Dialogues Year-End Tax Planning Guide WEALTH STRATEGIES FOR DISCUSSION

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1 Dialogues WEALTH STRATEGIES FOR DISCUSSION We can work with you and your tax professional to help you decide which year-end tax strategies may be beneficial to you. FOURTH QUARTER 2010 COURTESY OF THE SCHUSTER CASAZZA GROUP One Lincoln Centre Suite 1300 Oakbrook Terrace, IL Phone: Fax: Tollfree: SCOTT SCHUSTER, CFP First Vice President PAUL L CASAZZA Financial Advisor 2010 Year-End Tax Planning Guide There is enormous uncertainty about what the future holds for U.S. taxpayers in 2011 and beyond. Policymakers are debating whether to extend tax cuts initiated by President George W. Bush or to allow the cuts to expire on January 1, Reluctant to tackle the issue before the midterm elections, Congress will take up the question in late November. At the time this guide was published, the outcome of these deliberations was unknown; however, there are still key steps you can take as 2010 draws to a close. In the following pages, you ll find information, updates and ideas on many important tax topics to consider now. We can work with you and your tax professional to help you decide on strategies that may be beneficial to you. By Morgan Stanley Smith Barney LLC

2 DIALOGUES//2 Timely Strategies for Uncertain Times 1. CAPITAL GAINS AND LOSSES. With nearly every area of individual taxes in limbo right now, the typical considerations the ones that guide using your current and past gains and losses to help or assist in minimizing your current and future tax exposure become magnified. Strategy Your tax professional can run a preliminary analysis of your 2010 tax situation. He or she can look at carryovers of tax losses and advise you as to whether any potential losses on depreciated securities would be more valuable in 2010 or in future years. 2. PORTFOLIO ALLOCATION. The volatile financial markets may have thrown your portfolio allocation out of line. Year-end is a good time to check your asset allocation, and just as importantly to reassess your long- and shortterm goals in light of any changes in your life and the financial markets. Strategy Review your existing financial plan with us or create a plan for the first time. Once you have reviewed your goals, you can work together to access the investment expertise of the Morgan Stanley Smith Barney Global Investment Committee, which regularly publishes recommended asset allocation strategies for many investment objectives. 3. RETIREMENT. High-income investors now have the opportunity to convert assets from a Traditional IRA or employer-sponsored retirement plan to a Roth IRA. With a Roth account, the retirement assets you are working hard to build now will one day become retirement income, free of tax. Strategy To help you decide whether a Roth IRA makes sense for you, we can prepare a Roth Conversion Analysis. This report will show you the after-tax potential future value of your IRA balance, comparing the outcome of your current Traditional IRA with that of a Roth IRA. You ll also be able to see the wealth planning advantages of stretching a Roth IRA over multiple generations and the benefits of including income from the conversion over the next two years. With the current tax and legislative environment pointing toward a trend of higher personal income tax rates, consider the advantages of a Roth conversion in You ll have the option of paying the conversion taxes now, at a potentially lower rate, or spreading the tax payment across two years by including half the income in 2011 and half in 2012 at rates in effect in those years. 4. GIFTING TO INDIVIDUALS AND CHARITIES. After 2010, unless there is legislation to the contrary, estate taxes are scheduled to return to rates that are higher than they have been for many years. If you plan to leave an estate to your heirs, you may want to strategically transfer assets this year, free of gift tax, rather than later, when they may be subject to the higher estate tax rates. Strategies» $26,000 (for a married couple) free of gift tax to an individual or noncharitable entity. Read on to find out how you can accelerate your gifting in the current year; for instance, by contributing to a 529 college savings plan you can remove up to $130,000 (jointly) from your taxable estate. 1» If you want to use appreciated stock to make a charitable donation, do so before year-end to qualify for a potential income tax deduction this year and avoid paying any applicable capital gains taxes on the appreciation. You can also arrange to contribute long-term appreciated stock to a donor-advised fund, which is a relatively low-cost, flexible way to manage charitable giving. 5. TAX CREDITS. If you made energy-saving improvements to your home this year or purchased a new home by April 30, 2010, you may be able to claim a tax credit that could reduce your tax liability dollar-for-dollar. Strategy Review your receipts for home improvements with your tax professional to see if you qualify for these credits. 6. BUSINESS OWNERS. Like individuals, business owners need to prepare for possible tax increases. They may also be affected by the Small Business Jobs Act of 2010, which extends the depreciation bonus for a year, among other provisions. Strategies» Business owners may want to revisit certain strategies including when to take

