"I'm proud to be paying taxes in the United States. The only thing is --
I could be just as proud for half the money." - Arthur Godfrey
The tax laws are constantly changing.
Although these changes often make
tax preparation and planning more
complex and challenging they also
present opportunities for knowledgable
taxpayers. Individuals who can quickly
adjust to these changes and use them
to make appropriate adjustments to
their existing financial and tax planning
strategies are most likely to meet
their long-term goals. For instance,
within the last few years there have
been many changes in the areas of
retirement accounts, small-business,
capital gain taxation, estate taxation,
and other areas, many of which may
provide opportunities for tax savings.
Below are a few specifics
of some of these recent changes
Individual
Retirement Accounts
Higher Education
Tax Benefits
Interest, Penalties,
& Collections
Miscellaneous
Recent changes to IRAs have created
more tax planning avenues for retirement,
education, and other financial needs.
Expanded Eligibility
for Traditional IRAs
In the past, spouses
of those who were covered by employer-provided
retirement plans and with incomes that
exceeded a modest income threshold
were not eligible to deduct contributions
to a traditional IRA. Now however,
such spouses are eligible to deduct
IRA contributions of up to $4,000 ($4,500 for those over age 50)
a year for their own IRA even if their
spouse is an active participant in
his or her company-sponsored retirement
plan.
However, the married
individual who is not an active participant
in a retirement plan, but whose spouse
is, will lose this IRA deduction when
Adjusted Gross Income (AGI) exceeds
$150,000.
Exceptions to the
10% penalty on early IRA withdrawals
Normally if withdrawals
are taken from an IRA before retirement
(age 59 1/2), they are subject to
a 10% penalty as well as ordinary
income tax. However, exceptions in
which these withdrawals will not be
subject to the 10% penalty include:
-
Death or disability
of the IRA owner
-
Withdrawals are
part of one or more "substantially
equal periodic payments" over
the owner's life expectancy
-
Used to pay unreimbursed
medical expenses greater than
7.5% of AGI.
-
Used to pay medical
insurance premiums when the owner
has received unemployment insurance
for more than 12 weeks.
-
Used for qualified higher-education expenses.
-
Used for expenses for a first-time home purchase (up to $10,000).
Roth IRA
The Roth IRA is
similar to the traditional IRA in
that it allows annual contributions
to an IRA of up to $4,000 ($5,000 for those age 50 and over) with no
taxes due on contributions and earnings
as they accumulate. While
traditional IRAs allow a tax deduction
for the year of the contribution with taxes
deferred until the time of withdrawal,
the Roth IRA gives no IRA deduction,
but allows earnings and deferrals
to be withdrawn tax-free upon retirement.
For the taxpayer
to qualify for tax-free withdrawals,
he or she must generally be at least
age 59 1/2 and withdrawals must begin
at least 5 years after the first contribution
was made. (Other exceptions may also
apply as outlined below).
Another advantage
of the Roth IRA compared to the traditional
IRA is that the Roth IRA does not
require minimum distributions
after the taxpayer reaches age 70
1/2. For this reason, Roths allow more
estate planning flexibility.
Contributions to
a Roth IRA are limited for individuals
with higher incomes. Allowable contributions
are phased out when Modified Adjusted
Gross Incomes (MAGI) exceeds $150,000
for the taxpayer filing married filing
jointly and $95,000 for the single or Head of Household
taxpayer.
A taxpayer with
earned income may contribute to both
a regular IRA and a Roth IRA, but
for the year 2007 total contributions cannot exceed
$4,000 per taxpayer ($5,000 for those over age 50), per year.
Which IRA is right
for you? - Roth or Traditional?
The answer to this question depends on your
personal circumstances, but there are a few general guidelines
that can help you decide.
Generally if you
expect your marginal tax bracket to
be lower at the time you expect to
withdraw the funds, you should prefer
the traditional IRA. If you think
that your average tax rate will be
higher when you withdraw funds from
your IRA, you should lean toward a
Roth IRA. Also, in most instances,
the longer the period till you retire,
the more you should favor the Roth
IRA. And from the perspective of estate
planning, the Roth IRA is generally
considered more flexible and advantageous
as compared to the traditional IRA.
This is primarily because there are
no minumum withdrawl requirements
based on age as there is with the
traditional IRA. For this reason, the
income deferral with a Roth IRA
has the potential to continue for
multiple generations.
Families and individuals
now have many investment vehicles,
tax deductions and tax credits to
help pay for higher education expenses.
