Tax & Business Strategies Monthly Newsletter - April 2007

Tax Planning Strategies
The Earned Income Credit
Deducting Costs of Refinancing Your Home
Gambling Income and Losses
Taxing Your Child's Investment Income
Are You Paying or Receiving Alimony?
Beware of Tax Scams
Taxpayers Have Until April 17 to File Returns
Credit for Retirement Savings Contributions
Refund Status Available From IRS Website

Business & Management Practices
Do I Need a Business Plan?
Looking for Business Tax Deductions? Look No Further than Your Business Vehicle!
Clock is Ticking for Retirement Plan Contributions
Self-Employed Education Twists
Tax Tips for the Well-Traveled Businessperson

General Information
Haven't Filed an Income Tax Return? Here's What to Do.
When to Amend Your Return
Important Considerations When Selecting a Trustee
When to Throw Out Tax Records

Briefs
What Income Is Taxable and Nontaxable?
When Should You Start Taking Social Security?

TAX PLANNING STRATEGIES

The Earned Income Credit

The Earned Income Tax Credit (EIC) provides a refundable tax credit for people who work, but have lower incomes. If a taxpayer qualifies, it could be worth up to $4,500 for 2006. So a taxpayer will pay less federal tax or even receive a larger refund.

In 2005, over 22 million taxpayers received $41.4 billion dollars in EIC. The IRS estimates 20 to 25% percent of people who qualify for the credit do not claim it.

At the same time, there are millions of Americans who have claimed the credit in error, many of whom simply don’t understand the criteria.

If you were employed for at least part of 2006, you may be eligible for the EITC based on these general requirements:

• You earned less than $12,120 ($14,120 if married filing jointly) and did not have any qualifying children.
• You earned less than $32,001 ($34,001 if married filing jointly) and have one qualifying child.
• You earned less than $36,348 ($38,348 if married filing jointly) and have more than one qualifying child.

In addition, you must meet a few basic rules:

• You must have a valid Social Security Number.
• You must have earned income from employment or from self-employment.
• Your filing status cannot be married filing separately.
• You must be a U.S. citizen or resident alien all year, or a nonresident alien married to a U.S. citizen or resident alien and filing a joint return.
• You cannot be a qualifying child of another person.
• If you do not have a qualifying child, you must:
- be age 25 but under 65 at the end of the year,
- live in the United States for more than half the year, and
- not qualify as a dependent of another person.
• You cannot file Form 2555 or 2555-EZ (related to foreign earned income).

Members of the military can elect to treat all or none of their nontaxable combat pay as earned income for the purposes of computing the earned income credit. The one providing the largest EIC benefit can be used.

If you have questions about how the EIC might apply to you, a family member, or even a friend, please call this office for additional information. It is also important to understand that a taxpayer who might not normally be required to file a return might benefit from the EIC.


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Deducting Costs of Refinancing Your Home

There has been a lot a press in the recent weeks about sub-prime home mortgages. Some lenders have gotten into trouble and individual borrowers can no longer afford their home loans when the low initial 3 or 5-year ARM mortgage interest rates adjusted.

If you currently have a 3 or 5-year ARM loan, perhaps it is time for you to start looking for a fixed rate loan while your home value supports such a loan. Waiting and taking a chance that you will be unable to refinance at a later date might leave you stuck with the adjusted rate of your current loan.

Taxpayers who refinance their homes may be eligible to deduct some costs associated with those loans. The term "points" is used to describe certain charges paid to obtain a home mortgage.

Here are some things to remember when deducting points:

• Generally, for taxpayers who itemize, the points paid to obtain a home mortgage may be deductible as mortgage interest.

• Depending on circumstances, points can be fully deductible in the year paid.

• Points paid solely to refinance a home mortgage usually must be deducted over the life of the loan.

For a refinanced mortgage, the interest deduction for points is determined by dividing the points paid by the number of payments to be made over the life of the loan. This information is usually available from lenders. Taxpayers may deduct points only for those payments made in the tax year.

However, if part of the refinanced mortgage money was used to finance improvements to the home and if the taxpayer meets certain other requirements, the points associated with the home improvements may be fully deductible in the year the points were paid. Also, if a homeowner is refinancing a mortgage for a second time, the balance of points paid for the first refinanced mortgage may be fully deductible at pay off.

