Year-End Tax Tips

People scrambling to send in checks for last-minute write-offs of charitable contributions and business expenses often think that writing “Dec. 31” on them qualifies the purchases for 2010 deductions. Wrong. You need to mail the payments early enough for the letters to be postmarked by midnight on Dec. 31. The IRS won’t care if the checks don’t reach recipients until 2011, though.

The rules are similar with American Express, Visa and MasterCard; you’ll qualify for deductions if you authorize charges by year’s end even if the card issuer doesn’t bill you until 2011. (For store and gasoline cards, your deduction is pegged to when you actually pay their bills, not when you charge the purchases.)

This year, if you’re in the 10 or 15 percent bracket — taxable income below $67,900 for married couples and $33,950 for singles — profits on long-term capital gains (ones owned more than 12 months) won’t be taxed. That’s right: Your capital gains tax rate will be 0 percent.

Taking some gains may be especially worth considering if you think you may be in a higher bracket in the years to come. Most experts believe that capital gains rates are likely to rise over the next five years. And as long you’re doing some buying and selling, take the opportunity to rebalance your portfolio with lower cost assets, like no-load index funds. Not only are you likely to get better returns, but since index funds don’t trade much, you’ll have lower tax bills in the future.

Don’t qualify for the 0 percent capital gains rate? Consider unloading any assets in your portfolio that are worth less than you bought them for. Sell the losers anytime through December 31, the last trading day of the year, and claim tax losses on your 2010 return. Ideally, you’ll be able to offset any 2010 gains with losses to avoid owing taxes on the winners. But even if the losers outweigh the winners, you can offset up to $3,000 of the losses against ordinary income, such as salary, and carry into 2011 any unused capital losses.

The IRS won’t let you deduct a loss if you buy a “substantially identical” investment within 30 days, in what’s known as a wash sale. The wash sale rules also apply when your spouse buys the substantially identical security within 31 days of sale. To avoid the wash sale, you can either wait the requisite 31 days and repurchase the stock or fund you sold, or replace the security with something that is close, but not the same. For instance: Here’s another opportunity to replace a more expensive managed mutual fund with a low cost index fund. The rules are a little murky with mutual funds, since whether two funds are “substantially identical” can be a judgment call. But if you’re planning to sell an index fund at a loss, don’t run out and buy another fund that tracks the same index.

Maybe you’ve profited from the market’s run-up or own a stock or mutual fund that has ballooned over the past two years. Boost your 2010 deductions and avoid owing taxes on those gains by giving appreciated securities to a charity. You’ll write off their current market value (not just what you paid for them) and escape taxes on the accumulated gains. If you’d prefer giving a charity a stock or fund that has lost value, you’ll need to sell the investments and donate the proceeds. Than you can deduct the contribution and claim the loss.

Money saved in these programs grows tax-free, and 529-plan withdrawals used to pay for college sidestep taxes. In some states, you can deduct the contributions from your state income tax bill. You can invest up to $13,000 in 2010 without incurring a federal gift tax.

With a Roth, you don’t get a tax break when you put money in, but the money grows tax-free and won’t get taxed again if distributions are made properly. The government allows individuals to convert traditional IRA accounts into Roth accounts, but when doing so, you must pay the tax due on the traditional IRA.

Rolling over into a Roth account by the end of the year could make a lot of sense: Tax rates are currently low, and paying tax on the rollover now could save you money if tax rates rise in the future. There are also two special opportunities in 2010:

• The previous $100,000 AGI limit on Roth conversions is lifted, so even high earners can convert.
• For 2010 only, you can spread out the tax associated with the rollover over two tax years — 2010 and 2011.

Some employers require employees with flexible spending accounts (pretax dollars that pay out-of-pocket medical and child-care expenses) to forfeit contributions that go unused by Dec. 31. Others allow a grace period until March 15, 2011. If you have an FSA, check your company’s rules. Then, if you have cash sitting in the account and your deadline is year-end, spend it so you’ll avoid leaving money on the table. Either way, if you buy over-the-counter drugs with your FSA, do so before the end of 2010. You’ll need a prescription next year.

Take advantage of energy credits, some of which are set to expire at the end of this year. If you make energy-efficient home improvements — such as upgrading windows and doors, insulation, metal and asphalt roofs or central air conditioners — on your principal residence, you can get a tax credit of up to 30 percent of the total amount spent on the home, up to $1,500.

There’s another energy credit for 30 percent of the cost of installing renewable-energy improvements including solar water heaters and panels — with no dollar limit. Note that these things must be “placed in service” before December 31 — not just purchased, but installed and available for use. For information on the types of items qualifying for the credits, see the Tax Incentives Assistance Project.

Bonus: Three moves just for the self-employed.

If you’re your own boss, pencil out what you expect your income to be for 2010 and 2011. Entrepreneurs who anticipate being in a higher tax bracket next year should send out invoices soon for all fourth-quarter work, so they’ll receive the income in 2010. They should also delay making tax-deductible business purchases until January, when the write-offs will become more valuable. If you think you’ll bring in less money in 2011, do exactly the reverse.

Buy a computer, printer, or furniture for a business run out of your home office, and start using it before the end of the year. That way you should be able to write off the entire cost on your 2010 return — the limit to what you can expense is the lesser of $500,000 or your business’s 2010 taxable income.

Say you spend $10,000 for computers, copiers and the like. Instead of depreciating the equipment over the normal five years, you can write off the entire $10,000, lowering your taxes by $3,000 if you’re in the 30 percent bracket. The best part: You don’t have to cough up the cash for the full price of the equipment in 2010 to get the deduction; it’s fine to charge the purchases and pay them off in 2011.

Although employees can only write off medical expenses once the total exceeds 7.5 percent of their income, the self-employed get a much better tax deal. They can deduct 100 percent of health insurance premiums for themselves, their spouses and dependents, up to the total of their business’s net earnings. So write that insurance check before January. The 100 percent write-off doesn’t apply to newly minted self-employed people who are buying COBRA coverage through their former employers’ group plans, since they’re considered employees for tax purposes. But if you lost your job in 2010, your income may be low enough this year to meet the 7.5 percent threshold allowing you to write off COBRA costs.

Julian Block is an attorney and author specializing in taxes based in Larchmont, N.Y. Jill Schlesinger is editor-at-large of CBS MoneyWatch.com.

More on MoneyWatch:

• 5 Smart Year-End Tax Moves
• Roth IRAs: Should You Convert?
• Are Charities Fudging Their Numbers?
• Flexible Spending: What to Buy Now
• Freelancers: What You Can and Can’t Deduct
• Find Cheaper Health Insurance