prompting changes that firms will implement to reduce plan expenses and to prompt their employees to save more for retirement.
More employer payins will be discretionary. Although most plan sponsors that suspended matching contributions during the downturn will reinstate them, those payins won’t return before 2011, and they’ll probably be in a different form. Fewer firms will automatically match a set percentage of pay. More contributions will be tied to company performance. And many firms will stop obligating themselves to a contribution level at the start of the year but will wait until year-end to decide.
Companies will try to get more 401(k) accounts on autopilot to help workers boost savings. One idea: Having employee payins increase automatically each year until reaching a preset level…around 10% of pay…if the employee selects this option. The number of companies adopting automatic enrollment will continue to grow, though some will limit it to employees with at least two years of service. That way, firms can avoid incurring the administrative hassle and expense for short-timers.

Another subject:
Bad news from IRS for exchange-traded funds that invest in metals: Those funds do not qualify for the 15% rate on long–term capital gains. Instead, their top tax rate is 28%. It applies if the fund owned the metal for more than one year and the investor owned fund shares for over a year, IRS says privately.
The fund’s investors are deemed to own a share of the metal, such as gold, silver or platinum. The gain is treated as coming from the sale of a collectible.
The Service takes a different stance for IRAs investing in these funds. If the metal is held by an independent trustee, the Service will not treat the IRA as owning a share of the fund’s underlying metal. This favorable interpretation keeps the IRA from running afoul of the rule barring direct investments in bullion.