Before we take a look at traditional year-end tax planning, here are some of the developments that have made 2008 unlike any other year along with some possible strategies.

Stock losses Many people have taken huge hits in their investment and retirement portfolios from the crisis in the financial markets.  Not only have many stocks declined in value in recent months; others have become worthless.  In today's market, you are likely to have in your investment portfolio holdings that are currently priced below your purchase price.  Now might be a good time to sell those stocks or mutual funds to generate losses to offset capital gains and then up to $3,000 of your ordinary income. 

Alternatively, you may want to keep a loss security in your investment portfolio.  You may be able to sell the stock to recognize the loss and then reacquire it to continue your investment.  However, to use the loss on your 2008 tax return, you must wait 30 days after the sale to repurchase the security.  One strategy to avoid lost investment opportunities while fulfilling the 30-day rule is to purchase additional shares of the security now, especially if you anticipate that the stock price may rise during the next 30-day period.  After you have held the newly acquired stock for 30 days, you can sell the original shares at a loss that will be recognized for tax purposes.  Another strategy is to sell now and then reinvest the proceeds immediately in shares of a company in the same industry that are likely to perform similarly to the stock you just sold.  In either case, your loss qualifies for full capital loss treatment and can offset capital gains, with any excess used to offset up to $3,000 of ordinary income. 

Worthless stock also generates an immediate deduction.  The rules for "worthless" stocks are very strict. Your definition of worthless may be very different from the IRS' definition.  Stocks and securities must be totally worthless for a taxpayer to take a loss deduction.  A mere diminution in value, no matter how great, will not trigger a loss deduction. 

Stock Gains Given the state of government finances, the government debt, paying for two wars, the record financial bailout package that was recently passed by Congress, a new Democratic administration and the Democrat majority in both houses of Congress it is very likely that Capital Gains tax rates will go up in 2009. Unfortunately, even if Congress acts late in 2009 to change the Capital Gains tax rates, they can make the changes retroactive to January 1, 2009 if they wish. As a result it may be a good time to act now and sell any stock that has a low basis and would generate a gain. By selling low basis stock you are taking the uncertainty out of what the tax may be in the future on the potentially large gain such a sale of the stock could generate. Our Capital Gains tax rates are at the lowest rates that we have had in many years. The maximum rate is 15% for the highest income tax brackets. Depending on your tax bracket you may even pay as low as a 5% Capital Gains rate. If you also employ a strategy of selling stocks to capture the loss as discussed above, such a loss could offset all or part of your gains. If you really like the stock, you can always purchase it back and put it back into your portfolio. By doing this, you will establish a new basis and possibly purchase the stock at a lower value. However, unlike with losses, when you sell a stock for a gain you are not subject to the same rules that limit your ability to re-purchase the same stock only after waiting 30 days. You can re-purchase the same stock immediately. Remember that this strategy is only good if you want to insure you get the best Capital Gains tax rates and lock it in now and should only be used if you have the cash necessary to pay the tax, or enough losses to partially or fully offset the gains.

Retirement savings.  According to the Congressional Budget Office, nearly $2 trillion in retirement savings has been lost in the last 15 fifteen months.  In response, Congress may -- before the end of 2008 -- temporarily suspend the required minimum distribution (RMD) rules for IRAs and qualified retirement plans.  You cannot keep funds in a retirement plan indefinitely.  By April 1 of the calendar year following the year in which you reach age 70 1/2 , even if you have not retired, the remaining balance in a traditional IRA must be distributed to you in full or you must begin to receive RMDs from the account. RMDs from a qualified plan are not required until April 1 of the calendar year following the later of the year in which you reach age 70 1/2 or the year in which you retire. 

