|
|
|
 Individual Income Tax
Harvest Portfolio Losses
Review your investment portfolio and sell loss positions to offset your recognized gains. This is particularly important if you have short-term gains (which would otherwise be taxed at higher ordinary rates).
Be Aware of the new “Kiddie Tax” Threshold (Again in ’08!)
In 2006 and 2007, the “Kiddie Tax” rules were increased to apply to children under the age of 18 (previously applied to children under 14.) New for 2008, under the Small Business and Work Opportunity Tax Act (SBWOTA), the age limit is increased again to those children under the age of 19, or under 24 if the child is a student and doesn’t meet certain exceptions. Under the “Kiddie Tax” rules, a child’s unearned income (interest, dividends, etc.) above a threshold amount is taxed at his parents’ highest marginal tax rate. Parents may want to consider having their children sell certain appreciated stock now if the children will fall into the expanded “Kiddie Tax” rules in 2008. Also, be sure to consider the income tax implications of this new rule when transferring assets to your kids.
Illinois Credit for K-12 Education Expenses
Did you have children enrolled in kindergarten through twelfth grade in Illinois during 2007? If so, then you may qualify for up to a $500 Illinois tax credit. The tax credit is claimed for qualified education expenses paid for your children. Students must be full time, be Illinois residents, and be under age 21. Qualified education expenses consist of tuition, book fees, and lab fees. Note that both public and non-public schools qualify as Illinois schools for this credit. Be on the lookout, as many schools will issue a receipt for qualified K-12 education expenses at the end of the year. Even if you do not have a receipt, you will still qualify for the credit; just see your tax preparer to discuss the proper form to attach to your Illinois Individual Income Tax Return.
Practice Tax-Efficient Investing
Taxes have a major impact on your investment returns, and the tax law does not treat all investment income alike. Although your financial objectives should be the primary motivator for investment decisions, don’t forget some of the tax basics of investing:
-
Avoid excessive portfolio turnover in your brokerage and/or mutual fund accounts. Capital appreciation is taxed every time a security is sold. Regularly paying unnecessary capital gains tax will significantly reduce your returns.
-
Qualified dividends and long-term capital gains are taxed at a maximum 15% tax rate while interest income is taxed at a maximum 35% rate.
-
Tax-exempt private activity bond interest is taxable for AMT purposes.
Non-Deductible IRA (and Roth Conversion)
If you have not been able to contribute to a Roth IRA because of income limitations, consider making a non-deductible IRA contribution. Under the current law, you may convert your non-deductible IRA to a Roth IRA in 2010, when the $100,000 AGI limitation is removed.
AMT Planning
If the Alternative Minimum Tax (AMT) was a big problem in 2006, it is a complete disaster in 2007. AMT exemption amounts and allowable credits are substantially lower in 2007 than they were in 2006. Unless Congress acts, many more people will find themselves in AMT in 2007 than ever before.
AMT has the effect of disallowing certain deductions and credits; but in application it’s much more complicated. Therefore, it is usually very difficult to tell whether someone will be subject to AMT without running a detailed tax projection. Even with a tax projection, there are only a few options for planning around the AMT and those options are not much better than paying AMT (i.e. forcing income into the current tax year or avoiding tainted deductions until next year). Making matters worse, many upper-middle income taxpayers will find themselves perpetually in AMT making even good planning worthless.
You may be subject to AMT if: 1) you were in AMT last year, 2) you exercised ISOs, 3) you pay high real estate and/or state income taxes relative to your income, 4) you have ordinary income greater than $175,000, but less than $400,000, and/or 4) you had a large capital gain.
Clients making a large fourth quarter estimated tax payment and/or considering year end tax planning should seek a tax projection to ensure that the AMT doesn’t frustrate the intended benefits. Others anxious about AMT may also consider a tax projection with the caveat that most AMT problems don’t have a good fix.
Accelerate Your Charitable Donations
If you are feeling charitably inclined the last few weeks in December, be sure that you receive and retain support for those cash donations. New in 2007, charitable contributions must be substantiated with receipts, correspondence from the charity, or other types of bank records. The generic “miscellaneous” cash contribution can no longer be taken without proper substantiation. In addition, clothing and household good donations must continue to be in “good used condition or better” to qualify for a deduction.
