| Roth Conversions Earlier this year, TIPRA (Tax Increase Prevention and Reconciliation Act) removed the income limit for high earners who want to convert their traditional Individual Retirement Account to a Roth IRA. While elimination of the $100,000 income limit to convert traditional IRAs to Roth IRAs under TIPRA doesn't start until 2010, maximizing that opportunity can begin in 2006 with maximizing contributions in 2006 and each year thereafter to a nondeductible IRA that can then be converted into a Roth in 2010.
Hybrid Vehicles The tax credit for hybrid vehicles applies to those purchased on or after January 1,2006 and could be as much as $3,400 for those who purchase the most-fuel-efficient vehicles. Starting in 2006, this tax credit replaces the tax deduction of $2000, previously allowed for taxpayers who purchased a new hybrid vehicle before December 31,2005 for the clean-burning fuel deduction. The tax credit requires a different certification. Many currently available hybrid vehicles may qualify for this new tax credit, but the specific amount of the credit varies from model to model of eligible vehicle. If you purchase and take possession of a qualified hybrid motor vehicle in 2006, don't overlook the hybrid tax credit.
Substantiation for Cash and Household Items Cash Donations: For cash donations (donations consisting of cash, checks or other monetary contributions) made in tax years after August 17, 2006, the Pension Protection Act (PPA) made more strict the rules relating to charitable contributions by requiring that taxpayers must keep records of all cash donations no matter what the amount. Individuals must show a receipt from the charity, a canceled check, or credit card statement to prove their donation by indicating the amount of the contribution, the contribution date and the name of the donee. No tax deduction will be allowed if the taxpayer cannot provide the required supporting documentation. Taxpayers need not attach the documentation and mail it with their tax return but will need to keep the required documentation available in the event of an IRS audit.
Donations of Clothing and Household Items: For donations of clothing and household items made after August 17, 2006, the Pension Protection Act (PPA) requires that such items must be in at least "good" used condition or better. Unfortunately, the PPA does not define "good condition." I hope that the IRS will explain this term in forthcoming regulations. This requirement does not apply if the taxpayer claims a deduction of more than $500 for a single item of clothing or a household good and the taxpayer includes a qualified appraisal with respect to an item with the tax return on which the deduction is claimed. Household items include furniture, furnishings, electronics, appliances, linens and other similar items but do not include paintings, antiques, other objects of art, jewelry, gems or collections.
Credit for Qualified Energy Efficiency Improvements and Residential Energy Property Expenditures A taxpayer is allowed a limited non-refundable credit for the cost of qualified energy efficiency improvements made to an existing home and expenditures for residential energy property. The credit applies to property placed in service after 2005 and before 2008. The amount of the credit that a taxpayer can claim in a taxable year is the sum of (1) 10 percent of the amount paid or incurred by the taxpayer for qualified improvements installed during the year, and (2) the amount of the residential energy property expenditures paid or incurred by the taxpayer during the year. For purposes of the credit, the amount of residential property expenditures is limited to: - $50 for any advanced main air circulating fan;
- $150 for any qualified natural gas, propane, or oil furnace or hot water boiler; and
- $300 for any item of energy efficient building property.
The credit may not exceed $500 in total across all taxable years, and no more than $200 of the credit may be attributable to expenditures on windows.
The new pension law changes charitable donation rules In early August, Congress passed a major new law on pension plans. Buried in the fine print were some unexpected tax provisions. These could affect your ability to claim a deduction for certain kinds of charitable contributions. | If you itemize your deductions for charitable contributions, be aware of two changes: | |
| New rules apply to any contributions you make by cash or check, regardless of the amount. Starting in 2007, you’ll need either a formal receipt from the charity, or evidence such as a cancelled check or an entry in your bank records. The receipt or your bank records must show the date, amount, and name of the charity. Previously, for amounts up to $250, you could rely on your own written records provided they met certain standards. | |
| Also, new rules govern donations of used clothing or household items. Now you can claim a deduction only if the items are in “good” condition. Unfortunately, the new law doesn’t define what is meant by “good.” To back up your deduction, you might want to snap a photograph of the items using your digital camera or cell phone camera. Print out the picture and keep it with your receipt. | If you think these changes might affect you, please contact our office. We’ll be happy to provide more information.