Other closing costs – such as appraisal fees and other non-interest fees – generally are not deductible. Additionally, the amount of “adjusted gross income” can affect the amount of deductions that can be taken.

If you have questions about financing or refinancing a home or other real property, please call this office before you proceed. We frequently see taxpayers arranging their loans incorrectly, resulting in the loss or reduction of the tax benefits associated with the interest deduction.

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Gambling Income and Losses

Generally, a taxpayer must report the full amount of their gambling winnings for the year as income on their 1040 return (gambling as a trade or business is discussed later). Gambling income includes, but is not limited to, winnings from lotteries, raffles, horse and dog races and casinos, as well as the fair market value of prizes such as cars, houses, trips or other non-cash prizes.

A taxpayer may not reduce their gambling winnings by their gambling losses and report the difference. Instead, gambling winnings are reported in full as income and the losses (subject to limitation as discussed below) are deducted on Schedule A. Therefore, if a taxpayer does not itemize, they are unable to deduct gambling losses.

Frequently, taxpayers with winnings will expect to report only those winnings included on Form W-2G. However, those winnings reported on W-2G forms generally do not include all winnings for the year, and the tax code requires all winnings to be reported. All winnings from gambling activities must be included when computing the deductible gambling losses, which is generally always an issue in a gambling loss audit.

A taxpayer may deduct as a miscellaneous itemized deduction (not subject to the 2% limitation) gambling losses suffered in the tax year, but only to the extent of that year's gambling gains.

Gains - “Gains” include “comps” (complimentary goods and services the taxpayer may receive from a casino).

Losses - Losses from one kind of gambling are deductible against gains from another kind. IRS has ruled that transportation, meal and lodging expenses incurred while engaged in gambling activities are nondeductible personal expenses(1) which cannot be deducted against gambling winnings. (TAM 9808002) Individuals not engaged in the gambling business deduct gambling losses (to the extent of gambling gains) only as miscellaneous itemized deductions (but not subject to the 2%-of-AGI floor).

Comps - Gambling casinos often provide their customers with complimentary goods and services (“comps”) to encourage future patronage. IRS says that extraordinary comps, such as autos and jewelry, are taxable income. But it reserved the question of whether “normal comps,” such as food, drink, lodging and entertainment, can be excluded from income as purchase price adjustments.

Netting Specific Wagers - The amount of income from a winning bet or wager is the full amount of the winnings less the cost of placing that specific winning bet or wager. Thus, the winner of a sweepstakes includes as income the amount by which the prize money exceeds the ticket price, and the winner of a horse race includes as income the amount of prize money less the cost of the winning race ticket. In computing the amount of income from winnings, the cost of losing tickets (or other forms of wager) is not netted against the winnings.

Proving Gambling Losses - An accurate diary or similar record regularly maintained by the taxpayer, supplemented by verifiable documentation will usually be acceptable evidence for substantiation of wagering winnings and losses. In general, the diary should contain at least the following information:
(1) Date and type of specific wager or wagering activity;
(2) Name of gambling establishment;
(3) Address or location of gambling establishment;
(4) Names of other persons (if any) present with taxpayer at gambling establishment; and
(5) Amounts won or lost.

Verifiable documentation includes wagering tickets, cancelled checks and credit records. Where possible, IRS says the documentation should be backed up by other documentation of the activity or visit to a gambling establishment, e.g., hotel bills, airline tickets, etc. Affidavits from “responsible gambling officials” (not further defined) regarding gambling activities can also be used.

Other supporting documentation - Winnings and losses may be further supported by the following items:

• Keno — Copies of keno tickets purchased by the taxpayer and validated by the gambling establishment.

• Slot Machines — A record of all winnings by date and time that the machine was played.

• Table Games — Twenty-One (Blackjack), Craps, Poker, Baccarat, Roulette, Wheel of Fortune, etc. The number of the table at which the taxpayer was playing. Casino credit card data indicating whether credit was issued in the pit or at the cashier's cage.

• Bingo — A record of the number of games played, cost of tickets purchased and amounts collected on winning tickets.

• Racing — Horse, Harness, Dog, etc. — A record of the races, entries, amounts of wagers and amounts collected on winning tickets and amounts lost on losing tickets. Supplemental records include unredeemed tickets and payment records from the racetrack.