If the household scrooge is frowning on donating cash or goods, consider giving appreciated stock held for more than one year. The donation will be equal to the fair market value of the stock, and there is no long-term capital gains tax on the difference between your cost and its current fair market value. If the stock you want to donate has a lower fair market value than your cost, sell the stock, recognize the loss, and then donate the cash proceeds to charity. Note that the deduction amounts for appreciated stock are subject to stricter AGI limitations than cash contributions.
Last but not least, remember that charitable contributions placed on a credit card are deductible when charged, not when paid.
Donate Your IRA to Charity
Taxpayers 70½ and older can make up to $100,000 of tax-free distributions from an IRA to a qualified charity. The benefit is two-fold: 1) the traditional charitable contribution limitations don’t apply; and 2) the required minimum distributions are not included in AGI. Act fast; this provision expires at the end of the year.
Efficiently Utilize Debt
The tax law looks favorably on debt. Interest on home acquisition indebtedness (mortgage) up to $1,000,000 is deductible as is interest on up to $100,000 of home equity indebtedness. Investment interest expense is deductible to the extent of investment income. Interest on borrowings used in a trade or business is generally deductible. To the extent possible, borrowings should be structured to generate deductible interest expense. Refinancing credit card or auto debt with home equity indebtedness is a good first step.
In addition to generating interest expense, borrowing can also be a tax efficient alternative to a taxable sale to generate cash flow.
Track Additions & Improvements to your Home
Many of you are aware of the substantial tax savings that result from the home sale exclusion rules. Provided you meet certain qualifications, such as the ownership and use tests, married couples can exclude up to $500,000 of gain (single $250,000). However, if you sell your house for a gain, but fail to meet the exclusion tests and do not qualify for any of the exceptions, you will have to recognize capital gain. You may find yourself wishing that you had kept better records of all of the additions and improvements that you had done to your home (which increase your basis in the property). As the year winds down, consider documenting the cost of that new kitchen or remodeled bathroom. When you sell, you will be glad you did!
Establish a Donor-Advised Fund
Donor-advised funds provide the immediate tax benefit of a current year deduction while also affording you the time to decide which charities you would like to support. Donors may decide in a future year how much to give to qualified charities of their choice. Donors may contribute cash, appreciated securities, and in some cases IRAs into donor-advised funds, which are offered by many of the major mutual fund and brokerage firms (i.e. Schwab, Fidelity, and Vanguard).
Increase Withholding to Eliminate Estimated Tax Penalties
If you failed to make sufficient estimated tax payments this year and are potentially subject to estimated tax penalties, consider increasing your withholding in the final pay periods to avoid a penalty. Many times the extra withholding on a year end bonus can make the difference. You are required to pay 90% of the current year’s tax liability or 110% (100% for lower income individuals) of last year’s liability evenly throughout the year. However, income tax withholding is deemed paid evenly throughout the year regardless of the actual payment dates. Consequently, you may be able avoid an underpayment penalty by increasing your withholding late in the year.
Energy Credits
A $500 credit may be claimed for energy efficiency improvements made to your home. The credit is 10% of the acquisition cost subject to certain limitations. Improvements such as insulation, exterior doors and windows, and certain HVAC equipment qualify for the credit. Note that this credit expires after 2007.
Contribute to a 529 Education Plan
529 plans permit you to transfer funds into a “trust” for a designated beneficiary’s future education costs. The funds grow tax-free and distributions for qualified education costs are also non-taxable. Transfers into these plans count against your $12,000 annual gift exemption, so be careful to monitor your annual exclusion gifts when making 529 contributions. As an added benefit, contributions to an Illinois plan up to $10,000 ($20K on a jointly filed return) are deductible on your Illinois return. The 529 plan’s income and estate tax benefits make it the preferred educational savings vehicle.
Fund Retirement Plans
You can save for retirement while deferring tax on current earnings by maximizing contributions to your employer-sponsored retirement plan. The 2007 limit for employee contributions to 401(k) plans is $15,500. Those 50 and over can make an additional $5,000 “catch up” contribution. If you employer is full of holiday spirit and makes matching contributions, be sure to contribute enough funds to receive the full match. This match is the equivalent of “free money”. If your employer doesn’t have a retirement plan, you can make a $4,000 deductible IRA contribution.
