Year-end tax guide for 2011

Year-end tax guide for 2011

Table of contents

Introduction: Planning makes perfect .................................................................................................................... 1

1. Tax law changes: What’s new this year? ......................................................................................................... 2 Chart 1: Individual income tax rate scenarios under current law ........................................................................................3 Chart 2: AMT exemption for 2010 and 2011 ...................................................................................................................3 Chart 3: Estate, gift and GST tax rates and exemptions 2009–13 ....................................................................................4 Business perspective: New tax opportunities for business ................................................................................................5

2. Getting started: Individual tax rates and rules .................................................................................................. 6 Chart 4: 2011 individual ordinary income tax rates ..........................................................................................................6 Chart 5: 2011 tax benefit thresholds ...............................................................................................................................7 Action opportunity: Maximize above-the-line deductions ....................................................................................................8 Tax law change alert: Strict new rules for medical spending in 2011 .................................................................................8 Tax law change alert: Payroll tax holiday for 2011 ...........................................................................................................8 Chart 6: Employment tax rates and thresholds .................................................................................................................9 Action opportunity: Make up an estimated tax shortfall with increased withholding .............................................................9 Action opportunity: Bunch itemized deductions to get over AGI floors ..............................................................................10

3. Alternative minimum tax ...............................................................................................................................11 Tax law change alert: AMT relief extended through 2011 ...............................................................................................11 Chart 7: 2011 individual AMT rate schedule and exemptions ..........................................................................................11 Action opportunity: Accelerate income to “zero out” the AMT ..........................................................................................12

4. Investment income .......................................................................................................................................13 Chart 8: Investment income tax rates for 2010 and beyond ...........................................................................................13 Action opportunity: Avoid the wash sale rule with a bond swap ........................................................................................14 Tax law change alert: New broker reporting rules affect basis on stock sales ..................................................................14 Action opportunity: Use zero capital gains rate to benefit children ...................................................................................15 Tax law change alert: No tax on gain from QSB stock purchased in 2011 .......................................................................15 Action opportunity: Defer investment interest for a bigger deduction ...............................................................................16 Tax law change alert: Deduct interest on a mortgage of up to $1.1 million ......................................................................17 Tax law change alert: Primary residence gain exclusion limited .......................................................................................17

5. Executive compensation ...............................................................................................................................18 Action opportunity: Consider an 83(b) election on your restricted stock ...........................................................................19 Business perspective: Managing the pay plans in your business ......................................................................................20 Tax law change alert: New executive compensation rules ...............................................................................................20 Chart 9: Strategies for dealing with underwater stock options ........................................................................................21

6. Business ownership .......................................................................................................................................23 Chart 10: 2011 corporate income tax brackets .............................................................................................................23 Chart 11: Comparison of tax differences based on business structure ............................................................................24 Action opportunity: Organize or convert into a QSB ........................................................................................................24 Action opportunity: Set salary wisely if you’re a corporate employee-shareholder .............................................................24 Tax law change alert: No built-in gain tax for certain S corporations ................................................................................25

7. Charitable giving ...........................................................................................................................................27 Chart 12: AGI limitations on charitable contribution deductions .......................................................................................27 Action opportunity: Give directly from an IRA if 70½ or older ..........................................................................................28 Action opportunity: Give appreciated property to enhance savings ..................................................................................28

8. Education savings: The ABCs of tax-saving education ....................................................................................30 Chart 13: 2010 education tax break income phaseouts .................................................................................................30 Tax law change alert: Tuition and fees deduction extended through 2011 .......................................................................30 Action opportunity: Make payments directly to educational institutions ............................................................................31 Tax law change alert: Above-the-line loan interest deduction extended through 2012 .......................................................31 Action opportunity: Plan around gift taxes with your 529 plan .........................................................................................31 Tax law change alert: Coverdell ESA benefits extended ..................................................................................................32 Tax law change alert: Kiddie tax increases bite ..............................................................................................................32

9. Retirement savings .......................................................................................................................................33 Chart 14: Comparison of tax-preferred retirement savings vehicles .................................................................................33 Action opportunity: Wait to make your retirement account withdrawals ............................................................................34 Tax law change alert: Roth rollover limitation disappears ................................................................................................35 Action opportunity: Roll over into a Roth IRA ..................................................................................................................35 Action opportunity: Get kids started with a Roth IRA ......................................................................................................35 Business perspective: Maintaining your company’s retirement plans ...............................................................................37 Tax law change alert: Employees can roll over into Roth 401(k)s ....................................................................................37

10. Estate planning .............................................................................................................................................39 Chart 15: Estate, gift and GST tax rates and exemptions ...............................................................................................39 Tax law change alert: Transfer tax changes ...................................................................................................................39 Action opportunity: Exhaust your lifetime gift tax exemption ............................................................................................40 Action opportunity: Use second-to-die life insurance for extra liquidity ..............................................................................42 Action opportunity: Zero out your GRAT to save more ....................................................................................................43

Grant Thornton offices ........................................................................................................................................44

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Introduction

Planning makes perfect

Success isn’t easy and it certainly isn’t free. As your income increases, so does your tax burden. For successful individuals, tax rules become complicated quickly. Whether you’re managing your individual tax rates, the rates on your investments, the taxes on your privately held or pass-through business, or the income of executives and shareholders at your company, managing a tax burden has never been more difficult.

That’s where tax planning comes in. With so much at stake, don’t bury your head in the sand and wait for a big surprise on April 15. There are now more ways than ever to reduce your tax liability, but all of them take planning. Both the tax code and your economic situation are continually evolving. You need to think farther ahead, employ clearer strategies and use every tax break you can. Don’t act first and think about taxes later. A little foresight can go a long way.

To help answer as many of your questions as possible, this Grant Thornton guide discusses recent tax law changes and provides an overview of strategies to deal with your situation.

The guide includes information on the following:

• Tax law changes: We’ve dedicated a section to cover the most important tax changes for you and your business. Plus, look for our highlighted Tax law change alerts throughout each section of the guide.

• Action opportunities: We’ve highlighted our top 20 Action opportunities. These are strategies you can put into play right now.

• Business solutions: We know you don’t look at your tax situation as an individual taxpayer alone, but also as a shareholder, owner, employee or executive. We’ve added sections throughout the guide that focus on tax opportunities from the Business perspective.

As always, our guide will help show you how to tax-efficiently invest for education and retirement and transfer your wealth to loved ones in the most tax-efficient manner possible. However, this guide simply can’t cover all possible strategies, and there may be legislative tax changes after this guide goes to print. Our Washington National Tax Office tracks tax legislation as it moves through Congress. Be sure to contact us to find out what strategies will work best for you and what is happening on the legislative front.

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Chapter 1

Tax law changes: What’s new this year?

Congress walked back from the edge of a tax precipice in 2010 and agreed to extend the 2001 and 2003 tax cuts for two years. The scheduled expiration of these tax cuts at the end of 2010 had threatened to increase taxes on virtually every taxpayer in 2011. The compromise legislation passed last December extended the individual income tax cuts in their entirety through the end of 2012. This massive December tax bill also extended alternative minimum tax (AMT) relief and a number of popular temporary tax provisions known as “extenders.”

Yet lawmakers weren’t content with a simple extension of expiring tax laws — they also made some key changes. The December tax cut package made dramatic changes to transfer tax rules and offered taxpayers new tax incentives, such as 100 percent bonus depreciation and an employee payroll tax holiday. Earlier legislation, the Small Business Jobs Act of 2010, also included many tax incentives that could benefit businesses this year.

So far, Congress has been quieter in 2011. Lawmakers did repeal an onerous expansion of Form 1099 reporting rules early in the year, but as this guide went to print, had not yet enacted any major tax bills. Of course, 2011 is not over. Congress could still consider revenue increases or tax reform as part of a deficit reduction effort, and the president was pushing for a job creation tax package as this guide went to print. Check with Grant Thornton’s Washington National Tax Office for the latest information.

2001 and 2003 individual income tax cuts The biggest development by far was the extension of the 2001 and 2003 tax cuts. These tax cuts include rate cuts across the individual income tax brackets, plus scores of other tax benefits:• Thetoprateof15percentondividendsandcapitalgains

(on most sales and exchanges)• Thezerorateforcapitalgainsanddividendsinthebottom

brackets• Thetoprateonordinaryincomeof35percent• Therepealofthephaseoutsofthepersonalexemption

anditemizeddeductions• Marriagepenaltyrelief• $1,000childtaxcreditanditsrefundability• Theincreaseddependentcarecredit• $10,000adoptioncreditand$10,000incomeexclusion

for employer assistance• $2,000contributionlimitforCoverdelleducationsavings

accounts• Theabove-the-linedeductionforstudentloaninterest• Theexclusionforemployer-providededucationassistance

When originally enacted in 2001 and 2003, these tax cuts were given sunsets for a variety of policy, political and budget reasons. The sunset dates are now extended through 2012. Without legislation, the tax cuts will now expire in 2013 — at the same time new Medicare taxes enacted in the health care reform legislation are scheduled to take effect. These Medicare taxes will impose an additional 0.9 percent tax on earned income above$200,000forsinglesand$250,000forjointfilers,anda3.8percent tax on investment income above those thresholds. We’re likely to see another legislative battle over the tax cuts in 2012. See Chart 1 for what is scheduled to happen to tax rates under current law.

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Extenders and AMT The popular tax provisions known as “extenders” include over 30 tax provisions that have traditionally been renewed by Congress on a temporary basis. The provisions expired again at the beginning of 2010, but most were retroactively reinstated for all of 2010 and through 2011. They are now scheduled to expire at the end of 2011.

Key individual tax extenders include the following:• Electiontodeductstateandlocalsalestaxes• Above-the-linetuitiondeduction• $250above-the-lineteacherexpensesdeduction• Standarddeductionforpropertytaxesfornon-itemizers• Tax-freecharitabledistributionsfromindividualretirement

plans• Withholdingexceptionforinterest-relateddividends

of regulated investment companies (RICs)• Estatetaxlook-throughforRICstockheldbynonresidents

Lawmakers also completed an AMT “patch” for 2010 and 2011. The AMT relief increases the exemptions modestly over 2009 levels (see Chart 2).

Estate and gift taxesNo area of the tax code has shifted more dramatically over the last few years than transfer taxes. Under the 2001 and 2003 tax cuts, the estate tax and generation-skipping transfer (GST) tax were temporarily repealed for 2010. This relief was scheduled to be short-lived. Like the individual income tax cuts, all transfer tax relief was scheduled to expire beginning in 2011, with the rules reverting to those in place in 2000.

Instead, the compromise tax bill enacted in late 2010 puts in place a new transfer tax regime for 2010, 2011 and 2012. In general, the legislation:• reunifiesthegiftandestatetax;• increasesthegift,estateandGSTtaxexemptionamounts

to$5million;• providesforatopgift,estateandGSTtaxrateof

35percent;and• allowsportabilitybetweenspousesoftheirestatetax

exemption amounts.

Chart 1: Individual income tax rate scenarios under current law

Ordinary income tax brackets (2011 levels) Rates

Single Joint 2011–12 2013 + $0 – $8,500 $0 – $17,000 10% 15% $8,501 – $34,500 $17,001 – $69,000 15% 15% $34,501 – $83,600 $69,001 – $139,350 25% 28% $83,601 – $174,400 $139,351 – $212,300 28% 31% $174,401 – $379,150 $212,301 – $379,150 33% 36% Over $379,150 Over $379,150 35% 39.6%

Capital gains top rate 15% 23.8%*†

Dividend top rate 15% 43.4%* Interest income top rate 35% 43.4%*

* Includes new 3.8% Medicare tax on investment income† Top capital gains rate in 2013 is scheduled to be 20% for assets held 1 year and 18% for assets held 5 years, plus a 3.8% Medicare tax

Chart 2: AMT exemption for 2010 and 2011

2009 2010 2011 exemption exemption exemption

Single or head of household $46,700 $47,450 $48,450Married filing jointly $69,950 $72,450 $74,450Married filing separately $34,975 $36,225 $37,225

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Although the estate tax and GST tax were nominally reinstated for2010underthelegislation,theGSTtaxratein2010iszeroand estates of 2010 decedents can elect out of the estate tax if desired. In 2013, transfer taxes are once again scheduled to revert to the rules in place in 2000 — though legislative intervention is likely. See Chart 3 for the shifting transfer tax rules.

The drastic swings in transfer tax rules and rates present challenges and opportunities for estate planning. You will likely need to review your estate plan to make sure it still makes sense given the changes in tax law (and your own circumstances). See Chapter 10 for a full discussion of estate planning issues.

Payroll tax holiday The December tax cut compromise reduced the employee share of Social Security taxes under the Federal Insurance Contributions Act (FICA) from 6.2 percent to 4.2 percent in 2011. Social Security tax is imposed on wages up to an annually adjustedcapthatreached$106,800in2011,meaningtaxpayersatorabovethewagecapreceiveda$2,136taxcutfromthisprovision.

The reduction in FICA taxes also applies to the self-employment tax, reducing the combined rate from 15.3 percent to 13.3 percent for self-employment income earned in 2011. Consistent with the concept that this reduction comes from the employee’s share of employment taxes, this will not reduce the amount of self-employment taxes allowed as an above-the-line income tax deduction, which will continue to be calculated as one-half of 15.3 percent of self-employment income.

Chart 3: Estate, gift and GST tax rates and exemptions 2009–13

Estate tax Gift tax GST tax Exemption Top rate Exemption Top rate Exemption Top rate2009 $3.5 M 45% $1 M 45% $3.5 M 45%2010 $5 M* 35%* $1 M 35% $5 M 0%2011–12 $5 M 35% $5 M 35% $5 M 35% (portable) 2013 $1 M 55% $1 M 55% $1 M 55%

* May elect to apply law under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) (i.e., no estate tax in 2010, carryover basis)Note: Some of the exemption levels are to be indexed for inflation.

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Business perspective

New tax opportunities for business

It was another stormy economic year for many businesses, but on the tax front, it was mostly sunshine. Lawmakers again looked to the tax code to try and add fuel to the slow-burning economic recovery. The legislative efforts included not just extensions of current benefits, but many new tax provisions.

Business extenders Congress last year gave businesses a two-year extension, through 2011, of the popular business tax provisions known as “extenders.” These provisions are now scheduled to expire at the end of the year. These “extender” provisions include the following: • Researchcredit• 15-yearcostrecoveryforqualifiedleaseholdimprovements,

qualified restaurant buildings and improvements, and qualified retail improvements

• Newmarketstaxcredit• SubpartFexceptionforactivefinancingincome• Look-throughtreatmentforpaymentsbetweenrelated

controlled foreign corporations under foreign personal holding company income rules

Form 1099 reportingLawmakers gave businesses a break this year by repealing a drastic expansion of information reporting that would have forced businesses to issue millions of additional Form 1099 information reports beginning in 2012.

Trades and businesses are generally required to report (typicallyonaForm1099)paymentsover$600peryeartoa vendor for services, and the regulations generally exempt payments made to a corporation. These rules will now remain intact, as lawmakers repealed an expansion that would have also

required reporting on payments made for property, payments made to corporations and payments in connection with earning rental income. However, the legislation did not repeal new, higher penalties for information-reporting failures.

Organizing as a QSBQualified small business (QSB) stock has become an even more attractive investment. Legislation enacted in September 2010 offers a generous new tax planning opportunity to enterprises that meet qualified small business (QSB) requirements. QSB stock purchased after Sept. 27, 2010, and through the end of 2011, will never be subject to tax on the gains if the stock is held at least five years and all other requirements are met.

QSB stock must be original issue stock in a C corporation withnomorethan$50millioninassets(andmeetseveralothertests). Investments in QSB stock also come with several other tax benefits and restrictions. See Chapter 4 for a discussion from an individual investor’s perspective and Chapter 6 for a QSB tax planning opportunity from the business perspective.

Fully expensing business investments Legislation enacted in 2010 doubles a bonus depreciation tax benefitforpropertyplacedinserviceafterSept.8,2010,andbefore the end of 2011 — meaning taxpayers can expense the cost of eligible equipment placed in service before the end of the year. To qualify for bonus depreciation, property must generally have a useful life of 20 years or less under the modified accelerated cost recovery system (MACRS). The amount of business investment that can be expensed under Section 179 was alsoincreasedto$500,000fortaxyearsbeginningin2010and2011(withthephaseoutincreasingto$2million).SeeChapter6for a full discussion of these tax benefits.

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This can raise your effective federal tax rate to as high as 45 percent on the income. Generally, distributions must be made after reaching the age of 70½ to avoid penalties.

