Los Angeles Certified Health Business Development Consultant
As I once again prepare my annual Tax Highlights for my clients and friends, please remember that I am outlining only some of the new law. Planning for income taxes is best done at the beginning of the year. For those of you who have not planned early, there is still time to make use of some of the ideas in these Highlights. I encourage all of you to contact your financial advisor early in 2008 to begin the planning process. And now, to the task at hand . . .
On May 25, 2007, the President signed a $120 billion emergency war supplemental funding bill containing a $4.84 billion small business tax relief package and an increase in the federal minimum wage from $5.85 to $6.55 an hour (7-24-08) (CA $8.00 1-1-08)
The second of two extender bills signed by President Bush on December 20, 2006, at an estimated cost of $45 billion over the next five years extended several expiring tax provisions and added a few new ones as follows:
Highlights of some changes effective January 1, 2007 are:
° Charitable contributions, including cash, require receipts or canceled checks
° Mortgage insurance premiums are deductible as interest expense if AGI limit is met
° Health Savings Accounts (HSA)
▪ One-time transfer of flexible spending and health reimbursement account balances allowed to HSA
▪ Maximum deduction allowed even if deductible is a lesser amount
▪ Contribution limit not reduced for part year coverage
° Married couple in business together can elect to report their individual share of income on separate schedule C’s rather than on a partnership return
° Pension plan rollover allowed to non-spouse beneficiaries
Provisions that expire 12-31-07 unless extended by legislation in December – watch your local newspapers:
Be aware of two major changes that take
effect in 2008: (1) the kiddie tax expansion to children age 19 or age 24 if
they are full-time students and (2) the zero tax rate for long-term capital
gains of low income taxpayers.
INDIVIDUAL TAX CHANGES FOR 2007
Who is the custodial parent in a divorce? The new determination is decided by a ‘time’ test. The child must live in the home of that taxpayer for more than one-half the year (the greater number of nights during the year), or if the child resides with both parents for an equal period of time the custodial parent is the one with the higher adjusted gross income. In other words, under this rule change, the taxpayer may no longer rely on any state court order or divorce decree to determine who is the custodial parent.
If the custodial parent releases his or her claim to the dependency exemption, then the principal place of abode rule, the tie-breaking rule, and the support rule, do not apply – subject to certain eligibility rules. The release also releases the child tax credit and the additional child tax credit (if applicable). But the custodial parent (although releasing the dependency exemption) may still claim head of household status and claim the earned income credit and dependent care credit, if eligible.
Capital gains and dividends. The
maximum tax rate on qualified dividends and capital gains is 15 percent for
individual taxpayers in the top four tax brackets. For individuals in the
10- or 15-percent bracket, long-term capital gains and qualified dividends
are taxed at five-percent in 2007. Moreover, from 2008 through 2010, the
long-term capital gains rate for individuals in the 10- and 15-percent
brackets will drop to zero-percent.
The sale of personally created music or copyrights in musical works created by the taxpayer’s own efforts are now taxed at favorable capital gains rates. Previously, the music or copyrights were subject to ordinary income rates.
Earned income ceiling for social security benefits is $12,960 in 2007 and $13,560 in 2008. At full retirement age or over there is no limit on earned income.
Medicare Part B premium is being
surcharged by a premium in 2007 based on adjusted gross income, pursuant to
a tax law in the 2003 Medicare prescription drug bill. The surcharge can be
appealed due to changes such as death of a spouse, divorce, retirement, a
significant cutback in hours worked, and life-changing events including
marriage and more. The appeal is prepared on Form SSA-561-U2 available at
Cancellation of debt (COD) may create income. This may occur from foreclosure or credit card debt forgiveness. However, COD income is excludable from income if it occurred in bankruptcy, to an insolvent borrower only to the extent of insolvency, and several other situations. If you believe you may receive COD income, contact your tax advisor to determine in an exception applies.
Health Savings Accounts (HSA) , HSAs are a great program for people to pay for unreimbursed medical expenses on a tax-advantaged basis. Advantages for some are a) contributions are deductible (or excluded from taxable income if paid by employers) b) withdrawals are not taxed if used for medical expenses, c) account earnings are tax-exempt, and d) unused balances may accumulate without limit to be used in a year with high medical expenses.
New for 2007: A one-time rollover from an IRA to an HSA to pay medical expenses is permitted. subject to certain limitations and rules. Tax tip: There seems to be no downside to moving money from your IRA to your HSA. Dollars withdrawn from an IRA are taxable as ordinary income but dollars withdrawn from an HSA and used for medical expenses are not taxable.
