Successful tax planning includes a review of your available deductions and the impact of your filing status on your option to itemize. It is important that all of the technical requirements for your deductions are met (e.g., receipts from charities for donations). In addition, certain items are deductible only to the extent they exceed a percentage threshold (e.g., out-of-pocket medical expenses) of your adjusted gross income (AGI). By reducing your AGI, you increase the amount of itemized deductions you can claim because the floor limitation amounts based on AGI are reduced.
A strategy commonly used in year-end individual tax planning is to determine the best timing for claiming itemized deductions. Generally, it is beneficial for taxpayers to defer income and accelerate expenses. This strategy may enable you to itemize your deductions if you claimed the standard deduction in the past. This year however, there is more uncertainty due to the sunset of various tax incentives and the elimination of the “Bush tax cuts” after this year. If you defer income to 2013, will it be subject to higher tax rates?
Some tax provisions are not permanent and will expire if not extended by Congress. It is therefore important for taxpayers who are planning on using certain tax deductions to know when they expire to maximize their tax deductions. Examples of provisions that are not permanent include:
- Itemized deduction for state and local general sales taxes in lieu of state and local income taxes
- Mortgage insurance premium deduction
- Above-the-line deduction for qualified tuition and related expenses
- Alternative minimum tax (AMT) patch
- Nonrefundable tax credit offset of regular and AMT tax liability
- Tax-free IRA distributions to charity
Tax planning for higher-income taxpayers is more complicated. Generally, you must reduce your otherwise allowable itemized deductions if your adjusted gross income exceeds a specified threshold amount. Although the phase-out of itemized deductions and personal exemptions for higher-income taxpayers is eliminated through 2012, the phase-out limits are set to return in 2013. The phase-outs of itemized deductions are in effect another tax rate increase. Keep in mind that in households where both spouses work, they often fall within this “higher-income” taxpayer group.
The failure to take the alternative minimum tax (AMT) into account may also jeopardize your tax planning strategy, as the AMT continues to negate many itemized deductions. The AMT exemptions amounts have been increased in recent years, but there is uncertainty if this non-inflation indexed exemption will be increased in future years.
You may benefit from planning strategies designed to take advantage of the current tax laws. Maximizing your itemized deductions is an important aspect, but there are other issues that you may need to consider in light of your overall tax scenario. In order to achieve the greatest tax savings, it is best to run different tax liability scenarios over a multi-year period using a tax planning software program to determine your overall tax liability over that time period.