No change in the estate tax, but don't postpone your planning Last month Congress failed to pass a major tax bill that would have changed the rules on estate taxes. To encourage passage, the bill included a raise in the minimum wage and extension of a number of expired tax breaks for businesses and individuals. But in an election year, the bill proved too controversial and did not pass. So where does that leave estate taxes and your tax planning? Currently up to $2 million of any individual’s estate is exempt from tax. Above that amount, a top tax rate of 46% applies. The exemption will increase to $3.5 million in 2009 and in 2010 there will be no estate tax. But for that year only. Unless Congress acts, rates and exemptions are scheduled to revert to 2001 levels beginning in 2011. It’s highly unlikely that Congress will let that happen. In fact, another attempt to change the rules is expected this fall. A relaxation of the rules rather than outright repeal is most likely. The most recent proposal called for raising the exemption amount to $5 million for an individual and $10 million for a married couple. The tax rate on estates above the exclusion amount but less than $25 million would be the capital gains tax rate (currently 15%). Of course, these numbers may change in any new proposal. The uncertainty over estate tax legislation is not an excuse to avoid planning. All adults should have basic estate planning documents, regardless of their age or the size of their estate. These documents include a will or trust, medical directives, and guardianship documents for minor children. For assistance with your planning, give our office a call.
Consider this retirement planning opportunity Usually tax planning aims to reduce next April’s tax bill. But if you’re willing to look ahead to 2010, the recently enacted tax law introduced a new tax-saving opportunity. The new provision removes the income limit on converting a traditional IRA to a Roth IRA, starting in year 2010. Also, if you convert in 2010, you’ll be able to spread the tax over two years. Why would you want to convert? A major attraction of Roth IRAs is that distributions are tax-free, provided you meet the age and holding period rules. And there are no required annual distributions once you reach age 70. In contrast, you’ll generally pay tax at ordinary income rates on distributions from a traditional IRA. With a Roth IRA, you can enjoy tax-free growth and distributions whenever you want throughout your retirement years. That benefit has many traditional IRA holders wanting to convert. But until now, you couldn’t convert to a Roth IRA unless your adjusted gross income was below $100,000. In 2010 that restriction will disappear. And you’ll have the added bonus of spreading any tax you owe over two years. There’s even a near-term opportunity for the next four years. If you now earn more than the limit for contributing to a Roth IRA, you could still make nondeductible contributions to a traditional IRA. Then in 2010, you can convert that IRA into a Roth. To learn how you can maximize this planning opportunity, please give us a call.
Manage your AGI to save your tax breaks One number on your tax return has special importance. You’ll find it at the bottom of the first page. It’s called “adjusted gross income” or AGI for short. Why is it important? Because your AGI controls your qualification for numerous deductions and credits. It can even affect your eligibility for retirement plans. | For example, if your AGI is too high you could lose all or part of the following tax breaks: | |
| Deductions for medical expenses, work expenses, student loan interest, total itemized deductions, and personal exemptions. | |
| Tax credits such as the child credit, Hope and lifetime learning credits, and dependent care credit. | |
| Ability to contribute to a Roth or Education IRA, or to deduct a traditional IRA contribution. | | And that’s just a partial list. That’s why managing your AGI can be a smart move. Even a small reduction in AGI can sometimes qualify you for a bigger tax break. Consider the following ideas to reduce AGI: | |
| Reduce taxable wage income by contributing to a 401(k) plan or a deductible IRA. | |
| If you’re self-employed, manage income by delaying year-end invoices or accelerating purchases. Open a solo 401(k) plan to shelter income. | |
| Sell poorly performing investments to generate capital losses and offset investment gains. Evaluate investing in tax-exempt municipal bonds. | |
| Make sure you use all legitimate “above the line” adjustments, which directly reduce AGI. These include such items as student loan interest expense, self-employed health insurance deductions, health savings accounts, and moving expenses. | For suggestions on managing your AGI and an evaluation of the tax benefits, please contact our office.
To deduct business driving costs, keep good records If you use your car or truck for business, you’ll want to deduct your business driving costs. Generally you’ll have a choice of two methods. The standard mileage rate is an “all in” deduction which covers the total costs of running your vehicle, including gasoline, service, repairs, and depreciation. To use this method, you multiply the business miles driven by the standard rate. This gives your total deduction for business use of your vehicle. For 2006, the standard rate for business use is 44.5 cents per mile. If you use actual costs, you must keep records of all your actual expenses for gasoline, service, repairs, insurance, etc. You’ll also calculate the depreciation on your car. Then you allocate these costs between business and personal use of your vehicle, based on the miles you drive for each purpose. You’ll need to keep more detailed records of your expenses if you use the actual cost method. Whichever method you choose, it’s important to keep good records of the business miles you drive. In fact the IRS requires you to keep timely records of each business use. The simplest way is to use a mileage log book, available from office supply stores. Note your mileage before and after each business use, and jot down where you went and why. This will make it easy to calculate your business use at the end of the year, and you’ll be well-prepared if the IRS ever questions your deduction. You can’t use the standard mileage method in all circumstances, and the rules for business use can be complicated. If you have questions, please check with our office. We can advise you on the best method for your specific circumstances.
