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Loewer & Associates - Enrolled Agent and Accredited Tax Advisor - Kim P. Loewer


TAX FACTS AND TIDBITS


This page is where we publish our tax "tidbits" -
little tax facts and vignettes which stand alone
as fast-breaking items of interest.

    

CAPITAL GAINS IN 2008 - 2010
HOW MUCH WILL YOU OWE?

The original tax legislation a number of years ago was very clear and concise. Beginning in 2008 and extending through 2010 if you are a taxpayer in the 10% or 15% income tax bracket there is NO TAX on long term capital gains. Sound too good to be true? Perhaps. That was then - this is now. As the old saying goes, ‘the devil is in the details’.

Will Rogers, the noted American humorist, once observed “no man, woman, or child is safe as long as the Congress is in session”. Now with the enactment date for ‘tax free’ capital gains rapidly approaching, the budget deficit rising and political parties jockeying for position in the 2008 elections, what was once a straightforward concept is now becoming mired in bureaucratic red tape, exceptions, limitations and tax double-speak.

In order to clarify how the capital gains taxation will impact your 2008 - 2010 tax situation, Loewer & Associates has prepared an analysis of the tax provisions as we interpret them at this time. Additional changes are possible and we will keep you updated as those changes occur.

We would like to thank Spidell’s ElderClientPlanner.com for the authoritative research and examples used in this article.

Democratic presidential hopefuls are all talking about the capital gains rate. You might want to take advantage of the reduced capital gains rates before the rate goes up in 2011.

For a higher income taxpayer, it’s tough to plan to have a very low-income year for just one-year, but in 2006, Congress extended the lower capital gains rates enacted in 2003 for two more years. This three-year window may give more taxpayers the chance to receive some capital gains “tax-free.”

How it works

To take advantage of this opportunity, start with taxable income and remove the long-term capital gains. The amount remaining in a taxpayer’s taxable income (taxable excess) must be less than the upper threshold for the 15% marginal tax bracket for the taxpayer’s filing status ($31,850 for singles and $63,700 MFJ in 2007). Then, the amount of taxable income within the limit that is made up of qualified dividends and/or long-term capital gains will be taxed at 0%.

EXAMPLE: Karen, a single taxpayer, has taxable income in 2008 of $100,000. Of this amount, $75,000 is long-term capital gains, leaving $25,000 taxable excess. Using the top of the 15% marginal rate bracket for 2007, $6,850 ($31,850 - 25,000) of Karen’s capital gains will be taxed at 0%. The remaining $68,150 will be taxed at 15%.

Even higher-income taxpayers can benefit from deduction planning. Think of taxable income as a bucket from which we pluck out the long-term capital gains. Creative planners can think of a variety of ways to further reduce the amount that remains in the bucket after the gains have been “set aside.” Anything that reduces the remaining taxable excess below the top of the 15% marginal bracket allows for some “free” capital gains.

EXAMPLE: Eric and Carolyn have taxable income of $250,000 in 2008. Of that $250,000, $150,000 of their taxable income is from long-term capital gains. When we remove the gains from the taxable income bucket, they have taxable excess of $100,000. If they prepay their California income tax on the gain in the amount of $14,000, prepay their second installment of property taxes in the amount of $5,000, and make a $20,000 charitable contribution, they reduce the taxable excess to $56,000 ($100,000 - 14,000 - 5,000 - 25,000). Using 2007 marginal rates, $7,700 of their capital gains will be free, and the remaining $143,200 will be taxed at 15%.

Other strategies for reducing taxable income include:
• Defer receipt of income where taxpayer can control payment sources.
• Take a sabbatical or unpaid leave.
• Invest in tax-free income producing assets.
• Invest for appreciation rather than current income.
• Bunch deductible expenses.
• Prepay deductible expenses to the extent allowable.
• Perform deferred maintenance and repairs on rental properties generating taxable income.
• Maximize Section 179 expensing for new business assets acquired.
• If possible under RMD guidelines, reduce distributions from retirement plans.

The final step in taking advantage of the 2008-10 years regarding capital gains rates is to ensure collection of proceeds that are recognized as long-term capital gains before the favorable rates revert to 10% - 20% in 2011. Areas to consider:

• Accelerate collection on installment sales.
• Reposition investment portfolio allocation.
• Defer capital losses to offset higher-taxed capital gains.


Vermont Payroll Tax Alert

SUBCONTRACTORS – UNEMPLOYMENT TAX COVERAGE
AND WORKERS’ COMPENSATION INSURANCE

December 2007

Over the past couple years both the Vermont Department of Labor and insurance companies issuing workers’ compensation policies have been actively auditing small businesses that utilize subcontractors.  The scope and results of these audits have surprised most business owners.  Even worse, the additional tax and insurance premiums assessed after the audits have, in many instances, created severe financial burdens for the business.

It is important to remember that the rules and regulations regarding subcontractors vary between the Internal Revenue Service and the Vermont Department of Labor.  While Vermont may classify your subcontractor as a statutory employee for their purposes, the IRS may not take the same direction.  A Vermont audit and tax assessment will not automatically guarantee an audit from the IRS.  If you truly have subcontractors then their payments are NOT subject to federal Social Security, Medicare, or income tax withholding.  In addition the payments are not subject to Vermont income tax withholding.  You should report the amount you pay subcontractors on Form 1099-MISC as non-employee compensation and NOT on Form W-2.

As we end 2007 and prepare for 2008, let’s take an opportunity to review what issues are being audited, what the rules are, and how to ‘audit-proof’ your business.

VERMONT UNEMPLOYMENT INSURANCE: Although it is called ‘insurance’ this is really a tax imposed on businesses and collected by the Vermont Department of Labor.  Under Vermont’s unique “A-B-C Test” many subcontractors ARE subject to this tax even though the tax was originally enacted to protect employees without a job.  If a subcontractor is providing ‘substantially similar’ services to your customers – meaning the subcontractor does the same thing that your business does – then you must pay Vermont ‘unemployment tax’ on their earnings if they are a sole proprietor.  Fortunately the tax per individual subcontractor is not substantial.  The maximum compensation subject to the tax is $8,000 per year and the tax rate is generally one (1) percent, which produces a maximum tax of $80 per subcontractor.  The tax is reported and paid quarterly.  What to do?  Register with the Vermont Department of Labor, pay the tax, and avoid costly multiple year assessments of tax, penalties and interest if you are audited down the road.  The tax is relatively minor, even with several subcontractors, but the peace of mind you’ll enjoy will far outweigh the costs to your business.

VERMONT WORKERS’ COMPENSATION INSURANCE: This is truly an insurance policy purchased from a private insurance carrier.  Its purpose is to provide employees with medical and disability benefits if they were injured in the course of their employment.  Employers bear the responsibility for anyone they employ.  Vermont law defines “employer” broadly and includes work performed by independent contractors or subcontractors.  Under the same ‘substantially similar’ service test used in determining unemployment insurance coverage, the Vermont Department of Labor requires subcontractors to be covered by YOUR workers’ compensation insurance policy.  If you are audited by your insurance carrier the final assessment imposed could be a financial ‘knockout punch’ for your business.

Since questions in this area involve not only tax but also insurance issues, you should definitely consult with your insurance broker to navigate this potential minefield.  I am fortunate to deal with Laberge Insurance and Bill Laberge has been particularly helpful in this regard.

What is financially at stake should you be audited?  All payments to subcontractors could be subject to your workers’ compensation insurance rates.  In the case of a carpenter or builder whose rate is $17 per $100 of wages, payments to subcontractors of $50,000 would require a payment of $8,500.  Could your business sustain a financial hit of this magnitude?

