Dear
Clients and Associates:
As
2007 draws to a close, there is still time to reduce your 2007 tax bill and
plan ahead for 2008. This letter highlights several potential tax-saving opportunities
for you to consider. I would be happy to meet with you to discuss specific strategies.
Basic
Numbers You Need To Know
Because
many tax benefits are tied to or limited by adjusted gross income (AGI)-IRA
deductions, for example-a key aspect of tax planning is to estimate both your
2007 and 2008 AGI. Also, when considering whether to accelerate or defer income
or deductions, you should be aware of the impact this action may have on your
AGI and your ability to maximize itemized deductions that are tied to AGI. Your
2006 tax return and your 2007 pay stubs and other income and deduction-related
materials are a good starting point for estimating your AGI.
Another
important number is your "tax bracket," i.e., the rate at which your
last dollar of income is taxed. The tax rates for 2007 are 10%, 15%, 25%, 28%,
33%, and 35%. Although tax brackets are indexed for inflation, if your income
increases faster than the inflation adjustment, you may be pushed into a higher
bracket. If so, your potential benefit from any tax-saving opportunity is increased
(as is the cost of overlooking that opportunity).
top
IRA,
Retirement Savings Rules for 2007
Tax-saving opportunities continue for
retirement planning in 2007 due to the availability of
Roth IRAs, changes that make regular IRAs more attractive, and other retirement
savings incentives. As discussed herein, even more changes began in 2007.
Traditional
IRAs:
Individuals who are not active participants in an employer pension plan
may make deductible contributions to an IRA. The annual deductible
contribution limit for an IRA for 2007 is $4,000. Depending on AGI,
individuals who are active participants in an employer pension plan may
make deductible contributions to an IRA, but their contributions are
limited in amount depending on their AGI. For 2007, the AGI phase-out
range for deductibility of IRA contributions is between $52,000 and
$62,000 of modified AGI for single persons (including heads of
households), and between $83,000 and $103,000 of modified AGI for
married filing jointly. Above these ranges, no deduction is allowed.
The $20,000 spread for joint returns is new for 2007 (up from $10,000).
For
2007, a $1,000 "catch-up" contribution deduction is allowed for taxpayers
age 50 or older by the close of the taxable year who meet the other qualifications
for IRA deductions. Thus, the total deductible limit for these individuals may
be as high as $5,000.
In
addition, an individual will not be considered an "active participant"
in an employer plan simply because the individual's spouse is an active participant
for part of a plan year. Thus, you may be able to take the full deduction for
an IRA contribution regardless of whether your spouse is covered by a plan at
work, subject to a phase-out if your joint modified AGI is $156,000 to $166,000.
Above this range, no deduction is allowed.
Roth
IRA: This type of IRA permits nondeductible contributions of up to $4,000
a year. Earnings grow tax-free, and distributions are tax-free provided no distributions
are made until more than five years after the first contribution and the individual
has reached age 59 1/2. Distributions may be made earlier on account of the
individual's disability or death. The maximum contribution is phased out for
persons with AGI above certain amounts: $156,000 to $166,000 for joint filers,
and $99,000 to $114,000 for single filers (including heads of households). For
2007, a $1,000 "catch-up" contribution is allowed for taxpayers age
50 or older by the close of the taxable year, making the total limit $5,000
for these individuals.
Roth
IRA Conversion Rule: Funds in a traditional IRA may be rolled over into
a Roth IRA. Such a rollover, however, is treated as a taxable event, and you
will pay tax on the amount converted. No penalties will apply if all the requirements
for such a transfer are satisfied.
A
taxpayer's AGI (whether married, filing jointly, or single) is limited to $100,000
to make such a conversion and the taxpayer must not be a married individual
filing a separate return.
401(k)
Contribution: The 401(k) elective deferral limit is $15,500 for 2007,
up from $15,000 in 2006. If your 401(k) plan has been amended to allow for catch-up
contributions for 2007 and you will be 50 years old by December 31, 2007, you
may contribute an additional $5,000 to your 401(k) account, for a total maximum
contribution of $20,500 ($15,500 in regular contributions plus $5,000 in catch-up
contributions).
