As in the past, tax planning continues to be impacted by new legislation. In May, the Small Business and Work Opportunity Act of 2007 was passed, and Congress may still sneak in some additional tax law changes before year-end.
Below is a brief summary of current tax law, including planning tools to help reduce your 2007 tax bill, and ideas to assist with your tax and financial planning in 2008.
There has been no change in individual marginal tax rates for 2007. The tax brackets remain 10%, 15%, 25%, 28%, 33% and 35%.
While AMT rates remain 26% and 28% (depending on income levels), as of right now, last year’s reprieve that resulted from higher AMT exemption amounts is gone. For 2007, the AMT exemption levels revert back to $45,000 for married couples, and $33,750 for single taxpayers. Unless Congress acts before year-end, this means that many more taxpayers will be subject to the dreaded AMT for 2007. Careful tax planning remains a must to minimize the impact of AMT until Congress provides a permanent solution.
Personal exemptions, indexed for inflation, increased from $3,300 to $3,400 in 2007. The phase-out thresholds for exemptions increased by inflation to $234,600 for married filing jointly, and $156,400 for single taxpayers.
The 2007 standard deduction amounts increased by inflation, from $10,300 to $10,700 for married filing joint, from $5,150 to $5,350 for singles, and from $7,550 to $7,850 for head of household.
The basic strategy to accelerate deductions and defer receipt of taxable income has not changed. However, keep in mind that Alternative Minimum Tax may play a part in your overall tax liability, and may cause the normal strategy to need closer evaluation. In addition, the fact that several current tax laws are still due to expire in the coming years might affect your strategy. Be sure to consult with your tax advisor, or try out your shifting techniques on a tax program to be certain your tax planning efforts produce the desired impact.
FICA taxes remain 7.65% (15.3% for self-employed persons). The maximum Social Security limit for 2007 is $97,500. For 2008, the limit increases to $102,000. Medicare tax payments continue on all wages.
The age at which full benefits are available (full retirement age) has been increased from 65 to 67, on a phased-in schedule. This affects everyone born after 1937, and varies based on the year of birth. For those born between 1943 and 1954, full retirement is age 66. While early retirement at age 62 is still possible, benefits are reduced.
Retirees who have reached full retirement age may work without any reduction in Social Security benefits. However, the earnings limit still applies to workers who have not reached full retirement age. In 2008, benefits are reduced $1 for every $2 earned over $13,560 for those age 62 to full retirement age. In the year full retirement age is reached, benefits are reduced $1 for every $3 earned over $36,120, but only earnings before the month you reach full retirement age are subject to the reduction.
There is no change in the computation of how much Social Security will be taxed for 2007. For those with "provisional" income above $44,000 ($34,000 if single), you will be taxed on 85% of those benefits. The 50% tax rate remains for income between $32,000 and $44,000 ($25,000 and $34,000 if single). This differential in tax rates makes it very important to plan receipt of income to take advantage of the 50% rate.
Unfortunately, “kiddie” tax rules changed once again to increase the threshold age. Beginning in 2008, children 19 and over, and students over 24, will be taxed on their income at their lower tax rate. While the increase in age at which kiddie tax rules apply warrants careful review of educational and overall financial savings goals, income shifting, and hiring your children in your business, are still good techniques. In 2007, for children under 18, the kiddie tax rules remain as follows:
· Income of up to $850 is tax-free.
· Investment income of between $851 and $1,700 is taxed at the child's lower tax rate (as low as 5% for qualified dividends and capital gains).
· Investment income of more than $1,700 is taxed at the parent's marginal tax rate.
Retirement contributions (whether 401(k), 403(b), profit sharing, pension, SEP, or SIMPLE) still provide a major opportunity to reduce your tax bill, and whether pretax or post-tax, if you have an employer sponsored salary deferral plan, in most situations, it makes sense to maximize your contributions. Contribution limits for year 2007 and 2008 are $15,500 for 401(k) and 403(b) plans. If you are age 50 or older, there has been no change in the additional annual allowable “catch-up” contribution of $5,000.
For business owners, the maximum you can contribute to a qualified retirement plan for 2007 is the lesser of $45,000, or 25% of your compensation. The maximum compensation level for computing your contribution increased from $220,000 in 2006, to $225,000 in 2007.
The maximum IRA deduction is $4,000 for 2007, but increases to $5,000 for 2008. If you are age 50 or over, the additional annual “catch-up” contribution remains $1,000, for both 2007 and 2008.
For 2007, Individual Retirement Accounts (IRAs) are not deductible if you and your spouse are covered by a company retirement plan and your joint income exceeds $103,000 for married filing joint and $62,000 for singles. However, a deductible IRA is allowed if one spouse is covered by an employer-sponsored plan, but the other is not, as long as adjusted gross income is less than $166,000.
