March, 2007

Last Minute Tax Relief - Will You Benefit?

Congress passed the Tax Relief and Health Care Act of 2006 just prior to adjourning last year, and the bill was quickly signed into law. The new legislation makes several changes that could affect your personal income taxes.

Sales Tax
On your 2006 and 2007 returns, you'll once again have the option of deducting the state and local general sales taxes you paid (or a standard amount taken from an IRS table) instead of deducting state and local income taxes. The sales tax deduction was also available for 2004 and 2005, but had expired.

Tuition expenses Also extended for two years (2006 and 2007) is a deduction for the payment of qualifying higher education expenses. The deduction is capped at either $4,000 or $2,000, depending on your in come and filing status, and is not available if modified adjusted gross income (AGI) exceeds $80,000 ($160,000 married-joint). There is a trade-off involved with taking the deduction. You can't claim both the deduction and a Hope of Lifetime Learning credit for the same student's expenses.

Classroom expenses
If you're a K-12 educator, you may deduct up to $250 per year of amounts paid out-of-pocket for items used in the classroom. The last year for this deduction was to have been 2005, but the new law continues it for 2006 and 2007.

Home mortage Insurance
A new deduction for home mortgage insurance premiums is in place for 2007 only. Only premiums paid or accrued on insurance contracts issued after 2006 can qualify for the deduction , which phases out with AGI between $100,000 and $109,000 ($50,000 and $54,500 for married separate filers).

Alternative minimum tax
Among the hardest hit by the AMT have been individuals who exercised incentive stock options in recent years. Effective for 2007 through 2012, the new law makes some changes to AMT credit rules that should make it easier for these individuals and certain others to recoup the AMT they paid.

Energy-efficient property.
Installing qualifying solar water heating, fuel cell, and solar electric property in your residence can qualify you for a tax credit. The new law extends the credit for one year, through 2008.

A difference in fees of just one percentage point can significantly reduce the amount of money a 401(k) plan participant can save for retirement. To illustrate, the Government Accountability Office (GAO) provides this example in a recent report:

A 45 year old employee with 20 years until retirement changes employers and leaves $20,000 in the company's 401(k) plan until retirement. The $20,000 will grow to about $70,500 at retirement if the average annual net return is 6.5% (7% return minus a 0.5% charge for fees). If the fees are 1.5% a year, reducing the annual net return to 5.5%, the $20,000 account will grow to only about $58,400 - approximately 17% less.

According to the report, investment fees comprise the majority of plan fees, and participants are not receiving the fee information they need to make an easy comparison among investment options. Additional disclosure could be required in the future.

Along with provisions affecting individual taxpayers, the Tax Relief and Health Care Act of 2006 includes a variety of income-tax changes of interest to business taxpayers. Here are some highlights.

Research credit
The legislation breathes new life into the research credit, which under prior law applied only to qualified research expenses paid or incurred before January 1, 2006. The new law retroactively extends that credit for two years, though December 31, 2007. It also increases the credit rates for the alternative incremental research credit and introduces a new alternative simplified credit.

Depreciation changes
Under the new law, the cost recovery period for qualified leasehold improvement property and qualified restaurant property will remain 15 years for property placed in service through the end of 2007.

Energy efficient commercial buildings
Taxpayers that install energy efficient property in or on a commercial building located in the U.S. as part of a plan to meet a 50% energy use reduction test may elect to expense as much as $1.80 per square foot of their cost (less amounts previously deducted). Before the new law, this deduction was available only for property placed in service during 2006 and 2007. The new law extends the deduction through 2008.

Energy efficient home credit
Also extended through 2008 is a tax credit available to eligible contractors that construct new energy efficient residential homes. The credit (for as much as $2,000 per home) will remain available for homes acquired before 2009.

The 2006 law also revises the rules related to health savings accounts and makes a number of additional business -related changes. Please contact us if you have questions.

You're certianly not alone if you're carrying more credit card debt from month to month than you'd like to be. Breaking the cycle is rarely easy, but the benefits of wiping burdensome debt off your personal balance sheet can be huge. Here's how to get started..

Take a total

List your cards in interst-rate order, starting with the card that has the highest interst rate, along with the amount you owe on each.

Budget for more than the minimums

Review your expenses and figure out the maximum amount you can put toward repaying your credit card debts each month. You may need to cut corners, but keeping your goal in mind will help motivate you to find the extra money you need to pay more than the minimum amounts on your cards.

Focus on the highest rate debit first

In general, it's best to put additional amounts toward the card with the highest rate until it is paid off, then move on to the card that's next on your list, etc. All the while, you should avoid new charges and continue to pay the minimum amounts due on your other cards. As inspiration, consider an example of how paing an extra $25 a month compares to apying only the minimums (4% of outstanding balances):

Card 1 - Balance $3,000, Rate 17.5%
Card 2 - Balance $4,000, Rate 15%
Payoff time with only minimum monthly payments: 10 years, 10 months. Payoff time with an extra payment of $25 a month: 2 years, 4 months.