3 DIALOGUES//3 capital gains and losses and whether or not to make installment sales in light of possible tax increases.» The extension of the 50% depreciation bonus may allow some companies to preserve or increase cash flow by reducing their current tax liability.» If your company has a 401(k), 403(b) or 457(b) plan, you may be able to offer employees the opportunity to convert their existing retirement account to a Roth account. Review your plan document or check with your attorney or your plan provider to see if this is an option under your plan. 1 No further annual exclusion gifts and/or generationskipping transfers to the same beneficiary may be made over the same five-year period, and the transfer must be reported as a series of five equal annual transfers. If the donor dies within the five-year period, a portion of the transferred amount will be included in the donor s estate for estate tax purposes. Proposed Tax Changes for 2011 What Happens If the Tax Cuts Expire? If the entire package of Bush tax cuts expires at the end of the year, you can expect to see numerous changes: INCOME TAXES.» Income tax rates for almost all Americans will increase.» Taxpayers should consider accelerating income to 2010, before taxes increase, and delaying deductions to offset higher taxes in the coming years. CAPITAL GAINS.» Long-term capital gains will increase across the board.» This year, the top long-term capital gains rate remains at a historically low 15%. Unless extended, this rate is scheduled to sunset in 2011 so you may want to consider taking gains now.» For investments in taxable brokerage accounts, consider: selling appreciated securities this year instead of next year, when taxes may be higher. selling securities that have decreased in value to create a net capital loss that exceeds capital gains; the excess net capital loss can be carried forward to 2011 and beyond and used to shelter both short-term gains and gains recognized at the higher rates in those years. DIVIDENDS.» Dividends will be taxed as ordinary income up from a maximum rate of 15% currently» This affects all investors and those in the top tax brackets could see dividends taxed at as much as 39.6% more than double the current rate.» Clients should review their investments and consider holding high-paying dividend stocks in a tax-deferred account, such as an individual retirement account or a 401(k).

4 DIALOGUES//4 Manage Capital Gains with Capital Losses and Tax Swaps Year-end is an ideal time to sit down with us to review your portfolio and uncover opportunities to harvest capital losses, which can be used to offset capital gains and reduce your income tax liability. Evaluate your holdings for loss candidates, including equities, fixed income and mutual funds. If you sell securities for a profit during 2010, you can also offset gains by applying unused capital losses from previous years. The Internal Revenue Service (IRS) allows taxpayers to use capital losses to offset capital gains on a dollar-for-dollar basis. For tax reporting purposes, you must first net short-term gains against short-term losses (securities held for one year or less) and long-term gains against long-term losses (securities held for more than a year). Any WASH SALE RULE: KEY DATES Tuesday, November 30, 2010: Last day to double up for Doubling up on a security allows you to recognize a loss without missing any potential appreciation during the wash sale period. However, doubling up would increase your risk exposure in that security. Friday, December 31, 2010: Last day you can sell a security this year for a loss. (Note, however, that there may be operational limitations in ensuring that your transactions occur on this date, so plan ahead.) Monday,January 31, 2011: If you sold a security for a loss on December 31, 2010, you can avoid the wash sale rules if you wait until January 31, 2011 or later to repurchase the same or substantially similar security. Netting Gains and Losses Let s say you realize a short-term gain and loss of $30,000 and $20,000, and a long-term gain and loss of $25,000 and $60,000, respectively, this year. After matching short-term gains and losses as well as long-term gains and losses, you could use $3,000 of the $25,000 net capital loss to offset ordinary income in the current year. The remaining $22,000 capital loss could be carried forward to offset future years capital gains and/or ordinary income. remaining gains and losses can be netted against each other. If net capital