• Lotteries — A record of ticket purchase dates, winnings and losses. Supplemental records include unredeemed tickets, payment slips and winnings statement. Winnings from lotteries and raffles are gambling and therefore are included in gross income. In addition to cash winnings, the taxpayer must include in income bonds, cars, houses, and other noncash prizes at fair market value. If a state lottery prize is payable in installments, the annual payments and amounts designated as interest on the unpaid balance must be included in gross income.

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Taxing Your Child's Investment Income

Part or all of a child's investment income may be taxed at the parent's rate rather than the child's rate. Because a parent's taxable income is usually higher than a child's income, the parent's top tax rate will often be higher as well.

This special method, often referred to as the “kiddie tax,” of figuring the federal income tax only applies to children who are under the age of 18. For 2007, it applies if the child's total investment income for the year was more than $1,700. Investment income includes interest, dividends, capital gains and other unearned income.

Alternatively, a parent can, in many cases, choose to report the child's investment income on the parent's own tax return. Generally speaking, this option is available if the child's income consists entirely of interest and dividends (including capital gain distributions) and the amount received is less than $8,500. However, choosing this option may reduce certain credits or deductions that parents may claim.

In addition, wages and other earned income received by a child of any age are taxed at the child's normal rate.

The opportunity to transfer income from investments to children under 18 is substantially curtailed by the kiddie tax legislation. However, investing a child's funds in tax-free or tax-deferred investment vehicles such as the following can help avoid the kiddie tax:


• U.S Savings Bonds – Interest can be deferred until the bonds are cashed.

• Tax-Deferred Annuities - Interest can be deferred until the annuity is surrendered.

• Municipal Bonds – Generally produce tax-free interest income (may be taxable to the state).
• Growth Stocks - Stocks that focus more on capital appreciation than current income. The child could wait to sell them until after attaining age 18 and possibly be in school with no other income.

• Mutual Funds – That also focus on growth stocks or municipal bonds.

• Unimproved Real Estate – That provides appreciation without current income.

• Family Employment - If the family has a business, that family business could employ the child. The child’s earned income is not subject to “kiddie tax” and will generate a deduction for the family business (assuming the wages are reasonable for work actually performed). The child’s earned income can offset the standard deduction for a dependent and the excess income will be taxed at the child’s rate (not the parent’s). In addition, the child would also qualify for an IRA, which provides additional income shelter.

Please call this office if you would like an appointment to develop strategies to avoid the “kiddie tax.”


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Are You Paying or Receiving Alimony?

If you were recently divorced and are paying or receiving alimony under a divorce decree or agreement, you need to consider the tax implication for your income tax return.

Here are the general guidelines:

• Alimony payments received from your spouse or former spouse are taxable to you in the year you receive them. Because no taxes are withheld from alimony payments, you may need to make estimated tax payments or increase the amount withheld from your paycheck.

• Alimony payments you make under a divorce or separation instrument are deductible if certain requirements are met. Any payments not required by such a decree or agreement do not qualify as deductible alimony payments.

• Child support is never deductible. If your divorce decree or other written instrument or agreement calls for alimony and child support, and you pay less than the total required, the payments apply first to child support. Any remaining amount is then considered alimony.

If you received alimony, you must give the person who paid the alimony your Social Security number. Also, alimony is treated as compensation for purposes of an IRA, allowing you to make an IRA contribution even if you do not work.

It is important that the amount of alimony reported matches the amount claimed as income, because the IRS computer will match the amounts and if there is discrepancy they will initiate an inquiry.

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Beware of Tax Scams

Don’t fall victim to tax scams. These schemes take several shapes, ranging from promises of large tax refunds to illegal ways of “untaxing” yourself. Beware of these common schemes:

Telephone Tax Refund Abuse:

Don’t be misled by persons that suggest claiming improper amounts for the special telephone tax refund. In some cases, taxpayers have been requesting a refund of the entire amount of their phone bills, rather than just the three-percent tax on long-distance and bundled service to which they are entitled.

The IRS is investigating potential abuses in this area and will take prompt action against taxpayers who claim improper refund amounts. For most taxpayers, the telephone tax refund will be $30 to $60.

Identity Theft:

It pays to be extra careful when it comes to disclosing personal information. Identity thieves have used stolen personal data to access financial accounts, run up charges on credit cards and apply for new loans. The IRS is aware of several identity theft scams involving taxes or scammers posing as the IRS itself.

