Janell A. Israel & Associates Ltd
Dear Clients and Friends,
This year we have had important changes in the tax law, and Congress hopes to make even more changes. The Tax Increase Prevention and Reconciliation Act changed the age threshold for the “kiddie tax,” extended the lower rates on dividends and long-term capital gains through 2010, and will end in 2010 the $100,000 income limit for converting a traditional IRA to a Roth IRA.
The Pension Protection Act made permanent several provisions that were to expire soon, including Roth 401(k)s, the saver’s credit, the retirement plan start-up credit, the tax-favored treatment of Section 529 college plans, and higher contribution limits to retirement plans. It also changed the rules for charitable contributions.
Constant tax revision makes planning essential if you want to keep your tax bill as low as the law allows. This Letter is being sent to alert you to tax changes and to encourage you to make time now to do some year-end and longer-term tax planning.
Please call if you have questions after reading this Letter or if you would like to get together to review your tax situation. And, by all means, pass this Letter along to friends or associates who might be interested in this tax information.
For
a lower 2006 tax bill, make time now for planning
There’s good news and more good news in store for your year-end tax planning. First, if you act now, you still have time to make planning moves that will save you money on your 2006 return. And second, recently enacted tax laws may provide new tax-saving options.
Here are some sensible year-end
strategies to consider.
· Track your income
Knowing where you stand can influence the way you recognize income for the remainder of the year. For example, you might choose to postpone income to avoid missing out on certain deductions, credits, and other tax breaks that are limited by adjusted gross income levels.
Directing more of your pay to your retirement account for the last quarter of 2006 can help you claim larger benefits by reducing current-year taxable income. You can deposit as much as $15,000 in your 401(k) for 2006, plus a catch-up contribution of $5,000 if you’re age 50 or older. Contribute to a deductible IRA if you qualify.
Additional methods for postponing income that require advance planning include structuring eligible property sales to qualify for installment treatment and trading one property for another in a like-kind exchange.
· Adjust your investments
Schedule your annual investment rebalancing before year-end to take advantage of tax-saving moves. If you discover you need to sell investments to keep asset allocations in line with your goals, try to offset gains with losses. Remember, you can apply up to $3,000 of capital losses against ordinary income, which can help reduce your tax bill.
Another tax-smart investing tactic: Keep an eye on your holding period when making sales. Gains on certain assets you’ve owned for more than a year are generally eligible for a favorable maximum tax rate of 15%.
Timing investment purchases can also result in savings. For instance, you might consider waiting to purchase shares in a mutual fund until after an expected year-end taxable distribution.
Be aware of “wash sale rules” when buying securities, too. When you replace an investment with a substantially identical one within the 61-day period surrounding the sale, any loss is not currently deductible.
· Review charitable giving
Due to a new tax law, as of August 17, 2006, contributions of used clothing, furnishings, electronics, or other household items of minimal value will generally be nondeductible. The new rules state that such items must be in “good” condition to qualify for a charitable deduction. If you’re planning to itemize, you may want to donate cash before year-end instead of these items.
· Check special breaks
A recent change in the charitable contribution rules that provides a potential tax planning opportunity involves your individual retirement account. In 2006 and 2007, if you’re over age 701/2, you can make contributions directly from your IRA to a qualified charity. The amount you donate is not included in your income, but does count as part of your required minimum distribution.
This break means you can meet the annual distribution requirement for your traditional IRA without incurring tax on as much as $100,000. While you won’t get an itemized charitable deduction for these contributions, now’s the time to figure out whether the reduction in income and the related tax is more advantageous.
· Save energy and taxes
Install energy efficient improvements in your main residence by December 31, and you may be able to take a one-time credit of as much as $500 on your 2006 tax return. Qualifying purchases include insulation systems, exterior windows and doors, and metal roofs. There’s also a credit available (up to a maximum of $2,000) for solar water heaters. Check into the credit of up to $3,400 for buying a fuel efficient hybrid vehicle.
