Keep More of Your Money

Tax Article

Charles Schwab & Co., Inc.

Call us at 866-232-9890

Send us an email

Printer-friendly
Type Size: A A A
Email to a friend

Keep More of Your Money
by Rande Spiegelman, CPA, CFP®, Vice President of Financial Planning, Schwab Center for Financial Research
January 20, 2009

Reprinted from the January 2009 issue of Schwab Investing Insights®, a monthly publication for Schwab clients.

Times are tough. So it's especially important to take advantage of every tax break you're entitled to. After all, it's not what you make but what you keep that counts. Here are several tips to consider:

Position yourself to benefit from lower tax rates while they last
Given the recent financial downturn, it's looking less likely that Congress will push for any significant tax increases right away. The odds favor simply allowing the current lower ordinary income, capital gains and qualified dividend tax rates to expire and go back up after 2010, as they are already scheduled to do. (See the "Expiring Rates" table below.) In any event, now is a good time to discuss with your financial advisor steps you can take to reduce the impact of taxes on your pocketbook.

Expiring Rates
Federal Provision	Now	In 2011 (Pre-2001 Law)
Ordinary income tax brackets	10% 15% 25% 28% 33% 35%	N/A 15% 28% 31% 36% 39.6%
Long-term capital gains tax rate	15% or 0%	20% or 10%; greater than five years: 18% or 8%
Qualified dividend tax rate	15% or 0%	N/A
Alternative Minimum Tax (AMT)	Exemption: Married: $69,950 Single: $46,200	Exemption: Married: $45,000* Single: $33,750*
Estate tax	Exemption (top rate): $3.5 million (45%)	Exemption (top rate): $1 million (55%)

*Lower exemption amounts take effect in 2009 unless Congress extends the temporary 2008 AMT patch. Source: Internal Revenue Service (IRS).

Plan your taxes to take advantage of federal income tax changes
To keep pace with inflation, the IRS has widened the federal income tax brackets and increased certain exemptions, deductions and credits.¹ See the "2009 Federal Income Tax Brackets" table. For additional information, please visit the IRS Web site.

2009 Federal Income Tax Brackets
Marginal Tax Rate	Taxable Income
Marginal Tax Rate	Single	Married Filing Jointly
10%	$8,350 or less	$16,700 or less
15%	Over $8,350 up to $33,950	Over $16,700 up to $67,900
25%	Over $33,950 up to $82,250	Over $67,900 up to $137,050
28%	Over $82,250 up to $171,550	Over $137,050 up to $208,850
33%	Over $171,550 up to $372,950	Over $208,850 up to $372,950
35%	Over $372,950	Over $372,950

Source: IRS.

Make deductible charitable gifts from your IRA
If you own an IRA and are 70½ or older, you can still make tax-free charitable contributions of up to $100,000 directly from your IRA. Congress extended this option through the 2009 tax year.

See if you're exempt from the Alternative Minimum Tax
Congress raised the taxable income exemption amounts for the 2008 tax year—to $69,950 for married couples filing jointly and $46,200 for single filers. After this tax year, we're set to go back to the pre-2001 levels unless Congress legislates otherwise.

Take advantage of lower tax rates for children
In 2009, children under 19 will pay no federal income tax on the first $950 of unearned income (such as capital gains or interest) and will be taxed at their own rate on the next $950 (0% for long-term capital gains and most likely 10% on other unearned income). However, they will be taxed at their parents' tax rate on unearned income in excess of $1,900 for 2009. (This will also be the case for full-time college students under age 24, unless their earned income is greater than one-half of their parents' support.)

Individuals age 19 and older (and dependent full-time college students age 24 and older) pay taxes at their own rate. If they're in the 15% ordinary bracket or below, that means 0% tax on long-term capital gains and qualified dividends for tax years through 2010, unless Congress changes the law before then.

Boost your retirement savings and potentially enjoy tax benefits
As the "2009 Federal Limits ..." table below shows, the federal government increased the maximum amounts you can contribute to certain retirement accounts.

2009 Federal Limits for Retirement Accounts
Account	Contribution Limit	Additional Catch-Up Contribution for People Age 50 and Older
401(k), 403(b) and 457	$16,500	$5,500
SIMPLE IRA	$11,500	$2,500
QRP/Keogh and SEP-IRA	20% of net self-employment income (or 25% of compensation) up to $49,000	None
Individual 401(k)	20% of net self-employment income (or 25% of compensation) plus $16,500, up to $49,000	$5,500
Traditional IRA and Roth IRA	$5,000	$1,000

Source: IRS.

Among them:

Traditional IRAs. Money you put in a traditional IRA is generally tax-deductible unless you're an active participant in a qualified workplace retirement plan, such as a 401(k) or 403(b). In that case, restrictions apply. If you're a single filer, your contribution is partially deductible if your modified adjusted gross income (MAGI) is $55,000–$65,000. If you are a married couple filing jointly, your 2009 contribution is partially deductible if your MAGI is $89,000–$109,000. If you don't participate in a retirement plan at work (but your spouse does) and you file jointly, your contribution is partially deductible if your MAGI is $166,000–$176,000.²
Roth IRAs. Good news! If you didn't qualify for a Roth IRA before, you may now, as eligibility income limits have been expanded. If you're a single filer, in 2009 your contribution limit is $5,000 (or $6,000 if you're 50 or older) if your MAGI is $105,000 or less. The contribution limit is gradually reduced for those with MAGIs of $105,000–$120,000. If you are a married couple filing jointly, your contribution limit is $5,000 (or $6,000 if you're 50 or older) if your MAGI is $166,000 or less. That contribution limit is gradually reduced for those with MAGIs of $166,000–$176,000.

