SO WHAT'S MY TOP TAX RATE
GOING TO BE IN 2011?
2010 Year End Planning

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October 22, 2010

We've been answering this question in a number of different ways to various clients. With the uncertainty about the Bush tax cuts ending this year, one would think estimating your top tax rate is a simple matter of 35% (current) vs. 39.6% (proposed). However, upon close examination, the answer is generally "no difference, even if the higher rates apply!"

One's ultimate tax liability is the higher of two calculations: regular income tax or alternative minimum tax ("AMT"). If you're subject to the top AMT rate of 28%, your tax may not change at all.

Let's assume you're a high income earner (income in excess of $400,000) with capital gains, and also have mortgage expenses, property taxes, charitable contributions and investment expenses. In most cases you'll hit the alternative minimum tax rates.

The following is an example:

	ORDINARY TAX	AMT
	($000)
1. Gross income
a. Wages	400	400
b. Capital Gains	100	100
	500	500
2. Less: Deductions from AGI and Itemized Deductions
a. Interest	30	30
b. Taxes (property and state income taxes)	50	0
c. Charitable Gifts	10	10
d. Miscellaneous Expenses	20	0
3. Equals: Taxable Income before Exemptions	390	460
Tax Liability
Ordinary Income Tax	118
Alternative Minimum Tax		125

The AMT catches so many people because substantial deductions are disallowed under the AMT calculation. If you have substantial deductions not permitted under the AMT rules, while your ordinary tax calculation can drop dramatically, the AMT calculation remains static at a high rate of 28%. Accordingly, it may not take huge deductions to push your ordinary tax calculation below the AMT calculation. In the above example, if the ordinary income tax rate increased by 4.6% to 39.6, the increase in tax would not push the $118,000 figure past the $125,000 tax under AMT, so one's taxes would remain the same.

In 2011, if the top long term capital gains rate changes from 15% to 20%, the capital gains tax on $100,000 in both columns will increase by $5,000.

Investors with substantial long term capital gains almost always end up in AMT because the state income taxes are deductible under the regular income tax but not under the AMT calculation.

In the above example, the taxpayer is subject to AMT with the following results:

• Prepaying income or property taxes in 2010 would not result in any tax savings this year.
• Contributing to a charity will result in a 28% tax benefit since charitable deductions are permitted under the AMT calculation.
• Accelerating income from 2011 into 2010 might be an excellent strategy given the increase in the tax rates that might apply in 2011, but may also be needless if you're still in the 28% AMT rate next year.

To return to the question about your top tax rates for 2011, the answer will mostly depend on what makes up your income. For example, the top tax rate on dividends can possibly go from 15% to 39.6% in 2011. Your top tax rates in 2011 could be:

Earned Income Dividends Interest - Other Ord Income Capital gains - Long term

Current 2010 Rates 2011 Higher Rates Ord Tax AMT Rates 35% 28% 15% 15% 35% 28% 15% 15% Ord Tax AMT Rates 39.6% 28% 39.6% 28% 39.6% 28% 20% 20%

We've all become economists in the last two months, debating whether higher taxes will help or hinder the economy. The real economists are split on this question or prefer to sit on the fence by talking about whether more stimulus is good or bad for the economy.

We've all been abandoned by Congress and the economists. However, we will not do the same. Here is what you need to do given the current uncertainty as things stand today:

1. Estimate what your income and deductions will be for 2010 and 2011 (use 2010 estimates for both years if you don't know what next year will bring).
2. Calculate your tax under the current rates.
3. Calculate your tax under the worst case scenario using the 2011 rates.
4. Do nothing.
5. Wait until November 3 - the day after the elections.
6. Call your tax advisor.
7. Don't delay with (1) or (2). It takes time and documentation to properly implement good year end tax planning moves.

Rowbotham & Company can help with analyzing your tax situation and recommend some year end planning steps. Please contact Harriet Leung or Peter Trieu for further assistance.

FIRM ACTIVITIES
Investing in U.S. Real Property:
Asian Perspective - Real Estate Roundtable

Members of the firm recently gave a presentation at the Real Estate Roundtable on various tax structures and strategies for foreign investment in U.S. real property.

The presentation contains additional thoughts on year end planning for foreign investors.

Click here to view the presentation.

Contact Harriet Leung, Partner, Asia Practice if you have any questions.