Chapter 2

Getting started: Individual tax rates and rules

Whether you’re an executive, partner or owner, your business income eventually gets taxed at the individual level. That’s where tax planning needs to start.

Different types of individual income are taxed in different ways, and you want to start by looking at ordinary income. Ordinary income includes things like salary and bonuses, self-employment and business income, interest, retirement plan distributions and more.

Ordinary income is taxed at different rates depending on how much you earn, with rates increasing as income goes up. These tax brackets, along with many other tax preferences, are adjusted for inflation annually. Persistent low inflation provided another year of relatively shallow adjustments in 2011. Check Chart 4 for a full breakdown of the tax brackets for ordinary income in 2011 and Chart 5 for the 2011 adjustments to a number of other tax items.

The top tax rate that applies to you is usually considered your marginal tax rate. It’s the rate you will pay on an additional dollar of income. But unfortunately, the tax brackets for ordinary income don’t tell the whole story. Your effective marginal rate may be very different from the stated rate in your tax bracket. Hidden taxes that kick in at higher income levels when you reach the top tax brackets can drive your marginal tax rate higher. These hidden taxes largely include phaseouts of many tax benefits at high income levels.

Fortunately, two of the most costly phaseouts are currently repealed. The personal exemption phaseout (PEP) and “Pease” phaseoutofitemizeddeductionswillnotaffectyour2011return,and you will be able to enjoy these tax preferences in full this year. However, they are scheduled to return in 2013.

You want to avoid early withdrawals from tax-advantaged retirement plans, such as 401(k) accounts and IRAs. Distributions from these plans are treated as ordinary income, and you’ll pay an extra 10 percent penalty on any premature withdrawals (generally, withdrawals prior to reaching age 59½).

Chart 4: 2011 individual ordinary income tax rates

SINGLE FILERTaxable income Rate $0 – $8,500 10% $8,501 – $34,500 15% $34,501 – $83,600 25% $83,601 – $174,400 28% $174,401 – $379,150 33% Over $379,150 35%

MARRIED FILING JOINTLYTaxable income Rate $0 – $17,000 10% $17,001 – $69,000 15% $69,001 – $139,350 25% $139,351 – $212,300 28% $212,301 – $379,150 33% Over $379,150 35%

MARRIED FILING SEPARATELYTaxable income Rate $0 – $8,500 10% $8,501 – $34,500 15% $34,501 – $69,675 25% $69,676 – $106,150 28% $106,151 – $189,575 33% Over $189,575 35%

HEAD OF HOUSEHOLDTaxable income Rate $0 – $12,150 10% $12,151 – $46,250 15% $46,251 – $119,400 25% $119,401 – $193,350 28% $193,351 – $379,150 33% Over $379,150 35%

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Chart 5: 2011 tax benefit thresholds

Personal exemption $3,700 per person

Standard deduction $11,600 (MFJ) $8,500 (HH) $5,800 (S) $5,800 (MFS)

Maximum retirement plan contributions 401(k), 457 and 403(b): $16,500 ($22,000 if 50 or older) Simple: $11,500 ($14,000 if 50 or older) IRA: $5,000 ($6,000 if 50 or older) Defined contribution plans: $49,000 Defined benefit plans: $195,000

IRA benefit phaseout Traditional: Contribution deductibility phaseout begins at $90,000 (MFJ), $56,000 all others (if you’re covered by a retirement plan at work) Roth: Ability to contribute begins to phase out at $107,000 AGI (S), $169,000 (MFJ), $0 (MFS)

Standard mileage rates January–June July–December Business: 51 cents 55.5 cents Charity: 14 cents 14.0 cents Medical/moving: 19 cents 23.5 cents

Kiddie tax Not taxed: First $950 Child’s rate: $950 to $1,900 Parent’s rate: $1,901+ (Applies to children under 19 and college students under the age of 24 who do not provide over half of their own support)

Foreign income exclusion $92,900

Section 179 limit $500,000 (reduced by amount of Section 179 property exceeding $2 million)

Annual gift tax exclusion $13,000

Mandatory retirement account withdrawals Age 70½

Transportation fringe benefit exclusion $230

MFJ = married filing jointly; HH = head of household; S = single; MFS = married filing singly

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Payroll taxes take a biteEmployment taxes, often called “payroll taxes,” are imposed against earned income under the Federal Insurance Contributions Act (FICA). Earned income generally comprises wages, salaries, tips and self-employment income. There are two components to employment taxes: Social Security and Medicare. Generally, FICA requires matching contributions from the employer and the employee for both Social Security and Medicare taxes. Social Security taxes are imposed up to a wagecapthatisadjustedforinflationeachyearandis$106,800in 2011. Medicare taxes are uncapped and apply to all income.

If you are employed and your earned income consists of salaries and bonus, your employer will withhold your share of employment taxes and pay them directly to the government. If you are self-employed, you must pay both the employee and the employer portions of employment tax, though you can take an above-the-line deduction for the employer’s portion of the tax.

Payroll taxes are scheduled to become even more costly in 2013. The health care reform bill enacted in 2010 is scheduled to increase the employee share of Medicare tax in 2013 from 1.45 percentto2.35percentonanyearnedincomeabove$200,000(single)or$250,000(joint).What’sworse,aMedicaretaxonunearned income will be imposed for the first time. Income such asinterest,dividendsandcapitalgainsabovethe$200,000and$250,000thresholdswillbesubjecttoanadditional3.8percentMedicare tax beginning in 2013. This new employment tax on unearned income will not apply to distributions from IRAs and other qualified plans, which may provide an additional incentive tomaximizecontributionstothoseplans.SeeChart6fortheemployment tax rates under current law.

Tax law change alert: Strict new rules for medical spending in 2011The health care reform bill enacted in 2010 made many changes to health care-related tax rules that will be phased in over the next several years. Beginning in 2011, you can no longer use an HSA, flexible spending arrangement (FSA) or health reimbursement account (HRA) to pay for over-the counter dugs unless you have a prescription. Employers are also now operating under stricter rules to prevent improper HSA expenditures, and your penalty for misuse has increased from 10 percent to 20 percent.

Tax law change alert: Payroll tax holiday for 2011The Social Security tax rate is typically 6.2 percent for both employees and employers, while the Medicare rate is 1.45 percent. However, lawmakers provided a partial payroll tax holiday in 2011 that reduces the employee Social Security tax rate from 6.2 percent to 4.2 percent. The employer rate is unaffected.

This Social Security rate cut also applies to the self-employment tax, lowering the combined rate from 15.3 percent to 13.3 percent for self-employment income earned in 2011. Consistent with the concept that this reduction comes from the employee’s share of employment taxes, this will not reduce the amount of self-employment taxes allowed as an above-the-line income tax deduction, which will continue to be calculated as one-half of 15.3 percent of self-employment income.

Action opportunity: Maximize above-the-line deductionsNearly all of the tax benefits that phase out at high income levels are tied to adjusted gross income (AGI). The list includes personal exemptions and itemized deductions (except in 2010–12), education incentives, charitable giving deductions, the alternative minimum tax (AMT) exemption, the ability to contribute to some retirement accounts and the ability to claim real estate loss deductions.

These AGI-based phaseouts are one of the reasons above-the-line deductions are so valuable. They are not subject to the AGI floors that hamper many itemized deductions. They even reduce AGI, which provides a number of tax benefits. Most other deductions and credits only reduce taxable income or tax, itself, without affecting AGI.

Above-the-line deductions that reduce AGI could increase your chances of enjoying other tax preferences. Common above-the-line deductions include traditional Individual Retirement Account (IRA) and Health Savings Account (HSA) contributions, moving expenses, self-employed health insurance costs and alimony payments. Remember that beginning this year, HSA’s can no longer be used to pay for over-the-counter drugs unless you have a prescription, and penalties for improper expenditures have increased from 10 percent to 20 percent.

Save on taxes by contributing as much as possible to retirement vehicles that provide above-the-line deductions, such as IRAs and SEP IRAs. Don’t skimp on HSA contributions either. When possible, give the maximum amount allowed. Even if you withdraw the full amount that was contributed to pay medical expenses, at least you have effectively moved those medical expenses “above the line.” And don’t forget that if you’re self-employed, the cost of the high deductible health plan tied to your HSA is also an above-the-line deduction.

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Paying your taxAlthough you don’t file your return until after the end of the year, it’s important to remember that you must pay tax throughout the year with estimated tax payments or withholding.Youwillbepenalizedifyouhaven’tpaidenough.

Ifyouradjustedgrossincome(AGI)willbeover$150,000in 2011, you generally can avoid penalties by paying at least 90 percent of your 2011 tax liability or 110 percent of your 2010 liability through withholding and estimated taxes (taxpayers under$150,000needonlypay100percentof2010liability).Ifyour income is irregular due to bonuses, investments or seasonal income,considertheannualizedincomeinstallmentmethod.This method allows you to estimate the tax due based on income, gains, losses and deductions through each estimated tax period.

Leveraging deductions and managing tax burdenWhy pay tax now when you can pay tomorrow? Deferring tax is a traditional cornerstone of good tax planning. Generally this means you want to accelerate deductions into the current year and defer income into next year. So it’s important to review your income and deductible expenses well before Dec. 31. You need to take action before the new year to affect your 2011 return.

But the current legislative scenario presents a unique challenge. Many tax benefits in place right now are scheduled to disappear in 2013. You may be asking yourself if this is the year to reverse your tax strategy and accelerate income and defer deductions.

Remember to be cautious. Legislative action is likely to make a big difference in this area, as will your personal situation. Tax rates were scheduled to go up in 2011, but in the end no one saw a rate increase. Income acceleration can be a powerful strategy, but it should be employed only if you are comfortable with your own political analysis and are prepared to accept the consequences if you are wrong. Because today’s low tax rates are available through 2012, you should wait until next year before thinking of accelerating taxes. Even if some of the tax cuts expire in 2013, the time value of money will still make deferral the best strategy in most cases. Whether it eventually makes more sense for you to defer or accelerate your taxes, there are many items with which you may be able to control timing:

Income• Consultingincome• Otherself-employmentincome• Realestatesales• Otherpropertysales• Retirementplandistributions

Expenses• Stateandlocalincometaxes• Realestatetaxes• Mortgageinterest• Margininterest• Charitablecontributions

Chart 6: Employment tax rates and thresholds

Income subject to tax Individual rate Employer rateSocial Security Earned income up to $106,800 (adjusted annually) 4.2% in 2011 6.2% 6.2% in 2012+

Medicare All earned income 1.45% 1.45%

Medicare surtax Earned income over $200K (single) and $250K (joint) 0.9% in 2013+ 0%

Medicare investment income tax Dividends, capital gains and interest over $200K (single) 3.8% in 2013+ 0% and $250K (joint)

Self-employed taxpayers pay both the individual and employer rates on self-employment income.

Action opportunity: Make up an estimated tax shortfall with increased withholdingIf you’re in danger of being penalized for not paying enough tax throughout the year, try to make up the shortfall through increased withholding on your salary or bonuses.

Paying the shortfall through an increase in your last quarterly estimated tax payment can still leave you exposed to penalties for underpayments in previous quarters.

But withholding is considered to have been paid ratably throughout the year. So a big bump in withholding on high year-end wages can save you in penalties when a similar increase in an estimated tax payment might not.

It’s important to remember that prepaid expenses can be deducted only in the year they apply. So you can prepay 2011 state income taxes to receive a 2011 deduction even if the taxes aren’t due until 2012. But you can’t prepay state taxes on your 2012 income and deduct the payment on your 2011 return. And don’t forget the alternative minimum tax (AMT). If you are going to be subject to the AMT in both 2011 and 2012, it won’t matter when you pay your state income tax, because it will not reduce your AMT liability in either year.

Maximizing deductions can make a big differenceTimingcanoftenhavethebiggestimpactonyouritemizeddeductions. How and when you take these deductions is importantbecausemanyitemizeddeductionshaveAGIfloors.For instance, miscellaneous expenses are deductible only to the extent they exceed 2 percent of your AGI, and medical expenses are only deductible to the extent they exceed 7.5 percent of your AGI. Bunching these deductions into a single year may allow you to exceed these floors and save more. Also keep in mind that the AGI floor for medical expenses is scheduled to increase to 10 percent for taxpayers under 65 beginning in 2013.

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Action opportunity: Bunch itemized deductions to get over AGI floorsBunching deductible expenses into a single year can help you get over AGI floors for itemized deductions. Miscellaneous expenses that you may be able to accelerate and pay now include:• deductibleinvestmentexpenses,suchasinvestmentadvisoryfees,custodialfees,safedepositboxrentalsandinvestmentpublications;• professionalfees,suchastaxplanningandpreparation,accountingandcertainlegalfees;and• unreimbursedemployeebusinessexpenses,suchastravel,meals,entertainment,vehiclecostsandpublications—allexclusive

of personal use.

Bunching medical expenses is often easier than bunching miscellaneous itemized deductions. Consider scheduling your non-urgent medical procedures and other controllable expenses in one year to take advantage of the deductions. Deductible medical expenses include:• healthinsurancepremiums,• prescriptiondrugs,and• medicalanddentalcostsandservices.

Inextremecases—andassumingyouarenotsubjecttotheAMT—itmayevenbepossibletoclaimastandarddeductioninone year, while bunching two years of itemized deductions in another.

Keep in mind that medical expenses aren’t deductible if they are reimbursable through insurance or paid through a pretax Health Savings Account or Flexible Spending Account. The AMT can also complicate this strategy. For AMT purposes, only medical expenses in excess of 10 percent of your AGI are deductible.

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• Investmentadvisoryfees• Employeebusinessexpenses• Incentivestockoptions• Interestonahomeequityloannotusedtobuild

or improve your residence• Tax-exemptinterestoncertainprivateactivitybonds• Accelerateddepreciationadjustmentsandrelatedgain

or loss differences on disposition

Proper planning can help you mitigate, or even eliminate, the impact of the AMT. The first step is to work with Grant Thornton to determine whether you could be subject to the AMT this year or in the future. In years that you’ll be subject to the AMT, you want to defer deductions that are erased by the AMT and possibly accelerate income to take advantage of the lower AMT rate.

Chapter 3

Alternative minimum tax

The alternative minimum tax (AMT) is perhaps the most unpleasant surprise lurking in the tax code. It was originally conceived to ensure all taxpayers paid at least some tax, but has long since outgrown its initial purpose. The AMT is essentially a separate tax system with its own set of rules. How do you know if you will be subject to the AMT? Each year you must calculate your tax liability under the regular income tax system and the AMT, and then pay the higher amount.

The AMT is made up of two tax brackets with a top rate of28percent.Manydeductionsandcreditsarenotallowedunder the AMT, so taxpayers with substantial deductions that are reduced or not allowed under the AMT are the ones stuck paying. Common AMT triggers include the following:• Stateandlocalincomeandsalestaxes,especiallyin

high tax states• Realestateorpersonalpropertytaxes

Chart 7: 2011 individual AMT rate schedule and exemptions

AMT brackets AMT exemption

26% tax rate 28% tax rate 2011 exemption PhaseoutSingle or head of household $0 – $175,000 Over $175,000 $48,450 $112,500 – $299,300

Married filing jointly $0 – $175,000 Over $175,000 $74,450 $150,000 – $429,800

Married filing separately $0 – $87,500 Over $87,500 $37,225 $75,000 – $214,900

Tax law change alert: AMT relief extended through 2011 The AMT includes a large exemption, but this exemption phases out at high-income levels. And unlike the regular tax system, the AMT was never indexed for inflation. Instead, Congress must legislate any adjustments. Congress has been doing this on an approximately year-by-year basis for many years, and lawmakers in 2010 raised the exemption levels through 2011.

But it’s important to remember that Congress only increases the exemption amount with each year’s “patch,” while the phaseout of the exemption and the AMT tax brackets remain unchanged. See Chart 7 for a full breakdown. Without further AMT relief, the exemption will plummet in 2012 and subject millions more taxpayers to the AMT.

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The credit can be taken against regular tax in future years, as it is meant to account for timing differences that reverse in the future. AMT credits at least four years old can be taken in 50 percent increments over a period of two years, even in years when the AMT continues to apply. Under legislation passed in the last several years, there is no AGI phaseout for this benefit. If you haven’t kept careful records of your credits because you assumed that you would continue to be subject to the AMT and unable to use them, consider reviewing your prior-year returns to determine if you can benefit from this new provision.

Capital gains and qualified dividends deserve special consideration for the AMT. They are taxed at the same 15 percent rate either under the AMT or regular tax structure, but the additional income they generate can reduce your AMT exemption and result in a higher AMT bill. So consider your AMT implications before selling any stock that could generate a large gain.