Fortunately there is a solution to avoid having subcontractors be subject to your workers’ compensation insurance.  Require the subcontractors to purchase their own workers’ compensation policy and provide you with a certificate of insurance.  Be aware however that a basic policy, which can be purchased for a little over $700, may NOT suffice in the event of an audit.  According to my insurance broker, Bill Laberge, those policies generally exclude the policy owner from coverage and an aggressive insurance auditor may disallow that insurance certificate citing the fact that the subcontractor really doesn’t have workers’ compensation insurance coverage.  Check with your insurance broker for answers in your particular situation.

THE BOTTOM LINE: Proper planning now can save your business thousands of dollars of unnecessary penalties, interest, and insurance costs not to mention the time and aggravation of a nasty audit.  If you are following the requirements for unemployment insurance and workers’ compensation insurance then congratulations, you are taking the necessary steps to insure your business success.  If you need to comply with these regulations then now is the time to take action to correct the problems.

I realize you may have questions relating to your specific situation.  If you do please call me at (802) 545-5600 to set up an appointment or time to talk on the telephone.  I can address your concerns and assist you in developing a plan that can provide you with some peace of mind.


 Tax Surprises in Iraq Spending Bill
 
On May 25, the President signed the Iraq war-funding bill.  Look closely.  Congress couldn't resist tacking on a few tax provisions.
 
Kiddie Tax To Age 24.
One year ago, the "kiddie tax" was extended from age 14 to 18.  In 2008, it will affect students up to age 24!
 
The "Kiddie Tax" Idea.  To catch parents who move income into a child's lower bracket, there's a special rule.  A youngster with investment income over $1,700 is taxed at the higher of the tax rate of the child of the parent. Income from a job is not affected.
 
In the year the youngster reaches age 18, the rule does not apply.  Few families can afford to sock away enough money to generate this much investment income for a youngster.  But, for those who can afford it, this rule is a big problem.
 
Target 2008.  Here's the latest plan to collect extra tax from middle and high-income families.  Next year brings the lowest capital gains rates in history.  We currently have five tax "brackets".  Find your taxable income, and use these rates:
 
                            Taxable Inc. Up To                                Tax Rate
 
Singles                 $  7,825                                                    10%
                            $31,850                                                    15%
                     over $31,850                                                    25% & up
 
Couples                $15,650                                                    10%
                            $63,700                                                    15%
                     over $63,700                                                    25% & up
 

Long-term capital gains get lower rates.  The lower rates also apply to dividends of domestic corporations.  This type of income acts as if it "floats" at the top of the taxable income pile.  Any capital gain income falling in 25% or higher brackets is taxed at 15%. Long-term capital gain falling in the normal 10% or 15% brackets is taxed at 5%.  Sound good?  Wait until next year!  For 2008, 2009 and 2010 the rate on that 10% or 15% layer drops from 5% to ZERO!  Not one penny of tax!

 

Trap!  More "Kiddies" Next Year.  Families who can afford to save for college banked on using that 0% tax rate for help.  Transfer stocks to the youngster. Let the youngster sell to pay college costs - with no loss to income tax.  Congress has shot down this plan.  For 2008 and on, dependents between age 19 and 23 who are full-time students will be considered "kiddies".  Their long-term gains will be taxed at the higher tax rates of the parents.  The only way to avoid the rule is to show the youngster has enough W-2 income to cover more than half his/her support costs.  Not likely.

 

Expensing Business Equipment.  A business normally must depreciate equipment.  Small businesses can choose to write off limited amounts of equipment.  This applies for up to $112,000 of equipment, but only if the business spent less than $450,000 on new equipment.  Congress just raised the $112,000 to $125,000 and raised the total spending cap to $500,000.  The rules will be with us (and adjusted for inflation) through 2010.  After 2010 we are scheduled to return to the $25,000 limit from 2001 when these changes began.

 

Break for Mom and Pop Businesses.  When both spouses run a family business, IRS had insisted they file a partnership return, except in community property states. Now Congress says they may simply file a joint return and split the profits equally.

 

Other Business Items.  The Work Opportunity Tax Credit offers incentives to hire certain groups of workers.  The credit was set to expire after 2007, but is extended to those hired before September 1, 2011.  Several new categories of workers were added.  Several measures for businesses affected by Hurricane Katrina were extended.

 

Other Measures.  IRS is given more powers to deal with late return filings and erroneous refunds.  They also got stiff new penalties for tax practitioners.  The new sanctions cover all returns, not just income tax for all individuals and businesses.  Tougher standards, and larger fines will help IRS crack down on unscrupulous practitioners.  I'll be doing more research on "gray" areas.

 More Laws To Come? 

We're likely to see more changes.  However, some important items will likely be left for next year.  Reform of the Alternative Minimum Tax is still a hot issue, but complicated, and very expensive.  The Estate Tax is still unsettled after 2009.  We are not likely to see these resolved in 2007.

 
Mutual Funds For Beginners
 
The stock market is rocketing to new highs.  More and more people are turning away from banks and savings accounts.  They're jumping onto the mutual fund bandwagon.  It's a very different game.
 
More Growth - More Risk.  Generally speaking, money invested in the business community will grow faster than money deposited in a bank.  Generally.  Eventually.  Banks provide the money used by business for growth.  They collect interest.  They return some of the interest to account holders who supplied the money.  Business must generate more profits than the interest they pay.  It's practically a Law of Nature.
 
In the bank, your money is secure, but the growth is slow.  In the stock markets your "account" balance rises and falls.  If you invest in the wrong companies you could lose everything.  But, eventually the markets must show more growth (or else America is doomed!).
 
Mutual Funds vs. Stocks.  Most people don't buy individual stocks.  You need to "diversify" to protect against the occasional failure of a business.  In a mutual fund, hundreds of investors pool their money to buy a diversity of stocks.  Fund managers make the actual decisions.  The pool of investors share in the profits, the risks, and the cost of management.
 
Capital Gains Taxes.  Good news at tax time.  Interest you earn from a bank is taxed as "ordinary" income.  Stocks can yield two types of income, dividends (a share of the company profits), and capital gain (or loss) when the stock is sold.  Current tax law gives both dividends and long-term gains lower rates than other income.  If your taxable income is in 10% or 15% brackets, your long-term gain is taxed at only 5%.  If your tax rate is 25% or higher, most of your mutual fund income is taxed at 15%.  Quite a savings.
 
Record Keeping A Must!  You can ignore a bank account if you wish.  Your money is always there - along with some interest income.  The bank sends a Form 1099-INT each January showing the income you must report.  Easy.
Mutual funds take more work.  Sure, the dividend income is reported on Form 1099-DIV.  Gains, however, may come in two different forms:
 
    1.  Capital Gain Distribution.  This means the fund manager sold some of the fund's stock at a profit.  The profit is not paid to the investors.  It's used to buy some other stock.  That's how a fund grows.  Problem - you are taxed on this gain, even though you don't receive any money.  Tax law says it's a long-term capital gain, even if you invested just a few weeks ago.  Of course, you get the low tax rates mentioned above.
 
    2.  Gain/Loss Upon Sale.  When you sell some or all of your shares you must report the sale.  Your cost for the original shares (including any commission) is compared with what you receive upon sale (less any commissions paid) to measure the gain or loss.  If you have held the shares for more than one year those extra-low tax rates mentioned above will apply.
 
    Full Details Needed.  A full history of your investment is needed to measure your gain.  Suppose you invested $1,000 a few  years ago, and now sell for $1,400.  You might think your "profit" or "gain" is $400.  But, what about capital gain distributions.  Likely you have nearly $400 of such distributions over time - that's why the fund is now worth an extra $400.  You already paid tax on the $400.  You have no gain or loss.
 
