What Federal Employees Need to Consider for 2011 Year-End Tax Planning
Table 1. Individual Tax Provisions Expirations During
2011 and 2012
and Tax Increases Taking Effect in 2013*
Take Advantage of Low Ordinary Tax Rates and the 15 Percent Maximum Tax on Long Term Capital Gains and Qualified Dividends in Effect Through Dec. 31, 2012.
Note in Table 2 (2011 tax rate schedule) and Table 3 (2012 tax rate schedule) that while the marginal tax brackets -- 10,15,25,28,33 and 35 percent have not changed, the brackets have widened. That is, the upper limits of the brackets have increased.
The widening of the tax brackets for 2012 suggests immediate planning. Those employees who do not expect to be in a higher bracket for 2012 should attempt if possible to accelerate deductions into 2011. For example, making the January 2012 mortgage in December, accelerating 2012 charitable contributions planned for 2012 into December (checks must be mailed by Dec. 31, 2011 or charged to a credit card by Dec. 31, 2011, even though the credit card bill will be paid in 2012), or making the fourth quarter 2011 state estimated tax payment - due Jan. 15, 2012 - in Dec. 2011. For residences of states with no state income tax but with a state sales tax - this includes - Florida, Nevada, South Dakota, Tennessee, Texas, Washington state and Wyoming - purchasing "big ticket" items such as a car or a truck in Dec. 2011 and being able to deduct the sales tax as an itemized deduction on 2011 federal income taxes could result on savings to one's 2011 federal income tax liability.
For those employees who expect to be in a higher marginal tax bracket for 2012, consider the opposite strategy - delaying deductions into 2012. But if an employee owes the alternative minimum tax (AMT), the employee may have to reconsider this strategy. The AMT is a parallel tax to the regular federal income tax. Individuals pay the higher of the AMT and the regular tax. Taking certain types of deductions may make an individual more likely to owe the AMT. For example, deducting a significant amount of state income taxes, sales taxes, real estate taxes, mortgage interest and most miscellaneous itemized deductions could result in one's paying the AMT. Employees can check if they may be subject to the AMT by going to an AMT calculator located at http://www.Kiplinger.com/tools/AMT_Calculator.
Table 2. Ordinary Income Tax Rate Schedule -- 2011
Table 3. Ordinary Income Tax Rate Schedule -- 2012
Capital Asset Gains and Losses
The stock markets, and to some extent the bond markets, have been on an "investment roller coaster" during 2011. For those stock and bond investors who invest in non-retirement accounts, the tax code can be extremely beneficial. Not only is the top tax rate on long-term (capital assets owned for at least a year) capital gains a maximum 15 percent, but investors can also "time" gains and losses -- generate capital losses to offset any capital gains -- in order to minimize overall federal and state income taxes. Also, up to $3,000 of long-term capital losses not used to offset capital gains (because there are no non-retirement portfolio capital gains), can be deducted against ordinary income such as salary, pension or interest income. Unused capital losses carry over to future years for use in those years.
Employees with capital assets -- this includes stocks, bonds and mutual funds -- held in a non-retirement portfolio and whose market value has significantly decreased since first purchased - should consider selling some of these assets before Dec. 31 in order to utilize these capital losses. But employees should avoid selling solely for the purpose of saving on taxes, and they should also be mindful of transaction costs associated with selling capital assets.
Another word of caution: Employees should avoid "wash sales". A "wash sale" occurs when an investor sells a capital asset at a loss and within 30 days before or after the sale, the investor purchases the identical capital asset The IRS disallows capital losses deductions resulting from "wash sales". In contrast, a stock may be repurchased immediately if it is sold at a gain, even if the gain will be offset by a loss. Information about "wash sales" can be obtained in this article.
For those employees who itemize on their income taxes, making charitable contributions in the form of cash/check or property results in tax savings. Current rules allow a maximum charitable contribution deduction of up to 50 percent, 30 percent, of 20 percent of one's adjusted gross income (AGI) depending on both the recipient and the type of property donated. In general, the 50 percent limit applies to gifts of cash/checks and the 30 percent limit applies to gifts of appreciated capital assets. Tax professionals advise donating appreciated assets -- such as shares of stock -- directly to the charity rather than selling the asset, paying the capital gains and then donating the net cash proceeds to the charity. This is because the donor avoids the capital gains tax when the charity sells the appreciated stock is sold. The donor then gets a deduction equal to the stock's market value.
On the other hand, for capital assets that have decreased in value since their initial purchase, the donor should first sell the asset thereby incurring a capital loss. The loss can offset any capital gains or other income, and the resulting net sale proceeds can be donated to a charity thereby resulting in a double tax benefit for the capital asset owner. Any form of a charitable donation -- cash/check or property- requires that the donor have a receipt issued by the charity. The receipt must be in hand at the time the donor files his or her 2011 income taxes.
Contribute More to the Thrift Savings Plan (TSP)
Most federal employees have at least one more remaining pay date in 2011 and have this opportunity to contribute more to the TSP for calendar year 2011. They can increase their TSP contributions at any time. For 2011, all federal employees can contribute a maximum $16,500 in regular contributions to the TSP. Employees who will be age 50 or older as of Dec. 31, 2011 are eligible to contribute a maximum of $5,500 in "catch-up" contributions. Both regular and "catch-up" contributions are deducted from gross salary, resulting in federal and in most states, state income tax savings. The other non-tax reason for contributing more to the TSP: For increasing one's retirement savings that will ultimately provide additional pension income.
Medical and Miscellaneous Deductions
A wide variety of unreimbursed medical, dental and vision expenses are deductible. These expenses include out-of-pocket co-payments and deductibles (unless reimbursed from a health care flexible spending account or a health savings account) to medical-oriented mileage, to remediation educational expenses required for special-needs students. But these expenses can only be deducted as medical expenses if an individual itemizes on his or her taxes (files Schedule A), and only to the extent these out-of-pocket expenses exceed 7.5 percent of one's adjusted gross income (AGI). Some individuals "bunch" deductions into one year in order to qualify for this deduction. Some employees schedule necessary medical surgery or an end-of-year dental visit in order to qualify for this deduction. A list of qualifying medical expenses may be found in IRS Publication 502 -- Medical and Dental Expenses, which can be downloaded from http://www.irs.gov.
The same "bunching" can apply to miscellaneous deductions which are deductible on Schedule A to the extent that these expenses exceed 2 percent of one's AGI. Included among miscellaneous itemized deductions are union dues, tax preparation fees and tax software expenses, financial magazine subscriptions, and employee out-of-pocket expenses. A complete list of miscellaneous deductions can be found in IRS Publication 529, Miscellaneous Deductions, which can be downloaded from http://www.irs.gov.
About the Author
Edward A. Zurndorfer is a Certified Financial Planner, Registered Health Underwriter, Registered Employee Benefits Consultant and Enrolled Agent in Silver Spring, MD and the owner of EZ Accounting and Financial Services, an accounting, tax preparation and financial planning firm also located in Silver Spring, MD. He is an instructor at federal employee retirement seminars throughout the country and writes numerous columns and books on federal employee benefits.