Scammers use promises of refunds or threats of audits to convince taxpayers to reveal personal financial information, which they then use to steal their victims' identities. This technique is referred to as “phishing” and involves sending an e-mail to someone falsely claiming to be from a legitimate government entity or business. In the case of the IRS, the bogus e-mail often claims that the taxpayer is due a big refund or is under investigation. The e-mail frequently asks the taxpayer to link to the IRS' website. In reality, taxpayers are linking to a website created by the scam artists. Once there, they are tricked into revealing personal information, including bank account and credit card numbers and passwords.

The IRS never uses e-mail to contact taxpayers about issues related to their accounts. Thus, never respond to those types of e-mail. If you have any doubts, please call this office so we can investigate further through appropriate channels.

Frivolous Arguments:

Promoters have been known to make outlandish claims that the Sixteenth Amendment concerning Congressional power to establish and collect income taxes was never ratified; that wages are not income; that filing a return and paying taxes are merely voluntary; and that being required to file Form 1040 violates the Fifth Amendment right against self-incrimination or the Fourth Amendment right to privacy.

Don’t believe these or other similar claims. Such arguments are false and have been thrown out of court.

Taxpayers are ultimately responsible for their own tax returns. Becoming involved with tax scams can lead to huge tax liabilities, penalties, and interest that can become difficult to repay and put you in financial difficulty for years to come. Remember the old adage; “if it’s too good to be true, then it probably isn’t true.” Please call this office before becoming involved with any tax protestor groups or possible tax scam artists.

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Taxpayers Have Until April 17 to File Returns

This year, taxpayers have until Tuesday, April 17, 2007, to file their 2006 individual tax returns (and certain other forms) and pay any taxes due. The filing date was extended because April 15 falls on a Sunday in 2007, and the following day, April 16, is Emancipation Day, a legal holiday in the District of Columbia. Under the Tax Code, legal holidays observed in the District of Columbia have nationwide impact on federal tax deadlines.

The forms and actions to which the new deadline applies include:

• Filing 2006 federal income tax returns;
• Requesting an automatic six-moth extension to file 2006 federal income tax returns;
• Make tax year 2006 balance due payments;
• Make tax year 2006 contributions to a Roth or traditional IRA;
• Make individual estimated tax payments for the first quarter of 2007; and
• File individual refund claims for tax year 2003 (the three-year statute of limitations for 2003 refunds expires after April 17.

The extended deadline applies regardless of whether the action or filing is done electronically or on paper.

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Credit for Retirement Savings Contributions

Generally, taxpayers with lower incomes do not have sufficient financial resources to make retirement savings contributions, often leading to inadequate resources when it comes time to retire in the future. Recognizing this problem, Congress added the Retirement Savings Contributions Credit to the Tax Code a few years back. This credit was set to expire after 2007, but thanks to the Pension Protection Act passed in 2006, the credit has been made permanent and will be indexed for inflation after 2007.

What this means is that lower-income taxpayers can have a portion of their retirement savings contributions returned to them in the form of a tax credit of as much as 50% of the retirement savings contribution. The credit is phased out as a taxpayer’s modified AGI increases over set limits (see table below), and this credit applies only to the first $2,000 of contributions to retirement savings, even though the law allows substantially larger contributions.

CAUTION – The credit is not refundable. That is, it can only be used to reduce a taxpayer’s tax liability to zero. For example, if a married couple with a modified AGI less than $31,000 for 2007 contributed $2,000 to an IRA, they would have a $1,000 (50% of $2,000) Retirement Savings Contributions Credit.

However, if after all their deductions and exemptions, they only have a net tax liability of $500, then their credit would only provide them with $500 of tax benefit. Therefore, for taxpayers who are on a tight budget and counting on the full credit might first make sure they can actually benefit from the full credit before committing to the retirement savings contribution.

To qualify for the credit, a taxpayer:

• Must be at least age 18,
• Is not a full-time student, and
• Cannot be claimed as a dependent on another person’s return.

When figuring this credit, you must subtract the amount of distributions received from your retirement plans from the contributions you have made. This rule applies for distributions starting two years before the year the credit is claimed and ending with the filing deadline for that tax return.

The Retirement Savings Contributions Credit is in addition to other tax benefits which may result from the retirement contributions. For example, most workers at these income levels may deduct all or part of their contributions to a traditional IRA. Contributions to a 401(k) plan are not subject to income tax until withdrawn from the plan.