SIMPLE
Plan Contribution:
The SIMPLE plan deferral limit is $10,500 for 2007, up from $10,000 in
2006. If your SIMPLE plan has been amended to allow for catch-up
contributions for 2007 and you will be 50 years old by December 31,
2007, you may contribute an additional $2,500.
Catch-Up
Contributions for Other Plans: If you will be 50 years old by December
31, 2007, you may also contribute an additional $5,000 to your 403(b) plan or
SEP.
Saver's
Credit: A non-refundable tax credit is available based on the qualified
retirement savings contributions to an employer plan made by an eligible individual.
For 2007, only taxpayers filing joint returns with AGI of $52,000 or less, head of household
returns with AGI of $39,000 or less, or single returns (or separate returns
filed by married taxpayers) with AGI of $26,000 or less, are eligible for the
credit. The amount of the credit is equal to the applicable percentage (10%
to 50%, based on filing status and AGI) of qualified retirement savings contributions
up to $2,000.
Maximize
Retirement Savings: In many cases, employers will require you to set your
2008 retirement contribution levels before January 2008. You may want to increase
your contribution to lower your AGI in order to take advantage of some of the
tax breaks described above. In addition, maximizing your contribution is generally
a good tax-saving move.
top
2006 Pension Act Relief Changes for 2007:
Effective for distributions made after 2006, non-spouse beneficiaries
may roll over to an IRA or other plan structured for that purpose
amounts inherited as a designated beneficiary. The inherited amounts
are subject to the annual minimum distribution rules requiring
distributions over the person's life expectancy (recalculated
annually). Also, for taxable years beginning after 2006, the IRS must
make available a form for a taxpayer to file with the IRS directing the
IRS to send a refund directly to the taxpayer's IRA. Effective for
distributions made after September 11, 2001, a reservist (called up
between September 11, 2001, and before December 31, 2007, for more than
179 days) is excepted from the 10% premature distribution tax for
distributions before age 59 1/2 to a reservist, and allows the money to
be repaid within two years after the end of active service. Effective
for distributions made after August 17, 2006, public safety officers
can avoid the early 10% distribution penalty for distributions based on
separation from service if the officer is at least 50. Individuals who
worked for a bankrupt employer whose officers were indicted and whose
employer had at least a 50% match in the form of employer stock in its
401(k) plan can make an additional IRA catch-up contribution $3,000
(three times the otherwise applicable catch-up amount). The
contributions can be made for 2007, 2008, and 2009. For tax years
beginning after 2006, after-tax contributions from qualified plans may
be rolled over into defined benefit plans and 403(b) tax-sheltered
annuities.
Deferring
Income to 2008
If
you expect your AGI to be higher in 2007 than in 2008, or if you anticipate
being in the same or a higher tax bracket in 2007, you may benefit by deferring
income into 2008. Deferring income will be advantageous so long as the deferral
does not bump your income to the next bracket. Deferring
income could be disadvantageous if your deferred income is subject to
§409A, thus making the income includible in gross income and subject to
a 20% additional tax. Some ways to defer income include:
Delay
Billing: If you are self-employed, delay year-end billing to clients so
that payments will not be received until 2008.
Interest
and Dividends: Interest income earned on Treasury securities and bank
certificates of deposit with maturities of one year or less is not includible
in income until received. To defer interest income, consider buying short-term
bonds or certificates that will not mature until next year. If you have control
as to when dividends are paid, arrange to have them paid to you after the end
of the year.
top
Accelerating
Income Into 2007
In
limited circumstances, you may benefit by accelerating income into 2007. For
example, you may anticipate being in a higher tax bracket in 2008, or perhaps
you will need additional income in order to take advantage of an offsetting
deduction or credit that will not be available to you in future tax years. Note
however that accelerating income into 2007 will be disadvantageous if you expect
to be in the same or lower tax bracket for 2008. In any event, before you decide
to implement this strategy, we should "crunch the numbers."
