Daniel C. McArthur, Ltd. CPA (702) 385-1899-Security In Numbers

Deductions can be a powerful tax-saving tool because they reduce the amount of your income that’s taxed. And through 212, the income-based phase outs that limited the benefit of many deductions have been lifted. When possible, review your potentially deductible expenses with your tax advisor before you incur them, because the right timing can maximize their benefit.

The first step when planning for deductions is to consider the alternative maximum tax (AMT)—a separate tax system that limits some deductions and doesn’t permit others such as:

You may be able to time income and deductions to avoid the AMT, or at least reduce its impact—or perhaps take advantage of its lower maximum rate. But, planning for the AMT will be a challenge until congress passes long-term relief.

Typically, it has done so in the form of a “patch”—an increase in the AMT exemption. Such as patch is in effect for 2011, but, as of this writing not for 2012.

Property tax deduction. Before paying your bill early to accelerate the itemized deduction into 2011, review your AMT situation. If you’re subject to the AMT, you’ll lose the benefit of the deduction for the repayment.

Mortgage interest deduction. You generally can deduct interest up to a combined total of $1 million of mortgage debt incurred to purchase, build or improve your principle residence and a second residence. Points paid related to your principal residence may be deductible.

Home equity debt interest deduction. Interest on home equity debt used to improve your principle residence—and interest on home equity debt used for any purpose (debt limit of $100,000)—may be deductible. So consider using a home equity loan of line of credit to pay off credit cards or auto loans, for which interest isn’t deductible. But beware of the ATM: If the home equity debt isn’t used for home improvements, the interest isn’t deductible for ATM purposes.

Home sale gain exclusion. When you sell your principal residence, you can exclude up to $250,000 ($500,000 for joint fillers) of gain if you meet certain tests. WARNING: Gain on the sale of a principal residence generally isn’t excluded from the income if the gain is allocable to a period of “nonqualified” use. Check with your tax advisor for details.

Losses on the sale of a principal residence aren’t deductible. But if your part of the home is rented or used exclusively for your business, the loss attributable to that portion will be deductible, subject to various limitations.

Because a second home is ineligible for the exclusion, consider converting it to rental use before selling. It can be considered a business asset, and you may be able to defer tax on any gain through an installment sale or a Section 1031 (“like-kind”) exchange. Or you may be able to deduct a loss, but only to the extent attributable to a decline in value after the conversation.

Debt forgiveness exclusion. Homeowners who receive debt forgiveness in a foreclosure or a mortgage workout for a principle residence generally don’t have to pay federal income taxes on that foreclosure.

Consider bunching non-urgent medical procedures and other controllable expenses into one year to exceed the 7.5% floor. But keep in mind that for AMT purposes, only medical expenses exceeding 10% of your AGI are deductible.

HSA. If you’re covered by the qualified high-deductible health insurance, a Health savings Account allows contributions of pretax income (or deductible after tax contributions) up to $3,050 for self-only coverage and $6,150 for family coverage. (The limits will be $3,100 and %6,250, respectively, for 2012) Account holders age 55 and older can contribute an additional $1,000.

HSAs bear interest or are invested and can grow tax –defered similar to an IRA. With-drawls for qualified medical expenses are tax-free, and you can carry over a balance from year to year.

FSA. You can redirect pretax income to an employer-sponsored Flexible Spending Account up to an employer -determined limit. The plan pays or reimbursed you for medical expenses not covered by insurance. What you don’t use by the end of the plan year, you generally lose. If you have an HAS, your FSA is limited to funding certain “permitted” expenses.

The break allowing you to take an itemized deduction for state and local sales taxes is available for 2011 but, as of this writing, not for 2012. It can be valuable to tax payers who reside in states with no or low income tax or who purchase major items such as a car or boat. If you’re considering such a purchase, you may want to make it by year end in case the break isn’t extended.

Tax credits reduce your tax bill dollar-for-dollar, so make sure that you’re taking every credit you’re entitled to. For each child under the age of 17 at the end of the year, you may be able to claim a $1,000 credit. If you adopt in 2011, you may be eligible for a credit or use an employer adoption assistance program income exclusion; both are $13,360 per eligible child.

Tax credit. For children under the age of 13 or other qualifying dependents, you may be eligible for a tax credit for a portion of your dependent care expenses. Eligible expenses are limited to $3,000 for one dependent, $6, 000 for two or more. Income-based limits reduce the credit but don’t phase it out altogether.

FSA. You can contribute up to $5,000 pretax to an employer-sponsored child and dependent care Flexible Spending Account. The plan pays or reimburses you for these expenses. You can’t use those same expenses to claim a tax credit.

Whether you’re the parent of a newborn or a college student—or your children are somewhere in between—there are numerous tax breaks you and your family may benefit from. Some breaks also offer you the opportunity to teach your children about the value of saving for the future, and that’s a lesson they can benefit from for the rest of their lives.

IRAs for teens. IRAs can be perfect for teenagers because they likely have many years to let their accounts grow tax-deferred or tax-free. The 2011 contribution limit is the lesser of $5,000 or 100% of earned income.

