After a long presidential campaign, 2008 is drawing to a close. Although tax planning should be an ongoing process, the end of the year offers an opportunity to review your current position and take steps to minimize your tax liability.

Income Tax Considerations

Assess Your Tax Situation First Prior to implementing any tax plan; the most important step you or your business can take is to conduct a full assessment of your current tax situation. Such an assessment should include a review of current year income and deductions (including capital gains and losses); an estimate of income and deductions for future years; a review of any carryover items (e.g., net operating loss or charitable contribution carryover); and identification of taxable items for which you can control the timing. Once you have a full understanding of your current tax position, you will be able to make more informed decisions about what steps should be taken to minimize your tax exposure going forward. Below is a brief summary of some planning opportunities you may consider prior to year-end.

Accelerate Deductions and Defer Taxable Income

By deferring taxable income into a future year or accelerating deductions, you can reduce your current tax liability. Taxes can be paid in a later year allowing you to invest the savings in the interim. One common method for accelerating deductions is for taxpayers to make estimated tax payments for their fourth quarter state tax liability prior to year-end (ahead of the January 15 due date). You can claim a deduction for state taxes paid on your 2008 federal return.

Review Capital Gains and Losses

2008 has been a difficult year for the stock market. Like most investors, you may have realized losses in your portfolio. Consider selling some of your securities with losses to offset capital gains. Even if you did not sell securities at a gain during the year, you may have had capital gain income allocated to you from your mutual fund investments. Likewise, most dividends you receive are taxed at long-term capital gain rates. By selling securities with losses, you will be able to offset some or all of your capital gain income and reduce your overall tax obligation.

0% Long-Term Capital Gain Rate in 2008 for Low-Income Taxpayers

For 2008, the long-term capital gain rate for lower-income taxpayers (those in the 10% or 15% ordinary income tax brackets) has been reduced to 0%. While not applicable to many taxpayers, the 0% capital gain rate represents a planning opportunity for many, including retirees, prospective retirees, and parents and children. If you or a family member is in a lower-income tax bracket, you may consider selling securities in 2008 to take advantage of the 0% tax rate.

Gifts to Charity

A charitable contribution made before year-end can be claimed as a deduction on your 2008 income tax return. Also, by contributing publicly traded stock to a charity, you will avoid tax on the stock’s appreciation and be able to deduct the full value of the stock. Regardless of the type of contribution, you must maintain a proper record of your gifts. For gifts made in 2008, a donor contributing money to a charitable organization (regardless of the amount) must maintain a cancelled check, bank record or receipt from the donee organization showing the name of the donee organization, the date of the contribution and the amount of the contribution. If you give a non-cash gift, ask for a letter estimating the value of the gift. Gifts over $5,000 that are not cash or publicly traded stock require an appraisal.

Max Out Your 401(k)

Consider contributing the maximum amount to your 401(k) plan. The contribution limit for 2008 is $15,500. In addition, individuals who will be at least 50 years of age by the end of 2008 may make an additional “catch-up” contribution of $5,000 in 2008. The contribution limit for 2009 will be $16,500 and the catch-up contribution limit for 2009 will be $5,500.

Tax-Free Distributions From IRAs for Charitable Purposes

As part of the Emergency Economic Stabilization Act of 2008 (the financial bailout package), the provision allowing the direct rollover of funds from an IRA to charity was extended to include calendar years 2008 and 2009. As a result of the legislation, individuals age 70½ or older are permitted to make direct transfers of up to $100,000 annually from their individual retirement account to a charitable organization. By distributing funds directly from your IRA to charity, the distribution is not included in your taxable income. Conversely, you are not allowed to claim a tax deduction for the charitable contribution. Without this provision, if an individual wished to contribute IRA assets to charity, the individual would be required to take a distribution from his IRA and then contribute the proceeds of that distribution to charity. The individual would be required to include the distribution in income, but would be allowed a deduction for his contribution. Unfortunately, the deduction in many cases would not fully offset the additional income because of (among other things) the phase-out of itemized deductions for high-income taxpayers.

“Kiddie Tax” Extends its Reach

Originally enacted to prevent the transfer of unearned income from parents to their children in lower tax brackets, the so-called kiddie tax targets children with investment income in excess of $1,800, taxing such income at the same rates as their parents. Prior to 2007, the kiddie tax applied only to children age 14 and under. In 2007, the kiddie tax was expanded to apply to children under age 18. For 2008, the kiddie tax was expanded again to apply to any dependent child under age 19 and full-time students under age 24.

Avoid Underpayment Penalties

Make sure that you have paid enough in federal and state withholding taxes to avoid penalties. For 2008, you will avoid a penalty for the underpayment of estimated tax if your tax payments (including withholdings) have been timely made and are at least equal to 100 percent of the tax shown on your 2007 federal income tax return (110 percent, if your adjusted gross income for 2007 exceeded $75,000 if you were married, but filed separately, or $150,000 for other taxpayers) or 90 percent of the tax shown on your 2008 federal income tax return, whichever is less. When reviewing your 2008 tax payments, keep in mind that income tax withholdings are considered paid equally throughout the year, even if withholdings are made near the end of the year. If you anticipate that you have underpaid your estimated taxes for 2008, consider adjusting withholdings for the remainder of the year to avoid penalties for underpayment of estimated taxes.

