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Dear
Client:
As 2007 draws to a close, there is still time to reduce your 2007 tax bill and
plan ahead for 2008. This letter is being made available to provide an extensive
list of tax planning ideas for you to consider for 2007. If you would like to
discuss any items in more detail, please contact us at your convenience as we
would be happy to meet with you.
In addition, an RM&N representative will be contacting you to help project your
year-end tax liability and to assist with any 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).
IRA, Retirement Savings Rules for 2007
Tax-saving opportunities continue for retirement planning 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. Individuals who are active participants in an
employer pension plan also 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 for
2007. 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 591/2
. 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 also may contribute an
additional $5,000 to your 403(b) plan or SEP.
Saver's Credit:
A nonrefundable 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.
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.
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.
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. You can do this by paying in
2007, deductible expenses, such as mortgage interest (including for 2007
mortgage insurance premiums), due in January 2008.
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. Note that
in 2007, you can choose to deduct as an itemized deduction state and local sales
taxes instead of state and local income taxes.
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.
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
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
deadline for nonresidential real property and residential rental property is
extended to buildings placed in service before January 1, 2011, for certain IRS
identified portions of the GO Zone; and for personal property if substantially
all the use of such property is in such building and such property is placed in
service within 90 days of the date the building is placed in service.)The
original use of the property in the GO Zone must begin with the taxpayer on or
after August 28, 2005.
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:
For 2007, 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.
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 phase-out period kicks in. The
phase-out will reduce the credit from fully available to nothing being
available. The phase-out 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 phase-out), 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.
Investment 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 are 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.
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.
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.
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.
Very truly yours,
RUGGIERO, MARTINEZ & NORTON, P.A.
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