If you are prohibited from deducting IRA contributions for 2007, you may still make nondeductible contributions. Earnings on these contributions accumulate tax-free until they are withdrawn. If you make nondeductible IRA contributions, keep a record of contributions using IRS Form 8606 to be certain you are not taxed on the money when it is withdrawn.
Don't forget that non-working spouses are allowed to contribute the full amount to an IRA account, whether deductible or not, as long as the other spouse has sufficient earned income. This is an excellent opportunity to shelter additional income and allow earnings to accumulate tax-free.
If your adjusted gross income is below $166,000 ($114,000 for singles), a Roth IRA should be chosen instead of a nondeductible traditional IRA because earnings on a Roth IRA can escape taxation when withdrawn. In addition, if your adjusted gross income for 2007 will be below $100,000 you should consider converting your traditional IRAs to Roth IRAs.
The Coverdell Education Savings Account (formerly the Education IRA) is like a Roth IRA for children. For 2007, the contribution limit for children under the age of 18 remains $2,000 per year, and you have until April 16, 2008 to make your 2007 contribution. You obtain no deduction, but the money grows tax-free, until it is withdrawn tax-free for educational expenses. Qualified education expenses include elementary and secondary expenses as well as post-secondary expenses. You may not participate if your income is greater than $220,000 ($110,000 if single), but the child, or a relative (in a lower tax bracket), can contribute to a Coverdell account on the child's behalf.
Section 529 plans (like EdVest in Wisconsin) are becoming a more popular way to save for college. The contribution limits are more generous, there are no income limitations, and withdrawals used to pay college costs (including earnings) are tax-free. Most states also permit a tax deduction for 529 plan contributions. The Pension Protection Act of 2006 made the Section 529 provisions permanent, making the 529 plan an even more important college savings and estate-planning tool. However, unlike Coverdell accounts, 529 contributions must be made by December 31 each year, and withdrawals can only be used for post-secondary expenses.
Qualifying dividends are taxed at a top rate of 15% (or 5% if your tax rate is 15% or less). Likewise, long-term capital gains are taxed at 15% (or 5% if your tax rate is 15% or less). The best strategy remains as follows:
· In retirement (sheltered) accounts you want to own investments that are not eligible for the lower tax rate, such as high-quality taxable bonds, junk bonds, Real Estate Investment Trusts, high turnover stock funds and short-term stock holdings.
· In your taxable (unsheltered) accounts you want to hold investments such as index funds, tax-managed funds and long-term stock holdings, to take advantage of lower rates on capital gains and dividends.
As in the past, you should be mindful of a tax trap if you make after-tax investments in the month of December. Mutual fund companies distribute capital gains to shareholders no matter how long they have owned the fund. Therefore, you could receive an entire year of capital gains tax burden (distribution) even if you did not receive any cash, and even if you owned the fund for only a few weeks. This is a particularly important issue in 2007, with a strong market performance earlier this year. To find out when capital gains will be posted, call your broker, or look at the website for your mutual fund company.
Record keeping is important when you purchase and sell investments. If you purchase mutual funds or stock at different price levels, the IRS will assume the first-in, first-out method of determining gain (loss) for tax purposes, unless you specify (and document) a different method. Your choice can affect your tax bill. When prices on your investment keep rising, the last-in, first-out method results in the lowest tax bill.
Also remember that brokerage costs decrease your taxable gain, and bonds purchased between interest dates also require an interest adjustment for tax purposes. If you have questions, call your broker or us. Short-term and long-term gains and losses continue to be netted together, and net losses are deductible to a maximum of $3,000 per year, with an indefinite carry-forward.
One popular year-end strategy is to sell stocks or mutual funds where there are losses and buy similar (not the same) stocks or funds to maintain your position. Beware, however: if you transfer mutual fund assets from one group to another within a "family of funds" (say from a bond fund to a stock fund), while you usually avoid a commission, you have created a taxable event, and you will pay taxes on any gain realized.
The Internal Revenue Service allows one extra payment of monthly interest in one year. Therefore, if you make your January loan payment before December 31, it can be deducted this year. Be sure to verify that your lender has reported this payment correctly when they mail you your statement at year-end. Because of mail delays, send your payment on or before December 20, 2007 to allow enough time for it to be credited to your account before year-end.
You may deduct 14 cents per mile for travel in providing services to a charitable organization.
If payment for a charitable contribution is mailed or charged to a credit card before December 31, the deduction can be taken this year.
There is a bonus if you donate to a qualified charity stocks or mutual funds that have increased in value. You can deduct the full fair market value of the security and avoid paying capital gain tax on the appreciation. This only works if you have held the investment for more than 12 months.