· Check your business situation
Accelerating business income into the current year may make sense in certain situations, such as when you could lose deductions due to hobby loss rules. This strategy can also give you more access to breaks such as the manufacturing deduction and the immediate expensing of certain business assets.
Are you on track to make the most of the Section 179 deduction? For 2006 you can write off up to $108,000 of equipment and software that you purchase and use in your business.
What about your deduction for retirement plan contributions? Set up a qualified plan before December 31, and you can make the contribution early next year while still garnering the deduction for 2006.
Paying regular business expenses prior to year-end can help lower your taxable income, too, even if you put them on your credit card in December and write the check in January.
While you’re reviewing business expenses, update your corporate minutes to substantiate deductions. Additionally, consider increasing your basis in S corporations or partnerships as necessary to benefit from losses.
· Also consider these moves
If necessary, adjust your withholding before year-end to avoid tax underpayment penalties.
Avoid the marriage penalty. The standard deduction and 15% tax bracket for couples are double those of single taxpayers. But that doesn’t eliminate the marriage penalty for working couples in tax brackets above 15%. If a wedding or divorce is in your year-end plans, you might save taxes by changing the date.
If you turned 701/2 in 2006, you have until December 31 to decide whether to take your first required IRA distribution this year. You can postpone your first distribution until next April, but then you’ll have to take two distributions in 2007. Unless you’re still working, these rules also apply to other retirement plans (except Roth IRAs).
Use this year’s $12,000 gift tax exclusion. If you make annual gifts to family members or others, make sure you complete your gifts for 2006 by December 31.
Deduction? Credit? What’s the difference?
In the world of taxes, a credit is better than a deduction. A credit reduces your taxes dollar for dollar (a $1,000 credit cuts taxes by $1,000). A deduction reduces your taxes by your tax rate percentage (a $1,000 deduction for someone in the 28% tax bracket cuts taxes by $280).
Under today’s complex tax rules, many deductions and credits disappear once your income reaches certain levels. By knowing what tax deductions and credits you might qualify for, you may be able to do tax planning that will preserve your eligibility for these income-sensitive tax breaks.
Here’s a quick checklist of some of the available credits and deductions. Check those that might apply to you; then find out if you need to do some year-end planning to benefit from them.
Deduction for contributions to a health savings account.
Credit of up to $3,400 for the purchase of a hybrid clean-fuel car.
Saver’s tax credit of up to $1,000 for retirement plan contributions.
Business tax credit for providing child care facilities for employees.
Energy credits for home-builders and appliance manufacturers.
Deduction for energy-saving improvements made to commercial buildings.
Credit for energy-saving home improvements.
Expensing deduction up to $108,000 for the purchase of business equipment.
Credit of up to $10,960 for expense of adopting a child.
Credit for child care expenses.
Deduction for job-related moving expenses.
Earned income credit for low-income workers.
Deduction for job-hunting expenses.
Deduction for student loan interest.
Hope or lifetime learning credits for education expenses.
Deduction for home office expenses.
Deduction for disaster losses not reimbursed by insurance.
Deduction for home mortgage points.
Credits and deductions change frequently with revisions of the tax laws, and most of them have qualification requirements or income limitations. With regular tax planning, especially as year-end approaches, you’ll be able to benefit from more of these tax breaks. For help in identifying all the credits and deductions that could reduce your 2006 taxes, call us soon.
Tax
changes made by new pension law
On August 17, 2006, President Bush signed the Pension Protection Act of 2006. The Act mainly deals with the funding of traditional pension plans, requiring most plans to become fully funded over a seven-year period. This 900-plus page pension law also includes a number of important tax provisions. Here are the highlights of those tax changes.
