UBS 2010 Year End Tax Planning


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Tax Planning ideas to consider before 2010 comes to a close

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UBS 2010 Year End Tax Planning

  1. 1. Planning 2010 year-end planning guide ab Tax planning strategies 3 Investment planning ideas 4 Estate planning 5 Charitable planning 6 Retirement planning 7 Year-end planning checklist 9
  2. 2. Clarity in tax rates and related provisions may emerge from the lame duck Congress that returns following this year’s midterm election, or it may not. Clarity may come when the new Congress is seated in January, 2011, or it may not. Despite this uncertainty, there are a number of ideas that you may want to consider before 2010 ends. Your UBS Financial Advisor can work with you and your tax advisors to help you decide what strategies may be appropriate. Clients are encouraged to remain attentive to the deliberations in Washington, D.C., over the next few months. As 2010 winds to a close, individuals are confronted with an uncertain framework around federal income taxes, making an ordinary year-end planning process more challenging than ever. 2
  3. 3. 3 Tax planning strategies • Carefully time your loss recognition. Consider selling assets this year in taxable (i.e., nonretirement) accounts that have generated losses to use those losses to offset taxable gains. If, however, you anticipate large short-term gains in 2011, you may consider delaying tax loss harvesting of short-term losses until next January, being careful not to delay any sales so long that the holding period exceeds one year, which would convert the more favorable short-term losses into long-term losses. • Net gains and losses. Match your short-term gains and losses and long-term gains and losses to determine your capital gains and loss carry forwards. Note that you can use $3,000 of net capital loss to offset ordinary income for 2010 as well. • Trigger capital gains tax. If, however, you believe that income tax rates will rise next year, you may wish to sell assets by December 31 to trigger long-term capital gains tax at the present 15% rate, and defer losses until next year. • Review your deductions. To accelerate deductions, pay deductible expenses (unreimbursed medical expenses, property tax) in 2010, or defer those deductions to 2011 for a greater benefit if income tax rates rise. • Roth IRA conversion. Discuss with your Financial Advisor whether it makes sense to convert a traditional IRA to a Roth IRA. If you convert by December 31, you can recognize the income in 2010 or elect to declare 50% of the income in 2011 and 50% in 2012. It may make sense in your situation to recognize all of the income in 2010 in anticipation of potentially higher income tax rates in the near future. However, if you believe that current tax rates will be extended, you may want to defer the conversion itself—not just the recognition of income—until 2011 because you would then have until October 15, 2012 to decide to recharacterize (or undo) the conversion if circumstances change. • AMT liability. Review with your tax advisor to see where you stand for 2010 relative to the alternative minimum tax (AMT). If you are subject to AMT, and you have the ability to defer income from 2010, consider deferring if you may not be subject to AMT in 2011. If you are not subject to AMT, consider accelerating income (like exercising ISOs) that would have negative AMT consequences. Also consider accelerating deductions (like property tax payments) that would not provide an equivalent tax benefit in a year in which you were subject to AMT. In short, any analysis of the merits of accelerating or deferring income or gains should take potential AMT liability into account. In addition, Congress has not yet passed the AMT “patch” to raise the exemption limit for 2010. If the exemption is not extended, then in 2010 and future years, the AMT exemption is scheduled to revert to pre-2001 levels, which will affect many more taxpayers. Take note: Absent congressional action, the following federal income tax changes will occur on January 1, 2011: • The 33% and 35% individual tax brackets will increase to 36% and 39.6%. In addition, the lowest bracket (10%) will be eliminated. • The maximum tax rate for long-term capital gains will increase from 15% to 20% for individuals, with low income filers paying 10%. • Dividends will cease to be taxed at capital gains tax rates and will again be taxed at ordinary income tax rates (as high as 39.6%). • Beginning in 2013, an additional 3.8% Medicare tax on net investment income will be assessed on: individuals with modified adjusted gross income (MAGI) exceeding $200,000; married couples with MAGI exceeding $250,000; and trusts with MAGI exceeding approximately $12,000. • Also beginning in 2013, an additional 0.9% Medicare tax will be assessed on wage income over $250,000.