Parents, or others with the financial means, who would like to assist a young adult might consider gifting the after-tax cost of the retirement savings contribution, so that there is no out-of-pocket cost to the young adult. This would help them down the road to retirement savings.

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Refund Status Available From IRS Website

By using the “Where’s My Refund” tool on the IRS website, taxpayers can check on the status of their federal income tax refunds seven days after they e-filed their return. If they file a paper return, they can check four to six weeks after mailing their return.

“Where’s My Refund” is easy to use and is the fastest way to check on a refund. Even taxpayers who file Form 1040EZ-T just to claim the telephone excise tax refund can utilize “Where’s My Refund.”
Taxpayers can check their refund status online anytime from anywhere. It is available 24 hours a day, 7 days a week, worldwide, only by visiting IRS.gov.

Taxpayers can securely access their personal refund information by entering their Social Security number, filing status and the exact amount of their refund. These shared secrets, known only to the taxpayer and IRS, verify that the person is authorized to access the account.

For the first time this year, taxpayers who chose direct deposit can split their refunds among as many as three accounts held by up to three different U.S. financial institutions. Split refunds offer taxpayers the opportunity to manage their money by sending part of their refund to one account for immediate needs and another part to a savings or investment account. “Where’s My Refund” will include a message confirming the refund was split and the expected deposit date. It will not specify the amount of individual deposits or the accounts to which the deposits were made.

“Where’s My Refund” web address: http://www.irs.gov/individuals/article/0,,id=96596,00.html

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BUSINESS & MANAGEMENT PRACTICES

Do I Need a Business Plan?

Business plans are used primarily for raising capital and guiding growth. Not everyone who starts and runs a business begins with a business plan, but it certainly helps to have one.

If you are seeking funding from a venture capitalist, bank, or other lending institution, a comprehensive business plan that demonstrates sound business reasoning will help you negotiate through the funding process. The business plan will convince investors that your new venture is worth funding, that you have identified an opportunity and have gathered the management and organization needed to be successful.

A well-written business plan is the best way to show investors that you deserve their financial support. Make sure that your plan is clear, accurate, focused and realistic. Use it to convince prospective investors that you have the tools, talent and team to build and run a successful business.

A business plan can be a valuable tool in analyzing all aspects of your business as it grows. Since most business owners are in fact learning on the job, a business plan takes this information and analyzes different possibilities without the risk and cost of working them out in real time. A variety of marketing or pricing scenarios can be played out on paper before testing even occurs.

The business plan helps focus the entrepreneur by:

• Defining objectives and detail programs to achieve forecasted results.
• Creating a regular business review and course correction process.
• Evaluating a new product line, promotion, or growth opportunity.
• Analyzing the quality of staff and future staffing needs.
• Clarifying financial requirements and cash flow forecasts.
• Refining strategy when making difficult decisions.
• Determining the strength of the competition and analyzing market trends.

Understanding where your venture is heading can determine whether or not you need to plan. Your business plan can help you work smarter, anticipate the future, test ideas and help create a results-oriented organization.

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Looking for Business Tax Deductions? Look No Further than Your Business Vehicle!

With all the recent changes in the tax laws and regulations, the options for deducting the business use of a vehicle are both numerous and generous. In fact, there are so many options that some can easily be overlooked. Note: When a vehicle is used both for personal and business use, the expenses must be prorated based on miles driven for each purpose.

Listed below are some of those options for 2007:

o Lease or Purchase – Your first option deals with the manner in which you acquire the vehicle. Whether you decide to lease the vehicle or purchase it, you may choose to deduct the business use of the vehicle using either the actual expense method or the standard cents-per-mile method. Note: If you choose the actual expense method the first year, then the standard cents-per-mile method cannot be used in any future year.

o Trade-In or Sell Old Vehicle – If you are replacing an existing vehicle, you have the option either to trade in the old vehicle or to sell it. Without considering other economic factors, if the sale of the old vehicle would result in a gain, then you may wish to consider trading it in and avoid the need of reporting the gain and instead reduce the cost basis of the replacement vehicle. On the other hand, if the sale will result in a loss, then it would probably be better to sell the vehicle and take the loss on your return.

o Cents-Per-Mile Method – This method requires the least amount of bookkeeping. You need only record the business miles and total miles driven on the vehicle each year, and the business deduction is the business miles multiplied by the rate for the year ($0.485 for 2007). Note: This method cannot be used to compute the deductible expenses of five or more autos owned or leased by a taxpayer and used simultaneously, such as in fleet operations.

o Actual Expense Method – As the name implies, this method involves deducting the actual expenses of operating the vehicle. This requires keeping track of the operating costs, including fuel, oil, maintenance, repairs and insurance. In addition, either the annual lease expense or, depending on the class of vehicle, an allowance for wear and tear on the vehicle is added to the annual expenses. A record of the business and total miles must also be maintained to determine the business portion of the expenses.

o Class of Vehicle – The class of vehicle affects the limitations that are applied to the allowances for wear and tear available for a particular vehicle.