These include deduction of student
loan interest, Education tax credits
(Hope Scholarship and Lifetime Learning
Credit), and avoidance of early withdrawal
penalties from IRAs if proceeds are
used for higher education expenses.
Student Loan Interest
Deduction
For student loan interest, eligible
taxpayers are able to claim an income deduction
for interest paid during the tax year. The deduction has been phased out for
taxpayers with incomes
between $100,000 and $130,000 for
joint filers and between $50,000 and
$65,000 for single filers. The amount
of this deduction is limited to $2,500
per year.
Education Tax credits
- Hope Credit and Lifetime Learning
Credit
The Hope Credit
and the Lifetime Learning Credit are
both available for qualified expenses
paid to an eligible educational institution.
These credits directly offset the
amount paid for qualified tuition
and related expenses for students.
An eligible educational institution
includes almost all accredited, public,
private, profit and non-profit post
secondary institutions.
The amount of the
credit is based on payments for qualified
tuition and related expenses for the
taxpayer, his or her spouse, and a
person who is claimed as a dependency
exemption.
Qualified expenses
include tuition and fees required
for enrollment, but do not include
those for room and board. Qualified
expenses do also not include those
paid for with non-taxable funds such
as scholarships, Pell grants, employer-provided
educational assistance, etc.
Only one education
credit is allowed per student, per
year. For each student, the taxpayer
may choose either the hope or lifetime
learning credit or a tax-free withdrawl
from an education IRA. Also, the credit
can be claimed by only one person.
For example, if the taxpayer pays
qualified expenses for a dependent
child, either the taxpayer or that
child, but not both, may claim any
education credit for that year.
Hope Credit
The Hope credit
is available for the student who has
not completed more than two years
of postsecondary education in an educational
program leading to a degree, certificate,
or other recognized educational credential.
The student must be enrolled for at
least one-half of the normal full-time
workload. The credit may be claimed
for only two tax years for each eligible
student.
The amount of the
credit is 100% of the first $1,000
of qualified expenses paid plus 50%
of the next $1,000. The maximum credit
allowed is $1,500 for each eligible
student. Depending on the taxpayer's
filing status, this credit is completely phased
out after modified adjusted gross
income exceeds $50,000 (single) or
$100,000 (married filing jointly)
Lifetime Learning
Credit
The maximum amount
of the lifetime learning credit allowed
is $2,000 and does not increase based
on the number of eligible students. The credit
is based on 20% of the first $10,000
of qualified expenses for all students
within a single family. As with the
Hope credit, the lifetime learning
credit is phased out for those taxpayers
with higher modified adjusted gross
incomes.
Unlike the Hope
credit the lifetime learning credit
is allowed for a workload that is
less than one-half of a normal workload;
is not limited to a student within
the first two years of postsecondary
education; is allowed for graduate-level
degree work; and is not limited to two years of eligibility.
Exclusion of Interest
Income from EE Bonds used for higher
education expenses
If you receive interest during the year from series
EE or I US savings bonds and you pay qualified higher
education expenses during the same year,
you may be able to exclude bond interest
from your taxable income. To qualify
for the exlusion, the bonds must have
been issued after 1989 in your name
(or spouse if married). The owner
of the bonds must have been at least
24 years old when the bonds were purchased.
Qualified expenses include tuition
and fees (but not room and board) to
attend a college, university, or vocational
school. Qualified expenses also include
contributions to a qualified state
tuition program or to an education
IRA and must be for you, your spouse,
or a dependent.
Confidentiality
Protection expanded for certain tax
practitioners
The confidentiality
protection that taxpayers have previously
had with attorneys has been expanded
to federally authorized practioners
including attorneys, certified public
accountants, enrolled agents, or enrolled
actuaries allowed to practice before
the IRS
This confidentiality
protection exends does not extend
to other administrative or court agencies
outside the IRS. Confidential communications
are those that:
- Advise on tax matters within the
scope of the practitioner's authority
practice before the IRS,
- Would be confidential if between
you and an attorney, and
- Relate to noncriminal tax matters
before the IRS or noncriminal tax
proceedings brought in federal court
by or against the United States.
This confidentiality
requirement does not include those
between a federally authorized practitioner
and a corporate director, shareholder,
officer, employee, agent, or representative.
Under prior law, confidentiality protection
was provided only for certain communication
between a client and an attorney.
The most important
aspect of capital gains is the holding
period, which determines whether any
gains or losses will be short-term
or long-term for tax purposes. The
holding period for an asset to be
considered long-term is twelve months.
