UNDERSTANDING TAX CONCEPTS: DEDUCTION vs. CREDIT

We often hear the terms “tax deduction” and “tax credit” thrown out as benefits to taxpayers. While they are both valuable benefits, they are not exactly the same thing. A “tax deduction” permits a taxpayer to subtract a certain amount from his taxable income. His applicable tax rate is then applied to his modified taxable income to determine his tax liability. A “tax credit” is an amount subtracted from an individual’s tax liability once it has already been determined. Therefore, each dollar of “tax credit” is a dollar for dollar reduction of tax liability, while each dollar of “tax deduction” only provides a tax reduction equal to the tax rate times one dollar.

TAKE ADVANTAGE OF HISTORICALLY LOW INTEREST RATES

While the economy seems to be on the road to recovery, interest rates remain at historic lows. This environment provides you with a unique opportunity to pass wealth to younger generations while minimizing or avoiding gift tax consequences. Options available include, among others, intra family loans, where older generations can lend money to lower generations at an extremely low interest rate; grantor retained annuity trusts, whereby older generations can essentially transfer the appreciation of an asset while incurring little or no gift tax; and a charitable lead annuity trust which allows the donor to currently take a charitable deduction. To determine which, if any, estate planning technique best suits your needs please consult with an estate planning specialist.

DEALING WITH A LETTER FROM THE IRS

Receiving a letter from the IRS often causes the recipient to experience that heart dropping feeling, even before opening the letter. However, more likely than not, the issue can be dealt with quickly and simply. First, don’t panic. The IRS provides specific instructions for dealing with all of their correspondence, and their notices generally address very discreet issues. Review their letter, compare any proposed corrections to your tax return, and decide if you agree with the IRS’s assessment. Remember, the IRS may send you a notice for any number of reasons, including notification of changes to your account or requests for additional information. Of course, you may also engage a tax professional to review the document and provide a suggested course of action as well.

TAKE ADVANTAGE OF LOW LONG TERM CAPITAL GAINS RATES

Long term capital gains are currently taxed at a maximum of fifteen percent (15%). However, unless Congress decides to extend this Bush-era tax cut, long term capital gains tax rates will revert to pre-2003 levels in 2011 (meaning the long term capital gains rate will revert to twenty percent (20%)). If you are considering selling appreciated stock, or any other asset, in the next few years you may want to consider locking in a lower tax rate by selling this year. Remember, you can repurchase the exact stock you sold as long as you wait thirty days before repurchasing (thereby avoiding the so-called “wash sales” rules).

GOING GREEN TO SAVE SOME GREEN

Individual families who purchase and install certain energy efficient products, including but not limited to windows, doors, insulation, and roofs, are eligible to receive a tax credit for thirty percent (30%) of the cost, up to a total of $1,500. The upgrade must be “placed in service” between January 1, 2009 and December 31, 2010.

Individuals wishing to go further, and who install solar energy systems, geothermal heat pumps, small wind systems, and residential fuel cell and microturbine systems are eligible to receive a thirty percent (30%) tax credit for systems “placed in service” before December 31, 2016 with no tax credit cap.

Please consult your tax advisor before taking advantage of any of these programs. While the general principles are applicable to everyone, each program has its own little intricacies that must be examined on a case by case basis.