If
accelerating income will be beneficial, here are some ways to accomplish this:
Accelerate
Collection of Accounts Receivable: If you are self-employed and report
income and expenses on a cash basis, issue bills and attempt collection before
the end of 2007. Also see if some of your clients or customers might be willing
to pay for January 2008 goods or services in advance. Any income received using
these steps will shift income from 2008 to 2007.
Year-End
Bonuses: If your employer generally pays year-end bonuses after the end
of the current year, ask to have your bonus paid to you before the beginning
of 2008.
Retirement
Plan Distributions: If you are over age 59 1/2 and you participate in an
employer retirement plan or have an IRA, consider making any taxable withdrawals
before 2008.
You
may also want to consider making a Roth IRA rollover distribution, as discussed
above.
top
Deduction
Planning
Deduction
timing is also an important element of year-end tax planning. Deduction planning
is complex, however, due to factors such as AGI levels and filing status. If
you are a cash-method taxpayer, remember to keep the following in mind:
- Deduction In Year Paid: An expense is only deductible in the year in which
it is actually paid.
- Payment By Check: Date checks before the end of the year and mail them before
January 1, 2008.
- Promise To Pay: A promise to pay or providing a note does not permit you to
deduct the expense. But you can take a deduction if you pay with money borrowed
from a third party. Hence, if you pay by credit card in 2007, you can take the
deduction even though you won't pay your credit card bill until 2008.
AGI
Limits: The AGI
limits on itemized deductions affect deduction planning. Normally, overall itemized
deductions are reduced by 3% of the AGI exceeding $156,400 ($78,200 if married
filing separately). However, for 2007, the reduction is itself reduced to two-thirds
of what it otherwise would be. For
2008, the reduction is reduced by only one-third of what it otherwise
would be, thus allowing for more deductions than in 2007. Similarly, certain deductions may be claimed
only if they exceed a percentage of AGI: 7.5% for medical expenses, 2% for miscellaneous
itemized deductions, and 10% for casualty losses.
Standard
Deduction Planning: Deduction
planning is also affected by the standard deduction. For 2007 returns, the standard
deduction is $10,700 for married taxpayers filing jointly, $5,350 for single
taxpayers, $7,850 for heads of households, and $5,350 for married taxpayers
filing separately. If your itemized deductions are relatively constant and are
close to the standard deduction amount, you will obtain little or no benefit
from itemizing your deductions each year. But simply taking the standard deduction
each year means you lose the benefit of your itemized deductions. To maximize
the benefits of both the standard deduction and itemized deductions, consider
adjusting the timing of your deductible expenses so that they are higher in
one year and lower in the following year.
Medical
Expenses: Medical expenses, including amounts paid as health insurance
premiums, are deductible only to the extent that they exceed 7.5% of AGI. Consider
bunching medical expenses into years when your AGI is lower.
State
Taxes: If you anticipate
a state income tax liability for 2007 and plan to make an estimated payment,
consider making the payment before the end of 2007.
Charitable
Contributions: Consider
making your charitable contributions at the end of the year. This will give
you use of the money during the year and simultaneously permit you to claim
a deduction for that year. You can use a credit card to charge donations in
2007 even though you will not pay the bill until 2008. A mere pledge to make
a donation is not deductible, however, unless it is paid by the end of the year.
Note, however, for claimed donations of cars, boats and airplanes of more than
$500, the amount available as a deduction will significantly depend on what
the charity does with the donated property, not just the fair market value of
the donated property. If the organization sells the property without any significant
intervening use or material improvement to the property, the amount of the charitable
contribution deduction cannot exceed the gross proceeds received from the sale.
To
avoid capital gains, you may want to consider giving appreciated property to
charity.
top
Individuals
who are at least age 70 1/2 may exclude from gross income qualified
charitable distributions of up to $100,000 per year from an IRA.
Distributions from SEPs and SIMPLE accounts do not qualify. The
distribution must be made directly by the IRA trustee to a public
charity or to a private operating or flow-through foundation described
in §170(b)(1)(F). Distributions to other types of private foundations,
to supporting organizations, and to donor-advised funds are not
eligible. The distribution qualifies for the income exclusion only to
the extent that the distribution would have been includible in gross
income but for this special treatment. Although no charitable
contribution deduction is allowed for the distribution, it is necessary
that the entire amount of the distribution satisfy the requirements for
a charitable contribution deduction without consideration of the
percentage limitations. Thus, there can be no quid pro quo from the
charity that would otherwise reduce the amount of the deduction. This
exclusion is available only for distributions made before the end of
2007.