    Broker Often Helps.  Today most brokers and mutual fund companies keep these records for you. They send a "Statement of Realized Gain/Loss" when you sell.  IRS would like them to report your gain/loss directly to them.  This is all well and good - until you change brokers.  How can the new broker know your investment history?  If you invest using an on-line account, the information can be found in the "My Account" section, but many folks don't know how to use the feature.  Keep records!
 
     Reinvesting Dividends.  This is the most popular form of investing.  To maximize growth, the fund offers to use your dividends to buy more stock.  Now the records are a serious chore.  You made a buy when you started, but you buy more stock every time there's a dividend - often it's every single month!  After a few years there are dozens of purchases to track.  Thank goodness the brokers offer to provide a statement of your gain/loss. Don't lose it!!!
 
Hybrid Cars - Some Credits To Disappear
More and more hybrids qualify for up to $3,400 in tax credits.
Problem - Toyota's credits will end in September.
 
Gasoline prices continue to rise. Hybrid car sales increase just as rapidly.  These vehicles feature both a gasoline engine and an electric motor - plus a higher price tag.  Tax credits help cut the cost, but the credits' days are numbered.
 
Credits Limited.  If your tax bill is low, the credits can only reduce it to zero.  The extra credit is lost.  Also, your credit can be lost if you run into the Alternative Minimum Tax.  Call me before you buy - I may be able to tell whether the credit is available.
 
Toyota Credits To Decline.  IRS has approved more than 35 models for the credits so far.  Ask your car dealer, or check at the IRS website.  In theory, the credit can be as large as $3,400.  In fact, Toyota Prius has the highest credit so far at $3,150.  However, Prius's credit is already less, and soon will be gone.  Credits decline after more than 60,000 qualified vehicles are sold by a given manufacturer.  Toyota (who also makes Lexus) sold the 60,000th hybrid in June of 2006.  For all models of Toyota and Lexus hybrids, here's the scheduled "phase out":
 
            Until October 2006                    Full credit
            Oct. '06 until Apr '07                  50% credit
            Apr '07 until Oct '07                   25% credit
            Starting October 1, 2007            No credit 
 
For April 1 through September 30 of 2007, the Toyota credits are:
 
            $787.50 - Toyota Prius
            $650 - Highlander Hybrid
            $550 - Lexus RX 400h
            $387.50 - Lexus GS45oh
 
The numbers were twice this size for purchases earlier in 2007.  Ford, GM, Honda, Mazda, and Saturn all have vehicles qualifying for varying amounts of credit.  None have reached the 60,000-vehicle level to date.
 
I Get Questions
Here are a few questions that pop up over and over again.
 
Q Roth IRA.  I had to take some money from my Roth IRA.  I'm only 51 years old.  Will there be a tax, or penalty, or both?
A Perhaps Neither.  A Roth IRA has a peculiar "layering" of the dollars within it, much like a cookie jar.  The first dollars you take out are deemed to be the ones you contributed.  You got no tax break when you contributed, so there is no tax or penalty on these dollars.  The second layer of money is any that you "converted" from traditional IRA to Roth IRA.  You already paid the tax, and won't be taxed again, but a 10% penalty applies unless the conversion was more than 5 years ago.  The bottom layer is the growth money.  Take any of these dollars and both income tax and penalty (since you are not yet 59 1/2) will apply.
 
Q Closed Business.  I shut down my business last year, but paid the last of the expenses this year.  May I deduct these?
A Very Likely!  Assuming you were a "sole proprietor" filing Schedule C, we'll simply file another Schedule C and deduct the expenses. If your business was a partnership or corporation things are more involved, but we'll still get value from your expenses.
 
Q Large Medical Gift.  I've heard the most I can give to someone this year is $12,000.  I just paid $26,000 of my mother's medical expense.  Do I have a problem?
A Nope!  You fall under an exception.  A gift is limited to $12,000 in any year.  There is an unlimited exception for medical expense or school tuition.  The single catch is that the payments must be made to the provider or school rather than to your mother.  You may have a small bonus - your mother might qualify as your dependent, but I'll need more information from you.
 
Q Charity From Inheritance.  My mother passed away this year. I donated her furniture to a local charity.  Do I get a deduction?
A Depends.  We need to know who made the contribution.  I realize you did this, but who did the furniture belong to?  Was it your Mother's estate or trust making the donation?  If so, the deduction is not yours. If the furniture was now yours (that is, you inherited it), you may definitely claim a deduction for its fair market value.
 
Q Forgot a Stock Sale.  I just realized that I forgot to report a small stock sale on my last return.  The sale caused a tiny $20 loss. Is it worth worrying about this?
A  We Probably Need to Amend Your Return.  The $20 loss is not important.  There's another problem.  IRS receives Form 1099-B listing "gross proceeds" for any stock sale.  Since no sale appears on your return, IRS will say the full amount may be income.  If this was a "penny stock" you bought for $50 and sold for $30, we might be OK to ignore it.  IRS is not likely to bother you over a possible $30 of income.  But, suppose you bought the stock for $10,000 and sold for $9,980.  The IRS computer will spot you, and IRS will presume you have an additional $9,980 of income.  We can clear this up, of course.  However, you have just given IRS a chance to say "let's take a close look at this return before we send a letter".  Bad move!  You never want to invite them to inspect your tax return. If your case is like this, I suggest we file an amended return as soon as possible.
 
IRS Crackdown Coming
 
The "Tax Gap" - IRS Top Target.  Last year IRS concluded a massive study of 2001 income tax returns. They wanted to measure the "Tax Gap", the difference between the income tax we actually paid and what we should have paid.  Why did this take 5 years?  Late in 2001 IRS began the National Research Program (NRP) to study our 2001 income tax returns.  They randomly selected 46,000 returns for audit.  The audits were thorough and time-consuming.  The NRP took 3 years to complete.
 
    $345 Billion Shortfall.  The number is indeed large. Consider that in 2001 we paid income taxes of just under a trillion dollars.  We should have paid another $345 billion.  IRS says we should have paid over one-third more than we did.  Why?  Clearly, some tax is underreported.  IRS says the largest understatements come from self-reported items - no big surprise.
 
How To Fix It?  IRS wants to see more information reporting.  They'd like brokers to report gains/loss from stock sales.  Even more information on W-2s.  Reporting on government contracts.  And --- more and more.  They also want stiffer audits and more information on where the errors are most likely to be found.
 
Tougher Audits.  Early this year IRS set up new standard for audits.  We can expect more correspondence reviews on items that do not match IRS records.  Face-to-face meetings last longer, and auditors demand more and better records.  They ask more questions than ever - probing questions aimed at understanding spending patterns and life-style.  The only good news here is the total number of face-to-face audits will decline a bit as more time is spent on each case.
 
Random Audits Return.  It's been more than 10 years since IRS was forced to stop a different random audit program.  They used results to fine-tune their top-secret computer program to identify items most likely to yield extra tax revenue.  IRS did about 2,500 of these special audits each year.  They checked every single line on the tax forms.  Folks were asked to prove why most lines are left blank!  Taxpayers complained the program was too harsh and time-consuming, so Congress shut it down.
    They're back.  Same goal -  learn how well we comply with the system. The new audits are shorter, and focus on one or two areas of the return.  To gather enough information IRS needs more audits - 13,000 each year for 3 years. Chances you will see one - 1 in 9,000.  We won't know details until reports come in from folks who have faced the new audits.  The program is set to begin in October.  It probably will be 6-10 months before we hear any real details on what happens at the meetings.  Stay tuned.
 
