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 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).
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
59½.
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 59½ 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 59½ 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 70½ 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 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.
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,
Theodore Kleinman, CPA
