Last-minute moves that save taxes for 2009 and beyond

Although there are only about four weeks left to go before the year ends, it's not too late to implement some planning moves that can improve a client's tax situation for 2009 and beyond. This Practice Alert reviews some actions that clients can take before Dec. 31 to improve their overall tax picture.

Make year-end gifts. A person can give any other person up to $13,000 for 2009 without incurring any gift tax. The annual exclusion amount increases to $26,000 per donee if the donor's spouse consents to gift-splitting. Anyone who expects eventually to have estate tax liability and who can afford to make gifts to family members should do so. Besides avoiding transfer tax, annual exclusion gifts take future appreciation in the value of the gift property out of the donor's estate, and shift the income tax obligation on the property's earnings to the donee who may be in a lower tax bracket (if not subject to the kiddie tax).

Gifts that qualify for annual exclusion. The gift tax exclusion generally is not available for gifts of future interests. However, transfers to minors under the Uniform Gifts to Minors Act or Uniform Transfers to Minors Act do qualify for the exclusion. Also, a gift made to or for the benefit of a minor qualifies for the exclusion if the gift property and its income will pass outright to the beneficiary on reaching age 21 (or to the minor's estate if he or she dies before age 21). Also, gifts to so-called Crummey trusts, which give the beneficiary a limited right of withdrawal, qualify for the annual exclusion. ( Rev Rul 73-405, 1973-2 CB 321 )

Increase withholding to help avoid estimated tax underpayment penalty. An employee may discover that his prepayments of tax for 2009 have been too small because, for example, his estimate of income or deductions was off and he underwithheld, too little was withheld as a result of the making work pay credit, or he failed to make estimated tax payments for unanticipated income, such as gains from sales of stock. To ward off or reduce an estimated tax underpayment penalty, the employee can ask his employer to increase withholding for his last paycheck or paychecks to make up or reduce the deficiency. He can file a new Form W-4 or simply request that the employer withhold a flat amount of additional income tax.

Increasing the final estimated tax payment for 2009 (due on Jan. 15, 2010) can cut or eliminate the penalty for a final-quarter underpayment only. It doesn't help with underpayments for preceding quarters. By contrast, tax withheld on wages can wipe out or reduce underpayments for previous quarters because, as a general rule, an equal part of the total withholding during the year is treated as having been paid on each quarterly estimated payment date. ( Code Sec. 6654(g)(1) )

Deplete health FSA accounts. Employees who participate in their employer's health flexible spending account (FSA) should keep in mind that medical expenses reimbursed under the account generally must be incurred during the participant's period of coverage (normally 12 months) under the FSA. Although IRS has allowed employers to provide an additional 2 1/2 month grace period in which employees can incur expenses and still obtain reimbursements of these amounts, many employers have not availed themselves of this opportunity. As a result, an employee whose period of coverage ends on Dec. 31 should be sure to deplete his health FSA before the year's end (e.g., by getting new contact lenses) or he'll lose what's left in the account. Expenses are treated as having been incurred when the participant is provided with the medical care that gives rise to the expenses, and not when the participant is formally billed or charged for, or pays for, the medical care. ( Prop Reg § 1.125-5(e) , “On which taxpayer may rely”)

Qualified motor vehicle taxes. Unless Congress changes the law, for 2010, a taxpayer won't be able to deduct qualified motor vehicle taxes whether or not the taxpayer itemizes deductions. So if a taxpayer is intending to purchase a qualified motor vehicle soon, he should do it before year end. Provided the taxpayer meets certain conditions, it will assure him a deduction for any qualified motor vehicle taxes paid on the purchase whether or not he itemizes and whether or not Congress extends the optional itemized deduction for sales tax in lieu of income tax, which also is scheduled to expire this year. Even if the optional sales tax deduction is extended as expected, the taxpayer would have to give up the itemized deduction for state and local income taxes to take advantage of it for a 2010 purchase. By purchasing this year, the taxpayer can both deduct sales tax on a qualifying motor vehicle purchase and get an itemized deduction for state and local income taxes.