Tips For You
 
Donated Property - No IRS Help.  On August 16, 2006 we got a new rule on deductions for donated household items.  No deduction is allowed unless items are in "good used condition or better".  We've been waiting for IRS help in making this determination.  IRS Publication 561, Determining the Value of Donated Property, was re-written in April 2007.  No real help.  They tell us the value of such items is far less than the price paid when new.  They say the items may have little or no market value because of their worn condition, or they may be out of style, or no longer useful.  They do not explain "good used condition or better".  IRS says the "value list" offered by Goodwill, Salvation Army, and other is not an accurate valuation method.  Looks like we're on our own here.  I still recommend (a) don't try to claim deductions for junk, (2) make a fairly detailed list, with descriptions, and (3) take some snapshots.
 
College Savings Programs.  The new "kiddie tax" rules at the beginning of this newsletter may scare parents out of trying to save for a college education for a youngster.  We still have two "tax-favored" programs that avoid the issue.
 
    Coverdell Education Savings Accounts are much like an IRA for education.  An account is set up for a specific child's benefit. The most one may contribute for a given child is $2,000 per year.  Also, anyone may contribute, not just parents.
 
    Section 529 Plans.  Each state has one of these.  Many colleges also have one.  Contribution limits are much higher - over $100,000 total in most cases.
 
    Both plans allow income to build up without tax.  When money is withdrawn, even the growth is tax-free if the funds are spent on the proper education costs.  There are many other differences.  For a clear and readable explanation, look at the website www.collegesavings.org.  The big news - neither program generates kiddie tax problems.
 
In-Home Day Care Providers.  If you run a day care center at home IRS uses an allowance for meals and snacks.  No need to keep receipts.  The 2007 figures for each meal or snack served are:
            Breakfast - $1.11
            Lunch or dinner - $2.06
            Snacks - $0.61
You must record names of the children, hours or care, and meals and snacks provided.  The allowance often exceeds actual costs, but you are still allowed to use it.  Rates are higher for those living in Alaska and Hawaii.  Complete details are at www.fins.usda.gov under "Child and Adult Care Food Program".
 
Volunteer Work.  If you do work for your church, library, or other charitable group you are entitled to charitable deductions for your direct contributions, but not for your time.  Direct expenses could include office or hobby supplies, telephone or fax expense, photocopying, or the cost to provide refreshments at meetings.
 
    Mileage and Travel for such work are deductible, as long as there is no significant element of leisure or vacation involved.  For out-of-town events, include all fares, lodging and meals.  Local transport usually is just mileage.  The allowance is only 14 cents per mile for charity, but the value can add up quickly.  Be sure to make note of all the driving you do for the group, including shopping and preparation for the events.
TAX CALENDAR
 
Sept. 17            3rd Quarter estimated tax payments due.
 
Oct. 15              Extensions to file 2006 Form 1040 expire.
 
Oct. 31              3rd Quarter payroll returns due.
 
Dec. 31             Last chance for deductions in 2007.
 
Jan. 15              4th Quarter estimated tax payments due.
 

Make Standard Deduction Worth More by Bunching Deductible Expenditures

This year, the standard deduction for married joint filers is $10,700. The magic number for single filers is $5,350, while the figure for heads of households is $7,850. If your 2007 itemized deductions are likely to be just under or over this amount, it may pay to adopt the strategy of bunching together expenditures for itemized deductions every other year, while claiming the standard deduction in the intervening years. Examples of items that often work well for this strategy include the interest on your January home mortgage payment, charitable contributions, property taxes, and state income tax payments.

For example, say you’re a joint filer whose only itemized deductions are $4,000 of annual property taxes and $7,000 of annual home mortgage interest. If you prepay your 2008 property taxes by December 31, you could claim $15,000 of itemized deductions on your 2007 return ($4,000 of property taxes for this year, plus another $4,000 for the 2008 bill, plus $7,000 of mortgage interest). In 2008, you would only have the $7,000 of mortgage interest, but you can claim the standard deduction which will probably be around $11,000 after an inflation adjustment. This strategy allows you to cut your taxable income by a meaningful amount over the two-year period. You can then repeat the drill all over again in 2009 and 2010.

Consider Deferring Income

It may also pay to defer taxable income from this year to next year, especially if you expect to be in a lower tax bracket in 2008. For example, you can postpone taxable income by putting off client billings until late in the year so you don’t receive payment until 2008 (assuming you are a cash method taxpayer) and by prepaying deductible business expenses near year-end. Deferring income may also be helpful if you’re affected by unfavorable phase-out rules that reduce or eliminate various tax breaks (such as your itemized deductions, the child tax credit, the education tax credits, and so forth). By deferring income every other year, you may be able to substantially increase your eligibility for these tax breaks every other year.

Time Investment Gains and Losses

As you evaluate investments held in your taxable accounts, consider the impact of selling appreciated securities. Regular federal income tax rates for 2007 can go as high as 35%, whereas taxes on long-term capital gains (LTCGs) from 2007 sales are generally taxed at no more than a 15% federal rate. The preferential LTCG rates are only available for securities held for over one year and they expire after 2010. Therefore, it makes more sense than ever to hold appreciated securities for at least a year and a day before selling. That said, now may be a great time to cash in some long-term winners to benefit from the historically low tax rate.

However, if you expect to be in the 10% or 15% bracket for regular income taxes next year, you might benefit from postponing LTCGs until then. Why? Because LTCGs will be taxed at 0% to the extent they fall within the income limits for the lowest two regular income tax brackets. Obviously, 0% is the best tax rate you’ll ever see! For 2008, you should be in this sweet spot (where LTCGs will be taxed at 0%) if your taxable income (your income reduced by all your deductions and exemptions) doesn’t go over about $64,000 for joint filers, $43,000 for heads of household, and $32,000 singles.

Selling some loser securities (currently worth less than you paid for them) before year-end can be a good idea too. The resulting capital losses will offset capital gains from other sales this year (including short-term gains from securities owned for one year or less). If capital losses exceed capital gains, the excess losses can be used to shelter up to $3,000 of your high-taxed ordinary income from salaries, bonuses, self-employment, and so forth ($1,500 if you’re married and file separately).

Depending on your exact situation, you could actually collect greater tax savings by triggering capital losses during a year in which you have minimal or no LTCGs, so that the losses will offset higher taxed ordinary income. That could be next year rather than this year. Call us if you want help in identifying your tax-smart options.

Kiddie Tax Alert: Will Your Child Be 18 or Older at Year-end?

When the dreaded Kiddie Tax hits part of your child’s unearned income (typically from investments), it gets taxed at your higher marginal rate rather than at your child’s lower marginal rate. For 2007, the Kiddie Tax won’t affect a child who is age 18 or older as of year-end. Next year, however, the Kiddie Tax can hit part of the unearned income of a child who will be age 18 and a student who will be age 19–23 as of 12/31/08 if the child earned income (such as, wages) for the tax year doesn’t exceed one-half of his or her support.

As you can see, your child could be exempt from the Kiddie Tax this year (because he or she will be 18 or older at year-end), but not next year (because he or she will be a student age 19–23 without sufficient earned income). In this scenario, consider having your child trigger some taxable gains and income this year. They will be taxed at your child’s lower rate. Next year, that might not be true due to the new Kiddie Tax age rules. Keep in mind that, for this year, the Kiddie Tax only hits unearned income in excess of $1,700. The threshold for next year will probably be higher due to an inflation adjustment. Also, the student’s earned income is not subject to this tax.