Qualified state tuition program (Section 529 plans) law is now permanent. 529 assets are currently about $100 billion and expected to reach $300 billion by 2010. About 75% of 529 plans are sold through investment advisers. For more information see: www.collegesavings.org and www.savingforcollege.com as well as my 2006 Tax Bulletin.
Transfer of IRA funds directly to charity. An IRA owner age 70-1/2 or over can directly transfer tax-free, up to $100,000 per year to an eligible charitable organization. This provides an exclusion from gross income for otherwise taxable IRA distributions from a traditional or a Roth IRA in the case of qualified charitable distributions. This option expires at the end of 2007.
Transferred amounts are counted in determining whether the owner has met the IRAs required distribution rules. Since the IRA distribution to a charity is not included in taxable income, many AGI phaseouts are minimized. There are other advantages and certain limitations.
CHARITABLE CONTRIBUTIONS. Substantiation rules tightened. To deduct any charitable donation of money, you must have a bank record (canceled check, bank or credit union or credit card statements which should show the name of the charity and the date and amount paid), or written communication from the charity showing the name of the charity and the date and amount contributed.
You may donate by cash, check, electronic funds transfers, credit card, and payroll deduction. For payroll deductions, the taxpayer should retain a pay stub, W-2 form or other document furnished by the employer showing the total amount withheld for charity, along with a pledge card showing the name of the charity.
Cash contributions to a church collection plate are not deductible unless supported by a receipt or cancelled check. A record in your calendar or check register is not acceptable.
For contributions of $250 or more (or smaller contributions to one charity that aggregate $250 or more) to be deductible, you must obtain a written acknowledgement from the charity.
Tax tip: Contributions are deductible in the year made. Thus, donations charged to a credit card before the end of the year count for 2007. This is true even if the credit card bill isn’t paid until next year. Also, checks count for 2007 as long as they are mailed this year.
Donor Advised Funds (DAF). Contributions to a DAF established by a financial institution allow taxpayers the opportunity to control the timing of a charitable tax deduction while making actual gifts to a charity or charities at a different date.
Example: An income windfall puts you in the highest tax bracket for this year only. You may fund a DAF this year with a substantial donation, deduct the full amount this year but have the fund make distributions to your charity(s) in smaller increments each year.
Example: You wait until the last minute to do your year-end tax planning and on December 30 you find out how much tax you will owe. You can call your financial institution or discount broker, open a DAF and transfer to it the amount you would like to deduct for the year. You receive the charitable deduction this year and in the next year you can research several charities and authorize the transfer of funds to those charities.
Investment Travel and Conventions are not deductible unless in connection with your trade or business. So your away-from-home expenses related to attendance at investment, financial planning, or other income-producing conferences or activities, including registration fees, travel and transportation costs, and meals and lodging are not deductible.
ALTERNATIVE MINIMUM TAX – SIMPLY STATED.
The AMT is the most misunderstood tax code provision, surrounded in mystery
and feared by many. The AMT is just a tax on income calculated by a method
that is different (or alternative) than the method used to calculate the
regular tax. Taxpayers compare the two results and pay whichever is greater.
Is this fair? Certainly not! How did this state of affairs come
to be? . . .
. . . Back in 1969 concerns were raised that 155 wealthy families were avoiding income taxes by claiming extensive deductions. Lawmakers hoped that an alternative tax calculation would guarantee that high-income Americans would pay at least a minimum amount of taxes each year. As often happens with the tax law, one change after another was made until the AMT became a revenue generator.
Fast forward to 2006 when 4 million taxpayers paid the tax, compared with about 20,000 in 1970. If a new fix isn’t enacted very soon, the AMT could hit some 23 million taxpayers in 2008, some with incomes as low as $75,000. The other side of the coin is that the government may lose up to $50 billion in revenue if the AMT is eased back so as not to snare another 19 million taxpayers.
As of December 10th the Senate passed a bill to keep the AMT from spreading to 23 million taxpayers, but without including any of the offsetting revenue gathering provisions included in a House version of the bill passed last month. The Senate will now put pressure on House leaders to pass a version of the bill without the offsets. And so, the ball bounces back and forth.
Kiddie Tax – special rules that apply to the net unearned income of certain children under age 18. Under these rules, the net unearned income if a child is taxed at the parents’ tax rates if those rates are higher than those of the child. For 2008 The Small Business Tax Act expanded the Kiddie Tax to children who are 19 or who are full-time students over age 18 but under age 24, with certain adverse results.
Planning Pointers for the 2008 Kiddie Tax
Warning; Delaying the sale of stock until the child graduates from college may be expensive tax planning if the sale occurs after 2010 when the capital gain rates climb back up to 10% and 20%.