What Lies Ahead?

No one knows what the future holds. However, with a new administration taking office, there will likely be substantial changes to the tax code over the next several years. The timing of any changes will undoubtedly be affected by the current economic situation.

Some of the proposals offered by President-elect Obama include:

• Reinstate pre-2001 top individual tax rates of 39.6 and 36 percent for families making over $250,000 ($200,000 for singles).
• Elimination of all income taxes for seniors (age 65 and over) earning under $50,000.
• Raise capital gains and qualified dividend rates to 20 percent for families earning more than $250,000 ($200,000 for singles).
• Eliminate all capital gains taxes on start-ups and small businesses to encourage innovation. • Provide a refundable tax credit to small businesses that provide health insurance to employees to claim up to 50 percent on premiums.
• Retain existing payroll tax on first $102,000 of income (indexed for inflation). Exempt income from $102,000 to $250,000, then reinstate a 2-4 percent payroll tax (combined employee and employer) on income above $250,000. According to the President-elect, this proposal would not take effect for at least 10 years.
• Increase the estate tax exemption level to $3.5 million per person ($7 million per couple) and increase top estate tax rate to 45%.

Estate & Gift Tax Considerations: No Change to Federal Estate Tax

We still have a Federal estate tax. The death tax-free exemption amount is $2 million for 2008 and is scheduled to increase to $3.5 million in 2009. The top estate tax rate is 45% for 2008. Under current law, the estate tax is scheduled to be repealed for one year in 2010, but reverting to its pre-2001 Tax Act level of only $1 million per taxpayer for persons dying in 2011 or thereafter, with a top rate of 50%.

Annual Exclusion Gifts

In 2008, you may make a gift of $12,000 to any individual and certain trusts without any gift tax consequences. Married individuals may make gifts of up to $24,000. Gifts may be made outright or in trust and may be in the form of cash, securities, real estate, artwork, jewelry or other property. Giving property that you expect to appreciate in the future is an excellent way of utilizing your annual exclusion gifts because any post-gift appreciation is no longer subject to gift or estate tax. To take advantage of your annual exclusions for 2008, gifts must be made by December 31. Gifts over $12,000 or gifts that will be “split” between spouses must be reported on a gift tax return, which must be filed in April 2009. The annual exclusion amount increases to $13,000 in 2009 ($26,000 for married couples).

Payment of Tuition and Medical Expenses

In addition to annual exclusion gifts, you may pay tuition and medical expenses for the benefit of another person without incurring any gift or generation-skipping transfer (“GST”) tax or using any of your estate or GST tax exemption. These payments must be made directly to the educational institution or medical facility. There is no dollar limit for these types of payments and you are not required to file a gift tax return to report the payments.

Lifetime Gifts Using Gift Tax Exemption

In addition to annual exclusion gifts and the payment of tuition and medical expenses, individuals are also allowed a lifetime gift tax exemption. The gift tax exemption amount is currently a flat $1 million and is scheduled to remain at that level through 2010. Many clients make use of their $1 million lifetime exemptions by gift strategies such as Grantor Retained Annuity Trusts and other techniques that leverage the use of the exemption. A gift of appreciating property during your lifetime removes all future appreciation from your taxable estate at your death.

Generation Skipping Tax

The generation-skipping transfer (“GST”) tax is still in place. Generally, the tax applies to lifetime and death-time transfers to or for the benefit of grandchildren or more remote descendants, at a 45% flat rate for 2008. The tax is in addition to any gift or estate tax otherwise payable. However, each taxpayer is allowed a $2 million GST tax exemption for 2008, which is scheduled to increase to $3.5 million in 2009.

Consider Lifetime Gifts that take Advantage of both the Gift Tax Exemption and GST Exemption

Many clients utilize their $1 million gift tax exemption ($2 million for a married couple) by structuring long-term GST exempt trusts benefiting multiple generations. Such trusts will remain exempt from all gift and estate tax as long as the trust remains in existence. Under Illinois law, such trusts can last in perpetuity, thereby allowing you to create a family endowment fund for your children, grandchildren and future descendants.

For more information, please contact your attorney or a member of the firm’s Wealth & Succession Planning practice group which includes Karen K. MacKay, Stephanie H. Denby, Jonathan W. Michael, Martin P. Ryan, Melissa C. Selinger, Julia A. Turk, Gregory M. Winters and Melanie L. Witt at 312/840-7000 or burkelaw.com.

Circular 230 Disclosure: Any tax advice contained on this site was not intended or written to be used, and cannot be used (i) by any taxpayer for the purpose of avoiding any penalties that may be imposed on the taxpayer, or (ii) to promote, market or recommend to another party any transaction or matter addressed herein.