Consider Giving Appreciated Securities to Younger Family Members

A great way to reduce the tax hit on an appreciated security is to give it your child or grandchild. The child can hold the security until a year when the Kiddie Tax doesn’t apply and then sell. (Take care to avoid the new Kiddie Tax rules that will kick in next year.) The resulting capital gain may well be taxed at 0% if the sale takes place in 2008–2010 (assuming the current rate structure is left in place). For example, in 2008, the 0% LTCG rate will apply if the child isn’t subject to the Kiddie Tax and his or her taxable income doesn’t go over about $64,000 for joint filers, $43,000 for heads of household, and $32,000 singles.

Remember that giving the security to your child is considered a gift. However, you can use your annual $12,000 gift tax exclusion to shelter the transaction from any gift tax. For larger gifts, you can use up part of your $1 million lifetime gift tax exemption to avoid any gift tax hit. However, dipping into your $1 million exemption could result in a higher estate tax bill after you die.

Take Advantage of Favorable New Provisions

Several taxpayer-friendly changes kicked in this year. They include the following.

  • Bigger Section 179 Deduction. For its tax year beginning in 2007, your business may be able to take advantage of the increased Section 179 deduction. The maximum deduction is now a whopping $125,000 (up from $112,000). Under the Section 179 privilege, an eligible small business can often claim first-year depreciation writeoffs for the entire cost of most new and used equipment and software additions. If you are thinking about purchasing equipment, furniture, or other tangible property for use in your business, now may be the perfect time to do so. However, restrictions apply. Call us for details.

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  • Liberalized Health Savings Account (HSA) Rules. Deductible contributions can be made to HSAs set up for individuals who are covered by qualifying high-deductible health plans (HDHPs). You can then take federal-income-tax-free withdrawals from your HSA to reimburse yourself for qualifying out-of-pocket medical expenses. A law passed late last year generally allows bigger deductible HSA contributions for 2007. In addition, you may qualify to roll over amounts from your employer’s health care flexible spending account (FSA) plan or health reimbursement arrangement (HRA). You may even be able to roll over some money from your IRA. However, there are plusses and minuses to consider before embracing any of these ideas. Call us if you want to hear more about HSAs. (In general, the sooner in the year you obtain HDHP coverage and set up your HSA, the better.)

Take Advantage of Expiring Tax Breaks before They Become History

As the tax law currently reads, a host of valuable breaks are scheduled to expire at the end of this year. While the odds are good that some, or even most, of them will be extended by future legislation, don’t bet the farm on it. The prudent course is to take action before year-end to cash in on breaks that are meaningful to you or your business. Here’s a brief rundown on expiring provisions (this is not a complete list).

  • Itemized Deduction for State and Local Sales Taxes. The optional deduction for state and local sales and use taxes (in lieu of deducting state income taxes) will expire at the end of this year unless Congress takes further action. If you live in a state with low or no state income tax, you may want to make some big-ticket purchases (such as a new car or boat) before year-end to increase your sales tax deduction.

 

  • Credit for Nonbusiness Energy Expenditures. The up-to-$500 tax credits for nonbusiness energy efficiency improvements such as qualifying exterior windows and doors, insulation, and heat pumps will expire at the end of 2007 unless Congress extends them. The credit amounts are modest, but they could make it worth your while to make some energy-saving changes to your principal residence. Improvements must installed by 12/31/07 to qualify.

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  • Charitable Donations from IRAs. If you’ve reached age 70½, a law change from last year allows you to arrange to distribute up to $100,000 of otherwise taxable IRA money to specified tax-exempt charities. These so-called qualified charitable distributions (QCDs) are federal-income-tax-free to you, but you don’t get to claim any itemized deductions on your Form 1040. However, the tax-free treatment equates to a 100% writeoff and you don’t have to itemize your deductions to get it. This favorable provision will expire at the end of this year unless Congress extends it.

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  • Faster Depreciation for Leasehold and Restaurant Improvements. Favorable 15-year depreciation is allowed for qualified leasehold improvements and qualified restaurant improvements that are placed in service by 12/31/07. However, this break will expire at the end of this year unless Congress extends it. If that happens, the cost of these improvements in future years would generally have to be depreciated over 39 years.

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  • Breaks for Business Charitable Donations. Enhanced deductions are allowed for certain types of charitable donations made through 2007 by businesses. There are two enhanced deductions available to C corporations—one for donations of computer equipment and technology and another for qualified book contributions. Non-C corporation businesses get an enhanced deduction for donations of food inventories. Last, but not least, is a rule that provides favorable treatment for S corporation donations of certain appreciated assets. These enhanced deductions and special rules will be unavailable in tax years beginning after 2007 unless Congress extends them.

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  • Special Rules for Qualified Conservation Donations. Rules that provide extra-favorable treatment for qualified conservation contributions by individuals and farm businesses to charitable organizations will be unavailable in tax years beginning after 2007 unless Congress extends them.

Watch for These Unfavorable Changes

Several anti-taxpayer changes also kicked in this year or in the middle of last year when you might not have noticed. They include the following:

     

  • All Cash Donations to Charity Must Be Documented (No Exceptions). You’re no longer allowed any writeoffs for contributions of cash, checks, or other monetary gifts unless you retain either a bank record that supports the donation (such as a cancelled check or credit card receipt) or a written statement from the charity that meets tax-law requirements. For cash donations of $250 or more, a bank record is not enough. You must obtain a charity-provided statement that meets tax-law standards.

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  • Stricter Rules for Donated Used Clothing and Household Items. You’re no longer allowed to claim deductions for charitable donations of used clothing and household items that are not in good condition or better and of substantial value. The term household items means furniture and furnishings, electronics, appliances, linens, and the like. Be sure to keep a list and photo (to help establish the item’s condition) of donated items, as well as purchase documents, receipts to substantiate the value, and other proof of how you established the item's value.  Have an appraisal done for donations over $5,000.00.

Don’t Forget about Your Estate

The current federal estate tax exemption is $2 million. It’s scheduled to increase to $3.5 million in 2009 and then be completely repealed in 2010—but just for that one year. It now seems quite clear that if the promised repeal ever happens at all, it will just be for 2010. The more likely scenario is that we will continue to have a federal estate tax for 2010 and beyond, but possibly with a somewhat larger exemption than the current $2 million figure. Therefore, planning to avoid or minimize the federal estate tax should still be part of your overall financial game plan.

Whittling your estate down by making annual gifts continues to be a tax-smart strategy. If you have some favorite relatives or unrelated persons, you can give each of them up to $12,000 this year. Your spouse can do the same. These gifts will reduce your estate tax exposure without any adverse gift tax effects. Making multiple gifts over multiple years can dramatically reduce your exposure. So, the sooner you start an annual gifting program, the better. Contact us for more information on the best ways to avoid estate taxes.


Small Business and Work Opportunity Tax Act of 2007

In late May, Congress passed yet another major new tax law. This one is called the Small Business and Work Opportunity Tax Act of 2007 (the Act). The president signed it into law on May 25. The stated purpose of the new legislation was to provide small business owners with tax relief to help offset scheduled increases in the federal minimum wage. However, the Act also includes "revenue raisers" (better known as tax increases). This Tax Tidbit briefly summarizes the most important tax changes.

Unfavorable New Kiddie Tax Rules

If the Kiddie Tax applies to your child, part of his or her unearned income (typically from investments) will be taxed at your higher marginal federal rate rather than at your child’s lower rate. For 2008 and beyond, the Kiddie Tax can potentially come into play until the year during which a child turns 24. It finally cuts out for that year and for all subsequent years. More specifically, for 2008 and later years, the Kiddie Tax applies only when all of the following four requirements are met. The first three requirements are the same as before the new law. The fourth requirement (the one having to do with the child’s age) was changed.

