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Year end deduction planning

by Brett Backues on December 14, 2011
Individual Deductions
Timing is an important element of year-end tax planning.  Deduction planning is complex, however, due to factors such as Adjusted Gross Income (AGI) levels and filing status.  If you are a cash-method taxpayer, keep the following in mind:
Deduction in Year Paid:  An expense is only deductible in the year in which it is actually paid.  Under this rule, if your tax rate is going to increase in 2012, it is a smart strategy to postpone deductions until 2012.
Payment by Check:  Date checks before the end of the year and mail them before January 1, 2012.
Promise to Pay:  A promise to pay or providing a note does not permit you to deduct the expense.  But you can take a deduction if you pay with money borrowed from a third party.  This means that if you pay by credit card in 2011, you can take the deduction even though you won't pay your credit card bill until 2012.
AGI Limits:  For 2011, the overall limitation on itemized deductions is terminated.  In addition, certain deductions may be claimed only if they exceed a percentage of AGI: 7.5% for medical expenses, 2% for miscellaneous itemized deductions, and 10% for casualty losses.
Standard Deduction Planning:  Deduction planning is also affected by the standard deduction.  For 2011 returns, the standard deduction is $11,600 for married taxpayers filing jointly, $5,800 for single taxpayers, $8,500 for heads of households, and $5,800 for married taxpayers filing separately.  As you can see, the standard deduction for married taxpayers in 2011 is twice that of single taxpayers.  If your itemized deductions are relatively constant and are close to the standard deduction amount, you will obtain little or no benefit from itemizing your deductions each year.  But simply taking the standard deduction each year means you lose the benefit of your itemized deductions.  To maximize the benefits of both the standard deduction and itemized deductions, consider adjusting the timing of your deductible expenses so that they are higher in one year and lower in the following year.  You can do this by paying in 2011 deductible expenses, such as mortgage interest due in January 2012.
Medical Expenses:  Medical expenses, including amounts paid as health insurance premiums, are deductible only to the extent that they exceed 7.5% of AGI.  Consider bunching medical expenses into years when your AGI is lower.
State Taxes:  If you anticipate a state income tax liability for 2011 and plan to make an estimated payment, consider making the payment before the end of 2011. In 2011, taxpayers may elect to deduct as an itemized deduction state and local sales taxes instead of state and local income taxes.   This benefits taxpayers that reside in states without an income tax.  This provision expires at the end of 2011, so you would want to take advantage of it now by making large purchases in 2011 rather than waiting until 2012.
Charitable Contributions:  Consider making your charitable contributions at the end of the year.  This will give you use of the money during the year and simultaneously permit you to claim a deduction for that year.  You can use a credit card to charge donations in 2011 even though you will not pay the bill until 2012.  A mere pledge to make a donation is not deductible, however, unless it is paid by the end of the year.  Note: claimed donations of cars, boats and airplanes of more than $500, the amount available as a deduction will depend on what the charity does with the donated property, not just the fair market value of the donated property.  If the organization sells the property without any significant intervening use or material improvement to the property, the amount of the charitable contribution deduction cannot exceed the gross proceeds received from the sale.
To avoid capital gains, you may want to consider giving appreciated property to charity.
When considering your charitable contributions, please remember the following rules:
1.       No deduction is allowed for charitable contributions of clothing and household items if such items are not in good used condition or better.
2.       The IRS may deny a deduction for any item with minimal monetary value.
3.       The restrictions in (1) and (2) do not apply to the contribution of any single clothing or household item for which a deduction of $500 or more is claimed if the taxpayer includes a qualified appraisal with his or her return.  
Charitable contributions of money, regardless of the amount, will be denied as a deduction unless the donor keeps a cancelled check, bank record, or receipt from the organization to which they donated, showing the name of the organization, the date of the donation and amount of the contribution.
A special provision gives taxpayers the ability to distribute tax-free to charity up to $100,000 from a traditional or Roth IRA maintained for an individual whose has reached age 701/2 .  Ordinarily, such distributions would be taxable to the individual, who would not be able to offset the income fully because of the percentage limitations on charitable contribution deductions.  This provision expires at the end of 2011, so you would want to take advantage of it now.
Business Deductions
Self-Employed Health Insurance Premiums:  Self-employed individuals are allowed to claim 100% of the amount paid during the taxable year for insurance that constitutes medical care for themselves, their spouses and dependents as an above-the-line deduction, without regard to the 7.5% of AGI floor.
Equipment Purchases:  If you are in business and purchase equipment, you may make a “Section 179 Election,” which allows you to expense (i.e., currently deduct) otherwise depreciable business property.  For 2011, you may elect to expense up to $500,000 of equipment costs (with a phase-out for purchases in excess of $2,000,000) if the asset was placed in service during 2011.  Also, certain real property can qualify for the expense deduction, but of the $500,000 limitation, only $250,000 can be attributed to qualified real property.  Note that for assets placed in service in 2011, taxpayers can expense all of their business equipment purchases under a provision giving taxpayers 100% bonus depreciation, possibly negating the need for the §179 election.
In 2012, the dollar amounts for §179 expensing are scheduled to be $139,000, with a phase-out amount of $560,000.  Also, the allowance for real property does not apply for 2012.
In addition, careful timing of equipment purchases can result in favorable depreciation deductions in 2011.  In general, under the “half-year convention,” you may deduct six months worth of depreciation for equipment that is placed in service on or before the last day of the tax year.  If more than 40% of the cost of all personal property placed in service occurs during the last quarter of the year, however, a “mid-quarter convention” applies, which lowers your depreciation deduction.  A popular strategy in recent years is to purchase a vehicle for business purposes that exceeds the depreciation limits set by statute (i.e., a vehicle rated over 6,000 pounds).  Doing so would not subject the purchase to the statutory dollar limit of $11,060 for 2011 (due to bonus depreciation rules) or $11,260 in the case of vans and trucks (due to bonus depreciation rules).   Therefore, the vehicle would qualify for the full equipment expensing dollar amount.  However, for SUVs rated between 6,000 and 14,000 pounds gross vehicle weight, the expensing amount is limited to $25,000.
NOL Carryback Period:  If your business suffers net operating losses for 2011, you generally apply those losses against taxable income going back two tax years.  For example, the loss could be used to reduce taxable income—and generate tax refunds—for tax years as far back as 2009.  Certain “eligible losses” can be carried back three years; farming losses can be carried back five years.
Bonus Depreciation:  Taxpayers can claim 100% bonus depreciation for assets placed in service in 2011.  Bonus depreciation is also allowed for machinery and equipment used exclusively to collect, distribute, or recycle qualified reuse and recyclable materials and qualified disaster assistance property.  In 2012, the bonus depreciation amount is scheduled