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MONTHLY TAX NEWSLETTERDecember 2008
According to The Ultimate Book of Useless Information by Noel Botham, "a trilemma is a dilemma with a third alternative." While I wasn't actually able to find this word listed in any of the dictionaries in my house, year-end tax planning for 2008 can best be described as a trilemma.
Why is tax planning so complicated this year? Based on Obama's campaign promises, Democrats taking control of both Houses of Congress, and a US debt figure of ten trillion dollars and growing, there is a good chance that individual tax rates are on the rise for 2009 and beyond.
The higher the level of uncertainty, the more difficult planning becomes. Since no one knows for sure what will happen with the Tax Code in 2009, how should you handle your year-end tax planning?
Option 1: Take The Traditional Approach
Also known as the Bird In The Hand Approach, with the Traditional Approach you do whatever you can to save taxes today. Prior to December 31st, take advantage of any and all tax-saving opportunities that are available to you. You can find a list of year-end tax planning strategies in the third article of this month's newsletter.
What happens If tax rates jump up next year? So be it. Next year is when you'll figure out how to minimize your 2009 tax burden.
Option 2: Plan For Higher Taxes Next Year
If you think your tax rates are on the rise, then you may opt for Delayed Gratification. Even though foregoing some common year-end tax breaks will increase your taxes this year, benefiting from those breaks in next year's higher taxed environment might ultimately help you minimize your tax burden over this two-year period.
If you'd like to plan for higher taxes next year, accelerate taking income into 2008 if possible, and also hold off making your January 2009 mortgage payment and finalizing your 2008 charitable donations until after December 31st.
Option 3: Worry About The Alternative Minimum Tax
Nothing ruins good tax planning like the AMT. One positive spin to higher taxes is that fewer people may find themselves subject to this tax. As part of your year-end tax planning for 2008, don't overlook the impact of the AMT.
Remember, certain expenses such as state income taxes, real estate taxes, personal exemptions, miscellaneous itemized deduction, certain Home Equity Line of Credit interest, and a portion of allowable medical expenses are not allowable when calculating the AMT.
Counting the Days
January 20th is Inauguration Day. That means there are 51 days before the clock starts ticking on Obama's all important first 100 days as President. By working through the math, and adding 151 days to the December 1st date of this newsletter, that bring us straight to April 30th.
Assuming Obama is able to push through some of his tax agenda during his first 100 days in office, it could be as late as April 30th before you finally have a clear picture of the scope of the tax changes affecting you. This uncertainty is at the root of the trilemma surrounding your year-end tax planning for 2008.
Good news for taxpayers. Congress managed to extend relief from the dreaded Alternative Minimum Tax through 2008 as part of the 2008 Financial Bailout and Tax Package enacted on October 3, 2008. Each year since 2001, Congress has provided for a temporary fix to the AMT. Had nothing been done about the AMT, the number of taxpayers paying this tax was expected to jump to more than 20 million in 2008.
What is the AMT? The AMT is a parallel tax system that was instituted in the late 1960's to ensure that high-income taxpayers pay at least a minimum amount of taxes. Thirty-nine years ago, the tax laws were much different then today's tax code. Back then, the top tax bracket was 70% or higher, and deductions, credits, and other tax breaks were abundant. As a general rule, only high-income taxpayers were hit by this tax.
In recent years, however, more and more middle-income taxpayers are finding themselves paying this tax. Over the years, the top bracket has been cut in half to 35% while the upper limit for each of the tax brackets has increased substantially because of inflation. Even so, the AMT rates have held steady at 26% and 28%, and the allowable AMT exemption has not kept pace with inflation over this time period.
What is causing this AMT catastrophe each year? The biggest culprit is the AMT exemption that you're allowed to claim. The purpose of this exemption is to protect middle-income taxpayers from paying the AMT.
As part of this one-year fix, the AMT exemption for married couples has been increased to $69,950 for 2008, up from $66,250 allowed for 2007. Had Congress not acted, the AMT exemption was slated to be cut to just $45,000. The AMT exemption for single individuals is now set at $46,200, up from the pre-fix amount of $33,750.
Remember, the purpose of this exemption is to protect middle-income taxpayers from paying the AMT. This increase of $3,700 in the AMT exemption should help keep even more taxpayers from being hit by this tax in 2008.
With Obama taking office in January and the Democrats taking control of both Houses of Congress, no one knows what will happen with the tax rates in 2009. For that reason, we split our annual year-end tax planning advice into two groups - Definite & Maybe:
Let's start with those strategies that make sense no matter what happens with the Tax Code next year:
Now let's review some year end strategies that may not make sense if you feel that your income tax rates will increase in 2009. However, if you think your income will take a big hit next year due to the current economic mess, then these strategies would still make a lot of sense to you. That's why they are in the Maybe bucket.
For your final step, evaluate whether you'll save any taxes by postponing 2008 income or deductions into 2009 or by accelerating 2009 income or deductions into 2008. And now is the time to contact your tax preparer or one of the MDTAXES CPAs with any questions you have about year-end tax planning strategies.
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