losses still remain, up to $3,000 may be used to offset ordinary income. Any unused capital losses can be carried forward indefinitely. Consider a Tax Swap. If you choose to sell a security to offset gains, under IRS rules, you cannot deduct losses from the sale of securities in a wash sale. A wash sale occurs when you sell securities at a loss, and within 30 days before or after the sale, you:» Buy substantially identical securities» Acquire substantially identical securities in a fully taxable trade, or» Acquire a contract or option to buy substantially identical securities If you have a long-term conviction in the security sold, you can repurchase it after 31 days. You can also use a tax swap to maintain your asset allocation and diversification objectives, which entails the sale and purchase of securities with similar but not identical characteristics. Stocks are not considered identical if they have different issuers, and in the case of bonds, a different issuer or substantially different maturities or coupons. AMT Rates. The alternative minimum tax (AMT) is a concurrent tax system that follows an alternative set of rules to calculate income tax. AMT disallows some of the exemptions, deductions and credits that are used to calculate standard income tax. If you are subject to AMT, you will owe whichever tax is higher the AMT or your normal amount. For 2011, the AMT exemption amount is scheduled to revert to the pre-bush era ($45,000 married filing jointly and $33,750 separately). If this happens, millions of taxpayers will be subject to AMT in 2010 and subsequent years. There are a number of strategies that may help minimize your AMT exposure, including how you manage withholding on state income taxes, how you time your property tax payments, when you sell exercised stock options even your investment choices. Speak to your tax professional about the role these strategies may play in your situation.

5 DIALOGUES//5 Building and Managing Retirement Savings STRATEGIES FOR INDIVIDUALS Make Your 2010 Contributions Now. Retirement Account (IRA) for 2010 may be made through April 15, Waiting until April could deprive you of months of potential tax-deferred growth. The sooner the contribution is made, the sooner it can start working for your retirement account. If you have earned income, you can contribute up to $5,000 for 2010 or up to $6,000 if you are age 50 or older by year-end. Take Your RMD for If you are age 70 1 /2 or older and have a Traditional, Simplified Employee Pension (SEP) or Savings Incentive Match Plan for Employees (SIMPLE) IRA, or are the beneficiary of an Inherited IRA, be sure to take your 2010 Required Minimum Distribution (RMD) by December 31, If you turn age 70 1 /2 in 2010, you may delay taking your initial RMD until April 1, Be sure to take your RMDs on time to avoid any penalties Roth IRA Conversions Carry Added Benefits. This year, regulatory changes make it easier than ever to convert a Traditional IRA or employer-sponsored retirement plans to a Roth IRA even if you didn t qualify in the past because of your income level or marital status. The key benefits of a Roth IRA are that, first, distributions are tax-free 3 and, 2010 Retirement Plan Contribution Limits second, there is no requirement that you must stop contributions or begin taking withdrawals at a given age. Keep in mind that you will need to pay income tax on the amount converted to a Roth IRA, including pretax contributions and any investment earnings. However, 2010 conversions come with a one-time offer to help ease the tax burden you can spread your tax payment across two years. Instead of paying all the taxes when you file your taxes for 2010, you have the option to include half the income when you file your taxes for 2011 and half when you file your taxes for 2012 at rates in effect in those years. The conversion must be completed by December 31, Finally, if you convert to a Roth IRA in 2010 and the value of the account decreases due to market activity, you have the option of recharacterizing the account back to a Traditional IRA; in essence, undoing the conversion. STRATEGIES FOR BUSINESS OWNERS Reevaluate Your Company s Retirement Plan. If your company already offers a retirement plan, there have been significant changes over the years which may warrant a review, and potentially an update, to your plan. Along with your Financial Advisor, contact your ERISA attorney or retirement plan administrator to make sure you are in compliance in all areas. Also, ask specifically about ways your plan can be enhanced through plan design changes such as automatic enrollment, or the addition of new investment options. We can prepare a complimentary retirement plan evaluation that will assess your current program and determine the ideal type of plan for your business, based on your personal and business goals. Open a Qualified Retirement Plan by Year-End. Establishing a qualified retirement