As the tax year 2010 comes to a close tax planning for 2011 should begin, but how is it possible to plan given the legislative gridlock in Washington DC? The answer is that tax planning needs to focus on what is known and not the unknown.

What Is Known

Your 2009 US Federal individual income tax return should have been filed by now. Consequently, carry forward items such as capital losses, net operating losses, losses from private activities, charitable contributions, minimum tax credits and investment interest expense from 2009 to 2010 are available to factor into your 2010 year end planning.

Roth IRA conversions no longer have an income limitation and will not be subject to legislative changes. The disallowance of up to 80% of itemized deductions has been repealed for 2010, but will reappear in 2011. So perhaps 2010 is the time to take advantage of itemized deductions that were or will be nondeductible in 2009 and 2011. It is also likely that tax rates in the foreseeable future will never be any lower that what are in effect for 2010 on ordinary income, qualified dividends and capital gains.

Strategy

The November 2010 Congressional election will clarify year end tax strategy. If the Democrats retain power it is likely that a compromise tax bill will emerge prior to year end with a partial extension of the “Bush Era” tax cuts for a year or two. If the Republicans win one or both houses, a tax bill is unlikely until a new Congress is seated in late January 2011.

Consideration should be given to accelerating income into 2010 to take advantage of the low rates. The downside of doing so is the pre-payment of taxes if the “Bush Era” tax cuts are extended. It is likely that you will have until the Congressional Christmas break before you need to affect this strategy.

Income can be accelerated by requesting that your 2010 bonus that would normally be paid in 2011 be accelerated to December 2010, appreciated non qualified stock options could be exercised in 2010 versus 2011 and you can request that deferred compensation be paid to you in 2010 versus a later year. Income can also be accelerated by selling stocks that have appreciated and waiting until 2011 to sell stocks that have decreased in value. Converting an IRA into a Roth IRA will result in increased taxable income in 2010 and consideration could be given to selling real estate in 2010 versus 2011.

A Roth IRA conversion has a hidden tax trap. The law requires the income from a 2010 conversion to be taxed, half in 2011 and half in 2012. But the tax rates could be higher in those years. If you do a 2010 Roth IRA conversion and decide that the tax rates will be higher in 2011 and 2012, you can make an election to have the conversion taxed in 2010.

Estate Tax - 2010

The chances of the estate tax being revived retroactive to January 1, 2010 are rapidly fading. A reinstatement at this point in the year would undoubtedly be challenged in court on constitutional grounds and would take years to wend its way through the court system. At the time a well known sports figure died in 2010, there was a news report stating that his dying in 2010 resulted in a savings to his estate of over $500,000,000 in estate tax. If the estate tax law is retroactively changed, there is little doubt that a portion of the $500,00,000 tax savings will be used to purchase years of legal consultation and court appearances.

Estate Tax - 2011

A $1,000,000 estate tax exemption goes into place as of January 1, 2011. Current conjecture is that the politicians will eventually settle on an exemption of between $3,500,000 and $5,000,000 and that the top estate tax rate will be between 35% and 45%, retroactive to January 1, 2011.

2010 4^th Quarter Estimated Tax Payment

The 2010 4^th quarter estimated tax payment in due on January 17, 2011. November is a good time to review your 2010 projection of income and tax to ascertain what changes have taken place in the past 10 months, compare your projected income and deductions to actual income and deductions to date and then ascertain whether your 4^th quarter estimated tax payment needs to be increased or decreased. The Internal Revenue Service assumes that income is earned ratably throughout the year. So if you need to increase your 4^th quarter payment you will likely incur a penalty for late payment of tax because of the Internal Revenue Service assumption. It is possible to offset the penalty by categorizing income by quarter and proving to the Internal Revenue Service that there was no requirement for you to make a payment earlier in the year. One alternative to making an estimated tax payment and avoiding a penalty is to have a greater amount withheld from your November and December salary. For Federal withholding, the Internal Revenue Service assumes that the amounts have been ratably withheld throughout the year. Thus, your extra November and December withholding will not be allocated to the 4^th quarter, but to April, June, September and January on a ratable basis.

International Tax Audits

The Internal Revenue Service has now concentrated all their international resources into one division. This will allow the Internal Revenue Service to coordinate their enforcement of all international issues in one location. This division includes branches to deal with offshore compliance, US holders of foreign bank accounts and audits of high net worth individuals. We understand that enforcement and examinations have already commenced in Bermuda.

Pursuant to the requirements relating to practice before the Internal Revenue Service, any tax advice in this communication is not intended to be used, and cannot be used, for the purpose of (i) avoiding penalties imposed under the United States Internal Revenue Code, or (ii) promoting, marketing or recommending to another person any tax related manner.