1. Living Parent Requirement. One or both of the child’s parents are alive at year-end and in a higher marginal federal income tax bracket than the child. (Since you are reading this letter, this first requirement is probably met.)

2. Filing Requirement. Your child doesn’t file a joint return for the year.

3. Unearned Income Requirement. Your child’s unearned income for the year exceeds the annual threshold. For both 2006 and 2007, the threshold is $1,700. For 2008, it may be higher due to an inflation adjustment. If your child’s unearned income doesn’t exceed the threshold, the Kiddie Tax doesn’t apply. If your child’s unearned income exceeds the threshold, only the amount in excess of the threshold is hit with the Kiddie Tax. That means the excess income gets taxed at your higher marginal rate.

4. Age Requirement. Your child is—

    • under age 18 at the end of the year,

    • age 18 at the end of the year and doesn’t have earned income in excess of 50% of his or her support, or

    • age 19–23 at the end of the year, is a student, and doesn’t have earned income that exceeds half of his or her support.

Liberalized Section 179 Instant Deduction Rules

Under the Section 179 rules, many small businesses can immediately write off the entire cost of equipment and software additions in the year of acquisition. The Act extends the current very favorable Section 179 deduction rules for one more year—through tax years beginning in 2010. In addition, the Act makes the rules even more generous starting with tax years beginning in 2007 (this year) by increasing the maximum Section 179 deduction to $125,000 (up from $112,000). For 2008–2010, the $125,000 amount will be indexed for inflation.

Note: Unless Congress takes further action, the maximum Section 179 deduction will revert back to only $25,000 after 2010.

Liberalized Rules for S Corporations

The Act makes the following favorable changes (among others) to the S corporation tax rules.

     

  • S Corp Stock and Securities Gains Not Treated as Passive Income. When an S corporation has earnings and profits (E&P) from prior C corporation years, it can be exposed to a corporate-level tax on excess net passive income. In addition, the corporation’s S status can be revoked if more than 25% of gross receipts are from passive investment income for three consecutive years. Effective for tax years beginning after 5/25/07, gains from an S corporation’s sales of stock and securities won’t count as passive investment income for purposes of these unfavorable rules.

  • Pre-1983 E&P Eliminated for Certain S Corps. If a corporation was an S corporation for any tax year that began before 1/1/83 and was not an S corporation for its first tax year that began after 12/31/96, any earnings and profits (E&P) accumulated during pre-1983 S corporation years are eliminated from the corporation’s accumulated E&P balance. For an affected S corporation, this favorable provision can reduce the amount of distributions that will be treated as taxable dividends. The change takes effect at the start of the first S corporation tax year that begins after 5/25/07.

Other Revenue Raisers (Tax Increases)

In addition to the unfavorable Kiddie Tax changes, the Act includes (among others) the following additional revenue raisers (otherwise known as tax increases).

  • New Taxpayer Penalty. A new taxpayer penalty on erroneous claims for refunds or credits generally equals 20% of the disallowed portion of the claim for which there is no "reasonable basis." This change is effective for claims filed after 5/25/07.

  • Suspension of Interest and Penalties When IRS Fails to Issue Deficiency Notice. Pretty soon the IRS will be able to accrue interest and penalties for 36 months after the date a problematic tax return is filed without bothering to issue any specific deficiency notice to the taxpayer. After 36 months, the accrual of additional interest and penalties is suspended (finally) until the IRS gets around to issuing such a notice. Previously, the IRS could only accrue interest and penalties for 18 months without issuing a specific notice. This super-unfavorable change is effective for IRS notices issued after 11/25/07.

  • Hearings Before Employment Tax Levies. In certain circumstances, an employer can lose the right to have a hearing before the IRS issues a levy for unpaid employment taxes. This scary new rule is effective for levies issued on or after 9/22/07.

  • IRS User Fees. The IRS charges so-called user fees for various "services" such as issuing private letter rulings and approving accounting method changes. The Act permanently extends the IRS’s legal authority to charge user fees.

  • Minimum Bad Check Penalty. The new law increases the minimum penalty on taxpayers who issue bad checks (or money orders) to the government to $25 or the amount of the check (or money order), whichever is less. This change only applies to bad checks (or money orders) for less than $1,250 that are received after 5/25/07.


MIXING BUSINESS & PLEASURE WITH TRAVEL

Although business is business and pleasure is pleasure, the world rarely adheres to absolutes. Thus, this time of year you may want to mix some vacation days with your business travel. With a little planning, you can get Uncle Sam to subsidize your downtime. Here are the strategies for doing just that.

Combine Business and Vacation Plans for Domestic Travel

If you go on a business trip within the U.S. and add on some vacation days, you know you can deduct some of your expenses. The only question is how much. First, let’s cover just the pure transportation expenses. By this, we mean the costs of getting to and from the scene of your business activity, which includes travel to and from your departure airport, the airfare itself, baggage tips, cabs to and from the destination airport, and so forth. Costs for rail travel or to drive your personal car also fits into this category. The bottom line is your domestic transportation costs are 100% deductible as long as the primary reason for the trip is business rather than pleasure. On the other hand, if vacation is the primary reason for your travel, none of your transportation expenses are deductible.

The IRS doesn’t specify how to determine if the primary reason for domestic travel is business. Obviously, the number of days spent on business versus pleasure is the key factor. We can look to the rules covering foreign travel for guidance on this issue. They say your travel days count as business days, as do weekends and holidays if they fall between days devoted to business and it would be impractical to return home. "Standby days," when your physical presence is required, also count as business days, even if you’re not called upon to work on those days. Any other day principally devoted to business activities during normal business hours is also counted as a business day, and so are days when you intended to work but couldn’t due to reasons beyond your control (local transportation difficulties, power failure, etc.).

For domestic trips, you should be able to claim business was the primary reason for a sojourn whenever the business days exceed the personal days. Be sure to accumulate proof about this and keep the proof with your tax records. For example, if your trip is made to attend client meetings, log everything on your daily planner and copy the pages for your tax file. If you attend a convention or training seminar, keep the program and take some notes to show you attended the sessions.

Once at the destination, your out-of-pocket expenses (lodging, hotel tips, 50% of meals, seminar and convention fees, cab fare, etc.) for business days are fully deductible. Expenses for personal days are nondeductible (except in the "Saturday Night Stayover" situation covered later in this letter).

Example: You are a sole proprietor. You arrange a business meeting with an important client in San Francisco on Wednesday morning. You fly out Sunday evening and spend all day Monday sight-seeing. Tuesday you spend most of the day preparing for the meeting, attend the powwow the next morning, take the client to lunch, and return home Wednesday night. So, Sunday, Tuesday, and Wednesday count as business days. The business meeting obviously necessitated the trip, and you clearly didn’t spend an unreasonable amount of time on personal activities. Therefore, you can deduct your airline tickets, plus your lodging for Sunday and Tuesday nights, 50% of your meals for Sunday, Tuesday, and Wednesday, your other out-of-pocket expenses for those days, and 50% of the cost of lunching with your client.

Maximizing the Tax Benefits of a Saturday Night Stayover

A great way to maximize deductions for the personal portions of a trip is with a Saturday night stayover that reduces the overall cost of the trip. If you can show staying the extra day or two costs less (or no more) than coming back home immediately after the business meeting is over, the IRS allows you to deduct your additional meal and lodging expenses (subject to the 50% rule for meals) for the extra day(s). Naturally, you still must have a dominant business purpose for making the trip in the first place. Be sure to document that your airfare savings equaled or exceeded the out-of-pocket costs of staying the extra day(s). Keep the proof with your tax records.