Because of the recent decline in the financial market, some retirees are being forced to withdraw assets that are currently undervalued.  Suspending the RMD rules would help them but would not help individuals who must take RMDs to meet their everyday living expenses.  Consequently, Congress may also allow individuals to take early distributions from IRAs and other arrangements penalty-free (but still subject to income tax).  Although there is some leeway for "hardship" distributions, current rules are designed to discourage early distributions.  Keep in mind, however, that you are using funds today that you originally set aside for retirement.  If you do not put the funds back, they won't be there for retirement. 

Mortgage meltdown.  The collapse of the housing market has brought about higher default rates on subprime, adjustable rate and other mortgage loans made to higher-risk borrowers.  At the same time, financial institutions holding mortgage-backed assets are saddled with trillions of dollars in bad debt. 

The mortgage meltdown has surprised many homeowners with unanticipated tax consequences.  When a lender forecloses on property, sells the home for less than the borrower's outstanding mortgage and forgives part or all of the unpaid mortgage debt, the Tax Code traditionally considered the cancelled debt to be taxable income to the homeowner.  In 2007, Congress gave homeowners some relief. 

The Mortgage Forgiveness Debt Relief Act of 2007 and subsequent legislation excludes from taxation discharges of up to $2 million of indebtedness secured by a principal residence and is incurred in the acquisition, construction or substantial improvement of the principal residence. This special relief is available for tax years beginning January 1, 2007, and ending December 31, 2012. 

This treatment also covers mortgage workouts. If a lender determines that foreclosure is not in its best interest, it may offer a mortgage workout under which the terms of the mortgage are changed to result in a lower monthly payment.  This and other mortgage workouts technically would result in forgiveness of indebtedness income that would be taxable to the homeowner if it were not for the new law. 

Now that we’ve looked at some of the recent developments and more traditional ideas that should be considered how about some more non-traditional ideas

Personal Home Rental This is one of the most overlooked perks of the tax code. During the 2002 Winter Olympic Games many of my former law school professors took vacation and rented out their homes to visiting media for 14 days. Why? Because the tax code permits any homeowner to rent their home up to 14 days and not count the income received as taxable income. While it is not often that the Olympic Games come to your area, if you like to vacation and your home is in a desirable place where someone may want to visit you can advertise the home, rent it and take a vacation yourself using the same strategies. 

Better yet is the business owner who can rent his or her home to their business up to fourteen times a year for staff meetings, client meetings or staff and/or client parties. This trick has a double bonus because the business owner can deduct the cost from the income of the business as a legitimate business deduction, then put the money in his or her pocket on the personal side of things and not count it as income.  The only catch for this business trick is that to withstand IRS scrutiny your home must be rented to your business for fair rental value. In order to establish the value you should ask someone in the real estate industry such as a broker, agent or property manager to provide you a letter of opinion about what they think the daily fair rental value of your home may be.

Use a Business Entity that elects S Corporation Tax Status S Corporation tax status is a status granted by the IRS pursuant to Subchapter S of the Internal Revenue Code. Typically most people think that to have this status your business must be organized as a corporation under state laws. This isn’t so. In fact, we prefer to use a state recognized Limited Liability Company (LLC) that elects S Corporation tax status for federal tax purposes. Why? S Corporation tax status is perhaps the most flexible status for small business owners who net over $50,000 from their business each year in combined wage and/or profit. As a sole proprietor a partnership or an LLC taxed as a partnership each dollar earned is subject to federal Self Employment taxes in addition to any state or federal income taxes. These Self Employment taxes are made up of Social Security and Medicare and amount to 15.9% of the first $102,000 in 2008. As an entity that elects S Corporation, if the level of compensation to the owners is reduced to the lowest amount that is reasonable, the amount of employment taxes can likewise be reduced.  Determining the range of reasonable compensation for your business and where owner's compensation should fall within that range depends upon many variables.  Any profit beyond the compensation may be taken as a dividend or draw and will only be subject to income taxes. Like many tax strategies this one should not be tried without professional assistance. It is very important to structure the entity and the compensation properly so that you do not become the next poster child for the IRS’ audit division.

If you have any more questions about the news and tips here please contact our office.