If you have to pay the AMT, you may be able to take advantage of an AMT credit that has become more generous recently. You can qualify for the AMT credit by paying AMT on timing items such as depreciation adjustments, passive activity adjustments and incentive stock options. Most individuals paying the AMT do not have AMT credits and will not benefit from this new break. However, you may have earned credits if you’ve had business income from a partnership, S corporation or Schedule C business.

Action opportunity: Accelerate income to “zero out” the AMTYou have to pay the AMT when it results in more tax than your regular income tax calculation, typically because the AMT has taken away key deductions. The silver lining is that the top AMT tax rate is only 28 percent. So you can “zero out” the AMT by accelerating income into the AMT year until the tax you calculate for regular tax and AMT are the same.

Although you will have paid tax sooner, you will have paid at an effective tax rate of only 26 percent or 28 percent on the accelerated income, which is less than the top rate of 35 percent that is paid in a year you’re not subject to the AMT. If the income you accelerate would otherwise be taxed in a future year with a potential top rate of 39.6 percent, the savings could be even greater. But be careful. If the additional income falls in the AMT exemption phaseout range, the effective rate may be a higher 31.5 percent. The additional income may also affect other tax benefits, so you need to consider the overall tax impact.

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Medicare surtax on investment income such as dividends, capital gains and interest. This surtax, enacted in the 2010 health carebill,willaddanadditional3.8percenttaxoninvestmentincomeabove$200,000(single)or$250,000(joint)beginning in2013(seeChart8).

2011 is probably not the year to begin accelerating your investment income. First, the current low tax rates could very well be extended as they were at the end of 2010. More importantly, you still have next year to think about accelerating your gain, and you’ll have more information then on the legislative outlook. Deferral is a cornerstone of good tax planning and may still be the best strategy even if your tax rates do go up in 2013.

Regardless, your investment planning should go well beyond any one-time decision about a prospective tax increase. The various rules and rates on investment income offer many opportunities for you to manage your tax burden. Understanding the tax costs of various types of investment income can also help you make tax-smart decisions. It starts with understanding all the investment income tax rules. But remember that tax planning is just one part of investing. You should also consider your risk tolerance, desired asset allocation and whether an investment makes sense for your financial and personal situation.

Chapter 4

Investment income

Managing your investment tax burden can feel like driving with your eyes closed. The tax treatment of investment income should affecthowyouorganizeyourportfolio,butit’sdifficultwhenthe economy is so unpredictable.

The financial crisis and the slow recovery have taken the stockmarketonseveralwildturnssince2008.Youlikelyexperienced upheaval in your own business enterprises. Although the temptation may be to focus on economic decisions now and worry about taxes later, this is when tax planning becomes even more important. You can’t grope in the dark and hope it all works out in the future, especially with so much legislative uncertainty. Taxes on investment income are scheduled to rise in 2013 without congressional intervention. A little upfront consideration may save a lot in the long run.

First, investment income comes in a variety of forms, and it’s not all created equal. Income such as dividends and interest arises from holding investments, while capital gains income results from the sale of investments. And while investment income is often treated more favorably than ordinary income, the rules are complex. Long-term capital gains and qualifying dividends can be taxed as low as 15 percent, while nonqualified dividends, interest and short-term capital gains are taxed at ordinary income tax rates as high as 35 percent. Special rates also apply to specific types of capital gains and other investments, such as mutual funds and passive activities.

But more importantly, the top tax rates on investment income are scheduled to change dramatically over the next several years. If the 2001 and 2003 tax cuts expire as scheduled at the end of 2012, the top long-term capital gains rate would increase from 15 percent to 20 percent for property held more thanayearand18percentforpropertyheldmorethan5years.Dividends would be taxed as ordinary income at a top rate of 39.6 percent. Yet, it gets worse! Those rates don’t include a new

Chart 8: Investment income tax rates for 2010 and beyond

2011–12 2013+Ordinary income 35% 39.6%Qualifying dividends 15% 43.4%*Capital gain on property held more than a year 15% 21.8%*Capital gain on property held more than 5 years 15% 23.8%*

* These figures include a 3.8% tax on investment income above $200K (single) and $250K (joint)

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Managing capital gains and lossesTo benefit from long-term capital gains treatment, you must hold a capital asset for more than one year before it is sold. Selling an asset you’ve held for a year or less results in less favorable short-term capital gains treatment. (In 2013, assets held more than five years will be subject to a separate capital gains rate unless legislation changes the rules.) Several specific types of assets such as collectibles have special, higher capital gains rates, andtaxpayersinthebottomtwotaxbracketsenjoyazerorateon their capital gains and dividends in 2011 and 2012.

Your total capital gain or loss for tax purposes generally is calculated by netting all the capital gains and losses throughout the year. You can offset both short- and long-term gains with either short- or long-term losses. Taxpayers facing a large capital gainstaxbilloftenfinditbeneficialtolookforunrealizedlossesin their portfolio so they can sell the assets to offset their gains. But keep the wash sale rule in mind. You can’t use the loss if you buy the same — or a substantially identical — security within 30 days before or after you sell the security that creates the loss.

There are ways to mitigate the wash sale rule. You may be able to buy securities of a different company in the same industry or shares in a mutual fund that holds securities much like the ones you sold. Alternatively, consider a bond swap.

It may prove unwise to try and offset your capital gains atall.Upto$3,000innetcapitallosscanbeclaimedagainstordinary income (with a top rate of 35 percent in 2011, scheduled to increase to 39.6 percent in 2013), and the rest can be carried forward to offset future short-term capital gains or ordinary income.

Regardless of whether you want to mitigate a net capital gain, the tax consequences of a sale can come as a surprise, unless you remember the following rules:• Fortaxpurposes,thetradedateandnotthesettlementdate

of publicly traded securities determines the year in which yourecognizethegainorloss.

• Ifyouboughtthesamesecurityatdifferenttimesandprices,consider specifically identifying which shares are to be sold by the broker before the sale. Selling the shares with the highest basis will reduce your gain or increase your losses.

Action opportunity: Avoid the wash sale rule with a bond swapBond swaps are a way to maintain your investment position while recognizing a loss. With a bond swap, you sell a bond, take a capital loss and then immediately buy another bond of similar quality from a different issuer. You’ll avoid the wash sale rule because the bonds are not considered substantially identical.

Tax law change alert: New broker reporting rules affect basis on stock salesBeginning in 2011, brokers for the first time are required to report your basis to the IRS when you sell stock. Brokers must generally report the sales of securities on a first-in, first-out basis within an account unless the customer specifically identifies which securities are to be sold. The sale of any shares with unknown acquisition dates are reported first. Taxpayers have the option of electing an average basis method. Your broker may also use a default basis method, so make sure you check the rules and affirmatively elect the method you want to use.

Deferral strategiesDeferring taxes is normally a large part of good planning. Even with the possibility of capital gains rates going up in 2013, the time value of money will still make deferral the best option for many taxpayers. If you believe your rates will go up, you can also consider adjusting the strategies you’re using to defer gain, such as an installment sale or like-kind exchange.

Like-kind exchanges under Section 1031 allow you to exchange real estate without incurring capital gains tax. Under a like-kind exchange, you defer paying tax on the gain until you sell your replacement property.

An installment sale allows you to defer capital gains on most assets other than publicly traded securities by spreading gain over several years as you receive the proceeds. If you’re engaging in an installment sale, consider creating a future exit strategy. You may want to build in the ability to pledge the installment obligation. Deferred income on most installment sales made after 1987canbeacceleratedbypledgingtheinstallmentnoteforaloan. The proceeds of the loan are treated as a payment on the installment note itself. If legislation is enacted that increases the capital gains rate in the future (or makes clear that the scheduled increase will occur), this technique can essentially accelerate the proceeds of the installment sale.

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Action opportunity: Use zero capital gains rate to benefit childrenTaxpayers in the bottom two tax brackets pay no taxes on long-term capital gains and qualifying dividends in 2011 and 2012. If income from these items would be in the 10 percent or 15 percent bracket based on a taxpayer’s income, then the tax rate is zero.

If you have adult children in these tax brackets, consider giving them dividend-producing stock or long-term appreciated stock. They can sell the stock for gains or hold the stock for dividends without owing any taxes.

Keep in mind there could be gift tax and estate planning consequences. Income generated by gifts to children up to the age of 23 can also be subject to the “kiddie tax,” which taxes some of their unearned income at the marginal rate of their parents (see Chapter 8 for more information).

Mutual fund pitfallsInvesting in mutual funds is an easy way to diversify your portfolio, but comes with tax pitfalls. Typically, earnings on mutual funds are reinvested. Unless you (or your broker or investment adviser) keep track of these additions to your basis, and you designate which shares you are selling, you may report more gain than required when you sell the fund.

It is often a good idea to avoid buying shares in an equity mutual fund right before it declares a large capital gains distribution, typically at year-end. If you own the shares on the record date of the distribution, you’ll be taxed on the full distribution amount even though it may include significant gains realizedbythefundbeforeyouownedtheshares.Worseyet,you’ll end up paying taxes on those gains in the current year — even if you reinvest the distribution in the fund and regardless of whether your position in the fund has appreciated.

Small business stock comes with tax rewardsBuying stock in a qualified small business (QSB) comes with several tax benefits, assuming you comply with specific requirements and limitations. QSB stock must be original issue stockinaCcorporationwithnomorethan$50millioninassets(and meet several other tests).

There are other tax benefits for small business stock that meet separate eligibility requirements. If you sell small business stock under Section 1244 (generally stock in a domestic corporation withnomorethan$1millionincapital)foraloss,youcantreatupto$50,000($100,000,ifmarriedfilingjointly)asanordinaryloss, regardless of your holding period. This means you can use it to offset ordinary income such as salary and interest taxed at a 35 percent rate (or 39.6 percent rate in future years if tax rates go up as scheduled).

Tax law change alert: No tax on gain from QSB stock purchased in 2011Thanks to legislation meant to jumpstart the economy, you won’t have to pay a dime of tax on gain from QSB stock purchased in 2011, ever, as long as you follow all the rules. You can normally exclude only half of the gain on QSB stock held for five years. The new legislation doubles this exclusion to 100 percent for QSB stock bought after Sept. 27, 2010, and before the end of 2011. So invest in a QSB stock before the year is up, and enjoy any future growth in value totally tax-free.

You can also roll over QSB stock without realizing gain. If you buy QSB stock with the proceeds of a sale of QSB stock within 60 days, you can defer the tax on your gain until you dispose of the new stock. The new stock’s holding period for long-term capital gains treatment includes the holding period of the stock you sold.

Rethinking dividend tax treatmentThe tax treatment of income-producing assets can affect investment strategy. Qualifying dividends generally are taxed at the reduced rate of 15 percent in 2011, while interest income is taxed at ordinary income rates of up to 35 percent.

As long as dividends remain at a lower rate than ordinary income, dividend-paying stocks may be more attractive from a tax perspective than investments such as CDs and bonds. But there are exceptions. Some dividends are already subject to ordinary income rates. These include certain dividends from:• moneymarketmutualfunds,• mutualsavingsbanks,• realestateinvestmenttrusts(REITs),

• foreigninvestments,• regulatedinvestmentcompanies,and• stocks—totheextentthedividendsareoffsetbymargin

debt.

Some bond interest is exempt from income tax. Interest on U.S. government bonds is taxable on your federal return, but generally it is exempt on your state and local returns. Interest on state and local government bonds is excludible on your federal return. If the state or local bonds were issued in your home state, interest also may be excludible on your state return. Although state and municipal bonds usually pay a lower interest rate, their rate of return may be higher than the after-tax rate of return for a taxable investment.

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Review portfolio for tax balance You should consider which investments to hold inside and outside your retirement accounts. If you hold taxable bonds to generate income and diversify your overall portfolio, consider holding them in a retirement account where there won’t be a current tax cost.

Bonds with original issue discount (OID) build up “interest” as they rise toward maturity. You’re generally considered to earn a portion of that interest annually — even though the bonds don’t pay you this interest annually — and you must pay tax on it. They also may be best suited for retirement accounts.

Try to own dividend-paying stocks that qualify for a lower qualified dividend tax rate outside of retirement plans so you’ll benefit from the lower rate.

It’s also important to reallocate your retirement plan assets periodically. Assuming different investments yield different returns, it may not take long for your portfolio to have a very different allocation than you intended originally. And the allocation you set up for your 401(k) plan 10 years ago may not be appropriate now that you’re closer to retirement.

Planning for passive lossesThere are special rules for income and losses from a passive activity. Investments in a trade or business in which you don’t materially participate are passive activities. You can prove your material participation by participating in the trade or business for more than 500 hours during the year or by demonstrating that your involvement represents substantially all of the participation in the activity.

The designation of a passive activity is important, because generally passive activity losses are deductible only against income from other passive activities. You can carry forward disallowed losses to the following year, subject to the same limitations. There are options for turning passive losses into tax-saving opportunities.

For instance, you can increase your activity to more than 500 hours so the losses will not be passive. Alternatively, you can limit your activities in another business to less than 500 hours or invest in another income-producing business that will be passive to you. This will allow the other businesses to give you passive income to offset your passive losses. Finally, consider disposing of the activity to deduct all the losses. The disposition rules can be complex, so consult with a Grant Thornton tax adviser.

Rental activity has its own set of passive loss rules. Losses from real estate activities are passive by definition unless you’re a real estate professional. If you’re a real estate professional, you can deduct real estate losses in full, but you must perform more than half of your personal services annually in real property trades and businesses and spend more than 750 hours in these services during the year.

If you participate actively in a rental real estate activity but you aren’t a real estate professional, you may be able to deduct upto$25,000ofrealestatelosseseachyear.Thisdeductionissubject to a phaseout beginning when adjusted gross income (AGI)reaches$100,000($50,000formarriedtaxpayersfilingseparately).

Leveraging investment expensesYou are allowed to deduct expenses used to generate investment income unless they are related to tax-exempt income. Investment expenses can include investment advisory fees, research costs, security costs (such as a safe deposit box) and most significantly, investment interest. Apart from investment interest, these expensesareconsideredmiscellaneousitemizeddeductions and are deductible only to the extent they exceed 2 percent of your AGI.

Investment interest is interest on debt used to buy assets held for investment, such as margin debt used to buy securities. Payments a short seller makes to the stock lender in lieu of dividends may be deductible as an investment interest expense. Your investment interest deduction is limited to your net investment income, which generally includes taxable interest, dividends and short-term capital gains. Any disallowed interest is carried forward for a deduction in a later year, which may provide a beneficial opportunity.

If you don’t want to carry forward investment interest expense, you can elect to treat net long-term capital gain or qualified dividends as investment income in order to deduct more of your investment interest, but it will be taxed at ordinary-income rates. Remember that interest on debt used to buy securities that pay tax-exempt income, such as municipal bonds, isn’t deductible. Also keep in mind that passive interest expense — interest on debt incurred to fund passive activity expenditures — becomes part of your overall passive activity income or loss, subject to limitations.

Action opportunity: Defer investment interest for a bigger deductionUnused investment interest expense can be carried forward indefinitely and may be usable in later years. Many taxpayers elect to treat qualified dividends and long-term capital gains as investment income in order to deduct unused investment expenses. It could make sense instead for you to carry forward your unused investment interest until after 2013 when tax rates are scheduled to go up and the 15-percent rate on long-term capital gains and dividends is scheduled to disappear. The deduction could save you more at that time if taxes increase as scheduled.

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Your home as an investmentThere are many home-related tax breaks. Whether you own one homeorseveral,it’simportanttomaximizeyourdeductionsand plan for any gains or rental income. Generally, property tax isdeductibleasanitemizeddeduction,butisn’tdeductibleforAMT purposes.

Consumer interest isn’t deductible, so consider using home equitydebt(uptothe$100,000limit)topayoffcreditcardsorauto loans. But remember, home equity debt is not deductible for the AMT unless it’s used for home improvements.

When you sell your home, you generally can exclude up to$250,000($500,000forjointfilers)ofgainifyou’veuseditas your principal residence for two of the preceding five years, subject to new limitations based on how long the home may not have been used as your primary residence.

Maintain thorough records to support an accurate tax basis, and remember, you can only deduct losses if they are attributable exclusively to business or rental use (subject to various limitations).

The rules for rental income are complicated, but you can rent out all or a portion of your primary residence and second home for up to 14 days without having to report the income. No rental expenses will be deductible. If you rent out your property for 15 days or more, you have to report the income, but you can also deduct all or a portion of your rental expenses — such as utilities, repairs, insurance and depreciation. Any deductible expenses in excess of rental income can be carried forward.