plan for your employees can help attract and retain great employees. It can also offer important wealth building opportunities for you as the proprietor. If you don t have a company retirement plan, call us to get one started. If your business is operated on a calendar year basis, the plan has to be established by December 31, 2010 to qualify for a tax deduction for Explore Retirement Tax Credits. You may qualify for a number of credits and deductions that can help defray some of the costs in your plan. For instance, if your plan is new, you may be eligible to take a tax credit of up to 50% of the first $1,000 of qualified start-up costs of the plan. The credit is available for each of the first three years of the plan. You may also be able to deduct certain plan expenses, such as the expenses paid to begin or administer an eligible plan and/or educate employees about their plan. Your tax professional can offer more information on how this provision may affect your situation. 2 If you decide to delay your first RMD until April 1, 2011, you will be required to take two distributions in 2011 one for 2010 by April 1, 2011 and one for 2011 by December 31, This could result in the distributions being taxed at a higher marginal rate due to the increased income received during the year. 3 Distributions of earnings are tax-free if made at least five years after the year of the taxpayer s first Roth IRA contribution and after age 59 1 /2 or due to death, disability or for a first-time home purchase. Withdrawals of contributions are not taxed.

6 DIALOGUES//6 Other s for Business Owners With the Bush tax cuts set to expire, business owners may want to consider taking capital gains and accelerating income in 2010 to avoid higher taxes in Conversely, losses may prove to be more beneficial if held until Business owners who are in the process of selling their business via an installment sale method should consider electing out of that approach and accelerating income in 2010, ahead of potential tax increases. With the Small Business Jobs Act signed by President Obama, business owners should consider enhancements that are now being offered as part of the approved bill:» Bonus Depreciation. For businesses of all sizes, the Act extends the temporary 50% depreciation bonus for one additional year. It basically allows that 50% of the basis of qualified property may be deducted in the year the property is placed in service and the remaining 50% may be recovered under normal depreciation rules. Bonus depreciation may allow some taxpayers to preserve or increase cash flow by reducing current tax liability, and it may also enable some companies to increase a loss that can be carried back.» A New $30 billion Small Business Lending Fund. The bill will establish a new $30 billion Small Business Lending Fund which by providing capital to small banks with incentives to increase small business lending could support several multiples of that amount in new credit.» Roth Retirement Account Opportunities. Employers may be able to offer opportunities for employees and themselves to convert existing funds in company retirement accounts to a Roth account. One of the key benefits of a Roth is that distributions are tax-free. Review your plan document or check with your attorney or plan provider to see if this is an option under your plan. Preparing for Higher Estate and Gift Taxes Estate Taxes. On January 1, 2011, two of the most significant wealth planning taxes the federal estate tax and the generation-skipping transfer tax (GST tax), both of which were repealed in 2010 are scheduled to return to the pre-bush levels, unless there is legislation to the contrary. That means that the maximum amount you can transfer free of federal estate tax will be only $1 million, and the highest tax rate will jump to 55%. Recall that in 2009, the estate tax exclusion was $3.5 million and the highest marginal rate was 45%. Proposed Tax Changes for 2011 The generation-skipping transfer tax typically applies when assets are transferred more than one generation younger than the donor (such as grandchildren). The GST tax exemption, the amount that transfers free of tax, will be approximately $1 million and the tax rate will be 55%. In addition, the modified carryover tax basis will come to an end on December 31, 2010 and the step-up regime will apply again beginning January 1, This means that the income tax basis of property that passes from a decedent again will be stepped up to fair market value. GiftTaxes. The federal gift tax will change significantly, too. Although the gift tax exclusion, the amount that transfers free of tax, will remain at $1 million, the highest marginal rate will increase from 35% to 55%. WHAT TO DO BY YEAR-END.» Consider making gifts now at a maximum 35% rate, ahead of scheduled tax increases next year.» If you want to transfer wealth to grand