Employing your children. If you own a business, consider hiring your children. As the business owner you can earn up to $5,800 (the 2011 standard deduction for singles) and pay zero federal income tax. WARNING: They must perform actual work and be paid in line with what you’d pay nonfamily employees for the same work.

The income shifting that once—when the “kiddie tax” applied only to those under age 14—provided families with significant tax savings now offers much more limited benefits. Today the kiddie tax applies to children under the age of 19 as well to the full-time students under the age of 24 (unless the student provides more than half of their own support from earned income). For children subject to the kiddie tax, any unearned income beyond $1,900 (for 2011) is taxed at their parent’s marginal rate rather than their own, likely lower, rate. Keep in mind before transferring income-generating assets to them.

American Opportunity credit. An expanded version of what was previously known as the Hope Credit, this tax break covers 100% of the first $2,000 of tuition and related expenses and 25% of the next $2,000 of expenses. The maximum credit is $2,500 per year for the first four years of postsecondary education.

Lifetime learning credit. If you’re paying postsecondary education expenses beyond the first four years, you may be eligible for the Lifetime Learning credit (up to $2,000 per tax return).

Tuition and Fees deduction. If you don’t qualify for one of the credits because your income is too high, you might be able to deduct up to $4,000 of qualified higher education tuition and fees. The deduction is limited to $2,000 for taxpayers with incomes exceeding certain limits and is unavailable to taxpayers with higher incomes.

Tax-advantaged retirement plans offer valuable opportunities to save taxes now (or later, in the case of Roth accounts) and build up significant funds to help ensure you can live in the lifestyle you desire during retirement. But it takes planning to make the most of these opportunities and to avoid potential tax pitfalls. Many limits and rules apply to both contributions and distributions.

Contributing to a traditional employer-sponsored defined-contribution plan such as a 410(K), 403(b), 457, SARSEP or SIMPLE, is usually the first step in retirement planning:

If you are age 50 or older by year end you may be able to make an additional “catch up” contribution. If your employer offers a match contribute at least the amount necessary to get the maximum employer match so you avoid missing out on that “free” money.

If your employer has suspended matching contributions to reduce costs, don’t use that as an excuse to suspend your own contributions. Doing so will only exacerbate the negative impact on your retirement nest egg—plus your taxable 2011 income will increase compared to what it would be if you’d contributed to the plan.

If your employer provides a SIMPLE, its required to make contributions (though not necessarily annually). But the employee contribution limits are lower than for other employer-sponsored plans.

If you’re a business owner or self-employed. You may be able to set up a plan that allows you to make much larger contributions. Depending on the type of plan, you might not have to make 2011 contributions, or even set up the plan, before years end. Check with your tax advisor.

If your employer doesn’t offer a retirement plan. Consider a traditional IRA. You can likely deduct your contributions, though your deduction may be limited based on your income if your spouse participates in an employer-sponsored plan. You can make 2011 contributions at late as April 16, 2012.

A potential downside of tax-deferred savings is that you will have to pay taxes when you make withdrawals at retirement. Two retirement plan options allow tax-free distributions; the tradeoff is that contributions to these plans don’t reduce your current year income:

1. Roth IRAs. In addition to tax-free distributions, an important benefit is that, unlike other retirement plans, Roth IRAs don’t require you to take distributions during your lifetime. This can provide estate planning advantages: You can let the entire balance grow tax-free over your lifetime for the benefit of your heirs.

If for example , you name your child as the beneficiary, he or she will ne required to start taking distributions upon inheriting the Roth IRA. But the distributions will be tax-free and spread out over his or her lifetime, and funds remaining in the account can continue to grow tax-free for many years to come.

But Roth IRAs are subject to the same low annual contribution limit as the traditional IRAs, and your Roth IRA limit is reduced by any traditional IRA contributions you make for the year. It may be further reduced based on your income.

If you have a traditional IRA, consider whether you might benefit from converting all or a portion of it to a Roth IRA. A conversion can allow you to turn tax-deferred future growth into a tax-free growth and take advantage of a Roth IRA’s estate planning benefits.

There’s no longer an income-based limit on who can convert. But, unlike when the limit was first lifted last year, the converted amount is now taxable in the year of conversion. Whether a conversion makes sense for you depends on a variety of factors, such as your age, whether you can afford to pay the tax on the conversion, your tax bracket now and expected tax in retirement, and whether you’ll need IRA funds in retirement.

These plans may be especially beneficial for high-income earners who are ineligible to contribute to Roth IRAs. Under recent legislation, you may be able to make a rollover from your traditional account to a Roth account under the same plan, but there will be tax consequences similar to those of a Roth IRA conversion.

If you’re facing financial challenges this year, it may be tempting to make withdrawals from your retirement plans. But generally this should be a last resort. With a few exceptions, retirement plan distributions made before age 59 ½ are subject to a 10% penalty, in addition to income tax.

This means that you can lose a substantial amount to taxes and penalties. Additionally, you’ll lose the potential tax deferred future growth on the amount you’ve withdrawn.