If the home is classified as a rental for tax purposes, you can deduct interest that’s attributable to its business use but not any interest attributable to personal use.

Tax law change alert: Deduct interest on a mortgage of up to $1.1 million You can deduct mortgage interest and points on your principal residence and a second home. For many years, courts and the IRS had interpreted the tax code to limit your deduction to the interest from up to:• $1millionintotalmortgagedebtusedtopurchase,buildorimproveahome,PLUS• $100,000forhomeequitydebtthatisNOTusedtoacquirethehome.

This allowed taxpayers to deduct interest on up to $1.1 million in mortgage debt, but only if $100,000 was not used to purchase or build the home. The IRS in 2010 issued a revenue ruling (Rev. Rul. 2010-25) taking a more taxpayer-favorable position. The IRS has now ruled that debtusedtobuy,constructorimproveahomecanbetreatedasbothacquisitionandequityindebtedness—allowingtaxpayerstodeductinterest on up to $1.1 million in mortgage interest even if all of it was used to purchase or build the home.

Tax law change alert: Primary residence gain exclusion limitedNew rules limit how much gain you can exclude under the general exclusion rules applying to the sale of a principal residence. You will now have to include gain on a pro-rata basis for any years after 2009 that your home was not used as your principal residence. So if you use a home as a rental from 2010 through 2014, and then use it as a primary residence from 2015 through 2019, you will only be able to exclude half of any gain.

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There is potential alternative minimum tax (AMT) liability when the options are exercised. The difference between the fair market value of the stock at the time of exercise and the exercise price is included as income for AMT purposes. The liability on this bargain element is a problem because exercising the option alone doesn’t generate any cash to pay the tax. If the stock price falls before the shares are ultimately sold, you can be left with a large AMT bill in the year of exercise even though the stock actually produced no income. Congress has provided some relief from past ISO-related AMT liabilities, and a new more generous AMT credit is also available (see Chapter 3 for more information on the AMT credit). Talk to a Grant Thornton tax adviser if you have questions about AMT-ISO liability.

As noted above, if the stock from an ISO exercise is sold before certain holding period requirements are met (referred to as a “disqualifying disposition”), the gain is taxed at ordinary income tax rates. The employer is entitled to a compensation deduction for ISOs only if the employee makes a disqualifying disposition.

If you’ve received ISOs, you should decide carefully when to exercise them and whether to sell immediately or hold the shares received from an exercise. Acting earlier can be advantageous in some situations: • Exerciseearliertostarttheholdingperiodforlong-term

capital gains treatment sooner. • Exercisewhenthebargainelementissmallorthemarket

price is low to reduce or eliminate AMT liability. • Exerciseannuallyandbuyonlythenumberofshares

that will achieve a breakeven point between the AMT and regular tax.

Chapter 5

Executive compensation

Whether you’re an executive at a private or public company — or an employee-owner of an enterprise — you’ve likely come face to face with some complex executive compensation decisions. You’ve got to think beyond salary, fringe benefits and bonuses. You need to make sure you’ve got a grip on the tax consequences of more complex pay plans, such as stock options, deferred compensation plans and restricted stock.

Benefiting from incentive stock optionsStock options remain one of the most popular types of incentive compensation, and incentive stock options (ISOs) deserve special attention in your tax planning. If your options qualify as ISOs, you can take advantage of favorable tax treatment.

ISOs give you the option of buying company stock in the future. The price (known as the “exercise price”) must be set when the options are granted and must be at least the fair market value of the stock at that time. It is customary for the exercise price to be set at exactly the fair market value. Therefore, the stock must rise before the ISOs have any value. If it does, you have the option to buy the shares for less than they’re worth.

ISOs have several tax benefits:• Thereisnotaxwhentheoptionsaregranted.• Thereisnotaxwhentheoptionsareexercised.• Long-termcapitalgainstreatmentisavailableifthestockis

held for more than one year after exercise. (If the stock isn’t held for at least two years after the option’s grant date, and at least one year after the exercise date, then the increase in value over the exercise price as of the exercise date is taxed as ordinary compensation income rather than as a capital gain.)

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But be careful, because exercising early accelerates the need for funds to buy the stock. It also exposes you to a loss if the value of the shares drops below your exercise cost and may create a tax cost if the exercise generates an AMT liability. If you exercise an ISO and later feel that the stock price will fall, you can consider selling the stock in the same year as the exercise (i.e., resulting in a disqualifying disposition, as described above) in order to pay the higher ordinary income rate. In this situation, the AMT does not apply to the exercise. Tax planning for ISOs is truly a numbers game. With the help of Grant Thornton, you can evaluate the risks and crunch the numbers using various assumptions.

Considerations for restricted stockRestricted stock provides different tax considerations. Restricted stock is stock that is granted subject to vesting. The vesting is often time-based, but can also be performance-based so that the vesting is linked to company and/or individual performance.

Normally, income recognition is deferred until the restricted stock vests. You then pay taxes on the fair market value of the stock at the ordinary income rate. However, there is an election underSection83(b)torecognizeordinaryincomewhenyoureceive the stock. This election must be made within 30 days after receiving the stock and can be very beneficial in certain situations.

Action opportunity: Consider an 83(b) election on your restricted stockWith an 83(b) election, you immediately recognize the value of the restricted stock as ordinary income when the stock is granted. In exchange, you don’t recognize any income when the stock actually vests. You only recognize gain when the stock is sold, and it is taxed as a capital gain.

So why make an 83(b) election and recognize income now, when you could wait to recognize income when the stock vests? Because the value of the stock may be much higher when it vests. The election may make sense if the income at the grant date is negligible or if the stock is likely to appreciate significantly before income would otherwise be recognized. In these cases, the election allows you to convert future appreciation from ordinary income to long-term capital gains income.

The biggest drawback may be that any taxes you pay because of the election can’t be refunded if eventually you forfeit the stock or the stock’s value decreases. But if the stock’s value decreases, you’ll be able to report a capital loss when you sell the stock.

Understanding nonqualified deferred compensationNonqualified deferred compensation (NQDC) plans pay executives in the future for services being performed now. But they don’t have the restrictions of qualified retirement plans such as 401(k) plans. Specifically, NQDC plans can favor certain highly compensated employees and can offer executives an excellent way to defer income and tax.

However, there are drawbacks. Employers cannot deduct anyNQDCuntiltheexecutiverecognizesitasincome,andNQDC plan funding is not protected from an employer’s creditors. Also, employers must be in full compliance now with IRS rules under Section 409A that govern NQDC plans. The rules are strict, and the penalties for noncompliance are severe. If a plan fails to comply with the rules, plan participants are taxed on plan benefits immediately with interest charges and an additional 20 percent tax.

The new rules under Section 409A make several important changes. Executives generally must make an initial deferral election before the year they perform the services for the compensation that will be deferred. So an executive who wanted to defer some 2011 compensation to 2012 or beyond generally must have made the election by the end of 2010.

Additionally, there are the following rules:• Benefitsmusteitherbepaidonaspecifieddateaccordingtoa

fixed payment schedule or after the occurrence of a specified event — defined as death, disability, separation from service, change in ownership or control of the employer, or an unforeseeable emergency.

• Thedecisionaboutwhentopaythebenefitsmustbemadeatthe same time the election is made to defer the compensation.

• Oncethatdecisionismade,thetimingofbenefitpaymentscan be delayed, but generally cannot be accelerated.

• Electionstodelaythetimingorchangetheformofapayment must be made at least 12 months in advance of the original payment commencement date.

• Newpaymentdatesmustbeatleastfiveyearsafterthedatethe payment would have been made originally.

It is also important to note that employment taxes generally are due when the benefits become vested. This is true even though thecompensationisn’tactuallypaidorrecognizedforincometax purposes until later years. Some employers withhold an executive’s portion of the tax from the executive’s salary or ask the executive to write a check for the liability. Others pay the executive’s portion, but this must be reported as additional taxable income.

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Business perspective

Managing the pay plans in your business

Your executive compensation plan is the key to attracting, retaining and motivating your top employees. Your management employees likely expect cash incentives and equity-based rewards for meeting company goals. Key company goals can include earnings targets, share price appreciation, total shareholder return and top-line growth.

But in this down economy, companies are struggling to provide meaningful incentives to attract and retain their talent, who may be able to move to another company for the promise of future wealth accumulation, even in the down economy. At the same time, the fallout from the financial crisis has created aregulatoryandlegislativefeedingfrenzyonexecutivepayand governance. Regulators, shareholder advocacy groups and lawmakers are challenging traditional performance objectives and the risks associated with them.

These requirements are beginning to take effect. Call your Grant Thornton compensation and benefit professional to make sure you are ready to comply.

Now more than ever, equity awards to executives need to be linked with shareholder interests. Equity and bonus pay should also have a long-term focus. Vested stock grants and exercised stock options should be subject to meaningful holding periods, and incentives need to be linked to long-term performance objectives.

Dealing with underwater stock optionsHistorically, stock options have played a big role in most compensation programs, making up the lion’s share of equity compensation granted to employees and executives. But many companies across the economic spectrum have watched their stockplummetsince2008.Whencompanystockgoesthroughthe floor, stock options are left underwater — meaning the stock is worth less than the exercise price of the option.

These options no longer provide any meaningful retention or performance incentive for employees, as the stock value would have to rise significantly before the options are “in the money.” Underwater options are a big problem when they threaten to drive away top talent. There are a variety of viable approaches to address underwater options.

Tax law change alert: New executive compensation rulesLawmakersin2010enactedasweepingfinancialreformbill(Dodd-FrankWallStreetReformandConsumerProtectionAct)thatimposesstrict new executive compensation restrictions on public companies, including the following:• Say-on-pay:Mandatesanonbindingshareholdervoteonexecutivepaylevelsanddesign• Compensationcommitteeindependence:Requiresmembersofthecompensationcommitteetobeindependentandhavetheauthority

to engage independent compensation consultants • Clawbackpolicies:Requirescompaniestoincludeclawbackpoliciestorecoverincentive-basedcompensationifitwasearnedbased

on inaccurate financial statements that require a restatement• Enhanceddisclosures:RequirestheSecuritiesandExchangeCommission(SEC)toamenddisclosurerulestorequirecompanies

to compare executive compensation to stock price performance over a five-year period• Internalpayratio:RequirestheSECtoamenddisclosurerulestorequirecompaniestocompareCEOcompensationtothemedian

annual total compensation for all other employees

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Chart 9: Strategies for dealing with underwater stock options

Approach Advantages Disadvantages

Options-for-options: Underwater options Employees control exercise timing and taxation timing Potential remains for newly issued optionsare cancelled and new options are regranted to go underwaterimmediately May not be well-received by employees if prior stock options did not provide value

Options-for-stock: Underwater options are Eliminates potential future underwater options Employees lose control of taxation timing, except cancelled and restricted stock is granted for the ability to make an 83(b) election

Options-for-cash: Underwater options are Eliminates potential future underwater options Requires cashcancelled and replaced with a cash payment Typically provides immediate value to participants Employees lose control of taxation timing No retention value or upside unless payment is deferred and is subject to a vesting schedule

Encouraging performance with restricted sharesAs noted above, restricted stock is stock that’s granted subject to vesting, and it has emerged as a useful tool for providing executive compensation and long-term incentives. In the past, restricted stock was often considered a giveaway by investors and shareholder activists. But the vesting of restricted stock does not have to be time-based — it can also be linked to company performance. In the brave new world of executive compensation, performance shares can be a key component to linking pay to shareholder interests.

Performance shares link the vesting of restricted stock to company performance. This strategy has become more popular inthedowneconomyascompaniesseekwaystoincentivizetheir employees with noncash awards. As discussed earlier, restricted stock also gives employees the option of controlling taxationwithaSection83(b)election.Andthestrategybenefits

from a number of potential approaches to develop meaningful but achievable performance goals that motivate participants and drive shareholder value:• Market performance: Based on meeting a specified target

such as stock price• Operational performance: Based on specified operational

goals such as increasing operating profits • Absolute performance: Based on absolute performance

such as targeted growth or return percentage• Relative performance: Vesting occurs if performance

measures are above a peer group • Balanced scorecard: Considers both quantitative and

qualitative or strategic performance • Corporate focus: Vesting occurs only if corporate goals

are achieved • Business unit focus: Vesting conditions are specific

to individual business units

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ISO employer costs and benefitsThe tax benefits of incentive stock options for employees (discussed earlier) make them a very attractive form of compensation for the executives receiving them. But they can be less useful from the employer point of view because of the following:• TheemployerreceivesnoincometaxdeductionforISOs

unless the employee makes a disqualifying disposition.• Thereisaper-employeelimitof$100,000ontheamount

of ISOs that can first become exercisable for the employee during any one year. The limit is based on the value of stock at the grant date.

There are strict requirements employers must follow for stock options to qualify as ISOs: • Theexercisepricecannotbelessthanthefairmarketvalue

of the stock at the time the option is granted.• Theoptiontermcannotexceed10yearsfromthedatethe

option is granted. • Theoptionisexercisableonlybytheexecutiveandcannotbe

transferred to anyone else except upon the executive’s death.• Atthetimetheoptionisgranted,theexecutivecannotown

more than 10 percent of the total combined voting power of all classes of stock of the employer, unless:

– the exercise price is at least 110 percent of fair market value on the grant date, and

– the option term does not exceed five years.• Theoptionplanmustbeapprovedbytheemployer’s

stockholders within 12 months before or after the date the plan is adopted.

Finally, ISOs may be granted only to employees. ISOs may not be granted to individuals such as board members or independent contractors.

Privately held business strategiesPrivately held businesses often face unique executive compensation challenges. Many owners and shareholders want to give key employees and managers the benefits of equity ownership without actually giving up any actual equity share.

If you have a privately held business, consider a phantom stock plan or performance-based cash as a solution. These offer opportunities for your company to share the economic value of an equity interest without the equity itself. A typical phantom stock plan simply credits selected employees with stock units that represent a share of the firm’s stock. Essentially, it is a promise to pay the employee the equivalent of stock value in the future. Alternatively, a stock appreciation right (SAR) can be issued to provide an employee with a payment equal to only the appreciation in the stock value between the date the right is granted and some future date, rather than the full value of the stock.

You can value your stock by a formula or by formal valuation. The phantom stock or SAR can be awarded subject to a vesting schedule, which can be performance-based or time-based. A phantom stock plan must comply with restrictions on nonqualified deferred compensation unless the employee is paid for the value of the phantom stock shortly after vesting. The same holds true for SARs, but unlike phantom stock, SARs can meet certain other conditions that exempt them from the restrictions on nonqualified deferred compensation.

Performance-based cash similarly promises employees a cash bonus in the future for time-based or performance goals. If you have a partnership, be careful about granting a profits or “carried” interest. Congress recently abandoned legislation that would raise taxes on the carried interests in a partnership, but it could be revived in the future.

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Because many pass-through entities offer the same limited liability protection as a C corporation, tax treatment should be a major consideration when deciding between the two structures. (See Chart 11 on the following page for an overview of key differences.) The biggest difference is that C corporations endure two levels of taxation. First, a C corporation’s income is taxed at the corporate level. Then the income is taxed again at the individual level when it is distributed to shareholders as dividends. Generally, the income from pass-through entities is only taxed at the individual owner level, not at the business level.

Although this benefit is significant, it is not the only consideration. There are many other important differences in the tax rules, deductions and credits for each business structure. You always want to assess the impact of state and local taxes where your company does business, and owners who are also employees have several unique considerations. The choice of business structure can affect the ability to finance the business and may determine which exit strategies will be available. Each structure has its own pluses and minuses, and you should examine carefully how each will affect you. Call a Grant Thornton adviser to discuss your individual situation in more detail.

Chapter 6

Business ownership

Whether you’re an executive, shareholder or owner in a privately held business or public corporation, it’s not just your own tax burden you’re worried about. You also need to consider the business tax burden at the entity level. The soft economy has presented a number of challenges, but with adversity comes opportunity.

Lawmakers have responded to the economic downturn with a nearly unprecedented slew of tax incentives designed to help the economy recover. Many of these incentives are time-sensitive and come with detailed restrictions. It won’t always be easy or simple to take advantage of the opportunities, but that’s no excuse to ignore them. You need to examine your business activities and investments so you can leverage every new tax opportunity and help your company recover or expand.

Any business tax discussion should begin with the options for structuring, buying and selling business interests in the most tax-efficient manner possible.