7 DIALOGUES//7 children, you can do so this year without incurring the generation-skipping transfer tax, unless there is legislation to the contrary. Such transfers still will be subject to the gift tax.» If your estate is valued at over $3.5 million, or if you live in a state that imposes taxes on estates of any value, ask your estate tax attorney what strategies may be beneficial to you.» Now is a good time to create a grantor retained annuity trust (GRAT). All else being equal, GRATs perform best when a particular discount rate that must be used in structuring the GRAT is low. The rate for GRATs created in October 2010 was 2.0% the lowest the rate has ever been.» Consider the use of an Irrevocable Life Insurance Trust (ILIT) to offset any future estate taxes. You can create and fund an ILIT with annual gifts to the trust, thereby maximizing the benefits of the annual gift tax exclusion. The ILIT purchases life insurance on your life and uses your gifts to pay the premiums. As long as the trust is properly drafted, the insurance proceeds when paid as a death benefit will not be included in your taxable estate, are exempt from income tax, and can provide immediate cash to pay bills, expenses and taxes.» The low interest rate environment makes it a great time for intra-family loans as well. This is a simple but often overlooked way to transfer wealth downstream without gift tax consequences. Tax-Efficient Gifting Strategies Donate Appreciated Stock for Potential Double Tax Savings. Instead of cash, consider donating appreciated stock to your favorite charity. If you have owned a stock for more than one year, you can avoid paying capital gains taxes, and you may also be able to deduct the full value of the stock from your taxable income. If you want to keep the stock in your portfolio, you can separately reinvest in the stock. If you wish to donate stock that has lost value, you should sell the shares and donate the proceeds this way you realize a loss to offset income or gains in your portfolio. Consider the Timing of Deductions. If tax rates increase, it may be more advantageous to hold deductions, such as charitable contributions, to offset higher taxes in the coming years. On the other hand, it may make sense to accelerate deductions this year. There is potential for a larger deduction of a taxpayer s itemized deductions, because itemized deductions are not limited in 2010, but are expected to be in Complete Any Gift Transfers to Individuals by Year-End Gift transfers support your beneficiaries and help reduce the value of your estate and future estate taxes. You can transfer up to $13,000 per recipient in 2010 without incurring any federal gift tax. Spouses together may gift up to $26,000 per recipient. In addition, this might be a good year to consider larger gifts, even taxable ones, since the gift tax rate is at an all-time low. Consider a Donor-Advised Fund. If you are looking to create a legacy of charitable giving but haven t determined where to contribute, you might consider a donoradvised fund, which allows you to make a tax-deductible contribution this year, locking in the tax savings, and choose the recipients later. Saving for Education A variety of savings plans, tax credits and deductions are available to help you defray some of the expenses of higher education, and many of them have yearend deadlines for participation. 529 College Savings Plans. A 529 college savings plan is a great way to gift to loved ones. By funding their higher education, you will be helping them to take an important first step toward preparing for the future while potentially reducing your taxable estate. In addition to the flexibility and control that 529 plans provide the account owner, they offer several tax benefits that may aid in your year-end planning. For example, you can utilize your annual federal gift tax exclusion of up to $13,000 ($26,000 jointly) to fund a 529 plan free of gift tax. Moreover, if it suits your estate planning needs, you can accelerate multiple years worth of gifts into the current year, removing up to $65,000 ($130,000 jointly) per recipient from your taxable estate. 4 We can help you select the 529 college savings plan that best suits your needs from some of the country s most respected money management firms. 5 If you are one of the millions of people funding a college savings plan, you know that market conditions may have negatively affected many investment portfolios, including education savings. Now is the time to review plan options with us and make any necessary adjustments in how your funds are allocated. 6 If the beneficiary of the account is nearing or in college, we can also recommend asset allocations to help minimize the impact of a negative market. Education Tax Credits. If you pay for education expenses for yourself, your spouse or a dependent, document your