Additionally,
new restrictions on claiming charitable contributions that began in
2006 continue into 2007. These rules are the following: (1) no
deduction is allowed for charitable contributions of clothing and
household items if such items are not in good used condition or better;
(2) the IRS may deny a deduction for any item with minimal monetary
value; and (3) the restrictions in (1) and (2) do not apply to the
contribution of any single clothing or household item for which a
deduction of $500 or more is claimed if the taxpayer includes a
qualified appraisal with his or her return. Effective January 1, 2007,
charitable contributions of money, regardless of the amount, will be
denied a deduction, unless the donor maintains a cancelled check, bank
record, or receipt from the donee organization showing the name of the
donee organization, and the date and amount of the contribution.
Business
Deductions:
top
Self-Employed Health Insurance Premiums: Self-employed
individuals are allowed to claim 100% of the amount paid during the taxable
year for insurance that constitutes medical care for themselves, their spouses
and dependents as an above-the-line deduction, without regard to the 7.5% of
AGI floor.
Equipment Purchases: If
you are in business and purchase equipment, you may make a "Section 179
Election," which allows you to expense (i.e., currently deduct) otherwise
depreciable business property. In general, you may elect to expense up to $125,000
of equipment costs (with a phase-out for purchases in excess of $500,000) if
the asset was placed in service during 2007. In addition, careful timing of
equipment purchases can result in favorable depreciation deductions in 2007.
In general, under the "half-year convention," you may deduct six months
worth of depreciation for equipment that is placed in service on or before the
last day of the tax year. (If more than 40% of the cost of all personal property
placed in service occurs during the last quarter of the year, however, a "mid-quarter
convention" applies, which lowers your depreciation deduction.) A popular
strategy in recent years is to purchase a vehicle (usually an SUV) for business
purposes that exceeds the depreciation limits set by statute (i.e., a vehicle
rated over 6,000 pounds). Doing so would not subject the purchase to the statutory
dollar limit, $3,060 for 2007; $3,260 in the case of vans and trucks. Therefore,
the vehicle would qualify for the full equipment expensing dollar amount. However,
for SUVs (rated between 6,000 and 14,000 pounds gross vehicle weight), the expensing amount is limited to $25,000.
Taxpayers subject to the 2005 hurricanes can deduct the lesser of
$100,000 or the cost of qualified Gulf Opportunity Zone property, in
addition to the existing $125,000 amount for 2007. In general, the
property must be originally used by the taxpayer on or after August 28,
2005, and placed in service before January 1, 2008 (January 1, 2009,
for nonresidential real property and residential rental property). The
phase-out amount is also increased by the lesser of $600,000 or the
costs of qualified Gulf Opportunity Zone property placed in service
during the year.
NOL Carryback Period: If
your business suffers net operating losses in 2007, you may apply those losses
against taxable income going back two tax years. Thus, for example, the loss
could be used to reduce taxable income-and thus generate tax refunds-for tax
years as far back as 2005. Hurricane Relief: The NOL carryback period
is five years for any qualified Gulf Opportunity Zone loss.
Bonus Depreciation: Taxpayers
meeting certain criteria can claim a 50% bonus depreciation allowance for Gulf
Opportunity Zone business property that is placed in service before 2008 (before
2009, for nonresidential real and residential rental property) and exempts such
depreciation allowances from the alternative minimum tax. The original use of
the property in the GO Zone must begin with the taxpayer on or after August
28, 2005.
top
Education
and Child Tax Benefits
Child
Tax Credit: A tax credit of $1,000 per
qualifying child under the age of 17 is available on this year's return. The
credit is phased out at a rate of $50 for each $1,000 (or fraction of $1,000)
of modified AGI exceeding the following amounts: $110,000 for married filing
jointly; $55,000 for married filing separately; and $75,000 for all other taxpayers.
A portion of the credit may be refundable.
