Midyear tax planning

Situation:
Clients should be encouraged to do some midyear tax planning, especially given the many changes in the Internal Revenue Code recently enacted. The biggest effect is potentially from the change in the withholding tables effective April 1. Further, some clients pay estimated taxes and the amounts must be coordinated with the change in the withholding.
Solution:
Change in the withholding tables. If the taxpayer is single with little or no extra income, then the table withholding changes should not have an impact on the final tax liability. However, there might be a smaller refund next filing season because of the lower withholding. If the single individual has more than one job, two Forms W-2 could result in underwithholding of tax, and a liability would result next filing season. This is the result of the tables making the assumption that the W-2 for each job is the only income for that individual. The seam result could occur for married couples filing jointly, where the two incomes are added together on one return. The combined withholding could fall short of the tax that would be owed. Each spouse should review their respective withholdings and make appropriate adjustment as early in the year as is possible.

Dependents. Many items on an individual return flow from being able to claim dependency exemptions. The planner should check to determine if certain key ages are reached by any of the dependents claimed on the prior-year tax return. Key ages are 13 (availability of the child care credit), 17 (the per child credit of up to $1,000), possible use of the head-of-household rate table, the student rule if any child claimed graduated during 2009 and the resulting medical expenses and perhaps education credits that may change from 2008 to 2009.

Credits. In addition to those mentioned in the previous paragraph, energy improvements made to the residence would qualify for energy credits. If so, have those been taken into account in withholding or estimated tax planning? If the taxpayer is a sole proprietor or closely held business owner, it’s important to claim all the available business deductions and, if so, to change estimated payments. Cash flow is extremely important today to business owners. Has a new residence been acquired and the homebuyer credit been made available to the taxpayer? This should change any withholding or estimated tax payments.

Deductions. Deductions might increase because of changes in the law or
because of items that index for inflation. For example, many state and
local governments have increased taxes or accelerated estimated tax
payments, causing higher payments in 2009 than in 2008. The result could
be higher deductions on Schedule A for taxes. This is a double-edged
sword as non-tax items from Schedule A are available for the alternative
minimum tax and thus the taxpayer could find themselves subject to the
AMT. There are new deductions for taxpayers in states that do not have a sales tax. They would be able to deduct any state imposed excies taxes on a car
purchase. Some could have become unemployed during 2009 and would be
paying Consolidated Omnibus Budget Reconciliation Act medical payments
and planning on a medical deduction. However, with the new COBRA credit
for a portion of the payment this may not occur or result in lower
medical payments than the 71/2% of adjusted gross income and would
eliminate any medical deduction.

Retirees. If the taxpayer is a pensioner, have they deferred the minimum required withdrawal? If so, then the 2009 income could be lower than 2008, and estimated payments might be higher than required. This cash flow could be important to a retired individual. If two retirees are having withholding done at the source and are married, then the same problem of lower withholding table amounts could result in a tax liability next year.

For retirees, there are indications that there will be no cost-of-living-allowance adjustment to social security benefits Jan. 1, and this also means no increase to the Medicare B premiums. So tax planning for the older client over a two-year projection becomes important, as they may have to withdraw other funds just to keep cash flow even.

Mortgage or credit card refinancing. Restructuring mortgage debt to a lower principal amount with a lower interest rate will cause a lower deduction on Schedule A for 2009 than was claimed in 2008. Lowering deductions has the effect of increasing taxes and thus, coupled with possible lower withholding, could become a real problem come next filing season. In addition, if not insolvent or in bankruptcy, any debt forgiveness could be considered additional income with no withholding against it and thus causing a much high tax liability.

Income. On the income side, many companies are paying lower dividends or have eliminated dividends entirely, thus reducing income for the year. If tax payments are being made based on the prior year, the taxpayer could be overpaid and probably could use the cash flow from not making as large estimated payments or by changing withholdings.

Unemployment. Unfortunately, some taxpayers have become unemployed during the year. Possible changes in circumstances that would affect their planning would be a reduction in the amount of unemployment compensation that is taxable and additional deductions for job searches. Those who become unemployed might find that certain tax items that were not available in prior years when they were employed might now be available. Because AGI would be lower, any of the many items on Form 1040 that are a factor of AGI could now become available. Education credits, increased child care credit, the earned income tax credit, lower taxes on Social Security income and many others. To supplement income, some have made withdrawals from retirement accounts and thus could face not only tax but a premature-withdrawal penalty of 10%. That is all the more reason to do tax planning now, not later.

Finally, many 2008 provisions are due to expire this year, and some already have expired. Pending any congressional action, this could also result in changing tax position for many individuals.
Plan now, not later; a tax bill in March or April 2010 is not the kind of surprise that anyone wants. It is far better to be prepared than to be surprised.

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