8 DIALOGUES//8 expenses and discuss with your tax professional whether you qualify for a tax credit. Known by names such as the Hope Credit and the Lifetime Learning Credit, these credits may help reduce your tax obligation, dollar-for-dollar, based on your expenditures. Deductions. Take advantage of the tuition and fees deduction (included in the pending extenders bill), which may help reduce the amount of your income subject to tax by up to $4,000. Depending on your income, you may also be able to deduct interest on student loans used for higher education. Many professionals invest significantly in ongoing work-related education. If you do so, you may be able to claim a deduction for these expenses, provided qualifying expenses plus other job and certain miscellaneous expenses add up to more than 2% of your adjusted gross income. Don t Double Dip. You cannot take both deductions and tax credits for the same expense. Ask your tax professional to help you determine what you are qualified for, and to help you choose the one that will give you the lower tax. 4 No further annual exclusion gifts and/or generationskipping transfers to the same beneficiary may be made over the same five-year period, and the transfer must be reported as a series of five equal annual transfers. If the donor dies within the five-year period, a portion of the transferred amount will be included in the donor s estate for estate tax purposes. 5 Before investing, clients should consult with their tax advisor to consider whether tax or other benefits are only available for investments in their home state. 6 The account holder can reallocate the portfolio investments once every calendar year or whenever the designated beneficiary is changed. Tax laws are complex and subject to change. Morgan Stanley Smith Barney LLC, its affiliates and Morgan Stanley Smith Barney Financial Advisors do not provide tax or legal advice. This material was not intended or written to be used for the purpose of avoiding tax penalties that may be imposed on the taxpayer. Individuals are urged to consult their personal tax or legal advisors to understand the tax and related consequences of any actions or investments described herein. Please consider the investment objectives, risks, charges and expenses associated with municipal fund securities before investing. The offering statement contains this and other important information. To obtain an offering statement, please call your Financial Advisor. Read the offering statement carefully before investing. 529 college savings plan funds not used for qualified educational expenses are subject to applicable taxes and penalties. Before investing, investors should consider whether tax or other benefits are only available for investments in the investor s home-state 529 college savings plan. Variable annuities are sold by prospectus. Investors should carefully consider the investment objectives, risks, charges and expenses carefully before investing. The prospectus contains this and other important information and should be read carefully before investing. Variable annuities are long-term investments designed for retirement purposes and may be subject to market fluctuations, investment risk, and possible loss of principal. All guarantees are based on the claims-paying ability of the issuing insurance company. Taxable distributions (and certain deemed distributions) are subject to ordinary income tax and, if taken prior to age 59 1 /2, may be subject to a 10% federal income tax penalty. For clients whose account is carried by Morgan Stanley Smith Barney, insurance products are offered in conjunction with Morgan Stanley Insurance Services Inc. For clients whose account is carried by Citigroup Global Markets Inc., Morgan Stanley Smith Barney offers insurance products in conjunction with SBHU Life Agency, Inc. Since life insurance is medically underwritten, your client should not cancel their current policy until their new policy is in force. A change to their current policy may incur charges, fees and costs. A new policy will require a medical exam. Surrender charges may be imposed and the period of time for which surrender charges apply may increase with a new policy. Your clients should consult with their own tax advisors regarding any potential tax liability on surrenders. Asset allocation does not assure a profit or protect against loss in declining financial markets. Rebalancing does not protect against a loss in declining financial markets. There may be a potential tax implication with a rebalancing strategy. Please consult your tax advisor before implementing such a strategy. Morgan Stanley Smith Barney LLC and its affiliates do not provide tax or legal advice. To the extent that this material or any attachment concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law. Any such taxpayer should seek advice based on the taxpayer s particular circumstances from an independent tax advisor Morgan Stanley Smith Barney LLC. Member SIPC. GP P-Y10/10 CLF96000 JV /10

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