Example: You have a business meeting in New York on Monday morning. You and your spouse fly into town Saturday morning and spend the weekend seeing the sights in the Big Apple. Your round trip airfare is only $400 versus $1,200 if you came in Sunday night and left Monday. In this situation, Saturday is a personal day since you would normally fly in Sunday. No problem. As long as your meal and lodging expenses for Saturday are no more than $800, you can write-off your whole trip (subject to the 50% rule for meals). Of course, you generally can’t deduct the additional costs for your spouse (his or her airfare and meals and any extra charges for having two people instead of one in the hotel room), and you can’t deduct purely personal expenses like show tickets and baseball games. Still, this is a great deal tax-wise.

Deducting Foreign Travel Costs

When you travel outside the U.S. primarily for business reasons, the general rule is that you must allocate all your travel expenses, including transportation, between business and personal. However, there are two big exceptions, and you often can plan ahead to take advantage of them. You can deduct 100% of your transportation expenses if you meet either of the following rules:

     

  • The One-week Rule. You’ll meet this rule if your business trip is a week or less, not counting the day you leave, but counting the day you return. In this case, you can deduct 100% of your transportation costs and 100% of your other out-of-pocket expenses for business days (subject to the 50% rule for meals). You cannot deduct out-of-pocket costs incurred on vacation days. The good news: weekends and holidays falling between business days count as business days. Ditto for an intervening weekday between two business meeting days. "Standby days" when your physical presence is required for business also count, even if you spend most of your time on personal pursuits during those days. Finally, business days include the day of your return trip plus days you intended to work but couldn’t due to reasons beyond your control.

     

  • The 25% Rule. You can also deduct 100% of your transportation expenses for trips lasting over a week, as long as you spend less than 25% of your days on vacation. For this purpose, count the day of departure and day of return as business days. Also, count all the other types of business days mentioned under the one-week rule above. Once again, however, you cannot deduct meals, lodging, and other expenses allocable to personal days.

     

Even if you don’t qualify for either of the above two exceptions, you (or, more likely, your employer) can still deduct 100% of your transportation costs if you’re traveling under a reimbursement or travel allowance arrangement and you’re not a managing executive of the company or related to your employer. And finally, in sort of a catchall provision, 100% of your transportation costs to foreign destinations are deductible if you can prove a personal vacation was not a consideration in choosing to make the trip.

If 100% of your transportation expenses aren’t deductible under any of the above rules, the business percentage of your transportation costs are still deductible—assuming the trip is primarily for business. To calculate the business percentage, divide the days spent principally on business activities by the total number of days outside the country, counting departure and return days. The travel days count as business days, just as the other types of days are considered business days for purposes of the one-week rule and 25% rule. You can also deduct the out-of-pocket expenses allocable to your business days (subject to the 50% rule for meals).

Example: On Thursday, you fly to Milan, Italy for customer meetings on Friday and Monday. You vacation the following Tuesday through Friday and return home Saturday. The two travel days, the two meeting days, and the weekend days in between count as business days. However, the four vacation days amount to 40% of your time, so you fail the 25% test. Therefore, you must allocate your airfare between business and personal. You can deduct 60% of your airfare, plus your out-of-pocket expenses for the six business days.

Example: Same as above, except this time you have only two vacation days (20% of your total days). Remember, the weekend days between your business meetings also count as business days. Now you can deduct 100% of your airfare because you pass the 25% test. You can also deduct your out-of-pocket expenses for the eight business days.

Example: Same as above, except this time you return home on Thursday, three days after concluding your business meetings. Now, your trip is considered to last only a week (the departure day doesn’t count). So, you can deduct 100% of your airfare under the one-week rule. You also deduct your out-of-pocket expenses for all the business days.

Travel to Attend Foreign Conventions

If the reason for a trip outside North America is to attend a business convention directly related to your trade or business, you may qualify for deductions. However, you must follow all of the above foreign travel rules plus show it was just as reasonable for the meeting to be held on foreign soil as in North America and that the time spent in business meetings or activities was substantial when compared to that spent sight-seeing and other personal activities. Otherwise, you can only deduct the registration fees and other costs directly related to business while on your trip. Also, regardless of the location, you cannot deduct travel costs to attend investment or financial planning conventions and seminars.

Fortunately, the stricter rules for foreign conventions are inapplicable in many cases because the definition of "North America" for this purpose is very liberal. It includes Canada, Mexico, Puerto Rico, the U.S. Virgin Islands, American Samoa, the Northern Mariana Islands, Guam, the Marshall Islands, Micronesia, Palau, Netherlands Antilles, Bahamas, Aruba, Antigua, Barbuda, Barbados, Bermuda, Costa Rica, Dominica, Dominican Republic, Grenada, Guyana, Honduras, Jamaica, Saint Lucia, Trinidad and Tobago, Midway Islands, Palmyra Atoll, Baker Island, Howland Island, Jarvis Island, Johnston Island, Kingman Reef, and Wake Island.

Conventions on Cruise Ships

Deductions related to conventions directly related to your trade or business that are held aboard cruise ships are limited to $2,000 per individual per calendar year. In addition, the ship must be a U.S. registered vessel, and all of its ports-of-call must be in the U.S. or its possessions. Finally, the following information must be attached to your return in the year the deduction is claimed:

1. A signed statement showing the total days of the trip (excluding travel to and from the ship), the number of hours each day spent attending scheduled business activities, and the program of the convention’s scheduled business activities.

2. A statement signed by an officer of the sponsoring organization that includes a schedule of each day’s business activities and the number of hours you attended those activities.


With the current year winding down, it’s time once again to consider year-end tax planning as a way to keep more of your hard-earned money. Year-end planning changes each year due to changing tax rules, as well as changes in your own personal financial and tax situations. For 2006, there are new planning strategies resulting from the two Tax Acts Congress has passed so far this year, as well as the phase-in and expiration of some provisions of prior year Tax Acts. Here are a few tax-saving ideas to get you started. As always, you can call on us to help you sort through the options and implement strategies that make sense for you.

Know Your Alternative Minimum Tax Exposure

The first step in year-end planning is to see whether you might be subject to AMT this year (or next year for that matter). Taxpayers must compute their taxes under both the regular tax and AMT rules and then pay the greater of the two. The current rules encompass many unsuspecting taxpayers. However, some AMT tax relief was granted this year in the form of higher AMT exemptions for 2006. AMT greatly complicates tax planning because many great planning strategies that work in a regular tax situation have adverse consequences for AMT.

Certain items can increase your risk of AMT, including exercising incentive stock options, recognizing substantial long-term capital gains, and deducting a significant amount of state and local taxes or miscellaneous itemized deductions (like unreimbursed employee business expenses). But no one is safe from AMT anymore, and planning when AMT applies is tricky because each situation is unique. Therefore, if you have any of the items mentioned or suspect AMT might be an issue, please contact us so we can help you review and plan for your particular situation. Now that we’ve addressed the AMT matter, let’s move on to a variety of tax planning strategies that normally apply to the vast majority of taxpayers—that is, those in a regular tax situation.

Business Planning

Expense the Cost of up to $108,000 of Business Property. The Section 179 deduction allows business owners to deduct up to $108,000 of the cost of qualifying depreciable property placed in service in 2006. Property eligible for the immediate tax write-off can be new or used and includes "off-the-shelf" computer software. (Even property purchased on the last day of the year qualifies.) However, the allowable deduction cannot exceed your business’s net income and is reduced dollar-for-dollar to the extent the amount of qualifying property placed in service during the year exceeds $430,000. If you have plans to buy a business computer, office furniture, equipment, vehicle, or other tangible business property, you might consider doing so before year-end to maximize your 2006 deductions.