See if you can skip required retirement plan withdrawals
If you are 70½ or older, the IRS may normally require you to take annual required minimum distributions (RMDs) from both IRAs and qualified retirement plans. However, Congress suspended this rule for 2009 RMDs. Exception: If you turned 70½ in 2008, the waiver does not apply to first-year 2008 RMDs made by April 1, 2009.

Manage college expenses with these nifty tax benefits
Consider these tax-favored ways to pay for college costs:

A Coverdell education savings account. If you're a single filer, you may make a maximum contribution of $2,000 per year if your MAGI is $95,000 or less; the maximum allowed contribution is gradually reduced for those with MAGIs of $95,000–$110,000. If you're a married couple filing jointly, you may make a maximum contribution of $2,000 per year to a Coverdell if your MAGI is $190,000 or less; the maximum allowed contribution is gradually reduced for those with MAGIs of $190,000–$220,000.
A 529 college savings plan. Although there's no limit to how much you can contribute each year, each state's plan has its own lifetime limit—typically more than $200,000.³ You can also treat a 529 contribution as being made over five years for gift tax purposes. So a married couple could contribute up to $130,000 per child up front without using any of their lifetime gift tax credit (see below).
Tax credits. The maximum Hope credit you may claim is $1,800. The Lifetime Learning credit is 20% of the first $10,000 of qualifying education expenses. These credits gradually phase out for those with MAGIs of $50,000–$60,000 for single filers and $100,000–$120,000 for married couples filing jointly.
Tax deductions. You may be able to deduct up to $2,500 of student loan interest. The MAGI phaseout for eligibility is $60,000–$75,000 for single filers and $120,000–$150,000 for married couples filing jointly.

Plan your gifts and estate to make the most of these tax breaks

The gift tax annual exclusion amount has increased. For 2009, you generally can give up to $13,000 annually (or $26,000 for spouses splitting gifts) to any number of people, and none of the gifts will be taxable. You can also give unlimited amounts toward tuition or medical expenses if you pay the provider directly. Beyond that, the lifetime gift tax exemption is still $1 million. The top gift tax rate is 45%.
For 2009, the estate tax lifetime exemption amount has gone up to $3.5 million ($1,455,800 equivalent credit), and the top estate tax rate remains at 45%.

For more information on these and other changes, please read "2009 Inflation Adjustments Widen Tax Brackets and Expand Tax Benefits" on www.irs.gov.

Should You Sell Securities Now?
Should you sell some securities now, before long-term capital gains rates go up? Currently, profits on long-term investments (those held more than one year) are taxed at a top rate of 15%. Prior to the election, Obama had proposed raising the top rate back to 20% for families making over $250,000. That plan may be on hold for now.

But, even if Congress and President-elect Obama take no action, beginning on January 1, 2011, the top long-term capital gains tax rate is scheduled to return to 20% for securities held between one and five years, and 18% for those held more than five years.

If you have a better investment in mind or need the money now and were going to sell anyway, why not save 3% or 5% in taxes? But if you're going to turn around and reinvest the proceeds in the same security, then the prospect of long-term capital gains taxes reverting to 18% or 20% shouldn't in itself prompt you to sell.

You may be better off holding onto a security rather than selling it now and reinvesting the proceeds in the same security. Consider the two hypothetical scenarios below. Assume that you have a $1,000 long-term gain now and you expect the investment to generate an 8% average annual compound return. As the table below shows, in this hypothetical example, not selling now would lead to a higher net gain in 10 years.

	If You Sell Now	If You Don't Sell Now
Long-term gain now	$1,000	$1,000
15% capital gains tax	($150)	N/A
Net	$850	$1,000
Cell 3:1	Cell 3:2	Cell 3:3
Long-term gain after 10 years	$1,835	$2,159
20% capital gains tax	($197)*	($432)
Net	$1,638	$1,727

*[0.20 x ($1,835 - $850)]

Important Disclosures

1. In some instances, modified adjusted gross income (MAGI) may be used to determine eligibility for certain deductions. MAGI calculations vary, so consult your tax professional.
2. Within certain AGI (or MAGI) phaseout ranges, you receive partial deductibility (or eligibility to contribute, in some cases) for certain tax breaks. At or below the low end of the range, you can receive full deductibility (or eligibility), but at or above the high end of the range, you lose deductibility (or eligibility).
3. As with any investment, it is possible to lose money by investing in a 529 plan. Before investing, carefully consider a plan's investment objectives, risks, charges and expenses. Additionally, if you are investing in a 529 plan outside the state in which you pay taxes, you should consider your own state's 529 plan to determine if you can obtain any tax or other benefits offered by your own state's plan.

This report is for informational purposes only and is not an offer, solicitation or recommendation that any particular investor should purchase or sell any particular security or pursue a particular investment strategy. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Examples provided are for illustrative purposes only and are not representative of intended results that a client should expect to achieve.

Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner or investment manager. Tax laws and authorities are subject to change, either prospectively or retroactively, and any subsequent change could have a material impact on your situation.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

(0109-7712)

Return to Top

Market Insight Alert Email

New Schwab commentary every two weeks:

Monday: Liz Ann Sonders
Thursday: Schwab Sector Views
Friday: Schwab Market Perspective

Clients can sign up now