For these long-term capital assets,
gains are now generally taxed at 15%
(5% for those in the 15% marginal
tax bracket). For taxpayers in the two lowest
marginal income tax brackets, 10% and 15%, for 2008 long-term capital gains will be
taxed at 0%. Short-term gains (assets
held less than 12 months) are taxed at the
taxpayer's marginal tax bracket.
Because of the difference
in tax rates, long-term gains must
be considered separately from short-term
gains, with each taxed accordingly.
If capital losses
exceed gains, a taxpayer's net short-term
losses and net long-term losses are
combined. After such losses are netted
together, they may be used to offset
up to $3,000 of ordinary income ($1,500
for married filing separate taxpayers).
If net losses exceed this amount,
losses are allowed to be carried forward
to future years until used up.
Long-term gains
from the sale of deprecible real property
(e.g., rental real estate) are taxed
at 25% to the extend that gains were
due to amounts taken as straight line
depreciation. Additionally, net capital
gains from qualified small business
stock or collectibles (i.e., coins,
art, etc.) are now taxed at a maximum
of 28%.
Individuals who
itemize their deductions are allowed
deductions for contributions to, or
for the use of a charitable, religious,
educational, public or scientific
organization or the U.S., the states,
or other government units. These payments
must be voluntary and without expectations
of receiving benefits in return.
In order to deduct
these gifts, various kinds of documentation
are required depending on the size
and type of the gift. For donations
of cash, the donor should keep cancelled
checks or receipts, or other "reliable
written records" showing the name
of the donee organization, the date
of the contribution, and the amount.
If a cancelled check is not available,
the burden is on the taxpayer to establish
the reliability of any written records.
When property (non-cash)
is donated, the individual must have
a receipt from the charitable organization
or a reliable written record with
the name of the donee, the date and
location of the contribution, and
a description of the property, including
its estimated value. If there is value
received in return for the contribution,
the individual is allowed a deduction
for the amount that the contribution
exceeds the value of the gift received.
For example, paying $20 to a school
band in return for wrapping paper
with a value of $8 would allow the
taxpayer a $12 deduction.
If the value of
the gift is more than $250, there
must be written acknowledgement by
the donee organization that includes
the amount of money or a description
of the property. It must also specify
whether the organization provided
goods or services in whole, or in
part, in return for the property contributed,
and if so, how much.
If property is donated
which a value greater than $500, the
individual must file form 8283 "Non-cash
charitable contributions", and if
the value exceeds $5,000, there must
be an appraisal summary attached along
with this form.
The maximum child
tax credit for 2007 is $1,000. This
credit is allowed for taxpayers with
a child under age 17 (as of 12/31/07)
whom they can claim a dependency exemption
and who is a U.S. citizen or resident.
This credit is phased out when Adjusted
Gross Income (AGI) exceeds $110,000
for taxpayers filing jointly and $75,000
for taxpayers filing as single or head
of household.
Self-Employed Health
Insurance Deduction
For the tax year 2007
the health insurance deduction for
self-employed individuals is 100% (limited to the amount of self-employment profit)
of the amount paid for medical
insurance for the taxpayer and his
or her and family
Less stringent rules
to claim business use of the home
Under the new rules
for deducting expenses for the business
use of the home, you can deduct home office expenses if:
1) You use it "exclusively
and regularly" for administrative or
management activities of your trade
or business, and
2) You have no
other fixed location where you conduct
substantial administrative or management
activities of your trade or business.
Activities considered administrative
or mangerial include: billing customers,
clients, or patients; keeping books
and records; ordering supplies; and
setting appointments.
Exclusive use of
the home means that business part
of the home is only used for your
trade or business and you do not use
it for any personal purposes. Regular
use means that if that business part
of the home is only occasional, even
if not used for any other purpose,
then a business-use deduction will
not be allowed.
For individuals
who have reached the age that they will receive full Social Security benefits, no amount of wage income will reduce Social Security income.
However, individuals over 62 but under their full retirement age will begin to see Social Security benefits reduced after earned income exceeds $12,000 (for 2005). Specifically,
$1 in Social Security benefits is reduced for every $2 earned over this threshold. An individual with earned income who is within a year of receiving full Social Security benefits will see his or her benefits reduced by $1 for every $3 of earned income over $31,800.
Increase in level
of wages subject to Social Security
tax
For 2008, the maximum amount of wages
subject to the social security tax
is $102,000. This amount of tax paid
is equal to 12.4% and is shared equally
between the employer and employee (6.2% each).