  4. 4. 4 • Options. You may also wish to exercise nonqualified stock options (NQSOs) in 2010 in anticipation of potentially higher income tax rates next year. • Bonus depreciation. Recent legislation has revived the first-year bonus depreciation allowance for property placed in service through 2010. For certain tangible property, taxpayers may deduct a bonus depreciation amount equal to 50% of the property’s depreciable basis, over and above regular depreciation. As a result, the bonus allowance permits businesses to write off their costs more quickly. Unlike other depreciation allowances, bonus depreciation applies to businesses of all sizes. However, the new law carries a very short window of opportunity—qualifying equipment must be purchased and placed into service on or before December 31, 2010. Investment planning ideas • Wash sale rule. In general, the “wash sale” rule prohibits you from recognizing losses if you purchase substantially identical stock or securities within 30 days before or after the sale. If you don’t want to wait 30 days to buy the same stock or security, you may consider replacing the investment you sold at a loss with an exchange traded fund (ETF) tied to the company’s industry or sector. In this way, the ETF effectively serves as a temporary proxy for individual stock holdings and still enables you to recognize the loss on your original position. You can also replace actively managed mutual fund shares sold at a loss with an ETF, but if you plan to substitute one ETF for another, make sure the funds track different indexes. Wash sale dates to note November 30 Last day to “double up” for 2010. Doubling up on a security means that you buy a second lot of a security in the same amount as the original holding, thereby allowing you to recognize a loss by selling on December 31 without missing any potential appreciation during the wash sale period. December 31 Last day to sell a security in 2010 for a loss. January 31 If you sold a security for a loss on December 31 without previously “doubling up,” you must wait until January 31, 2011 or later to repurchase the same or substantially similar security in order to avoid the wash sale rule. • Fixed income gains. This year has been another strong year for bonds and bond funds as interest rates are at or near all-time lows. As such, we suggest investors pay close attention to embedded gains in your individual bond positions or bond mutual funds. If triggering gains otherwise makes sense, consider selling appreciated bonds to trigger the long-term capital gain. Assuming you can repurchase the same bond, your new basis would be the new purchase price. Because bonds mature at a price of 100, and your basis would be over 100, you can amortize the premium over the remaining term of the bond, in effect realizing a capital loss each year that can be used to offset other income. This strategy works best for corporate bonds, less so for Treasuries and not at all for municipal bonds due to their respective tax treatments. Take note: The UBS Office of Public Policy believes it is likely that the current rates under the “Bush tax cuts,” including those for wealthy taxpayers, will be extended through 2011. The issue will be dealt with in the lame duck session or early next year (and if the tax rates expire on December 31, Congress could address them retroactively in January or February). However, even if the current rates are extended for a year, most experts believe that, with budget deficits and national debt soaring, tax rates will rise in the future.
  5. 5. 5 • Concentrated stock positions. The prospect of higher tax rates for the foreseeable future means that investors should consider accelerating planned divestment before December 31. If you believe that income tax rates will rise in the near future, you might want to consider accelerating planned divestment/diversification. As the capital gains rate increases, the tax cost of diversifying out of a position also increases. • Portfolio review. The end of the year is an excellent time to re-evaluate the goals of your portfolio, the risk level you are comfortable with and the liquidity events that are going to shape the next 2, 5, 10+ years of your life. The volatility of the past three years may have given you pause or concern, and it is important for you to discuss these concerns with your Financial Advisor. This can not only help give you peace of mind, but can be valuable in terms of identifying the best tax planning techniques to utilize. Estate planning • Annual exclusion gifts. Make annual exclusion gifts by December 31. Each person may make annual, gift tax-free gifts of $13,000 ($26,000 for a married couple) to any number of individuals. • Taxable gifts. Consider making taxable gifts to take advantage of the 35% gift tax rate in effect for 2010. This would apply to those who have used their entire $1 million lifetime gift tax exemption amount and wish to make taxable gifts in excess of that amount. Note that it is possible Congress could enact retroactive legislation to reinstate in 2010 the 45% gift tax rate in effect in 2009. • Gifts to grandchildren. Consider making gifts to grandchildren in light of the repeal of the generation skipping transfer (GST) tax in 2010. • Funding education through 529 plans. Consider funding 529 plans by December 31 to apply 2010 annual gift tax exclusion treatment to the contributions. You can “front-load” 529 plans by making five years’ worth of annual exclusion gifts to a 529 plan. In 2010, you could transfer $65,000 ($130,000, for a married couple) to a 529 plan without generating gift tax. • Opportune estate planning strategies. Take advantage of historically low interest rates by establishing Grantor Retained Annuity Trusts (GRATs) or entering into intra-family loans. For GRATs created in November, the hurdle rate is 2.0%, meaning that assets inside the trust need only to grow in excess of 2.0% in order to succeed in transferring wealth. Note that there is proposed legislation in Congress to restrict the ability to use short-term, zeroed-out GRATs in the future. The proposed bill would require: 1) A 10-year minimum term for GRATs 2) A remainder interest, valued at inception, to be greater than zero—thereby eliminating the use of “zeroed-out” GRATs that do not generate a taxable gift 3) Annuity payments to be structured so that the payments do not decrease over time • Family limited partnerships. If appropriate, consider discussing with your attorney or tax advisor whether to establish a family limited partnership or family limited liability company in advance of possible legislation that could curtail the ability to take valuation discounts on transfers of interests in these sorts of entities for gift or estate tax purposes. Take note: Absent congressional action, the estate and generation-skipping transfer (GST) taxes are scheduled to return in 2011, with a $1 million estate tax exemption per person and a $1 million GST exemption per person (indexed for inflation since 1998), with a top rate of 55%. Similarly, the gift tax exemption is scheduled to be $1 million—no change from 2010—also with a top rate of 55%.