Tax treatment of business structuresBusiness structures generally fall into two categories: C corporations and pass-through entities. C corporations are taxed as separate entities from their shareholders and offer shareholders limited liability protection. See Chart 10 for corporate income tax rates.

Pass-through entities effectively “pass through” taxation to individual owners, so the business income is taxed at the individual level. (See Chapter 2 for more on individual taxes and the individual rate schedule.) Some pass-through entities, such as sole proprietorships and general partnerships, don’t provide limited liability protection, while pass-through entities such as S corporations, limited partnerships, limited liability partnerships and limited liability companies can.

Chart 10: 2011 corporate income tax brackets

Tax rate Tax bracket 15% $0 – $50,000 25% $50,001 – $75,000 34% $75,001 – $100,000 39% $100,001 – $335,000 34% $335,001 – $10,000,000 35% $10,000,001 – $15,000,000 38% $15,000,001 – $18,333,333 35% Over $18,333,333

Note: Personal service corporations are taxed at a flat 35% rate.

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If you work in a business in which you have an ownership interest, you need to think about employment taxes. Generally all trade or business income that flows through to you from a partnership or limited liability company is subject to self-employment tax — even if the income isn’t actually distributed

to you. But if you’re an S corporation or C corporation employee-owner, only income you receive as salary is subject to employment taxes. How much of your income from a corporation comes from salary can have a big impact on how much tax you pay.

Chart 11: Comparison of tax differences based on business structure

Pass-through entity (one level of taxation) C corporation (two levels of taxation)

Tax treatment Income is not taxed at business level and flows through Income taxed at corporate level at corporate rates to owners where it is taxed at individual rates Shareholders then taxed on any dividends they receive

Loss treatment Lossesflowthroughtoownerswheretheycanbetaken Lossesremainatthecorporatelevelandarecarried individually (subject to basis and at-risk limitations) backward or forward to offset past or future corporate- level income

Tax rates Top individual tax rate is currently 35%, but is scheduled Top corporate tax rate is generally 35% to increase to 39.6% in 2013 Income distributed as dividends is taxed a second time, generally at 15% (scheduled to increase to 39.6% in 2013, but could be limited to 20%)

Action opportunity: Organize or convert into a QSBLegislationenactedin2010presentsauniqueopportunityforeligibleenterprisestoorganizeasorconvertintoaqualifiedsmallbusiness(QSB) in 2011. The benefits of investing in QSB stock from an individual investor’s perspective were discussed in Chapter 4, but the opportunity may be even more valuable from the business side. The new legislation offers an excellent opportunity for eligible enterprises to raise capital at a reasonable rate or provide owners with a tax-efficient growth opportunity.

Under the new law, 100 percent gain exclusion is available for QSB stock purchased after Sept. 27, 2010, and before the end of 2011, meaning this stock will never be subject to tax if it is held at least five years and all other requirements are met. QSB stock must be original issue stock in a C corporation with no more than $50 million in assets (and meet several other tests).

The exclusion provides an obvious opportunity for a business already established in the C corporation structure or considering establishment as a C corporation for nontax reasons (such as a future public stock offering). These businesses, if they meet the business activities and asset tests, should consider organizing or issuing stock before the end of 2011 to take advantage of the full exclusion.

But the opportunity isn’t just for C corporations. Under QSB tax rules, partnerships may perform a conversion into a C corporation in which the converted partnership interests are treated as stock acquisitions that can qualify for the QSB stock gain exclusion. S corporation stock cannot be converted QSB stock, but any new stock issued after a revocation of S status or a C conversion can be eligible for the exclusion.

But be careful before acting on this strategy because there are many reasons why the pass-through structure may still offer a better result. QSB stock must be held for five years, and the ongoing earnings of the business in the meantime will be subject to tax both at the corporate level, and to the extent it is distributed, at the individual level. And if the end game is to exit the business, most buyers will prefer an asset sale that will be taxed at only one level when sold by a pass-through. Contact a Grant Thornton tax professional if you want to know more about this opportunity.

Action opportunity: Set salary wisely if you’re a corporate employee-shareholderIf you are an owner of a corporation who works in the business, you need to consider employment taxes in your salary structure. The combined employee and employer 2.9 percent Medicare tax (increasing to 3.8 percent in 2013 for income over $200,000 for single filers and $250,000 for joint filers) is not capped and will be levied against all income received as salary. S corporation shareholder-employees may want to keep their salaries reasonably low and increase their distributions of company income in order to avoid the Medicare tax. But C corporation owners may prefer to take more salary (which is deductible at the corporate level) because the Medicare tax rate is typically lower than the 15 percent tax rate they would pay if they instead received the income as a dividend.

But remember to tread carefully. You must take a reasonable salary to avoid potential back taxes and penalties, and the IRS is cracking down on misclassification of corporate payments to shareholder-employees. There are also legislative proposals to apply the Medicare tax to more S corporation income, so check with a Grant Thornton tax adviser for a legislative update.

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Sellers should also consider whether they prefer a taxable sale or a tax-deferred transfer. The transfer of ownership of a corporation can be tax-deferred if made solely in exchange for stock or securities of the recipient corporation in a qualifying reorganization,butthetransactionmustcomplywithstrictrules. Although it’s generally better to postpone tax, there are advantages to executing a taxable sale: • Taxratesarescheduledtoincreasein2013.• Thesellerdoesn’thavetoworryaboutthequalityofbuyer

stock or other business risks that might come with a tax-deferred sale.

• Thebuyerbenefitsbyreceivingastepped-upbasisintheacquisition’s assets and does not have to deal with the seller as a continuing equity owner, as would be the case in a tax-deferred transfer.

• Thepartiesdon’thavetomeetthestringenttechnicalrequirements of a tax-deferred transaction.

A taxable sale may be structured as an installment sale if the buyer lacks sufficient cash or the seller wants to spread the gain over a number of years. Contingent sales prices that allow the seller to continue to benefit from the success of the business are common. But be careful, the installment sale rules create a trap for sellers if the contingency is unlikely to be fulfilled. Also, installment sales may not be as advantageous as usual because tax rates are scheduled to go up in 2013.

Careful planning while the sale is being negotiated is essential. A Grant Thornton tax adviser can help you detect certain traps and find the exit strategy that best suits your needs.

New tax incentivesLimited time only! Lawmakers have given businesses a slew of new temporary tax incentives in order to boost the economy. Many are aimed at narrow sectors of the business community such as small businesses, but others can be taken by all businesses.

Don’t wait to develop an exit strategyMany business owners have most of their money tied up in their business, making retirement a challenge. Others want to make sure their business — or at least the bulk of its value — will be passed to their loved ones without a significant loss to estate taxes. If you’re facing either situation, now is the time to start developinganexitstrategythatwillminimizethetaxbite.

An exit strategy is a plan for passing on responsibility for running the company, transferring ownership and extracting your money. To pass on your business within the family, you can give away or sell interests. But be sure to consider the gift, estate and generation-skipping transfer tax consequences (see Chapter 10 on estate planning).

A buy-sell agreement can be a powerful tool. The agreement controls what happens to the business when a specified event occurs, such as an owner’s retirement, disability or death. Buy-sell agreements are complicated by the need to provide the buyer with a means of funding the purchase. Life or disability insurance can often help but can also give rise to several tax and nontax issues and opportunities.

One of the biggest advantages of life insurance as a funding method is that proceeds generally are excluded from the beneficiary’s taxable income. There are exceptions to this, however, so be sure to consult a Grant Thornton tax adviser.

You may also want to consider a management buyout or an employee stock ownership plan (ESOP). An ESOP is a qualified retirement plan created primarily so that employees can purchase your company’s stock. Whether you’re planning for liquidity, looking for a tax-favored loan or supplementing an employee benefit program, an ESOP can offer you many advantages.

Assess tax consequences when buying or sellingWhen you do decide to sell your business — or are acquiring another business — the tax consequences can have a major impact on your transaction’s success or failure.

The first consideration should be whether to structure your transaction as an asset sale or a stock sale. If it’s a C corporation, the seller typically will prefer a stock sale for the capital gains treatment and to avoid double taxation. The buyer generally will wantanassetsaletomaximizefuturedepreciationwrite-offs.

Tax law change alert: No built-in gain tax for certain S corporations When a C corporation converts to an S corporation, it generally must pay a built-in gains tax on any appreciated assets sold in the first 10 years after the conversion (if the asset was held when the corporation converted). This threat of corporate-level built-in gains tax often forces S corporations to inefficiently hold onto assets they would otherwise sell to reallocate capital.

Lawmakersrecognizedthisproblemduringtheeconomicdownturnandreducedthe10-yearholdingperiodfordispositionsin2009through2011. For tax years beginning in 2011, no built-in gains tax will be imposed on an S corporation that converted at least five years earlier.

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General business creditsUnder a new temporary provision, sole proprietorships, partnershipsandnonpubliclytradedcorporationswith$50million or less in average annual gross receipts over the last three years can carry back their 2010 general business credits for five years and carry them forward for 25 years. These credits may also fully offset the alternative minimum tax (AMT). The general business credit encompasses most business-related credits in the tax code, including the research credit, work opportunity tax credit, and alternative energy and conservation credits. Normally, it can be carried back just one year and carried forward only 20 years.

Expensing business investments In an effort to jump-start business investment, Congress and the president expanded the ability of taxpayers to immediately deduct the cost of many types of investments in their businesses.

Legislation enacted in 2010 doubles a bonus depreciation taxbenefitforpropertyplacedinserviceafterSept.8,2010,andbefore the end of 2011 — meaning taxpayers can fully deduct the cost of eligible equipment the year it is placed in service. To qualify for bonus depreciation, property must generally have a useful life of 20 years or less under the modified accelerated cost recovery system (MACRS).

This tax benefit is generally only available for property placed in service before the end of the year (there are different rules for certain property with long production periods and most airplanes), but Congress could extend it. If no legislation is enacted, property placed in service in 2012 will qualify for regular bonus depreciation, in which 50 percent of the cost is deductible in the year it’s placed in service and the rest is depreciated using normal rules.

The amount of business investment that can be expensed under Section 179 was also increased. Businesses can expense upto$500,000underSection179intaxyearsbeginningin2010and 2011, and this limit will not begin to phase out until the total amount of Section 179 property placed in service for the year exceeds$2million.Inaddition,qualifiedleaseholdimprovementproperty, qualified restaurant property and qualified retail improvement property will qualify under Section 179 up to alimitof$250,000.

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Ordinary income property includes items such as stock held less than a year, inventory and property subject to depreciation recapture. You can receive a deduction equal to only the lesser of fair market value or your tax basis.

Long-term capital gains property includes stocks and other securities you’ve held more than one year. It’s one of the best charitable gifts because you can take a charitable deduction equal to its current fair market value.

But beware. It may be better to elect to deduct the basis rather than the fair market value because the AGI limitation will be higher. Whether this is beneficial will depend on your AGI and the likelihood of using — within the next five years — the carryover you’d have if you deducted the fair market value and the 30 percent limit applied.

Chapter 7

Charitable giving

The economic downturn did surprisingly little to blunt charitable giving. That may be because giving to charity remains one of the most popular tax planning opportunities: You enjoy notonlysizabletaxbenefits,butalsothesatisfactionofhelpingothers.Plusyoucancontrolthetimingtomaximizeyourtaxbenefits. Well-planned gifts can trim the estate tax while allowing you to take care of your heirs in the manner you choose.

Choosing what to giveThe first thing to determine is what you want to give to charity: cash or property. There are adjusted gross income (AGI) limits on how much of your gift you get to deduct depending on what you give and who you give it to. Contributions disallowed due to the AGI limit can be carried forward for up to five years (see Chart 12 for the deduction limit by donation and the type of charity).

Outright gifts of cash (which include gifts made by check, credit card or payroll deductions) are the easiest. The key is to makesureyousubstantiatethem.Cashdonationsunder$250must be supported by a canceled check, credit card receipt or written communication from the charity. Cash donations of $250ormoremustbesubstantiatedbythecharity.Despitethe simplicity and high AGI limits for outright cash gifts, it may prove more beneficial to make gifts of property. Gifts of property are a little more complicated, but often provide more tax benefits when planned properly. Your deduction depends in part on the type of property donated: long-term capital gains property, ordinary income property or tangible personal property.

Chart 12: AGI limitations on charitable contribution deductions

Public charity or Private nonoperating operating foundation foundation

Cash, ordinary income 50% 30%property andunappreciated property

Long-termcapitalgains 30% 20%property deducted atfair market value

Long-termcapitalgains 50% 30%property deducted at basis

Note: The deduction for your total charitable contributions for the year is subject to a limitation based on your adjusted gross income and the type of charity.

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Tangible personal property can include things like a piece of art or an antique. Your deduction depends on the type of property and the charity, and there are several rules to consider:• Personalpropertyvaluedatmorethan$5,000(otherthan

publicly traded securities) must be supported by a qualified appraisal.

• Ifthepropertyisn’trelatedtothecharity’stax-exemptfunction (such as a painting donated for a charity auction), your deduction is limited to your basis in the property.

• Ifthepropertyisrelatedtothecharity’stax-exemptfunction(such as a painting donated to a museum), you can deduct the property’s fair market value.

Benefit yourself and a charity with a CRTA charitable remainder trust (CRT) may be appropriate if you want to donate property to charity and would like to receive (or would like someone else to receive) an income stream for a period of years or for your expected lifetime. The property is contributed to a trust and you, or your beneficiary, receive income for the period you specify. The property is distributed to the charity at the end of the trust term.

So long as certain requirements are met, the property is deductible from your estate for estate tax purposes and you receive a current income tax deduction for the present value of the remainder interest transferred to charity. You don’t pay capital gains tax immediately if you contribute appreciated property. Distributions from the CRT generally carry taxable income to the non-charitable beneficiary. If someone other than you is the income beneficiary, there may be gift tax consequences.

A CRT can work particularly well in cases where you own non-income-producing property that would generate a large capital gain if sold. Because a CRT is a tax-exempt entity, it can sell the property without having to pay tax on the gain. The trust can then invest the proceeds in income-producing property. This technique can also be used as a tax-advantaged way to diversify your investment portfolio.

To keep CRTs from being used primarily as tax avoidance tools, the value of the charity’s remainder interest must be equal to at least 10 percent of the initial net fair market value of the property at the time it’s contributed to the trust. There are other rules concerning distributions and the types of transactions into which the trust may enter.

Reverse the strategy with a CLTA grantor charitable lead trust (CLT) is basically the opposite of the CRT. For a given term, the trust pays income to one or more charities, and the trust’s remaining assets pass to you or your designated beneficiary at the term’s end. When you fund the trust, you receive an income tax deduction for the present value of the annual income expected to be paid to the charity. (You also pay tax on the trust income.) The trust assets remain in your estate.

With a non-grantor CLT, you name someone other than yourself as remainder beneficiary. You won’t have to pay tax on trust income, but you also won’t receive an income tax deduction. The trust assets will be removed from your estate, but there may be gift tax consequences. Alternatively, the trust can be funded at your death, and your estate will receive an estate tax deduction (but not an income tax deduction).

A CLT can work well if you don’t need the current income but want to keep an asset in the family. As with other strategies, consider contributing income-producing stocks or other highly appreciated assets held long-term.

Action opportunity: Give directly from an IRA if 70½ or olderCongress recently extended through 2011 a helpful tax provision that allows taxpayers 70½ and older to make tax-free charitable distributions from individual retirement accounts (IRAs). You don’t get to take a charitable deduction for the gift, but making a tax-free IRA distribution could save you more in taxes.

A charitable deduction erases taxable income after you’ve already calculated your AGI and can be reduced by limitations and phaseouts. If you instead make the gift straight from an IRA distribution, the amount of the gift won’t be included in income at all, lowering your AGI. You’ll see the difference in many AGI-based computations where the below-the-line deduction for charitable giving doesn’t have any effect.

Action opportunity: Give appreciated property to enhance savingsConsider donating appreciated property to charity because you avoid paying tax on the long-term capital gain you’d incur if you sold the property. So donating property with a lot of built-in gain can lighten your tax bill.

But don’t donate depreciated property. Sell it first and give the proceeds to charity so you can take both the capital loss and the charitable deduction.

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Keep control with a private foundationConsider forming a private foundation if you want to make large donations but also want a degree of control over how that money will be used. A foundation is particularly useful if you haven’t determined what specific charities you want to support.

But be aware that increased control comes at a price: You must follow a number of rules designed to ensure that the private foundation serves charitable interests and not private interests. There are requirements on the minimum percentage of annual payouts to charity and restrictions on most transactions between the foundation and its donors or managers.