· Higher plan limits. A 2001 tax law set higher contribution limits for IRAs, SIMPLEs, SEPs, 401(k)s, and 457 plans. But these larger contribution amounts were set to expire after 2010 along with most of the other provisions in the 2001 law. The Pension Act makes these higher contribution limits permanent and generally indexes the limits for inflation in the future.
· Saver’s credit. The saver’s tax credit that provides for a credit of up to $1,000 annually for lower-income individuals’ contributions to retirement plans is made permanent. The income-based phase-out ranges for the credit will be indexed for inflation, a change that will make the credit available to more taxpayers.
· Plan start-up credit. The tax credit for small businesses that start a new retirement plan (up to $500 per year for three years) is made permanent.
· Roth 401(k)s. Roth 401(k)s, which had been scheduled to end after 2010, are made permanent. This change may increase their popularity among both employers and employees.
· Nonspouse rollovers. Starting in 2007, the Pension Reform Act permits tax-free rollovers of a deceased person’s IRA or retirement plan into a nonspousal beneficiary’s IRA. Before this change, only spouses enjoyed this tax-free option.
· Tax refunds. Beginning next year, taxpayers will be allowed to have all or part of their income tax refund directly deposited into their IRA.
· Penalty easing. Generally a 10% penalty applies to early withdrawals from retirement accounts. The new law provides an exception to the penalty for military reservists called to active duty and for certain public safety employees (e.g., police, firemen, and medical emergency personnel).
· Section 529 plans. Distributions from Section 529 plans used to pay for college expenses were scheduled to lose their tax-free status after 2010. The Pension Act makes the tax-favored treatment for 529 plans permanent.
· Charitable donations. The rules are tightened for donations of cash, clothing, household items, and easements. No tax deduction will be allowed for contributions made by cash or check, regardless of the amount, without a receipt from the charity or a bank record. No deduction will be allowed for used clothing or household goods unless the items are in “good” condition.
· IRA donations. Older taxpayers will temporarily be permitted to make direct donations to charities from their IRA without first paying tax on the distribution. A $100,000 annual limit applies.
This new law has many more provisions, some of which could affect you or your business. It will be important to consider these recent changes as you do your year-end planning. For details on how the law might affect you, be sure to give us a call.
The “kiddie tax”: A new age applies
Attention, parents: The kiddie tax rules changed this year, and that could affect your 2006 year-end tax planning.
The kiddie tax applies to your child’s unearned income, such as interest, dividends, capital gains, and rents. If this type of income exceeds $1,700 this year, the excess is subject to tax at your highest rate, rather than at your child’s lower rates. Once your child reaches a certain age, the kiddie tax no longer applies. That magic age used to be 14. The 2006 tax law passed in May changed the age threshold to 18, effective for all of 2006.
If you made certain moves relying on the age 14 kiddie tax threshold, you may find that you’ll be paying higher taxes on stock sales or other investment income of a child under age 18. While there’s no way around the kiddie tax if you’ve already sold investments your child owned during 2006, there are strategies you can employ going forward. Here are some possibilities.
· Savings bonds. Consider purchasing savings bonds. The interest on bonds held in your child’s name can be deferred until the bonds are cashed – which you would do after your child reaches age 18. If you meet the income restrictions, you might buy the bonds in your name instead. When the proceeds are used to pay for college expenses, the interest is not taxable.
· Munis. Tax-free municipal bonds can help minimize the kiddie tax, too, but keep an eye on the alternative minimum tax rules.
· College savings plans. Earnings on investments in 529 college plans and Coverdell education savings accounts are tax-free, as are distributions used to pay for college expenses.
You have other options as well, such as hiring your child in your business. Give us a call to discuss the right choice for you.
Not every tax-cutting strategy mentioned in this letter is appropriate for everyone, and other options not discussed may be more suitable in your particular situation. To make your 2006 tax-cutting efforts most effective, call now and let’s get together for your tax planning review. We can help you identify the steps you can take to keep your taxes as low as the law allows.
Sincerely,
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