Under the provisions of the Pension Protection Act of 2006 (PPA), every cash donation must now be supported by a cancelled check, credit card receipt or written communication from the charity. Moreover, to be deductible, non-cash clothing and household donations must be in at least “good condition”. Remember, if you have total non-cash contributions of $500 or more during the year, some additional information is needed about the donations, such as how you determined the worth of the donated property, what it originally cost, and how you acquired the property. If your gift is over $5,000, an appraisal is required, and specific rules about the value of your deduction now apply to donations of vehicles.
Keep in mind, you must obtain a receipt from charities for all gifts over $250, as a cancelled check is not considered sufficient support. Also, for non-cash gifts, the receipt must describe the gift in detail, but it need not confirm its value.
Finally, if you receive something in exchange for your donation, say a meal or a complimentary ticket, the charity must tell you in writing what portion of your donation is deductible.
For those taxpayers 70½ or older, for 2007 the Pension Protection Act allows a donation of up to $100,000 each year to a favorite charity directly from an IRA. No tax deduction is allowed for the contribution, but savings is recognized on the tax that would otherwise have been owed on the IRA distribution. This strategy works best for those with very large estates that are likely to be assessed significant estate taxes.
Only medical expenses in excess of 7.5% of adjusted gross income are allowed as a deduction, so generally tax benefit is only received when there is a major illness. The standard rate for use of your car for medical reasons (or when computing deductible moving expenses) is 20 cents per mile for 2007. This rate decreases to 19 cents per mile for 2008.
Casualty losses, such as flood damage are allowed, but only if losses exceed 10% of adjusted gross income.
Miscellaneous deductions (such as IRA fees, subscriptions to trade magazines, tax and investment advice, safe deposit box fees and employee business expenses) must exceed 2% of adjusted gross income before they are deductible.
Through December 2007, homeowners can claim certain credits for energy-efficient building components, such as home insulation, new windows, and programmable thermostats. Other credits are available for solar cells, solar water heaters, etc. There are numerous limitations associated with each type of credit, so a close review of the rules will be needed to determine the amount of your credit.
Most rental real property is considered a “passive” investment. For adjusted gross income under $100,000, up to $25,000 of losses are deductible, but only if you actively participate in managing the property.
For adjusted gross income over $100,000, the deduction is phased-out, with no deduction available for taxpayers having income over $150,000. However, you can deduct all rental real estate losses from regular income (and the $25,000 loss limit does not apply) if you spend over half your total working time (at least 750 hours a year), on realty development or management.
All individuals are eligible to give $12,000 per year to as many persons as they wish and avoid gift taxes. Couples can give up to $24,000 per year to one individual and avoid gift taxes. Tuition and medical expenses paid on someone’s behalf also avoid gift and estate tax, regardless of the dollar amount, as long as the payments are made directly to the educational or medical institution.
Most people do not realize that proceeds paid to beneficiaries from your insurance policies may be included in your taxable estate. In addition, proceeds from a retirement plan are taxed twice when you die, once as part of your estate, and once on the beneficiary’s tax return. Consult your estate planning attorney for details.
The federal estate tax exclusion amount is $2 million through year 2008. If you have not had an estate planning attorney review your situation in the past 3 years or so, now would be a good time to do so.
The deduction for business meals and entertainment continues to be 50%, but you may not claim any part of club dues, even if your membership is solely for business reasons. In addition, business travel deductions are limited to expenses for yourself and your employees. You are not allowed to claim expenses for a non-employee spouse, dependent or other individual traveling with you.
Receipts are not required (but are recommended) for business expenses under $75. However, upon audit you do need some evidence to support the expense.
The standard mileage rate was 48.5 cents per mile for 2007, and increases to 50.5 cents per mile for 2008.
Form 1099 is required for all purchases of services over $600, unless you paid the money to a corporation. One exception - Form 1099 needs to be issued for legal services, even if the law firm is a corporation.
Don’t forget that Wisconsin and most other states continue to have a strong focus on "Use Tax". If you make any out-of-state purchases (using the Internet or catalogs for example) without the payment of sales tax, you should be reporting the Use Tax on your state tax return.
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Happy holidays and best wishes for the start to a prosperous new year!
Arnow & Associates
7402 North Seneca Road
Fox Point, Wisconsin 53217
(414) 964-4000
Notice and Disclosure
We are required by Internal Revenue Service regulation to include a disclaimer whenever certain types of written advice are provided. To the extent this document contains written advice relating to a matter of Federal tax, this advice is not intended, was not written to be used, and cannot be used by the intended recipient or any other taxpayer, for the purpose of avoiding Federal tax penalties.
The information contained in this document does not cover all tax strategies that may apply, is not a complete guide to tax planning, and does not constitute the rendering of legal, accounting, or other professional advice or opinions on specific facts or matters. Before implementing any ideas suggested here, consult with your tax advisor regarding your specific tax situation.
LJA xtax2 11/19/07