• Vehicles with No Limitations: The following vehicles qualify for the Sec.179 deduction, regular depreciation and bonus depreciation. Depending on the methods selected, virtually any amount of the cost of this type of vehicle can be deducted in the year of purchase.

- Qualifying Non-Personal Use Vehicle - A vehicle that has been specially modified with the result that it is not likely to be used more than a de minimis amount for personal purposes.

- Exempt Vehicles – A vehicle used directly in a taxpayer’s trade or business of transporting persons or property for compensation or hire, such as an ambulance, hearse, taxi, clean fuel vehicles, bus or commuter highway vehicles.

• Those With Limitations: The following vehicles are limited by the luxury auto rules:

- Luxury Vehicle – Generally, a vehicle weighing less than 6,000, costing more than an annually inflation-adjusted threshold ($14,800 for 2006) and not falling into one of the other previous categories. This threshold and the annual limits are not determined until late in the year. The first-year depreciation deduction for this type of vehicle is limited to $2,960 (2006).

- Sports Utility Vehicles – Generally, a vehicle weighing 6,000 pounds or more, but less than 14,000 pounds (typically sports utility vehicles). Although not subject to the luxury vehicle limit above, the §179 deduction for this type of vehicle is limited to $25,000. Excluded from this limitation is any vehicle that:

o is designed for more than nine individuals in seating rearward of the driver's seat;
o is equipped with an open cargo area, or a covered box not readily accessible from the passenger compartment, of at least six feet in interior length; or
o has an integral enclosure, fully enclosing the driver compartment and load carrying device, does not have seating rearward of the driver’s seat, and has no body section protruding more than 30 inches ahead of the leading edge of the windshield.

- Special Trucks & Vans – Defined as passenger autos that are built on a truck chassis, including minivans and sport-utility vehicles (SUVs). These vehicles are subject to the annual luxury vehicle limitations, but are allowed an additional $300 added on to those limitations.

• Vehicles With Other Limitations - In addition to those described above, there are certain other seldom-encountered vehicles, such as electric vehicles and certified clean fuel vehicles, with other special allowances.

o Interest and Taxes – In addition to the other deductions discussed above, the business portion of personal property taxes, license and interest on the debt to purchase the vehicle are also deductible when the vehicle expenses are being deducted on a business schedule.

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Clock is Ticking for Retirement Plan Contributions

With the April tax deadline looming, the window of opportunity to maximize retirement and other special-purpose plan contributions for 2006 is closing. Many of those contributions not only build the retirement nest egg, but also deliver tax deductions for the 2006 tax return. Let's take a look at some of the ways a taxpayer can benefit.

• Traditional IRA - The maximum contribution to an IRA for 2006 is $4,000 ($5,000 if over 49 years old). The 2006 contribution can be made up to April 17, 2007. If the taxpayer is covered by another retirement plan, a deduction for the contribution may not be allowed, or the permitted deduction may be less than the maximum, depending on the income. Contributions not eligible to be deducted may be subject to a penalty unless they are withdrawn by April 17th or designated as nondeductible (on IRS Form 8606). The contribution limit for 2007 is the same as 2006.

• Roth IRA - This is a nondeductible retirement account, but the earnings are tax-free upon withdrawal, provided that holding period and age requirements are met. Roth IRAs are a good alternative for many taxpayers who aren’t eligible to deduct contributions to a traditional IRA. The maximum deductible contribution for the 2006 tax year is $4,000 ($5,000 if the taxpayer is over 49 years old). The 2006 contribution can be made up to April 17th. The 2007 contribution limit is the same as 2006.

Caution: The $4,000 and $5,000 IRA contribution limits apply to a combination of both the traditional and Roth IRA contributions.