  6. 6. 6 Charitable planning • Charitable income tax deduction. In order to obtain an income tax charitable deduction for 2010, gifts must be made by December 31. If the gift is property that will require an appraisal (generally required for gifts of property with a value in excess of $5,000, other than publicly traded stock), you should start the process as soon as possible. Also, it may take several weeks for a transfer of stock via stock certificate or stock power to be complete, so you should plan ahead. Note that the phase-out rules for itemized deductions do not apply in 2010 (but are scheduled to return in 2011), so federal income tax deductions can be optimized in 2010. • Timing of charitable gifts. Consider the timing of charitable gifts—if the deduction could benefit you more in 2011, it may make sense to wait to make the charitable gift in 2011. • Assets to give to charity. To avoid capital gains, you may want to consider giving appreciated property to charity (as opposed to selling the property, recognizing the gain and contributing cash to charity). Most people do not think of fixed income holdings when looking at low basis assets to give to charity. In part, this is because fixed income assets historically tend to have relatively small capital gains. However, the recent interest rate environment has created significant capital gains in many individual bonds and bond funds. If you believe interest rates are likely to rise in the future, now may be an opportune time for gifting fixed income assets to charity, which may have additional benefits if done as part of an asset reallocation strategy. • Donor advised funds. You may want to consider establishing a donor advised fund with UBS. Transferring assets to a donor advised fund can allow you to receive an immediate charitable income tax deduction (at the maximum amount allowed for gifts to public charities) while affording you time to decide on the ultimate charitable beneficiaries. • Charitable Lead Annuity Trust. Consider establishing a Charitable Lead Annuity Trust (CLAT) to take advantage of low interest rates. A CLAT provides for annual payments to charity for a given term, with the remainder generally passing to a continuing trust for your children. As with GRATs, CLATs perform best when interest rates are low. • Private foundations. Managers of private foundations may wish to discuss the following ideas with their tax advisors to optimize the efficiency of the foundation: – In order to avoid the 1-2% excise tax on net investment income, consider making grants of low basis stock in lieu of selling the stock to raise cash for the grants and thereby triggering gains. – Consider offsetting gains with losses. Private foundations cannot carry forward capital losses. If your foundation has significant losses, it can sell securities that have appreciated, recognize the gain and buy the securities back in order to establish a higher basis in Take note of limitations on the charitable income tax deduction: • Gifts to public charities. Contributions of cash can be deducted up to 50% of the taxpayer’s adjusted gross income (AGI), and the full fair market value of other appreciated property can generally be deducted up to 30% of AGI. • Gifts to private foundations. Contributions of cash can be deducted up to 30% of AGI, and the full fair market value of publicly traded stock (if owned for over a year) can be deducted up to 20% of AGI. The deduction for gifts of other appreciated property may be limited to the taxpayer’s cost basis.