At least once a year, you should follow up to see how much progress you are making toward your financial goals. Here's how the process might work.

Goal

Let's say Barb wants to build a $1 million retirement fund. She has $250,000 now, and she wants to retire in 20 years, using an assumed annual investment return of 6%, Barb needs to save $5,083 a year.

Progress Check

Barb checks her progress after one year and sees that her fund is worth $265,000 - less than the amount she should have, based on her plan. Barb decides to find out why she has fallen behind.

Explanation

A look at her records reveals that not only did she fall short of her yearly savings target, her investment return was somewhat lower than projected. To compensate, Barb decides to bump up next year's target savings rate.

Using a similar approach can help you stay on track toward your goals.

Are you the parent of a child headed to college in the fall? With college bills pending, you may be looking at your options for helping your child meet expenses.

Liquidating College Savings Accounts

Money that you've saved in a 529 plan or Coverdell Education Savings Account for your child will probably be your first source of cash, if available. Withdrawals for eligible expense are tax free.

Selling Securities

If you plan to sell securities, consider whether you'll come out ahead by giving the securities to your child and having your child sell them as needed. Assuming your child is at least age 18 in the year the securities are sold, any gains will be taxed at your child's tax rate, which is likely to be lower than your own. Gift taxes won't be an issue if you limit your annual gifts to your child to $12,000 ($24,000 for you and your spouse).

Withdrawing from an IRA

Taking money from your individual retirement account (IRA) may be another option you're considering. As long as the withdrawals are for qualified higher education expenses, you won't have to pay the 10% penalty tax on early withdrawals, even if you haven't reached age 59-1/2. However, you'll still owe regular income taxes if your withdrawal is from a traditional IRA. In contrast, withdrawals of Roth IRA contributions are tax free, as are withdrawals of Roth account earnings if you're met certain tax law requirements.

Gift cards have become quite popular, as evidenced by the 53% of consumers who indicated they hoped to receive one in a National REtail Federation pre-holiday survey conducted last year. Despite their popularity, research by Synergistics Research Corporation indicates that almost 14% of people who receive a gift card never use the card's full value - a boon for the issuing business.

Recently release IRS statistics indicate that 36,000 non-profit organizations reported gross unrelated business income totalling more than $8 billion for 2003. After accounting for deductions, over half of those organizations reported taxable unrelated business income. Their combined tax liability: $220.9 million.

Some 19.5 million businesses in the United States had no paid employees in 2004, according to the U.S. Census Bureau. Almost 17 million of the businesses were run by self-employed sole proprietors. The statistics include only businesses with annual receipts of $1,000 or more ($1 or more in the construction industries) that were subject to federal income taxes.

From the U.S. Bureau of Labor Statistics: In 2006, 15% of workers had access to employer assistance for child care.

Fred's sister has asked him for a loan to start a business. Fred would like to help her out, but he's not sure how much he can afford to lend her and what the tax ramifications would be.

Lending money to a family member or friend requires at least as much caution as any other important financial decision. Fred is smart to proceed slowly.

On the question of affordability, Fred needs to assess his own financial situation. If making the load will severely strain his budget - now or in the future - he should probably rule it out entirely. After all, starting a new business is always risky, and there's no guarantee that his sister will be able to pay him back on schedule. If Fred determines that he can comfortably make the loan, he'll want to make sure that his sister has a detailed business plan and that she shares it with him, for her protection as well as his own.

Family loans can have complicated income, gift, and estate-tax consequences. If Fred decides to go ahead, he should have a formal loan agreement drawn up that spells out the interest rate and repayment terms. Without documentation, the IRS could argue that the transaction was a gift rather than a bona fide loan.

As experienced financial and tax professionals, we are always available to help our clients make important decisions about their personal finances. Don't hesitate to contact us if you need assistance.

Question: Is there an easy way to check on the status of my federal income-tax refund?
Answer: The IRS has an online tool that taxpayers can access at http://www.irs.gov. You'll need to provide your Social Security number, filing status, and the exact amount of the refund.

Question: My small business did very well in 2006. While I'm pleased with the profit, I'm concerned about a large tax liability. Is there a retirement plan my business can contribute to at this late date and still take a 2006 tax deduction?
Answer: You might consider starting a Simplified Employee Pension (SEP) plan. Tax deductible contributions may be made to a SEP plan as late as the federal income-tax return filing deadline for the year (including any extension received). Note that contributions would be required for all employees meeting the tax law's eligibility requirements.