• SEP-IRA (Simplified Employee Pension) - SEP-IRAs are tax-deferred plans for sole proprietorships and small businesses. They are probably the easiest way to build retirement dollars, requiring virtually no paperwork. Maximum contributions depend on the net earnings from the business. For 2006, contributions are the lesser of 25 percent of compensation or $44,000. It increases to $45,000 for 2007. The 2006 contribution can be made up to the due date of the return, including extensions. Thus, unlike a traditional or Roth IRA, funding of a SEP-IRA for 2006 may occur up to October 15, 2007, provided the tax return is on extension.

• Solo 401(k) Plans - A growing number of self-employed individuals with no employees are forsaking the SEP-IRA for a newer type of retirement plan called the Solo 401(k) or Self-Employed 401(k), mostly for its higher contribution levels.

For 2006, the maximum contribution to a Solo 401(k) is the sum of: a) up to 25% of compensation, and b) salary deferral up to $15,000. The total of A and B can't exceed $44,000 or 100% of compensation. The maximum contribution rises to $45,000 for 2007. On a last note, a Solo 401(k) account must be established by December 31, 2006 to make 2006 contributions. If one was not established, open one now for 2007 contributions.

• Health Savings Accounts (HSA) - An HSA is a tax-exempt trust or custodial account established exclusively for the purpose of paying qualified medical expenses of the account beneficiary. An HSA is designed to assist individuals that have high-deductible health plans (HDHP). A taxpayer is only eligible to establish an HSA if he or she has an HDHP.

The maximum 2006 contribution for eligible individuals with self-only coverage under an HDHP is the lesser of 100% of the annual deductible under the HDHP (minimum $1000) or $2,700.

The maximum 2006 contribution for eligible individual with family coverage under an HDHP is the lesser of 100% of the annual deductible under the HDHP (minimum $2000) or $5,250.

Amounts contributed to an HSA belong to individuals and are completely portable. Every year, the money not spent on medical expenses stays in the account and gains interest tax-free, just like an IRA. Unused amounts remain available for later years (unlike amounts in Flexible Spending Arrangements that are forfeited if not used by the end of the year).

• Coverdell Education Savings Accounts – These plans were originally called Education IRAs, but that moniker created confusion since they were really not retirement accounts. They are now called Coverdell Education Savings Accounts, named after the late Senator from Iowa. Contributions, which can be made for a beneficiary who is under 18 years of age, are not tax-deductible, but the money grows tax-free if the distributions are used to pay qualified education expenses. The maximum annual contribution is $2,000 per beneficiary. Contributions do not count toward IRA annual contribution limits; they are also due by April 17, 2007 to be considered as having been made for 2006.

Please note that information for each plan or account above has been abbreviated. Contact us for specific details on how they may apply to your situation. If you have already filed your return for 2006 and wish to take advantage of one or more of the opportunities discussed, please call the office before you make the contribution and before the contribution deadline for the type of account you are considering. On the other hand, if you wish to start your retirement savings program for the 2007 tax year, we can set up an appointment to see which plans best suit your situation.

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Self-Employed Education Twists

Self-employed taxpayers should consider their options carefully when it comes to applying tax benefits for their own education tuition and expenses. Tax law provides multiple ways to benefit from the educational expenses, and one may provide more benefit to you than another, based on your particular set of circumstances. In addition, your tuition may qualify for one tax benefit, while other education expenses qualify for another.

• As a Business Expense – Generally, if the education qualifies, it is better to take the cost as a business expense, since as a business expense it will offset both income taxes and self-employment tax. The expenses can include tuition, books, supplies, and allowable travel for the education. To qualify as a business expense, the education must either be to maintain or improve your skills or be required in your business. You may, however, not wish to use the education’s costs as a business expense when doing so limits your net profit and consequently limits your pension plan contribution. Another situation when you may not want to claim the education costs as a business expense is when your Schedule C only has a very small profit or shows a loss for the year.

• As an Adjustment to Income – If the education expense is tuition at an institution of higher education and you are under the AGI phase-out limit for this deduction, you have the option to deduct up to $4,000 as an adjustment to overall income for the year. You can take this deduction whether or not the education maintains or improves your skills required in your business. Other expenses related to this education such as books, supplies, and travel can still be deducted on your Schedule C as long as the education maintains or improves your skills required in your business. The deduction is a maximum of $4,000 if AGI does not exceed $65,000 ($130,000 for married couples filing jointly) or a maximum of $2,000 if AGI doesn’t exceed $80,000 ($160,000 for married joint filers). 2007 is the last year this deduction is available unless extended by Congress.

