Year-end tax planning: Who should try to reduce AGI for 2010?

At this time there is a great deal of uncertainty over which income tax rates will apply for 2011. Unless Congress acts, virtually everyone will be subject to higher tax rates starting next year. Although, few expect that this “doomsday scenario” will become reality, we do not believe Congress will take any substantive actions to prevent this from occurring. This uncertain state of affairs leaves us in a quandary about year-end income tax planning moves.

Who should try to reduce Adjusted Gross Income (AGI) for 2010?

The obvious reason, is the belief that income or tax rates will be lower in 2011. The less obvious is that numerous tax breaks (tax credits, deductions, and other tax benefits) are reduced or eliminated if a taxpayer’s adjusted gross income (AGI), or modified AGI (MAGI), exceeds specified thresholds. Commonly known as “Phase outs”. This is point at which your income increases to a level that you  start losing the ability to deduct certain types of items.

As year-end nears, taxpayers who do not anticipate being subject to higher rates next year should consider reducing their 2010 AGI by deferring taxable income into 2011, or by accelerating deductions, if doing so will keep their income level for the current tax year below the relevant phase-out thresholds (or will mitigate the effect of the phaseouts). On the other hand, for taxpayers who do anticipate being subject to higher rates next year the best bet might be to take the opposite tack: accelerate as much income as possible from 2011 into 2010, to take advantage of today’s rate structure, even if some tax breaks are reduced because of the effect of increased AGI on phase-out thresholds. Comparative calculations would of course have to be made to see just how much the advantage of lower rates might be offset by the loss of tax breaks.

The following are the key tax breaks that are subject to phase out in 2010 and 2011. Some of these tax breaks may themselves be unavailable in 2011. The impact of these phase outs are fact dependent and are impacted by your filing status and other provisions, so please contact us to discuss your specific situation.

  • Nondeductible Roth IRA contributions
  • Deductible Traditional IRA contributions
  • Child care credit for qualified children under age 17
  • American Opportunity Tax Credit for higher education expenses (expires at end of 2010)
  • Lifetime Learning Credit for higher education expenses
  • Deductible interest on student loan
  • Coverdell Education Savings Account (ESA)
  • Adoption assistance/adoption credit
  • Passive loss limit from active participation in rental real estate

If you think any of these provisions will apply to you in 2010, please let us know and we will send you detailed phase out information.

ALERT! For 2010, neither itemized deductions nor personal exemptions are phased out at higher levels of AGI. However, unless Congress acts, for 2011, most itemized deductions of higher-income taxpayers will be reduced by 3% of AGI above an inflation-adjusted figure (but the reduction can’t exceed 80%), and a higher-income taxpayer’s personal exemptions are phased out when AGI exceeds an inflation-adjusted threshold. If this provision goes into effect, this could be a reason for affected taxpayers to accelerate income to 2010 from 2011.

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