Violations can result in substantial penalties. Ensuring compliance with the rules can also make a foundation expensive to run. In addition, the AGI limitations for deductibility of contributions to nonoperating foundations are lower.

Provide influence with a donor-advised fundIf you’d like to influence how your donations are spent but you want to avoid the tight rules and high expenses of a private foundation, consider a donor-advised fund. They are offered by many larger public charities, particularly those that support a varietyofcharitableactivitiesandorganizations.

The fund is simply an agreement between you and the charity: The charity agrees to consider your wishes regarding use of your donations. This agreement is nonbinding, and the charity must exercise final control over the funds, consistent with the charitablepurposesoftheorganization.

To deduct your contribution, you must obtain a written acknowledgmentfromthesponsoringorganizationthatithasexclusive legal control over the assets contributed.

Key rules to rememberWhatever giving strategy ultimately makes the most sense for you, keep in mind several important rules on giving: • Ifyoucontributeyourservicestocharity,youmaydeduct

only your out-of-pocket expenses, not the fair market value of your services.

• Youreceivenodeductionbydonatingtheuseofpropertybecause it isn’t considered a completed gift to the charity.

• Ifyoudriveforcharitablepurposes,youmaydeduct 14 cents for each charitable mile driven.

• Givingacartocharityonlyresultsinadeductionequal to what the charity receives when it sells the vehicle unless it is used by the charity in its tax-exempt function.

• Ifyoudonateclothingorhouseholdgoods,theymust be in at least “good used condition” to be deductible.

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The second and often better opportunity is a tax-preferred savings account to pre-fund education, which comes in the form of either a 529 plan or a Coverdell education savings account (ESA). Unfortunately, all of these tax incentives — except 529 savings plans — phase out based on adjusted gross income (AGI)(see Chart 13 for the various phaseout thresholds).

Deductions and creditsIf you are eligible, the credits typically provide a better tax benefit than the deductions. But if you have children who are out of college and paying back student loans, remind them they may be eligible for the above-the-line student loan interest deduction, which is scheduled to become less generous in 2013. The above-the-line tuition and fees deduction can also be very valuable because it reduces adjusted gross income (AGI), and it has been extended through 2011.

Chapter 8

Education savingsThe ABCs of tax-saving education

Go ahead, breathe a sigh of relief. Many of the most valuable tax benefits for education had been scheduled to become a little less valuable in 2011, or even expire altogether. Legislation passed in late 2010 postponed these changes until 2013. So you still have plenty of choices on how to leverage the tax code to get the most out of your education spending.

This means you have plenty of opportunities to save on your tax bill while giving your children and grandchildren the best education possible. But it also means you have to consider your options carefully to make sure you use the tax preferences that will best help your bottom line.

Generally, there are two ways the tax code offers savings on education. First, there are deductions and credits for education expenses, including the American Opportunity credit, the Lifetime Learning credit and the student loan interest deduction.

Chart 13: 2010 education tax break income phaseouts

Single filers Joint filers529 plan contributions No limit No limitCoverdell ESA contributions $95,000 – $110,000 $190,000 – $220,000American Opportunity credit (formerly Hope Scholarship credit) $80,000 – $90,000 $160,000 – $180,000LifetimeLearningcredit $50,000–$60,000 $100,000–$120,000Tuition and fees deduction $65,000 – $80,000 $130,000 – $160,000Student loan interest deduction $60,000 – $75,000 $120,000 – $150,000

Tax law change alert: Tuition and fees deduction extended through 2011The above-the-line deduction for tuition and fees was extended in 2010 through the end of 2011. The deduction this year is $4,000 if your AGI is below $65,000 (single) or $130,000 (joint). You are allowed a lesser $2,000 deduction if your AGI is above those thresholds but below $80,000 (single) or $160,000 (joint). This tax benefit is scheduled to expire for 2012, but could be extended. Check with a Grant Thornton tax professional for an update.

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The American Opportunity credit has been extended through 2012. It was added by the 2009 economic stimulus bill and temporarily replaces the Hope Scholarship credit for 2009 through2012.Itisequalto100percentofthefirst$2,000oftuitionand25percentofthenext$2,000,foratotalcreditofupto$2,500.Itisalso40percentrefundableandallowedagainstthealternative minimum tax (AMT). Unlike the Hope Scholarship credit, the American Opportunity credit is available for the first four years of college education. It covers tuition, certain fees and course materials (not room or board) at colleges, universities, vocational or technical schools.

The Lifetime Learning credit can be used anytime during the college years, as well as for graduate education, but it is less generous. It provides a credit of up to 20 percent of qualified collegetuitionandfeesupto$10,000,foramaximumcreditof$2,000.For2009through2012,italsophasesoutatamuchlower income threshold than the American Opportunity credit. Bear in mind that you cannot use both credits in the same year for the same student. Because the American Opportunity credit is more generous and has a higher AGI phaseout, it’s likely that the Lifetime Learning credit will be useful only if you are paying tuition beyond the first four years of college education. If your AGI is too high to claim either credit, consider letting your child take the credit. But neither you nor the child will be able to claim the child as an exemption.

Section 529 savings plansSection 529 savings plans allow taxpayers to save in special accounts and make tax-free distributions to pay for tuition, fees, books, supplies and equipment required for college enrollment.

529 plans come in two forms, prepaid tuition plans and college savings plans. Prepaid tuition plans allow you to “buy” tuition at current levels on behalf of a designated child. They can be offered by states or private educational institutions, and if your contract is for four full years of tuition, tuition is guaranteed when your child attends regardless of the cost at that time. Your state may also offer tax benefits for investments in the state qualified tuition programs.

College savings plans can only be offered by states but can be used to pay a student’s qualifying tuition at any eligible educational institution. They offer more flexibility in choosing schools and more certainty on benefits. If the student doesn’t use all of the account funds, the excess can be rolled over into the plan for another student.

529 plans have many benefits: • Theplanassetsgrowtax-deferred,anddistributionsused

to pay qualified higher education expenses are tax-free. • Contributionsaren’tdeductibleforfederalincometax

purposes, but some states offer state tax benefits.

Action opportunity: Make payments directly to educational institutionsIf you have children or grandchildren in private school or college, consider making direct payments of tuition to their educational institutions. Your payments will be gift tax-free, and they will not count against the annual exclusion amount of $13,000 (for 2011) or your lifetime gift tax exemption. Just make sure the payments are made directly to the educational institution and not given to children or grandchildren (or a trust for their benefit) to cover the cost.

Tax law change alert: Above-the-line loan interest deduction extended through 2012The above-the-line deduction for qualified student loan interest was extended in its current form through the end of 2012. It is scheduled to be much less generous in 2013 unless legislative action is taken. The maximum deduction will remain at $2,500, but only interest in the first 60 months of the payment period will be deductible. In addition, the deduction will phase out from AGI levels of $40,000 to $55,000 for singles and from $60,000 to $75,000 for joint filers (compared to $60,000–$75,000 and $120,000–$150,000, respectively).

Action opportunity: Plan around gift taxes with your 529 planA 529 plan can be a powerful estate planning tool for parents or grandparents. Contributions to 529 plans are eligible for the annual gift tax exclusion ($13,000 per beneficiary in 2011), and you can also avoid any generation-skipping transfer (GST) tax when you fund a 529 plan for agrandchild—withoutusingupanyofyourGSTtaxexemption.

Plus, a special break for 529 plans allows you to front-load five years’ worth of annual exclusion gifts ($65,000) in one year, and married couples splitting gifts can double this amount to $130,000 per beneficiary.

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• Therearenoincomelimitsforcontributing,andtheplanstypically offer much higher contribution limits than ESAs.

• Generally,thereisnobeneficiaryagelimitforcontributionsor distributions.

But there are disadvantages, too:• Youdon’thavedirectcontroloverinvestmentdecisions,

and the investments may not earn as high a return as they could earn elsewhere. (But you can roll over into a different 529 plan if you’re unhappy with one plan’s performance, or withdraw your balance and take a loss if your account is in a loss position.)

• Thereisalsoariskthechildmaynotattendcollege,andtheremay not be another qualifying beneficiary in the family.

Contributions to a 529 plan are subject to gift tax, so contributionsovertheannualgifttaxexclusion($13,000in 2011) will use up your lifetime gift tax exemption (or be subject to gift tax).

Coverdell ESAsCoverdell ESAs are similar to 529 plans. The plan assets grow tax-deferred and distributions used to pay qualified higher education expenses are income tax-free for federal tax purposes and may be tax-free for state tax purposes. Contributions are also not deductible. The accounts have distinct advantages, but many of their benefits are scheduled to expire at the end of 2012. Legislation is very possible in this area, so check with a Grant Thornton tax professional for an update.

As currently structured in 2011, ESAs have two distinct advantages over 529 plans: • Theycanbeusedtopayforelementaryandsecondary

school expenses (this will no longer be the case in 2013 without legislative action).

• Youcontrolhowtheaccountisinvested.

However, they also have disadvantages:• Theyarenotavailableforsomehigh-incometaxpayers

due to the AGI phaseout, which is scheduled to decrease in 2013 for joint filers. (Consider allowing others, such as grandparents, to contribute to an ESA if your AGI is above the phaseout threshold.)

• Theannualcontributionlimitisonly$2,000perbeneficiary(shrinkingto$500in2013withoutlegislativeaction).

• Contributionsgenerallycannotbemadeafterthebeneficiaryreaches18.

• Anybalanceleftintheaccountwhenthebeneficiaryturns30will be distributed subject to tax.

• Anotherfamilymemberunder30hastobenamedasthebeneficiary to avoid a mandatory distribution and maintain the account’s tax-advantaged status.

• Aswith529plans,thereisalwaysariskthechildwillnotattend college and there is no other qualified beneficiary.

Watch out for the kiddie taxBe careful with an alternative technique that was popular in past years: transferring assets to children to pay for education with an account under the Uniform Gift to Minors Act (UGTA) or Uniform Transfer to Minors Act (UTGA).

These accounts allow you to irrevocably transfer cash, stocks or bonds to a minor while maintaining control over the assetsuntiltheageatwhichtheaccountterminates(age18or21 in most states). The transfer qualifies for the annual gift tax exclusion, but the expanding kiddie tax could limit any tax benefits.

Tax law change alert: Coverdell ESA benefits extended The benefits of Coverdell ESAs were extended through 2012 along with the rest of the 2001 and 2003 tax cuts. These benefits are now scheduled to expire for 2013. If no legislation is enacted, the annual contribution limit will fall from $2,000 to $500; the ability for joint filers to make contributions will phase out from AGI of $150,000 to $160,000 instead of $190,000 to $220,000; and they will no longer be available for use on elementary and secondary school expenses.

Tax law change alert: Kiddie tax increases biteThe kiddie tax was expanded recently to apply to children up to the age of 24 if they are full-time students (unless they provide over half of their own support from earned income). For those subject to the kiddie tax, unearned income beyond $1,900 in 2011 will be taxed at the marginal rates of their parents.

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provides no shortage of defined contribution options to help you build enough wealth to live comfortably in retirement. Even if you’ve already amassed your fortune, you may want to leverage retirement tax incentives to mitigate your tax burden.

Defined contribution plansDefined contribution plans let you control how much is contributed. They come in employer-sponsored versions like 401(k)s, 403(b)s, 457s, SIMPLE IRAs and SEP IRAs, or in non-employment versions like individual retirement accounts (IRAs). All of these accounts have contribution limits and different rules and benefits, and some allow extra “catch-up” contributions if you’re 50 or older (see Chart 14).

Chapter 9

Retirement savings

2011 hasn’t made saving for retirement any easier. The economic downturn has continued to batter stocks, threatening the stability of the savings of millions of taxpayers. And as the economy struggles to recover, the wild swings in the stock market make it difficult to know where to invest your assets. Tax considerations are becoming more important, because in uncertain times, you need to leverage every incentive the tax code gives you.

There are plenty of opportunities. Depressed asset values can offer new tax strategies such as Roth conversions. Now may be the perfect opportunity to rethink your retirement portfolio and make sure you’re prepared for the future.

Lawmakers have loaded the tax code with incentives for saving for retirement. Most people count on leveraging these tax-advantaged retirement vehicles to their fullest unless they have a generous defined benefit plan. Fortunately, the tax code

Chart 14: Comparison of tax-preferred retirement savings vehicles

Maximum contribution Income limit Tax benefit Minimum distributions

Qualified plan: $16,500 None Contributions are pre-tax (unless Age 70½401(k), 403(b), 457 + $5,500 age 50 you’re making Roth contributions) Traditional IRA $5,000 $90,000 (joint) Contributions are deductible Age 70½ + $1,000 age 50 $56,000 (single) Roth IRA $5,000 $169,000 (joint) Distributions after age 59½ None + $1,000 age 50 $107,000 (single) are tax-free SIMPLEIRAs $11,500 None Contributionsarepre-tax Age70½

SEP IRAs $49,000 None Contributions may be made by Age 70½ the employer only and are not included in employee income

Note: Distributions from all accounts before age 59½ are generally included in income and levied with an additional 10% tax, with varying exceptions. All allow for tax-free growth within the accounts.

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Because of their tax advantages, contributing the maximum amount allowed is likely to be a smart move. The tax benefits of these accounts (in the traditional versions) are twofold. Usually, contributions are pretax or deductible, so they reduce your current taxable income. And assets in the accounts grow tax-deferred — meaning you will pay no income tax until you receive distributions.

Unfortunately, you must begin making annual minimum withdrawals from most retirement plans at age 70½. These required minimum distributions (RMDs) are calculated using your account balance and a life expectancy table. They must be made each year by Dec. 31 or you can be subject to a 50 percent penalty on the amount you should have taken out (although your initial RMD when you turn age 70½ can be deferred until April 1 of the following year). You may not be required to make distributions if you’re still working for the employer who sponsors your plan.

Employer-sponsored defined contribution accounts have several advantages over IRAs, which are, of course, maintained by an individual. For one, many employers offer matching contributions, and there are no income limits for contributing. Contributions to traditional IRAs are not deductible above certain income thresholds if you are offered a retirement plan through your employer. For 2011, the deductibility of IRA contributions phases out between an adjusted gross income (AGI)of$90,000and$100,000forjointfilersandbetween$56,000and$66,000forsinglefilers.

Many high-income taxpayers maintain IRAs that were opened when they were earning less or consist of rollovers from employer-sponsored plans. If you’re above the deductibility threshold, you can also consider making nondeductible contributions because the tax-free growth of the account still provides a benefit. However, be aware that your distributions will be ordinary income rather than capital gain. You can roll over nondeductible contributions into a Roth version without paying tax, but it may be easier to make contributions directly to a Roth account if you are not above the Roth IRA income limit.

Action opportunity: Wait to make your retirement account withdrawalsTaxpayershavenochoicebuttobeginmakingdistributionsfromIRAs,401(k)and403(b)plans—andsome457plans—oncetheyreach 70½. But many taxpayers want to know whether they should begin making distributions earlier or wait and make only the required distributions.

If your account is appreciating and you don’t need the money immediately, consider waiting to make withdrawals until you’re required to do so. Your assets will continue to grow tax-free. Not only is your account balance likely to be larger if you wait, but if you live long enough, your total distributions should also be greater.

When to choose a Roth versionFour of the defined contribution plans — 401(k)s, 403(b)s, governmental 457(b)s and IRAs — offer Roth versions. The tax benefits of Roth accounts are slightly different from traditional accounts. They allow for tax-free growth and tax-free distributions, but contributions are not pretax or deductible.

The difference is in when you pay the tax. With a traditional retirement account, you get a tax break on the contributions — you only pay taxes on the back end when you take your money out. For a Roth account, you get no tax break on the contributions up front, but never pay tax again if distributions are made properly.

A traditional account may look like the best approach because it often makes sense to defer tax as long as possible. But this isn’t always the case. Roth plans can save you more if you’re in a higher tax bracket when making distributions during retirement, or if tax rates have gone up. Plus, there are no required minimum distributions for Roth IRAs. So if you don’t need the distributions, the account continues to grow tax-free for the benefit of your designated beneficiaries.

Unfortunately, high-income taxpayers cannot make contributions to a Roth IRA. For 2010, the ability to make Roth IRA contributions begins to phase out at an AGI of $169,000forjointfilersand$107,000forsinglefilers.However,if you participate in an employer-sponsored 401(k), 403(b) or 457(b) plan that allows Roth contributions, these income limits don’t apply for making contributions to the plan.