The self-employed individual is responsible
for the entire amount. The 2.9% Medicare
tax is also shared by employer and
employee and is not subject to a wage
limit.
2007 Mileage Rates:
Business-48 cents/mile
Charitable-14 cents/mile
Medical-20 cents/mile
Moving-20 cents/mile
Increases to section
179 deduction
The deductable limit of
section 179 property has been increased
to $125,000 for 2007.
Every taxpayer has
two options for claiming deductions
from his or her income: the standard
deduction or the itemized deduction.
Those taxpayers with allowable itemized
deductions greater than the standard
deduction are allowed to take the
larger deduction on their taxes.
For 2007, the following
standard deduction according to filing
status are:
Single: $5,350
Married Filing Jointly:
$10,700
>Married Filing Separately:
$5,350
Head of Household:
$7,850
In addition, the taxpayer
receives an additional standard deduction
of $1,300 if over the age of 65 or legally blind and
filing single or head of household, $1,050 if married.
*For certain individuals
such as nonresident aliens and married
spouses filing separately, if their
spouse itemizes, no standard deduction
will be allowed for the other spouse
and these individuals should itemize
any available deductions.
Many taxpayers, especially
those with mortgages or who pay a
large amount of state and local taxes,
will far surpass the amounts of these
standard deductions. In almost every
case, these taxpayers should itemize
their deductions.
Those taxpayers
that make the choice to itemize their
deductions instead of taking the standard
deduction, should make sure to maximize
those deductions and claim every allowable
expense.
Alternative
Minimum Tax
More and individuals
are becoming aware of the Alternative
Minimum Tax, many who don't realize
how and why this tax is imposed. Even
many taxpayers with modest incomes,
who, because of claiming certain common
itemized and personal exemptions,
are getting caught in the AMT web
despite a lack of "real" tax preferences.
The original rationale for this tax
was to make sure that certain high
income individuals did not avoid taxes
through the use of excessive deductions.
However, excepting changes to the
law the number affected by this tax
will continue to grow in the years
ahead.
Taxpayers subject to
this tax will face a flat tax rate
of 26% to 28% (after deducting a flat
exemption based on filing status).
Many AMT taxpayers will be those individuals
who have large long-term capital gains
(which are taxed at 20%) or tax-exempt
earnings, both of which can increase
the amount of tax subject to the AMT.
Additionally, the amount of income
which is subject to the AMT is reduced
by a flat exemption ($25,000 to $45,000
depending on filing status), and the
amount of this exemption has not increased
with inflation (or income). For these
reasons, it is easy to see why more
and more individuals will finds themselves
subject to this tax. So individuals
who anticipate having either large
capital gains, tax-exempt interest,
incentive stock options, or other
"preference" items, should calculate
in advance their estimated tax liability
accounting for the AMT. Since this
tax is fairly complicated, it warrants
taking the situation to a competent
tax advisor.
Using
the Specific Identification method
of reporting stock and mutual fund
sales can reduce your taxable gain.
If you bought shares
of stock or a mutual fund, including
through dividend reinvestment you
can increase or decrease the amount
of taxable gain reported for a given
year depending on your personal circumstances.
To do this you'll have to know the
"basis" (cost) of each of your shares.
Basically that means knowing how much
you paid for certain shares and the
date you made the investment. For
instance if you can identify the shares
you sell with the highest basis (the
ones with the highest cost), you'll
reduce the amount of gain (and tax)
reported. On the other hand, if you
have a loss on the shares, you might
want to sell recently purchased shares
to report a short-term loss (and keep
the shares you've owned longer for
a later long-term gain).
However, if you choose
to use this method, it's important
to be consistent, using the same method
from year to year. For instance, you
can't use your average cost for mutual
fund sales in a prior year and then
identify specific shares for the same
fund in a later year (which have already
been partially taxed). Additionally,
if you don't specify which shares
you are selling and do not use your
average cost, the law assumes that
you are selling the shares that you
have owned the longest. Regardless
of the method you choose, remember
to keep good records carefully document
any correspondence with a broker instructing
such a sale.
David Alan Pace, CFP, CFA, EA, Pace Financial Services
This document is for information purposes only. No part of this report may
be reproduced in any manner without the written permission of Pace Financial
Services. The views and opinions expressed in this report are not intended
to
serve as specific investment or financial planning advice or recommendations, and
individuals should discuss their specific financial goals and available
options with a professional advisor.
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