Temporary Payroll Tax Cut

On December 23, 2011, Congress passed, and the President signed, legislation that extends the 2011 temporary payroll tax cut by two months, to the end of February 2012.  The Federal Insurance Contributions Act (FICA) consist of two separate taxes:  6.20% on the first $106,800 (for 2011) of compensation for Old Age, Survivors and Disability Insurance (OASDI); and 1.45% on all compensation without limit for Medicare Hospital Insurance.  These taxes are imposed on both the employee and the employer.  For 2011, the 6.20% rate was reduced to 4.20% for the employee's share only.  The rate reduction expired December 31, 2011, and Congress squabbled over how to extend the tax cut into 2012.  Congress only managed a two-month extension and so will need to address this issue again shortly.  A similar extension was made for the self-employment tax rate.

In 2012, the OASDI tax applies to the first $110,100 of compensation.  However, the new law only permits the 2% rate cut to apply to the first $18,350 of 2012 compensation (two-twelves of $110,100) during January and February by means of a 2% recapture tax.  This provision prevents those who can control the timing of their compensation from front-loading their compensation to gain the full benefit and also relieves a burden on employers to monitor the tax withholding rate based upon the amount of compensation paid during this two month period.  The recapture tax would be paid on the employee's 2012 income tax return.  However, the recapture provision only applies if the rate cut actually ends on February 29, 2012.  Congress is expected to extend the tax cut to all of 2012.

Last Minute 2011 Year-End Tax Planning

Even at this late date in December, there are "last minute" steps that you can take to save income taxes.  The following bulleted list briefly describes a number of these steps.

1. Determine your 2011 and 2012 marginal income tax rates.  The marginal rate is the tax rate you would pay on the next one dollar of income.  If your 2011 marginal tax rate is lower than what you anticipate for 2012, then try to accelerate income into 2011 and defer deductions into 2012.  Do the reverse if your 2011 tax rate is higher than your 2012 rate.
2. Consider selling stocks for which you have capital losses in order to reduce the amount of your capital gains subject to tax.  Be careful to avoid the "wash sale" rule when reinvesting the sale proceeds.  The wash sale rule prohibits tax losses on the sale if the same security is purchased within the 30-day period before the date of sale and within the 30-day period after the date of sale.
3. Consider converting a portion of your traditional IRA or 401(k) account into a Roth IRA or Roth 401(k) account by December 30th.  The conversion is essentially a question of tax rates in the year of conversion vs. your tax rate in retirement.  If you are in the 15% bracket in 2011, convert enough to fill up the 15% rate bracket which extends to taxable income of $69,000 for joint filers and $34,500 for single filers.  Taxable income is your net income after all deductions and exemptions.  Before converting, be sure that you have enough cash outside the retirement account to pay the conversion tax.  This idea saves future taxes since the Roth account is tax-exempt.
4. For those age 70 1/2 or older, don't forget to receive the 2011 required minimum distribution from your IRA or qualified retirement plan.  Failure to take the RMD incurs a 50% penalty on the amount not taken.  Ending this year is the ability to make a direct charitable contribution from your IRA and have it count as part of your 2011 RMD.  Certain rules and limitations apply.
5. For those who would like to reduce their taxable estate, make a $13,000 present-interest gift to your heirs before the end of the year.  To be considered a completed gift in 2011, gifts made by check should be deposited in the bank by the recipient no later than December 30, 2011.  Each year there is a $13,000 "annual exclusion" from the gift tax.  It is a "use it or lose it" tax benefit.  For a married couple, the gift can be doubled to $26,000 if each spouse participates.

Big tax changes are on the horizon given the need to address the federal budget deficits, and because the so-called Bush tax cuts expire at the end of 2012.  The year 2013 could be the year for important tax changes.  We will keep an eye out on these changes and report on them in future blog posts.

Home Energy Credit Expires After 2011

A personal income tax credit of $500 is available for certain energy-saving home improvements completed by December 31, 2011.  Prior to 2011 the credit was much larger in amount.  The energy credit expires after 2011, so now is the time to complete any needed improvements to your home that can qualify for the tax credit.  This credit has a lifetime limit of $500 of which only $200 may be claimed for windows.  If you claimed this credit in the amount of $500 or more since 2005, no further credit may be claimed in 2011.  The energy credit may offset the 2011 alternative minimum tax.

The 2011 credit is 10% of the cost of certain energy efficient improvements as follows:

1. Insulation, exterior windows and doors, and certain roofs.  The cost of installing these items is not included in the credit calculation.
2. High-efficiency heating and air conditioning systems, water heaters, and stoves that burn biomass fuel.  The cost of installing these items is included in the credit calculation.

Only improvements that meet certain energy savings standards qualify for the credit.  Check the manufacturer's tax credit certification statement before purchasing.

Significant additional tax credits are available for homeowners installing certain alternative energy equipment, such as solar power, geothermal, wind, and fuel cell technologies.  See the IRS website at http://www.irs.gov/newsroom/article/0,,id=249922,00.html for more information.