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Tax law change alert: Roth rollover limitation disappearsThe good news is that the $100,000 income limitation on converting to a Roth IRA disappeared in 2010. No matter what your income, you can now roll over a traditional retirement account such as a 401(k) or IRA into a Roth IRA if you want the unique benefits that Roth accounts offer. In addition, if your employer offers a Roth alternative within your qualified plan and allows certain distributions, under a new provision enacted last year, some taxpayers can now roll over from their 401(k) directly into a Roth version within the employer plan. (See the Tax law change alert in the Business perspective section of this chapter for more information.)

Keep in mind the special temporary rule in place for 2010 conversions to Roth IRAs. The tax on a 2010 Roth conversion is paid in equal installments in 2011 and 2012 (unless you elected out of this tax treatment), so if you converted in 2010 you must pay half of the tax this year. If you roll over into a Roth after 2010, you must pay all the tax in the year of the conversion.

Action opportunity: Roll over into a Roth IRAThe elimination of the $100,000 AGI limit on rolling over into a Roth IRA couldn’t have come at a better time. To roll over, you must pay tax on the investments in your traditional account immediately in exchange for no taxes at withdrawal. So why pay taxes now instead of later? Why may now be a good time to act?• Taxratesarescheduledtogoup.Thecurrenttopindividualtaxrateisscheduledtoincreasefrom35percentto39.6percentin2013,

though legislation could change this.• Youraccountmaybeatalowpointinvaluethankstoadownturnthathasbatteredstocks.Lessvalueinyouraccountmeanslesstax

on the rollover. Taxes could be a lot higher when your account recovers. Remember, when you roll over to a Roth, you’re removing all future appreciation from taxation.

• Thedownturnmayhaveleftyouwithbusinessorotherlossesthatwilloffsetthetaxfromtherollover.• Youmustpaythetaxonyourrolloverfrommoneyoutsidetheaccount.Thistoohasasilverlining.Yourfullaccountbalanceafterthe

rollover becomes tax-free, effectively increasing the amount of your tax-preferred investment.• TherearenorequiredminimumdistributionsforaRothIRA,soyoucanletyourmoneyenjoytax-freeappreciationaslongasyouwant

—orgrowtax-freeuntildeath.Afterdeath,thetax-freedistributionstoyourheirscanbemadeoverseveralyears.What’smore,byprepaying the income tax on the account during the conversion, you’ve effectively removed that amount from your estate for estate tax purposes.

• Youcan,ineffect,reverseaRothIRAconversionby“recharacterizing”therolloverasacontributiontoatraditionalIRA(optionisnotavailable for rolling over into a Roth 401(k) within an employer plan). This makes it a fairly safe tax play. You have until your extended filing deadline to recharacterize contributions, so you can make a conversion and then reverse it if the assets decline in value. You can even consider making a series of separate conversions to a Roth IRA with different assets so you can selectively reverse the rollover for specific assets that decline in value.

Caution: Be careful trying to get around the Roth IRA contribution income limits. You cannot make nondeductible contributions to an IRA and then roll over these contributions separate from deductible contributions. The amount you roll over will be taxed in proportion to the amount of total deductible and nondeductible contributions you have in all your traditional IRAs.

There are also a number of reasons why you may NOT want to roll over into a Roth IRA:• Thetimevalueofmoneystillmakesdeferraloftaxesapowerfulstrategy.• Alargeconversioncangeneratealotofincome,whichcouldaffectothertaxitemstiedtoAGI(includinghowmuchofyour

Social Security benefits are taxed).• Payingtaxnowmaynotmakesenseifyou’llbeinalowertaxbracketduringretirement.• Payingtaxnowmaynotmakesenseifyouplanonmovingtoalowertaxstatetoretire.• InorderforaRothdistributiontobetax-free,youmustwaitfiveyearsafteryou’vemadeyourfirstRothIRAcontributionto

make any distributions, even if you’ve reached age 59½ (unless you die, become disabled or acquire your first home).

Action opportunity: Get kids started with a Roth IRAA Roth IRA can offer your children unique benefits. For one, Roth IRA contributions can be withdrawn tax- and penalty-free at any time and for any reason. Early withdrawals are subject to tax and a 10 percent early withdrawal penalty only when they exceed contributions.

Additionally, if a Roth IRA has been open for five years, there are two exceptions to early withdrawal penalties that can be particularly helpful to young IRA owners:• Withdrawalsinexcessofcontributionsusedtopayqualifiedhighereducationexpensesarepenalty-free,butthey’resubjecttoincome

tax.• Withdrawalsupto$10,000inexcessofcontributionsusedforafirst-timehomepurchasearebothtax-andpenalty-free.

To make IRA contributions, children must have earned income. If your children or grandchildren don’t want to invest their hard-earned money, considergivingthemtheamountthey’reeligibletocontribute—butkeepthegifttaxinmind.

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Considerations after a job changeWhen you change jobs or retire, you’ll need to decide what to do with your employer-sponsored plan. You may have several options.

In general, it is not a good idea to make a lump sum withdrawal. You’ll have to pay taxes on the withdrawal, as well as a 10 percent penalty if you’re under the age of 59½. Your employer is also required to withhold 20 percent for federal income taxes.

Ifyouhavemorethan$5,000inyouraccount,youcanleave the money there. You’ll avoid current income tax and any penalties, and the plan assets can continue to grow tax-deferred. This may seem like the simplest solution, but it may not be the best. Keeping track of both the old plan and a plan with a new employer can make managing your retirement assets more difficult. Plus, you’ll have to be mindful of any rules specific to the old plan.

You can avoid any penalties and continue to defer taxes if you roll over to your new employer’s plan, assuming your new employer’s plan allows for it. This may leave you with only one retirement plan to track. It can be a good solution, but first be sure to compare the new plan’s investment options to the old plan’s options.

Rolling over into an IRA may be the best alternative. You avoid penalties and continue to defer taxes, and you have nearly unlimited investment choices. Plus, you can roll over new retirement plan assets into the same IRA if you change jobs again. Such consolidation can make managing your retirement assets easier.

If you choose a rollover, request a direct rollover from your old plan to your new employer’s plan or IRA. If the funds from the old plan are paid to you, you’ll need to make an indirect rollover to your new plan or IRA within 60 days to avoid the tax and potential penalty on those funds. The check you receive from your old plan will be net of federal income tax withholding, but if you don’t roll over the gross amount you’ll be subject to income tax and a potential 10 percent penalty on the difference.

Most withdrawals from tax-deferred retirement plans before age 59½ will be subject to a 10 percent penalty in addition to the normal income tax on the distributions. There are a few exceptions to the early withdrawal penalty. You won’t have to pay if the following is true:• Youbecomedisabled.• Youareage59½orolder.• Thedistributionsarearesultofyourinheritingtheplan

account.• Youtakedistributionsassubstantiallyequalperiodic

payments over your life expectancy (or the joint lives of you and your beneficiary), and the payments don’t commence until you leave your employer.

• Distributionsbeginbecauseofearlyretirementorotherjobseparation, and the separation occurs during or after the year you reach age 55 (except IRAs).

• Thedistributionisusedfordeductiblemedicalexpensesexceeding 7.5 percent of adjusted gross income.

• Yougetdivorcedandthedistributions(exceptfromIRAs)are made pursuant to a qualified domestic relations order (QDRO).

401(k) plans have their own “hardship” distribution rules based on “immediate and heavy financial need.” But those rules merely allow a participant to get funds out, not escape the income tax or the 10 percent penalty.

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Business perspective

Maintaining your company’s retirement plans

Few things were hit harder by the difficult economy than retirement plans. The economic downturn strained the ability of businesses to pay plan costs. So now may be a good time to re-examine the best and easiest way for your business to provide competitive retirement benefits. The good news is: You have plenty of options to consider.

If you’re the business owner or self-employed, you also want to keep yourself in mind. Often, you will have more flexibility tosetuparetirementplanthatallowsyoutomaximizeyourcontributions. You can deduct contributions you make to the plan for your employees, and if you are a sole proprietor, you can deduct contributions you make to the plan for yourself. But keep in mind that if you have employees, generally they must be allowed to participate in the plan.

Weathering the storm in your 401(k) plan Qualified plans such as 401(k), 403(b) or 457 plans remain among the most popular retirement plans for employers. But they can be costly and complex to administer. Unless you operate your 401(k) plan under a safe harbor, you must perform nondiscrimination testing annually to make sure the plan’s benefits don’t favor highly compensated employees.

The downturn forced many companies to trim costs by cutting 401(k) matching contributions, though many companies have now restored those contributions in whole or in part. If

you are still considering cutting the matching contributions in your plan, you need to keep in mind the potential effect on nondiscrimination testing. Many employees participate in 401(k) plans because of the matching contribution, and a reduction can drive down future plan participation rates among rank and file workers. A drop in participation could lead to problems in nondiscrimination testing, resulting in limits on 401(k) benefits for key executives.

You can always use a safe harbor to avoid nondiscrimination testing, but the safe harbors also require employer contributions. If you operate under a safe harbor but need to conserve cash and cut costs by ceasing 401(k) contributions, you must amend the plan and give employees advance notice. Employees must have the option of changing their contributions during this advance notice window, and the nondiscrimination test must be performed for the entire year.

Despite the challenges of a qualified plan such as a 401(k), it is still an attractive option for many reasons:• Thereremainssignificantdesignflexibilityinaqualifiedplan

to allow sponsors to provide value to their top executives. • Nonqualifiedplansarenotastax-effectiveforplansponsors

as qualified plans because the employer does not receive a current tax deduction for contributions to a nonqualified plan.

Tax law change alert: Employees can roll over into Roth 401(k)sLegislationpassedinlate2010allowsemployeesforthefirsttimetorolloverdistributionsfromaqualifiedplansuchasa401(k)or403(b)into a Roth account within the employer plan (assuming the employee is eligible to receive distributions). But first, the employer must offer a Roth alternative. If your plan does not already, you can consider offering a Roth as an enhancement of your employee benefit options.

Employees may not roll over their own contributions unless they have separated from service, reached age 59½, have died or become disabled, or received a qualified reservist distribution. Employer contributions may be eligible for a rollover if they have vested and your plan allows the distribution. Unlike a rollover from a traditional IRA to a Roth IRA, a participant may not elect to unwind the in-plan Roth rollover. Once an amount has been rolled over into a Roth account inside the plan, the amount must stay within the Roth account.

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• Employercontributionstoaqualifiedplanarenever subject to FICA taxation and other payroll taxes.

• Distributionscanberolledoveronatax-freebasis,soanexecutive’s taxable event is delayed until the actual payout from a tax-qualified retirement vehicle, such as an IRA.

• TheuseofqualifiedretirementplansavoidsSection409Apenalty risks.

Using the flexibility of a profit-sharing planA profit sharing plan can give your business a lot of flexibility. It is a defined contribution plan with discretionary contributions, so there is no set amount you must contribute.

If you do make contributions, you will need to have a set formula for determining how the contributions are divided among your employees. The maximum 2011 contribution for eachindividualis$49,000or,forthosewhoincludea401(k)arrangement in the plan and are eligible to make catch-up contributions,$54,500.Yourspecificcontributionlimitisa function of your income. You can make deductible 2011 contributions as late as the due date of your 2011 income tax return, including extensions — provided your plan exists on Dec. 31, 2011.

You cannot discriminate in favor of highly compensated employees, and must perform nondiscrimination testing. Employees cannot contribute (unless you include a 401(k) feature in the plan), and the administration of these plans can be difficult.Buttheycanbeusedbybusinessesofanysizeandcanbe offered along with other retirement plans.

Increasing contributions with a SEP A Simplified Employee Pension (SEP) provides a simplified method for you to contribute to a retirement plan for yourself and your employees. Instead of setting up a profit-sharing plan, you adopt a SEP agreement and make contributions directly to traditional IRAs for you and each of your eligible employees. A SEP is funded solely by employer contributions, and employees are always 100 percent vested in their IRAs.

A SEP is much easier to administer than a profit-sharing plan, and the administrative costs are low. Plans can have flexible annual contribution obligations, but one of the benefits is the high limit on contributions. They can provide an excellent way for business owners to protect savings in a tax-preferred vehicle. Themaximum2011contributionisthelesserof$49,000or25percent of your eligible compensation (net of the deduction for thecontributions),whichmeansyoucancontribute$49,000ifyoureligiblecompensationexceeds$245,000.Youcanestablishthe SEP in 2012 and still make deductible 2011 contributions as late as the due date of your 2011 income tax return, including extensions. Catch-up contributions aren’t available with SEPs.

Using a SIMPLE for your small business A Savings Incentive Match Plan for Employees (SIMPLE) offers small businesses (100 or fewer employees) a simplified way to provide retirement benefits to employers. SIMPLE plans come in two types: the SIMPLE IRA and the SIMPLE 401(k). Unlike a SEP, employees are allowed to contribute to their SIMPLE accounts.

Like a SEP, employers are required to contribute and employee contributions are immediately 100 percent vested. Employers are required to offer their contributions either as:• dollar-for-dollarmatchingcontributionsupto3percentof

an employee’s compensation, or• fixednonelectivecontributionsof2percentofcompensation.

Considering a defined benefit plan freeze The struggling economy and depressed stock market have made it difficult for many employers to maintain their defined benefit plans. Defined benefit plans offer employees a fixed retirement income, and employer contributions are tax deductible. The plans set a future pension benefit and then actuarially calculate the contributions needed to attain the benefit. Because they are actuarially driven, the contribution limits are often higher than other types of plans.

But a defined benefit plan is costly and administratively complex, and plan sponsors retain all the investment risk. It’s no surprise plan sponsors have been terminating plans in record numbers in recent years. If you have a defined benefit plan that youareconsideringterminating,thinkaboutafreezeinstead.Itcan be costly to terminate a plan, even in the case of moderate underfunding. Each participant’s accrued benefit becomes 100 percent vested immediately upon plan termination, and a standard termination requires that all benefits be made available in an alternative form, such as purchasing annuities for each participant. A distress termination can only occur under certain circumstances, and severe termination penalties may be imposed.

Aplanfreezemaybeanexcellentalternativetocontaincosts.Afreezecaneitherclosetheplantonewparticipants,stopbenefit accruals or a combination of both. Important factors to consider include the following:• Continued administration: Afrozendefinedbenefitplan

must be administered, which includes making contributions and benefit payments, having actuarial reports completed, and filing Form 5500 returns.

• Replacement plan: Consider whether or not the company willreplacethefrozenplanwithanothertypeofplan,such asa401(k),andanalyzethecostandbenefitsassociatedwiththe replacement plan.

Stay mindful of increases in income and net worth. What may have been an appropriate estate plan when your income and net worth were much lower may no longer be effective today. Remember that estate planning is about more than just reducing taxes. It’s about ensuring that your family is provided for and that you leave the legacy you desire.

Estate taxEstate taxes are levied on a taxpayer’s estate at the time of death.For2011and2012,theestatetaxhasa$5millionlifetimeexemption (adjusted for inflation after 2011) and a top rate of 35 percent. Inherited assets enjoy a full step up in basis to their value at death.

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Chapter 10

Estate planning

You may be tempted to take your estate plan and throw it out the window. How do you plan properly when the transfer tax laws keep changing? You’ve spent a lifetime building your wealth, and you’d like to provide for your family and perhaps even future generations after you’re gone. But the three main transfer taxes — gift tax, estate tax and generation-skipping transfer (GST) tax — have been subject to wild legislative swings over the last several years.

The drastic swings in transfer tax rules and rates present challenges and opportunities for estate planning. It’s more important than ever that you keep your plan up to date. Estate planning is an ongoing process. You should review your plan regularly to ensure it fits with any changes not only in tax laws, but also in your own circumstances.

Family changes such as marriages, divorces, births, adoptions, disabilities and deaths can all lead to the need for estate plan modifications. Geographic moves also matter. Different states have different estate planning regulations. Any time you move from one state to another, you should review your estate plan. It’s especially important if you’re married and move into or out of a community property state.

Tax law change alert: Transfer tax changesA tax cut compromise bill enacted at the end of 2010 ushered in a brand new transfer tax regime for 2010, 2011 and 2012. In general, the legislation:• reunifiesthegiftandestatetax;• increasesthegift,estateandGSTtaxexemptionamountsto$5million;• providesforatopgift,estateandGSTtaxrateof35percent;and• allowsportabilitybetweenspousesoftheirestatetaxexemptionamounts.

There are special rules in place for 2010 decedents, when the estate and GST taxes temporarily expired altogether. The new legislation reinstates the taxes, but only nominally. The applicable GST tax rate for 2010 is zero. And estates of 2010 decedents can elect to apply the law either under a repeal of the estate tax or the new regime.