If you must make an early withdrawal and you have a Roth account you may be better off withdrawing from that. You can withdraw up to your contribution amount free of tax and penalty.

Another option, if your employer-sponsored plan allows it, is to take a loan from the plan. You’ll have to pay it back with interest (which generally won’t be deductible), but you won’t be subject to current taxes or penalties.

Normally, once you reach age 70 ½ you must take annual required minimum distributions (RMDs) from your IRAs (except Roth IRAs) and defined contribution plans. If you don’t comply, you can owe a penalty equal to 50% of the amount you should have drawn but didn’t. You can avoid the RMD rules for a Roth 401(k), Roth 403(b), or Roth 457 by rolling the funds into a Roth IRA.

So, should you take distributions between ages 59 ½ and 70 ½ , or more than the RMD after the age 70 1/2 ? Distributions in any year your tax bracket is low may be beneficial. But also consider the lost future tax-deferred growth, if applicable, whether the distribution could: 1) cause your Social Security payments to become taxable, 2) increase Medicare prescription drug charges, or 3) affect other deductions or credits with income-based limits.

There’s good news and bad news this year when it comes to estate planning. On the positive side, the 2011 Tax Relief Act prevents pre-2001 tax act law (lower exemptions and higher rates) from going into effect in 2011 as originally scheduled. The act also provides some new tax saving opportunities. But on the negative side, these provisions apply only through 2012. Thus much uncertainty remains, making estate planning an ongoing challenge.

The 2010 Tax Relief act retroactively brought back the estate tax for 2010 (along with the unlimited step-up in basis), but with an exemption increase and a rate reduction compared to 2009. It extended these levels through 2012. The act also temporarily provides exemption “portability” between spouses.

If you have a loved one who died in 2010 and have not consulted a tax advisor, be sure to do so. The option is available to follow the pre-2010 Tax Relief act estate tax repeal/limited step-up in basis regime instead of the new regime, but which is better depends on a variety of factors.

The generation-skipping transfer tax generally applies to transfers (both during life and at death) made to people two generations or more below you, such as your grandchildren.

The GST tax also had been repealed for 2010, and the 2010 Tax relief act brought it back with the same exemption amounts as for the estate tax through 2012. However, the act set the GST tax rate for 2010 at 0%. The GST tax rate goes back up to match the top estate tax rate for 2011 and 2012.

Gifts to your spouse are tax-free under the marital deduction ( a limit applies to noncitizens), but most other gifts are potentially taxable. The gift tax was never repealed, and it follows the estate tax exemptions and top rates for 2011 and 2012. Any gift tax exemption used during life reduces the estate tax exemption available upon death.

If you can afford to so do without compromising your own financial security, consider using part or all of your gift tax exemption this year and the next, in case the $5 million exemption isn’t extended beyond 2012.

But keep in mind that you can exclude certain gift up to $13,000 per recipient each year ($26,000 per recipient id your spouse elects to split the gift with you or you’re giving community property) without using up any of your gift tax exemption. So first consider maximizing your annual exclusion gifts.

· To minimize your own income tax, don’t gift property that’s declined in value. Instead sell the property so you can take the tax loss and then gift the sale proceeds.

Plan gifts to grandchildren carefully. Annual exclusion gifts are generally exempt from the GST tax, so they also help you preserve your GST tax exemption for other transfers. For gifts that don’t qualify for the exclusion to be completely tax-free, you generally must apply both your GST tax exemption and your gift tax exemption.

Gift interests in your business. If you own a business, you can leverage your gift tax exclusions and exemption by gifting ownership interests, which may be eligible for valuation discounts. So for example if the discounts total 30%, in 2011 you can gift ownership interest equal to as much as $18,571 tax-free because the discounted values doesn’t exceed the $13,000 annual exclusion. WARNING: The IRS may challenge the value; a professional appraisal is strongly recommended.

Gift FLP interest. Another way to benefit from valuation discounts is to set up a family limited partnership (FLP). You fund the FLP and then gift limited partnership interests. WARNING: The IRS scrutinizes FLP’s so be sure to set up and operate yours properly.

Pay tuition and medical expenses. You may pay these expenses for a loved one without the payment being treated as a taxable gift, as long as the payment is made directly to the provider.

Trusts can provide significant tax savings while preserving some control over what happens to the transferred assets. Here are some trusts you may want to consider:

· A qualified terminable interest property (QPRT) allows you to give your home to your children today—removing it from your taxable estate at a reduced tax cost (provided you survive the trust’s term)—while you retain the right to live in it for the trust’s term.

· A grantor-retained annuity trust (GRAT) works similarly so a QPRT but allows you to transfer other assets; you receive payments from the trust for a certain period.

Finally GST —or “dynasty”—trust can help you leverage both your gift and GST tax exemptions, and it can be an excellent way to lock in the current $5 million exemptions.

Along with protecting your family’s financial future, life insurance can be used to pay estate taxes, equalize assets passing to children who aren’t involved in a family business, or pass leverage funds to heirs free of estate tax. Proceeds are generally income-tax-free to the beneficiary. And with proper planning, you can ensure proceeds aren’t included in your taxable estate.