Did you make a mistake? When to amend your tax return You’ve filed your return, you’ve received your refund check, and you don’t want to think about last year’s taxes again. Oops! You discover you made a mistake on your return. You might have overlooked a big deduction, you might find a missing receipt, or come across a dividend check that you didn’t report. Don’t worry. You can correct the mistake by filing an amended return. Sometimes there’s not even a mistake on your original return. For example, you might find out that stock you own became worthless in an earlier year. You have to claim the loss in the year the stock became worthless, so you file an amended return for that year. Whatever the reason, it’s a relatively simple process. If you’re an individual, you file Form 1040X. Corporations use Form 1120X. As a general rule, you have three years to file an amended return, or two years from when you paid the tax, whichever is later. You may have longer if you’re carrying back business losses or claiming a worthless security. You’ll have to fill out a separate form for each year that has changed. You won’t need to complete a whole new return, however. On Form 1040X, you just show the items that have changed and compute the difference in tax for the year. If the change means a bigger refund, the IRS will send it to you. If you owe more tax, you should pay it when you file the amended return. If you think one of your earlier returns was wrong, please give us a call. We can assess the problem and file an amendment if needed.
The alternative minimum tax: Don’t relax yet Are you at risk for the alternative minimum tax (AMT) in 2006? This “parallel” tax system has caught more and more middle-income taxpayers in recent years, often showing up as a nasty, last-minute tax surprise. The recently signed Tax Act provided some relief, but only for this year. And the relief provisions won’t help everyone escape the tax. That’s why it pays to plan ahead and see whether you might be liable this year or next. The AMT was set up in the 1960s to make sure wealthy taxpayers didn’t use deductions and exemptions to avoid paying any tax. It applies a 26% or 28% tax rate to income above a certain exempt amount. The problem is that the exempt amount was never indexed for inflation, so more and more middle-income earners find themselves above the threshold. For 2006 only, the exempt amount is $62,550 for married filers, $42,500 for singles. This may sound generous. But you can’t claim personal or dependent exemptions, the standard deduction, or some itemized deductions against the AMT. So if you have a large family or pay high property and state income taxes, you could be vulnerable. Exercising incentive stock options can also trigger an AMT bill. And unless Congress acts again, the amounts will fall back to lower levels next year. It's wise to find out if you’re likely to be affected by the AMT, this year or next. If you are, you may be able to take steps to minimize your overall tax bill. Strategies might include adjusting when you make tax payments or charitable contributions, accelerating income, or changing how you exercise stock options. Please contact us if you think you might be affected. We can assess the risk and help you develop solutions.
New “kiddie tax” covers more kids Do your children have savings accounts or other investments held in their own name? If so, the tax on those investments could change. That’s because of a change in recent tax legislation, which expanded the “kiddie tax” to cover children up to age 18. Previously it applied only up to age 14. And the change is retroactive to the beginning of 2006. The new rule could limit a common tax-reduction strategy known as income shifting. It also means you should carefully review all savings and other investments held in your child’s name to make sure you know how they’re being taxed. The kiddie tax applies to investment earnings such as interest and dividends. It doesn’t cover earned income — wages from your kid’s summer job, for example. Here’s how it works. The first $850 of your child’s investment income is generally free of tax. The next $850 is taxed at the child’s own rate. But all unearned income above that amount is taxed at your tax rate, which is usually higher than your child's. The intent is to limit income shifting. That’s the strategy of putting investments in a child’s name to take advantage of their lower tax rates. Previously the kiddie tax limited the benefits of income shifting up to age 14. Now it extends the limit to age 18. Remember, though, income shifting can still produce some tax savings. Up to $1,700 of your child’s investment earnings may be taxed at a lower rate than you pay. But also remember that giving assets to your child has nontax implications too. Please contact our office if you have questions about how the kiddie tax might affect you.
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