How it works. For purchases on or after Feb. 17, 2009 and before Jan. 1, 2010, the definition of taxes allowed as a deduction was expanded to include qualified motor vehicle taxes paid or accrued within the tax year. ( Code Sec. 164 ) The deduction generally is allowed to itemizers ( Code Sec. 164(a)(6) ) and to those claiming the standard deduction. ( Code Sec. 63(c)(1)(E) )

Qualified motor vehicle taxes are State or local sales or excise taxes imposed on the purchase of a qualified motor vehicle. ( Code Sec. 164(b)(6)(A) ) A qualified motor vehicle is a (1) passenger automobile, light truck or motorcycle the gross vehicle weight rating of which is not more than 8,500 pounds and (2) a motor home. The original use of the motor vehicle must begin with the taxpayer. ( Code Sec. 164(b)(6)(D) ) Only taxes on that part of the qualified motor vehicle's purchase price not exceeding $49,500 may be deducted. ( Code Sec. 164(b)(6)(B) )

The amount of sales or excise taxes that may be treated as qualified motor vehicle taxes is phased out ratably for a taxpayer with modified AGI (MAGI) between $125,000 and $135,00 ($250,000 and $260,000 on a joint return). MAGI is adjusted gross income for the tax year increased by any amount excluded from gross income under Code Sec. 911 (foreign earned income and foreign housing exclusions), Code Sec. 931 (exclusion of income derived from American Samoa) or Code Sec. 933 (exclusion of income from Puerto Rico). ( Code Sec. 164(b)(6)(C) )

Interplay with pre-2010 optional sales tax deduction for itemizers. The deduction for qualified motor vehicle taxes is not available to a taxpayer who elects to deduct state and local sales and use taxes under Code Sec. 164(b)(5) in lieu of income taxes as an itemized deduction. ( Code Sec. 164(b)(6)(F) )

Interplay with AMT. The deduction for qualified motor vehicle taxes is allowed in computing the alternative minimum tax (AMT). ( Code Sec. 56(b)(1)(E) ) This is to be contrasted with the optional itemized deduction for state and local sales and use taxes, which is not allowed in computing the taxpayer's alternative minimum taxable income. ( Code Sec. 56(b)(1)(A)(ii) )

Credit for hybrids and other environmentally friendly cars. In addition to obtaining a sales tax deduction, a taxpayer can claim a tax credit if before the year's end he buys and places in service a qualifying fuel efficient car. These include qualified fuel cell motor vehicles, advanced lean-burn technology motor vehicles, qualified hybrid motor vehicles and qualified alternative fuel motor vehicles. A taxpayer can claim this credit even if the car isn't used in a trade or business or for the production of income. The most widely available type of these vehicles is the hybrid. However, the credit for a particular manufacturer's cars phases out—i.e., is reduced and eventually eliminated—for hybrids (and advanced lean-burn technology vehicles) that are bought in the calendar quarter after the one following that in which the manufacturer records the sale of its 60,000th vehicle. For the second and third calendar quarters after that in which the 60,000th vehicle is sold, taxpayers may claim 50% of the credit. For the fourth and fifth calendar quarters, taxpayers may claim only 25% of the credit. No credit is allowed after the fifth quarter. ( Code Sec. 30B )

In addition, two tax credits may be available to taxpayers in 2009 who purchase an electric vehicle. In certain cases, a taxpayer may qualify to claim both the Code Sec. 30D new qualified plug-in electric drive motor vehicle credit, created by the Emergency Economic Stabilization Act of 2008 (EESA, P.L. 110-343 ), and the Code Sec. 30 plug-in electric vehicle credit, created by the American Recovery and Reinvestment Act of 2009 (ARRA, P.L. 111-5 ). However, a taxpayer can only claim one credit for the same vehicle. For details, see Weekly Alert ¶  20 04/30/2009 .

Purchase of energy saving home improvements before year's end. It is still not to late to achieve tax savings (as explained in detail at Weekly Alert ¶  30 08/13/2009 and summarized below) by purchasing energy saving home improvements before year end.

Nonbusiness energy property credit. In 2009 and 2010, a taxpayer can claim a credit under Code Sec. 25C equal to 30% of the sum of the cost of: qualified energy efficiency improvements to his home (e.g., energy-efficient windows, doors, insulation materials, and certain roofs) and residential energy property expenditures (e.g., high-efficiency heat pumps, air conditioners, water heaters, and stoves that burn biomass fuel), up to an aggregate amount of $1,500.

Residential energy efficient property. Beginning in 2009, there is no limitation on the 30%-of-cost credit amount under Code Sec. 25D for qualified solar electric property costs, qualified solar water heating property costs, qualified small wind energy property costs, and qualified geothermal heat pump property costs. The previous limitation on the credit amount for qualified fuel cell property costs—$500 for each 0.5 kilowatt of capacity—remains the same.


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