  7. 7. 7 the assets. Note that the wash sale rule does not apply here because the foundation is recognizing a gain (not triggering a loss). – Note that approximately 5% of the value of the foundation’s net investment assets for 2009 must be distributed for charitable and administrative purposes by December 31, 2010. Accordingly, foundation managers should determine liquidity needs to meet the payout requirement. – Consider making a “conduit election” so contributions to the foundation can be treated as though made to a public charity for income tax purposes. This can be useful if: — The foundation will distribute all of the contributions it receives — You have contributed assets to the foundation other than publicly traded stock and do not want your deduction limited to your cost basis — The foundation has “banked” excess grants from prior years (when the foundation distributed more than the required 5%) – Consider granting to a donor advised fund if you run out of time and can’t decide which charities should receive some or all of the 5% grant requirement. – To establish a private foundation in 2010, UBS—through its relationship with Foundation Source—can facilitate the establishment if you inform us of your intent before December 20, 2010. Contact your Financial Advisor for more information. Retirement planning • Maximize contributions to retirement accounts. Make 2010 contributions to Roth or traditional Individual Retirement Accounts by April 15, 2011. The following chart summarizes the 2010 and 2011 annual contribution limits to IRAs and retirement plans: Plan Under age 50 Age 50 or older IRA (traditional* or Roth) $5,000 $6,000 401(k), 403(b), 457(b), SAR-SEP** 16,500 22,000 SIMPLE** 11,500 14,000 * The maximum deductible contribution may be reduced depending on your MAGI. ** Salary deferral contributions. • RMDs. Required Minimum Distributions (RMDs) generally must be taken from retirement plans by December 31 (except for the first RMD which can be delayed until April 1 of the year following the year in which the taxpayer turns age 70½, and if the taxpayer is still employed and the employer’s plan permits RMDs to begin at the later of 70½ or retirement). The RMD rules apply to IRAs and all employer-sponsored retirement plans, including profit-sharing plans and 401(k), 403(b) and 457(b) plans. If you have more than one IRA, you can take the RMDs for multiple IRAs from one account. The same holds true for 403(b) plans, but not for other types of employer-sponsored retirement plans, like 401(k) and 457(b) plans.
  8. 8. 8 • Asset selection for RMDs. When selecting assets for an RMD, you may wish to consider the transfer of an appreciated bond held in the retirement account. If a bond currently held in a retirement plan has a high coupon, it may also have an elevated (premium) price. If the bond is distributed as part of an RMD, your basis in the bond will be its (premium) price on the date of distribution. As discussed above in the “Fixed income gains” section, you can then amortize that premium over the remaining term of the bond, in effect realizing a capital loss each year. The high coupon would be earned in a taxable account rather than in the tax-free environment of the IRA, however, so that adverse consequence will need to be weighed against the benefit of the capital loss. • Charitable rollover from IRA. Note that Congress did not extend into 2010 the ability for individuals over age 70½ to transfer in 2009 up to $100,000 from an IRA to a charity free from tax. It is possible that Congress could act before year-end to extend this provision for 2010.
  9. 9. Executives and other individuals subject to high income tax brackets Review your deductions Consider a Roth IRA conversion Monitor your AMT liability Consider exercising nonqualified stock options Investors Carefully time your loss recognition Net short- and long-term gains and losses Recognize capital gains if tax rate increase is a concern Watch out for the wash sale rule in recognizing losses Consider recognizing fixed income gains Review your portfolio for your current risk level and circumstances Wealth transferors Utilize the annual exclusion Consider taxable gifts Consider gifts to grandchildren Fund education through 529 plans Utilize GRATs and other opportune estate planning strategies Philanthropists Review optimal timing of charitable gifts Ensure a 2010 tax deduction, if intended for this year Select optimal assets to give to charity Consider donor advised funds Take advantage of low Interest rates through CLATs Business owners, employees and retirees Consider benefits of bonus depreciation to business Contribute to retirement plans Withdraw RMDs Select optimal assets for RMDs Monitor legislation for charitable rollovers from IRAs UBS Financial Services Inc. 100108-1669-048 UBS Financial Services Inc. and UBS International Inc. are subsidiaries of UBS AG. UBS Financial Services Inc. does not provide legal or tax advice. Any discussion of tax matters contained herein is not intended to be used, and cannot be used or relied upon, by any taxpayer for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing or recommending to another party any transaction or tax-related matter(s). 529 Plans are sold via Program Descriptions (sometimes called Program Brochures), which contain detailed information regarding the plan, risks, charges and tax treatment. Clients can obtain a free Program Description of their choice from the investment management company sponsoring a 529 Plan or a Financial Advisor. Read the Program Description carefully before investing. Exchange Traded Funds (ETFs) are sold by prospectus, which contains detailed information about an ETF, including its investment objectives, risks, charges and expenses. For a free copy of the prospectus, clients should contact their Financial Advisor. Read the prospectus carefully before investing. 2010 year-end planning checklist ©2010UBSFinancialServicesInc.Allrightsreserved.MemberSIPC. The following tips should be reviewed with your legal and tax advisors in light of your individual circumstances before implementing ab 9