Credit
for Adoption Expenses: For 2007, the adoption credit limitation is $11,390
of aggregate expenditures for each child, except that the credit for an adoption
of a child with special needs is deemed to be $11,390 regardless of the amount
of expenses. The credit ratably phases out for taxpayers whose income is between
$170,820 and $210,820.
HOPE
Credit and Lifetime Learning Credit:
The maximum HOPE credit for 2007 is $1,650 (100% on the first $1,100, plus 50% of the
next $1,100) for qualified tuition and fees paid on behalf of a student (i.e.,
the taxpayer, the taxpayer's spouse, or a dependent) who is enrolled on at least
a half-time basis. The credit is available for only the first two years of the
student's post-secondary education.
The
Lifetime Learning credit maximum in 2007 is $2,000 (20% of qualified tuition
and fees up to $10,000). A student need not be enrolled on at least a half-time
basis so long as he or she is taking post-secondary classes to acquire or improve
job skills. As with the HOPE credit, eligible students include the taxpayer,
the taxpayer's spouse, or a dependent.
For 2007, both the HOPE credit
and the Lifetime Learning credit are phased out at modified AGI levels between
$94,000 and $114,000 for joint filers, and between $47,000 and $57,000 for single
taxpayers.
Coverdell
Education Savings Account: The aggregate annual contribution limit to a Coverdell education savings
account is $2,000 per designated beneficiary of the account. This limit is phased
out for individual contributors with modified AGI between $95,000 and $110,000
and joint filers with modified AGI between $190,000 and $220,000. The contributions
to the account are nondeductible but the earnings grow tax-free.
Student
Loan Interest: You may be eligible for
an above-the-line deduction for student loan interest paid on any "qualified
education loan." The maximum deduction is $2,500. The deduction for 2007
is phased out at a modified AGI level between $110,000 and $140,000 for joint
filers, and between $55,000 and $70,000 for individual taxpayers. Rules
are in effect to coordinate education provisions, such as the qualified higher
education expense deduction, the Hope and Lifetime Learning credits, Coverdell
education savings accounts, and qualified tuition plans, to prevent double benefits.
Kiddie Tax:
2007 is the last year that you can avoid the kiddie tax rules for your
dependent children who are age 18 or over by year end. Beginning in
2008, the kiddie tax will apply to 18-year old children who have
unearned income in excess of the threshold amount, do not file a joint
return and who have earned income, if any, that does not exceed
one-half of the amount of the child's support. The tax also may apply
to children between the ages of 19 and 23 and if, in addition to the
above rules, they are full-time students. For 2007, the kiddie tax
threshold amount is $1,700.
top
Energy
Incentives
Alternative Motor Vehicle Credit:
For 2007, a credit is available for purchases of motor vehicles powered
by certain alternative fuels. The dollar amount of the credit depends
on fuel savings and weight of the vehicle. The most popular vehicles
subject to the credit are hybrids. However, when a particular
manufacturer sells in the United States its 60,000th of the particular
hybrid, a phaseout period kicks in. The phaseout will reduce the credit
from fully available to nothing being available. The phaseout begins in
the second calendar quarter following the calendar quarter where the
manufacturer sold its 60,000th hybrid vehicle following December 31,
2005. Credits are also available for lean-burn technology vehicles
(subject to the same phaseout), qualified fuel cell motor vehicles, and
qualified alternative fuel motor vehicles. If you have an interest in
purchasing a hybrid vehicle before the end of 2007, please contact me
and I can calculate the allowable credit. The amount of the credit
could affect your decision on which vehicle to purchase.
Residential Energy Efficient Property Credit:
Tax incentives are available to taxpayers who install certain energy
efficient property, such as photovoltaic, solar water heating or fuel
cell property. In 2007, a credit is available for the expenditures
incurred for such property up to a specific dollar limitation. The
property purchased cannot be used to heat swimming pools or hot tubs.
The credit is set to expire for property placed in service after 2008.
If you have made improvements to your home or plan to by the end of
2007, please contact me to discuss the amount of the credit you may
qualify for.