Roth IRA
Have you maxed out your 401(k)? A Roth IRA will allow you to contribute additional moneys to a tax-advantaged retirement plan (high income taxpayers are not eligible). For 2007, the $4,000 contribution limit for a Roth IRA remains the same and those 50 and over can make an additional $1,000 “catch up” contribution. Roth IRA contributions are funded after-tax and grow tax-free. Future distributions from a Roth IRA are exempt from tax. You have until April 15, 2008 to make the contribution. Note that you may contribute to both a deductible (traditional) IRA and a Roth IRA in the same year, but the total contributions cannot exceed $4,000. General rule of thumb: if you qualify, you should make the Roth contribution. Also, if your minor children have earned income, they should be making a contribution too.
Business Income Tax
Accelerate Planned Asset Purchases Into 2007
Small businesses can deduct the first $125,000 of certain capital expenditures immediately (limitations apply for businesses with over $500,000 in acquisitions). Making capital expenditures by this year-end will allow you take this deduction in the current year. If your business is close to reaching the $125,000 limit for equipment purchases in 2007, consider postponing additional purchases until 2008, when the limit is increased to $128,000.
Employ Your Minor Children
Business owners with minor children should consider paying compensation to them. The business will receive a deduction and the children will pay no or little tax. Furthermore, the child’s earnings could be invested in a Roth IRA for even more tax efficiency.
Write-off Bad Debts
Accounts receivable that become wholly or partially worthless during the year can be written down for an ordinary deduction. It is not enough to simply provide a reserve; therefore you should identify specific receivables which have become worthless during the year.
New Rules for Nonqualified Deferred Compensation
Be aware that the new nonqualified deferred compensation rules under Code Section 409A will begin on January 1, 2008. These rules apply to a wide range of nonqualified deferred compensation plans. Although the IRS will allow retroactive compliance with the written plan requirements during 2008, it has maintained that operational compliance start on January 1, 2008. Penalties for noncompliance are substantial and will result in the loss of tax deferment. The rules under 409A are complex, and you should review your plan documents with your advisors to confirm compliance.
Accrue Holiday Pay
An accrual basis taxpayer is generally entitled to a deduction for January 1, 2008 holiday pay in 2007 if the liability is accrued in 2007 and supported by the company’s holiday pay policy.
Manufacturing Deduction
US manufacturers can deduct 6% of Qualified Production Activity Income (net income from US manufacturing activities, plus natural resource production, film production, construction, engineering, and architecture). The deduction percentage increases to 9% in 2010.
FICA Limitations
The limitation for FICA tax has increased to $97,500 for 2007 and $102,000 for 2008. It is possible in many self-employed and small business contexts to minimize employment taxes via appropriate structuring. The increase in the FICA limitations gives additional incentive to do so.
Health Savings Accounts
A developing trend in medical insurance is the use of Health Savings Accounts (“HSA”). These plans combine a high deductible medical insurance plan with a tax deductible savings account. HSA plans should be considered by small businesses as a means to decrease medical costs as well as by healthy participants as a means of tax efficiently building medical savings.
Standard Business Mileage Rate
The standard business mileage rate for 2007 is 48.5 cents/mile. In 2008, we will see an increase of two cents per mile, to 50.5 cents/mile. This optional standard mileage rate is used by employees and self-employed taxpayers to compute deductible costs of operating an automobile for business purposes.
Gift and Estate Tax
Estate tax reform does not seem to be a high legislative priority. Therefore, it is a distinct possibility that we will be back to a $1 million estate exemption in 2011. Current planning may prove to pay big dividends.
Annual Exclusion Gifts
Each year you can gift up to $12,000 to any person without paying gift tax. Married couples can gift $24,000 per year. For added control and asset protection, you can make these gifts to certain trusts for the benefit of your kids. Annual exclusions are a use it or lose it proposition so if you have a taxable estate, don’t let them go to waste.
Irrevocable Life Insurance Trust
Purchase life insurance via an irrevocable life insurance trust. If appropriately structured, this will keep the insurance proceeds out of your estate. This simple step can prevent the estate tax from eroding as much as half of your insurance proceeds (which also reduces the amount and cost of life insurance you need).
Consider Asset Protection
Wealthy individuals should consider from time to time whether their asset holdings could be structured to more efficiently protect them from creditor claims. Trusts, entities, insurance, and retirement plans can all play a key role in protecting assets from legal claims.
We hope you find these tips useful for current and future tax-planning. Have a happy holiday season, and we look forward to assisting you in the near future.
NDH Group, Ltd.
|
|