Paying Dividends in Lieu of Owner Salaries. If you expect to personally be in the 28% or higher tax bracket for 2006 and you own a corporation that you expect to be in the 15% income tax bracket (taxable income of $50,000 or less), you could net more cash after taxes by paying yourself some dividends in lieu of additional salary. This is because dividend income is subject to a maximum 15% tax rate, while your salary is subject to your 28% or higher tax rate, plus you and your corporation must pay payroll taxes on your salary.

Any dividends paid to you must be paid to other owners as well. Thus, if there are multiple shareholders, paying dividends could alter the bottom-line cash flow reaped by the various shareholders, which may make this strategy unworkable in some situations. However, in the context of family-owned C corporations, this may be a good thing—a family recipient who is in the 10% or 15% tax brackets (which many children are) will pay taxes of only 5% on this dividend income.

New Twists for Charitable Donations

Another common year-end planning strategy is to increase charitable donations. However, this year offers some new twists.

Tax-free IRA Distributions for Charity. Taxpayers who are age 70½ or older may temporarily (in 2006 and 2007) be able to claim tax-free treatment for otherwise taxable distributions from traditional IRAs, when the IRA money is paid out directly to a tax-exempt charity. This new "qualified charitable distribution" is subject to a $100,000 annual cap. Since the qualified charitable distribution is federal-income-tax-free, you don’t get any federal income tax deduction for the contribution. However, the income exclusion is definitely better than a deduction for seniors who might not otherwise itemize deductions. It may also pay off even if you do itemize by reducing taxable Social Security and increasing itemized deductions restricted by the adjusted gross income (AGI) limitations.

Changes for Gifts of Clothing and Household Items. The Pension Protection Act of 2006 raised the bar for the quality of used clothing and household items qualifying for a charitable deduction. After 8/17/06, generally you can no longer deduct donations of used clothing and household goods unless they are in "good used" or better condition. So, no more write-offs for that "junk" piling up in your closet, attic, garage, or basement. Unfortunately, the new law doesn’t define "good used" or better condition. Fortunately, donations of used clothing and household items that are in good or better condition continue to be tax deductible and still present a great tax saving opportunity for taxpayers who itemize their deductions. Eligible household items include furniture and furnishings, electronics, appliances, linens, and similar items. However, be sure to keep a list and a photo (to help establish the item’s condition) of the donated items.

You can still deduct individual items that appraise for more than $500 even if they are not in "good condition." However, this will require you to get a qualified written appraisal, which must be attached to your tax return.

Reap Tax Savings with Energy Efficient Purchases

Residence Credits for Energy Efficient Improvements. For 2006 or 2007, there are two new tax credits available for energy efficient improvements made to your home:

1. Nonbusiness Energy Property Credit. This credit is generally limited to a lifetime amount of $500, although other limits may also apply. Basically, the credit will equal (a) 10% of what you pay for qualified energy efficiency improvements (such as, certain energy efficient insulation, windows, doors and roofs), plus (b) 100% of what you pay for qualified residential energy property (such as, certain energy efficient heat pumps, hot water heaters or boilers, and advanced main air circulating fans) on your principal residence (no vacation homes).

2. Residential Energy Efficient Property Credit. This credit equals 30% of expenditures for the following types of equipment: (a) qualified solar water heating equipment (limited to a maximum credit of $2,000), (b) qualified electricity generating solar photo voltaic property (maximum credit of $2,000), and (c) qualified fuel cell property (maximum credit of $500 for each .5 kilowatt of capacity). The credit only applies to equipment you place in service in your personal U.S. residence, and it cannot be claimed for equipment used to heat a swimming pool or hot tub. The credit for fuel cell property is only available for your principal residence; however, the two solar credits apply to any residence (including vacation homes).

You can rely on the manufacturers certification that the property qualifies for the credit. If you’re planning on making any of these improvements to your home in the near future, you’ll want to do so before the end of the year if there’s any possibility you’ll be subject to AMT this year or the next. Why? These credits can be used to offset AMT in 2006, but absent Congressional extension, they won’t be in 2007.

Hybrid Vehicle Credit or Alternative Fuel Motor Vehicle (AFMV) Credit. If you are considering a hybrid vehicle or AFMV purchase in the near future, please give us a call. The IRS is constantly updating the list of vehicles that qualify for tax credits. The hybrid credits vary in amount by vehicle with the maximum credit being $3,400. The AFMV credits can be up to $4,000 per vehicle.

The full hybrid credit is available only up until the end of the quarter in which the manufacturer records the sale of the 60,000th vehicle. For the second and third calendar quarters following the sale of the 60,000th vehicle, the credit is reduced to 50% of the full credit. For the fourth and fifth calendar quarters, taxpayers may claim only 25% of the full credit. No credit is allowed after the fifth quarter—so the early bird gets the worm.

Education Planning

529 Plan Benefits Now Permanent. The Pension Act of 2006 made permanent the current ultra-favorable federal income tax treatment of Section 529 plans used to finance college education costs. Of particular importance, qualified Section 529 plan distributions (i.e., those used for qualified higher education expenses) will continue to be federal-income-tax-free, even after 2010 when they were previously scheduled to be taxable again. This eliminates the concern that funds distributed after 2010, when many 529 plan beneficiaries would be in college and withdrawing the plan assets for educational expenses, could be taxed. If you haven’t previously taken advantage of these plans, it may be time to reconsider them.

Investment Planning

Lower Tax Rates on Capital Gains. Long-term capital gains and qualifying dividend income are subject to a tax rate of only 15% for taxpayers in a regular tax bracket of 25% or higher and 5% for taxpayers in the lower regular tax brackets. Given tax rates as high as 35% for other types of income, this is quite a break. To be eligible for the lower 15% (or 5%) capital gain rate, a capital asset must be held for more than a year. So, when disposing of your appreciated stocks, bonds, investment real estate, and other capital assets, pay close attention to the holding period. If it’s less than one year, consider deferring the sale so that you can meet the greater-than-one-year period. While it’s generally not wise to let tax implications drive your investment decisions, you shouldn’t ignore them either.

When selling stock or mutual fund shares, the general rule is that the shares you acquired first are the ones you sell first. However, if you choose, you can specifically identify the shares you’re selling when you sell less than your entire holding of a stock or mutual fund. By notifying your broker of the shares you want sold at the time of the sale, your gain or loss from the sale is based on the identified shares. This sales strategy gives you better control over the amount of your gain or loss and whether it’s long-term or short-term.

Harvesting Capital Losses. It’s always a good idea to periodically review your investment portfolio to see if there are any losers you should sell. This is especially true as year-end approaches, since it’s the last chance to offset capital gains recognized during the year or to take advantage of the $3,000 ($1,500 for married separate filers) limit on deductible net capital losses. But, don’t forget the wash-sale rule. This rule defers your loss if you purchase a substantially identical security within the period beginning 30 days before and ending 30 days after the date of sale.

Retirement Planning

IRA Contributions. Don’t forget to make your traditional or Roth IRA contributions before the due date (4/16/07) of your tax return. For 2006, IRA contributions generally can be made up to the lesser of (1) $4,000 ($5,000 if age 50 or older by the end of 2006) or (2) 100% of compensation. Compensation includes wages, salaries, other amounts derived from or received for personal services actually rendered including self-employment income, and alimony. For married couples, IRA contributions up to $4,000 ($5,000 if age 50 or older by the end of 2006) can be made for each spouse if the combined compensation of both spouses is at least equal to the contributed amount and they file a joint return.

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