The favorable new transfer tax rates aren’t built to last. Beginning in 2013, the transfer taxes are scheduled to revert to the rules in place in2000(seeChart15).Legislationislikelyinthisarea,socheckwithaGrantThorntontaxprofessionalforanupdate.

Chart 15: Estate, gift and GST tax rates and exemptions

2011–12 2013 Exemption Top rate Exemption Top rateEstate tax $5 million 35% $1 million 55%Gift tax $5 million 35% $1 million 55%GST tax $5 million 35% $1 million 55%

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Estates of 2010 decedents are generally subject to the same rules. However, executors of estates for 2010 decedents are allowed to elect to use the prior rules in place under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). This legislation repealed the estate tax for one year in 2010 and removed the step-up in basis for assets acquired from a decedent. If the executor elects out of the estate tax, the decedent’s assets will not receive a step up in basis, although the rules generally provide$1.3millioninadditionalbasisallocations.TheIRShasprovided some relief on the filing deadlines for the estates of 2010 decedents. Please check with a Grant Thornton tax adviser for more information.

The estate tax allows unlimited marital deductions for transfers between spouses. Your estate generally can deduct the value of all assets passed to your spouse at death if your spouse isaU.S.citizen,andnogifttaxisdueifyoupassedtheassetswhile alive. There is also no limit on estate and gift tax charitable deductions. If you bequeath your entire estate to charity or give it all away while alive, no estate or gift tax will be due.

The estate tax exemption is now also fully portable between spouses. To use a predeceased spouse’s unused estate tax exemption amount, the executor must file an estate tax return that computes the unused estate tax exemption amount and makes an election on the return that allows the surviving spouse to use the predeceased spouse’s unused estate tax exemption amount.

In2013,theestatetaxisscheduledtoreverttoa$1million exemption and 55 percent rate, with no portability of the exemption between spouses. Legislation is likely to be considered to alter these rules.

GST taxesThe GST tax is an additional tax applied to transfers of assets to grandchildren or other family members that skip a generation (including nonrelatives 37½ years younger than the donor). The GST includes a lifetime exemption. This exemption is currently setat$5million,butisscheduledtoplummetto$1millionin2013. Your estate may benefit in the long run if you use up this exemption while you’re alive. But remember, you’ll also need to use your gift and estate tax exemptions to make these transfers completely tax-free.

For 2010 through 2012, the GST tax rate is the highest estate tax rate, which is 35 percent. However, the applicable GST rate iszeroin2010.Generation-skippingtransfersmadein2010willnot generate any GST tax, so most taxpayers will NOT want to

allocate any GST exemption to their gifts in 2010. Direct skips have GST exemption automatically allocated to them, so an election out of these automatic allocation rules will need to be made on gift tax returns filed for 2010. The IRS has provided some filing deadline relief related to 2010 GST allocations. Please check with a Grant Thornton tax adviser for more information. Without legislative action, the GST tax rate is scheduled to revert to 55 percent in 2013.

Gift taxesGift taxes are applied on gifts made during a taxpayer’s lifetime. The gift tax also offers both a lifetime exemption and a yearly exclusion. Gifting remains one of the best estate planning strategies.

You want to formulate a gifting plan to take advantage of the annual gift tax exclusion. The annual exclusion is indexed for inflationin$1,000incrementsandis$13,000perbeneficiaryin2011. You can double this generous exclusion by electing to split a gift with your spouse. So even if you want to give to just four beneficiaries,youandyourspousecouldgiftatotalof$104,000this year with no gift tax consequences. If you have more beneficiaries you’d like to include, you can remove even more from your estate every year.

For 2011 and 2012, the gift and estate tax are “reunified” witha$5millionlifetimeexemptionand35percentrate.Any gift tax exemption used during a taxpayer’s lifetime will effectively reduce the taxpayer’s estate tax exemption. Under the Economic Growth and Tax Relief Reconciliation Act (EGGTRA), the gift and estate tax were decoupled as the estate tax exemption amount steadily increased over several years while thegifttaxexemptionamountremainedat$1million.Withoutlegislativeaction,thegifttaxisscheduledtoreverttoa$1millionexemption and a top rate of 55 percent in 2013.

You can also avoid gift taxes by paying tuition and medical expenses for a loved one. As long as you make payments directly to the provider, you can pay these expenses gift tax-free without using up your annual exclusion.

When deciding what assets to gift, keep in mind the step up in basis at death. If it’s likely that the loved ones to whom you gift property won’t sell it before you die, think twice about giving it to them. If it stays in your estate, the property gets an automatic step up in basis to fair market value at the time of your death (unless legislation changes these rules). This could result in significant income tax savings for your heirs upon later sale.

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Action opportunity: Exhaust your lifetime gift tax exemptionConsider exhausting your lifetime gift tax exemption. Using all of the $5 million exemption to give away assets now can save you in the long run. That’s because giving away an asset not only removes it from your estate, but also lowers future estate tax by removing future appreciation and any annual earnings.

Assuming modest five percent after-tax growth, $5 million can easily turn into almost $13.5 million over 20 years. If you gave away the assetsduringyourlife,onlytheoriginal$5milliongiftwillbeaddedtoyourestateforestatetaxpurposes—notthelargervaluecreated by the appreciation of the gifted assets.

To maximize tax benefits, choose your gifts wisely. Give property with the greatest potential to appreciate. Don’t give property that has declined in value. Instead, sell the property so you can take the tax loss, and then give the sale proceeds. Be aware that giving assets to children under 24 may have unexpected income tax consequences because of the kiddie tax. (See Chapter 8 for more information on the kiddie tax.)

Whether or not you own a business, there are many reasons to consider a family limited partnership (FLP) or limited liability company, including the ability to consolidate and protect assets, increase investment opportunities and provide business education to your family. Another major benefit of these structures is the potential for valuation discounts when interests are transferred. For example, you can transfer assets (such as rental property or investments) to an FLP, and then gift FLP interests to family members. The valuation discount, combined with careful timing of the gifts, may enable you to transfer substantial value free from gift tax. An FLP can work especially well for transfers of rapidly appreciating property.

Butbecareful:TheIRSisscrutinizingFLPs.TheIRShas had some success challenging FLPs in which the donor retains the actual or implied right to enjoy the FLP assets, or when the donor retains the right to manage the FLP. You shouldn’t transfer personal-use assets to an FLP, transfer so much of your assets as to leave insufficient means to pay for living expenses or have unfettered access to FLP assets for your own use. The White House and congressional lawmakers have also proposed legislation that would limit valuation discounts through FLPs. If you wish to create an FLP, you should discuss the risks with a Grant Thornton tax professional and determine the best way to proceed.

Using business interests in giftingInterests in a business can save you in transfer taxes, whether it is a business you own or a limited partnership you set up. There is a pair of special breaks for business owners:

• Section 303 redemptions: Your company can buy back stock from your estate without the risk of the payment to the estate being treated as a dividend for income tax purposes. Such a distribution generally must not exceed the tax, funeral and administration expenses of the estate, and the value of your business must exceed 35 percent of the value of your adjusted gross estate. But be careful. If there isn’t a nontax reason for setting up this structure, the IRS can challenge its validity.

• Estate tax deferral: Normally, estate taxes are due within nine months of death. But if closely held business interests exceed 35 percent of your adjusted gross estate, the estate may qualify for a deferral. No payment (other than interest) for taxes owed on the value of the business is due until five years after the normal due date. Then the tax can be paid over as many as 10 equal annual installments. Thus, a portion of your tax can be deferred for as long as 14 years from the original due date.

If you’re a business owner, you may be able to leverage your gift tax annual exclusions by gifting ownership interests that are eligible for valuation discounts. So, for example, if the discounts total 30 percent, you can gift an ownership interest equal to as muchas$18,571tax-freebecausethediscountedvaluedoesn’texceedthe$13,000annualexclusion.ButtheIRSmaychallengethe value, and an independent and professional appraisal is highly recommended to substantiate it.

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Action opportunity: Use second-to-die life insurance for extra liquidityBecause a properly structured estate plan can defer all estate taxes on the first spouse’s death, some families find they do not need any life insurance at that point. But significant estate taxes may be due on the second spouse’s death, and a second-to-die policy can be the perfect vehicle for providing cash to pay those taxes.

A second-to-die policy also has other advantages over insurance on a single life. Typically, premiums are lower than those on two individual policies, and a second-to-die policy generally will permit an otherwise uninsurable spouse to be covered. Work with a Grant Thornton private wealth services professional to determine whether a second-to-die policy should be part of your planning strategy.

Leverage life insuranceLife insurance can replace income, provide cash to pay estate taxes,offerawaytoequalizeassetsamongchildrenwhoareactive and inactive in a family business, or be a vehicle for passing leveraged funds free of estate tax.

Life insurance proceeds generally aren’t subject to income tax, but if you own the policy, the proceeds will be included in your estate. Ownership is determined by several factors, including who has the right to name the beneficiaries of the proceeds.

In general, to reap maximum tax benefits you must sacrifice some control and flexibility as well as some ease and cost of administration. Determining who should own insurance on your life is a complex task because there are many possible owners, including you or your spouse, your children, your business or an irrevocable life insurance trust (ILIT).

To choose the best owner, consider why you want the insurance — to replace income, to provide liquidity or to transfer wealth to your heirs. You must also consider tax implications, control, flexibility, and ease and cost of administration. You also may want to consider a second-to-die policy.

• Qualified terminable interest property (QTIP) trust: This type of trust passes trust income to your spouse for life with the remainder of the trust assets passing as you’ve designated. A QTIP trust gives you (not your surviving spouse) control over the final disposition of your property and is often used to protect the interests of children from a previous marriage. The trust takes advantage of the estate tax maritaldeductiontominimizetheestatetaxliabilityoftheestate of the first-to-die spouse.

• Irrevocable life insurance trust (ILIT): The ILIT owns one or more insurance policies on your life, and it manages and distributes policy proceeds according to your wishes. An ILIT keeps insurance proceeds, which would otherwise be subject to estate tax, out of your estate (and possibly your spouse’s). You aren’t allowed to retain any powers over the policy, such as the right to change the beneficiary. The trust can be designed so that it can make a loan to your estate or buy assets from your estate for liquidity needs, such as paying estate tax.

• Crummey trust: This trust allows you to enjoy both the control of a trust that will transfer assets at a later date and the tax savings of an outright gift. ILITs are often structured as Crummey trusts so that annual exclusion gifts can fund the ILIT’s payment of insurance premiums.

Trusts offer versatile planning toolsTrusts are often part of an estate plan because they can be versatile and binding. Used correctly, they can provide significant tax savings while preserving some control over what happens to the transferred assets. There are many different types of trusts you may want to consider:

• Marital trust: This trust is created to benefit the surviving spouse and is often funded with just enough assets to ensure that no estate tax will be due upon the first spouse’s death. The remainder of the estate, which would equal the estate tax exemption amount, is used to fund a credit shelter trust. The trust takes advantage of the estate tax marital deduction to minimizetheestatetaxliabilityoftheestateofthefirst-to-diespouse.

• Credit shelter trust: This trust is funded at the first spouse’s death to take advantage of his or her full estate tax exemption. The trust benefits the children primarily, but the surviving spouse can receive income and perhaps a portion of principal during the spouse’s lifetime. In 2011 and 2012, the estate tax exemption is portable between spouses, but this is scheduled to change in 2013 if legislation is not enacted.

• Qualified domestic trust (QDOT): This marital trust canallowyouandyournon-U.S.-citizenspousetotakeadvantage of the unlimited estate marital deduction.

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Action opportunity: Zero out your GRAT to save moreGrantor retained annuity trusts (GRATs) allow you to remove assets from your taxable estate at a reduced value for gift tax purposes while you receive payments from the trust. The income you receive from the trust is an annuity based on the value of the assets on the date the trust is formed. At the end of the term, the principal passes to your beneficiaries.

It’s possible to plan the trust term and payouts so there is no taxable gift. This is called “zeroing out” the GRAT. A GRAT is zeroed out when it is structured so the value of the remainder interest at the time the GRAT is created equals or just exceeds zero. So the remainder’s value for gift tax purposes is zero or close to zero.

Caution: There are legislative proposals that would require GRATs to have a remainder interest greater than zero and require a minimum 10-year term. The 10-year minimum term would make a GRAT a riskier planning technique because typically the tax benefits of GRATs are only achieved when the grantor outlives the term. While the proposals would only affect GRATs created after the date of enactment, they would affect the technique of “rolling” GRATs in which the payments of a short-term GRAT are reinvested in a new short-term GRAT.

• Dynasty trust: A dynasty trust allows assets to skip several generations of taxation. You can fund the trust either during your lifetime by making gifts or at death in the form of bequests. The trust remains in existence from generation to generation. Because the heirs have restrictions on their access to the trust funds, the trust is excluded from their estates. If any of the heirs have a real need for funds, the trust can make distributions to them. Special planning is required if you live in a state that hasn’t abolished the rule against perpetuities.

• Qualified personal residence trust (QPRT): This is a trust that holds your home but gives you the right to live in it for a set number of years. At the end of the term, your beneficiaries own the home. You may continue to live there if the trustees or owners agree, and you pay fair market rent.

• Grantor-retained annuity trust (GRAT): A GRAT allows you to give assets to your children today — removing them from your taxable estate at a reduced value for gift tax purposes (provided you survive the trust’s term) — while you receive payments from the trust for a specified term. At the end of the term, the principal may pass to the beneficiaries or remain in the trust. It’s possible to plan the trusttermandpayoutstominimize,orevenzero-out,ataxable gift.

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Year-end tax guide for 2011

Grant Thornton offices

OklahomaOklahomaCity 405.218.2800Tulsa 918.877.0800

OregonPortland 503.222.3562

PennsylvaniaHarrisburg 717.265.8600Philadelphia 215.561.4200

South CarolinaColumbia 803.231.3100

TexasAustin 512.391.6821Dallas 214.561.2300Houston 832.476.3600SanAntonio 210.881.1800

UtahSaltLakeCity 801.415.1000

VirginiaAlexandria 703.837.4400McLean 703.847.7500

WashingtonSeattle 206.623.1121

Washington, D.C.Washington,D.C. 202.296.7800

WisconsinAppleton 920.968.6700Madison 608.257.6761Milwaukee 414.289.8200

KansasWichita 316.265.3231

MarylandBaltimore 410.685.4000

MassachusettsBoston 617.723.7900

MichiganDetroit 248.262.1950

MinnesotaMinneapolis 612.332.0001

MissouriKansasCity 816.412.2400St. Louis 314.735.2200

NevadaReno 775.786.1520

New JerseyEdison 732.516.5500

New YorkAlbany 518.427.5197Long Island 631.249.6001Downtown 212.422.1000Midtown 212.599.0100

North CarolinaCharlotte 704.632.3500Raleigh 919.881.2700

OhioCincinnati 513.762.5000Cleveland 216.771.1400

National Office 175 W. Jackson Blvd., 20th FloorChicago,IL60604-2687312.856.0200

Washington National Tax Office1250 Connecticut Ave. NW, Suite 400Washington, DC 20036-3531202.296.7800

ArizonaPhoenix 602.474.3400

CaliforniaIrvine 949.553.1600Los Angeles 213.627.1717Sacramento 916.449.3991SanDiego 858.704.8000SanFrancisco 415.986.3900SanJose 408.275.9000WoodlandHills 818.936.5100

Colorado Denver 303.813.4000

FloridaFortLauderdale 954.768.9900Miami 305.341.8040Orlando 407.481.5100Tampa 813.229.7201

GeorgiaAtlanta 404.330.2000

IllinoisChicago 312.856.0200OakbrookTerrace 630.873.2500Schaumburg 847.884.0123

Tax professional standards statementThis document supports Grant Thornton LLP’s marketing of professional services, and is not written tax advice directed at the particular facts and circumstances of any person. If you are interested in the subject of this document we encourage you to contact us or an independent tax advisor to discuss the potential application to your particular situation. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein. To the extent this document may be considered to contain written tax advice, any written advice contained in, forwarded with, or attached to this document is not intended by Grant Thornton to be used, and cannot be used, by any person for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.

The information contained herein is general in nature and based on authorities that are subject to change. It is not intended and should not be construed as legal, accounting or tax advice or opinion provided by Grant Thornton LLP to the reader. This material may not be applicable to or suitable for specific circumstances or needs and may require consideration of nontax and other tax factors. Contact Grant Thornton LLP or other tax professionals prior to taking any action based upon this information. Grant Thornton LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. No part of this document may be reproduced, retransmitted or otherwise redistributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, re-keying or using any information storage and retrieval system without written permission from Grant Thornton LLP.

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