Energy-efficient improvements. There is still time until the end of 2007 to receive tax credits for insulation systems that reduce heat loss/gain, exterior windows including skylights, exterior doors, and other devices.
Gift tax annual exclusion remains at
$12,000 during 2007 and 2008 for transfers of present interests in property
to any one donee.
IRA AND PENSI0N PLAN NEWS
The baby boomers, born between 1946 and 1964, represent almost 1/3 of the United States population. The 2000 census found that of the country’s 281 million people, 76.9 million, were 50 and older, up 21% from 1990. That means that in the next 10 to 15 years about ½ of the baby boomers (40 million!) are going to question, worry and plan for retirement. There are three rules for comfortable retirement:
Pension and IRA provisions taking effect in 2007 and later
Contribution Amounts (not to exceed earned income):
Traditional IRA maximums are $4,000 in 2007 and $5,000 in 2008. An additional $1,000 contribution is allowed for those 50 and over in 2007. A non-working spouse may make IRA contributions based on the earned income of his or her spouse. Active participation in an employer-sponsored retirement plan limits the deduction and is phased out as AGI exceeds certain levels.
Roth IRA maximum in 2007 is $4,000, which is phased out for AGI over certain amounts.
Conversion rules change in 2010. Prior to that taxpayers with modified AGI of $100,000 or less generally may convert a traditional IRA into a Roth IRA. The amount converted is includible in income as if a withdrawal had been made.
Tax tip: High-income taxpayers not able to contribute to a traditional or Roth IRA may want to contribute to a nondeductible IRA over the next several years. Then in 2010, you will be able to convert that nondeductible IRA into a Roth regardless of you high AGI and there will be little tax at the conversion since you will have a basis in the IRA. Only earnings will be taxable, and that tax can be spread over the 2 years 2011 and 2012. However, for those with other IRAs in addition to the nondeductible IRA the results will not be as attractive as for someone with only a nondeductible IRA, due to an ‘ordering rule’.
Plan limitation amounts.
Maximum defined contribution plan contribution and SEP IRAs $45,000 (2007), $46,000 (2008). Maximum 401(k), 403(b) and others $15,500 (2007 and 2008). Maximum annual benefit for defined benefit plan $180,000 (2007) and $185,000 (2008).
One person (Solo) 401(k) plans. Even though the Profit Sharing Plan limit has increased to 25%, sole proprietors might consider a single participant 401(k) plan. In order to contribute $45,000 to a Profit Sharing Plan in 2007, a sole proprietor must have $234,200 of net self-employment income. However, a self-employed individual only needs $155,600 of self employment income in order to contribute $45,000 to a single participant 401(k) plan.
Warning: If you work full time as an employee and also consult as an independent contractor, your annual 401(k) plan contribution is limited to $15,500 ($20,500 if 50 or older.) If you contribute the maximum at your full time job, the benefit of the single participant 401(k) disappears, as you cannot contribute more to a 401(k) plan through your sole proprietorship.
Other Solo 401(k) pointers
BUSINESS TAX CHANGES FOR 2007
Accident and Health Plans. If a sole proprietor hires his spouse as a bona fide employee, 100% of the cost of the spouse’s (and her children) accident and health coverage, including medical expense reimbursements, are deductible. Additionally, the cost of the coverage and medical reimbursements is excludable from the employee spouse’s income. This technique can amount to a huge annual tax savings over the medical expenses taken as an itemized deduction. This benefit also applies to partners, LLC members, and single member LLCs treated as sole proprietors. However this rule doesn’t apply to the spouse of an S corporation over 2% shareholder.
Caution: The medical expense reimbursement plan cannot be considered discriminatory.
Cost Segregation Studies (CSS). The underlying incentive for preparing a CSS is the significant tax benefits derived from utilizing shorter recovery periods for computing depreciation deductions. The result is generally a positive cash flow. For more details, see my Tax Highlights for 2006, page 3 at my web site: www.llrcpa.com.
Domestic Production Deduction will provide certain businesses with a HUGE tax benefit as the potential deduction has doubled in 2007 compared to 2006. A comprehensive explanation is provided in my 2006 Highlights on my web site.
Section 179 expensing for business personal property is $125,000 for 2007.phasing out for costs in excess of $500,000. To take the deduction, the equipment must be in used by December 31, 2007.
Social security taxable wage limit increases from $97,500 (2007) to $102,000 (2008)
Board of Equalization (BOE) is increasing compliance for persons needing a Sellers Permit but do not have one. If you are an online seller of valuables or junk on eBay, Amazon, etc you are required to have a sellers permit if you:
This rule applies if you make more than two sales for substantial amounts during any 12-month period (not calendar year).