Nonbusiness Energy Property Credit:
Tax incentives are available to taxpayers who remodel their home and/or
incorporate specific energy efficient property. In 2007, a credit is
allowed for the purchase of qualified energy efficiency improvements.
Such property includes advanced main air circulating fans, natural gas,
propane, oil furnace or hot water boiler, windows, insulation material,
exterior doors, etc. that meet certain energy efficiency standards. The
credit is capped in dollar amounts per item of property. The credit is
set to expire for property placed in service after 2007.
Business
Credits
Small Employer Pension Plan Startup Cost Credit:
For 2007, certain small business employers that did not have a pension
plan for the preceding three years may claim a nonrefundable income tax
credit for expenses of establishing and administering a new retirement
plan for employees. The credit applies to 50% of the first $1,000 in
qualified administrative and retirement-education expenses for each of
the first three plan years.
Employer-Provided Child Care Credit:
For 2007, employers may claim a credit of up to $150,000 for supporting
employee child care or child care resource and referral services. The
credit is allowed for a percentage of “qualified child care
expenditures” including for property to be used as part of a qualified
child care facility, for operating costs of a qualified child care
facility and for resource and referral expenditures.
top
Investment
Planning and Gift Planning
The
following rules apply for most capital assets in 2007:
- Capital gains on property held one year or less are taxed at an individual's ordinary income tax rate.
- Capital
gains on property held for more than one year are taxed at a maximum
rate of 15% (5% if an individual is in the 10% or 15% marginal tax
bracket).
Timing of Sales:
You may want to time the sale of assets so as to have offsetting
capital losses and gains. Capital losses may be fully deducted against
capital gains and also may offset up to $3,000 of ordinary income
($1,500 for married filing separately). In general, when you take
losses, you must first match your long-term losses against your
long-term gains, and short-term losses against short-term gains. If
there are any remaining losses, you may use them to offset any
remaining long-term or short-term gains, or up to $3,000 (or $1,500) of
ordinary income. When and whether to recognize such losses should be
analyzed in light of the changes in the capital gains rates applicable
to your specific investments.
Dividends: Qualifying dividends received in 2007 are subject to rates similar to
the capital gains rates. Therefore, qualifying dividends will be taxed at a
maximum rate of 15%. Qualifying dividends includes dividends received from domestic
and certain foreign corporations.
Social
Security
Depending
on the recipient's modified AGI and the amount of Social Security benefits,
a percentage-up to 85%-of Social Security benefits may be taxed. To reduce that
percentage, it may be beneficial to defer receipt of other retirement income.
One way to do so is to elect to receive a lump sum distribution from a retirement
plan and to rollover that distribution into an IRA. Alternatively, it may be
beneficial to accelerate income so as to reduce the percentage of your Social
Security taxed in 2008 and later years.
top
Other
Tax Planning Opportunities
We
also can discuss the potential benefits to you or your family members of other
planning options available for 2007, including §529 qualified tuition programs, which were made permanent
by legislation enacted in 2007.
top
Alternative
Minimum Tax
In
2007, the alternative minimum tax exemption amounts are: (1) $45,000
for married individuals filing jointly and for surviving spouses; (2)
$33,750 for unmarried individuals other than surviving spouses; and (3)
$22,500 for married individuals filing a separate return. These
exemption amounts are significantly lower than in 2006. Also, for 2007,
nonrefundable personal credits cannot offset an individual's regular
and alternative minimum tax. This is another change from 2006. Unless
Congress acts, many more people will be subject to the AMT. We should
carefully discuss your situation to see if this reduction of exemption
amounts brings you into the AMT.
Some
of the standard year-end planning ideas will not reduce tax liability if you
are subject to the alternative minimum tax (AMT) because different rules apply.
Because of the complexity of the AMT, it would be wise for us to analyze your
AMT exposure.
top
Tax
Planning
If
you have any questions, please do not hesitate to call. I would be happy to
meet with you at your convenience to discuss the strategies outlined above.
There is still time to implement these strategies to minimize your 2007 tax
liability.
top
Very
truly yours,
E.
Samuel Wheeler, CPA
E.
Samuel Wheeler, CPA
November 20, 2007