• As a Tax Credit – As with the adjustment to income above, if the education expense is tuition at an institution of higher education, you might qualify for the lifetime learning credit. It may be more beneficial than the business expense or AGI adjustment for the tuition portion of the expenses, especially if you are in a lower tax bracket or the business profits are low. The lifetime learning credit allows you a credit of 20% of the cost of your tuition (up to $10,000 of costs) as a tax credit. It, too, has an AGI phase-out limitation. For 2007, the credit for single taxpayers phases out between $47,000 and $57,000 and $94,000 to $114,000 for joint filers.

If you have any questions regarding these various options, please call our office.

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Tax Tips for the Well-Traveled Businessperson

Did you know that food and lodging expenses may be deducted when away from home for business purposes? This may be particularly beneficial to self-employed individuals that travel extensively. Like everything in the tax law, there are certain rules to follow.

The IRS requires that lodging expenses (and other expenses of $75 or more) be substantiated by records or other evidence. Acceptable records include diaries, logs, receipts, paid bills and expense reports.

The records should disclose the amount, date, place and essential character of the expense.

• Keep good records of travel expenses.
• Document the business purpose and the expected business benefit.
• Retain your travel itinerary to document the business activity while away.

Travel expenses are deductible only if the individual is away from their "tax home" for more than one business day. That usually means their regular place of business.

Meal expenses are deductible only if the trip is overnight or long enough that there is a need to stop for sleep or rest to properly perform one’s duties. The amount of the meal expenses must be substantiated, but instead of keeping records of the actual cost of meal expenses, a "standard meal allowance*" ranging from $45 to $58 can generally be used, depending on where and when the individual travels. Generally, the deduction for unreimbursed business meals is limited to 50% of the cost that would otherwise be deductible.

Actual lodging expenses must be substantiated with actual receipts and are 100% deductible. If meals are included in the lodging expense, they must be kept separate since meals have the 50% limitation as noted above.

* The standard meal allowance depends on the locality and is set by the U.S. General Services Agency (www.gsa.gov). It is also known as the federal M&IE (meals and incidental expenses) rate.

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GENERAL INFORMATION

Haven't Filed an Income Tax Return? Here's What to Do.

Taxpayers should file all tax returns that are due, regardless of whether or not full payment can be made with the return. Depending on an individual’s circumstances, a taxpayer filing late may qualify for a payment plan. All payment plans require continued compliance with all filing and payment responsibilities after the plan is approved.

Facts about Filing Tax Returns

• Failing to file a return or filing late can be costly. If taxes are owed, a delay in filing may result in penalty and interest charges that could substantially increase your tax bill. The late filing and payment penalties are a combined 5% per month (25% maximum) of the balance due.

• If a refund is due, there is no penalty for failing to file a tax return. But by waiting too long to file, you can lose your refund. In order to receive a refund, the return must be filed within three years of the due date. If you file a return, and later realize you made an error on the return, the deadline for claiming any refund due is three years after the return was filed, or two years after the tax was paid, whichever expires later.

• Taxpayers who are entitled to the Earned Income Tax Credit must file a return to claim the credit, even if they are not otherwise required to file. The return must be filed within three years of the due date in order to receive the credit.

• If you are self-employed, you must file returns reporting self-employment income within three years of the due date in order to receive Social Security credits toward your retirement.

Taxpayers who continue to not file a required return and fail to respond to IRS requests may be subject to a variety of enforcement actions, all of which can be unpleasant. Thus, if you have returns that need to be filed, please call this office so we can help you bring your tax returns up-to-date.

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When to Amend Your Return

As hard as you and your tax return preparer may try to file a complete and accurate tax return by the due date, circumstances such as the following may work against your efforts:

• Investment firms frequently send out corrected 1099 forms and annual statements.
• Some 1099s arrive after the filing due date.

• You may have rolled over an IRA account or sold a stock at a loss and forgot to have it reported on your tax return.

• A significant deduction may have been overlooked, which is easy these days with the added complications of our tax code.

• The unexpected K-1 from your aunt’s estate that you were unaware of.

Whatever the reason may be, your returns can be amended to reflect the correct information or amounts.

If you are amending for a refund, then the amended return must be filed before the statute of limitation expires on the return being amended. That is generally three years from the April due date of the return.


Thus, the statute only applies to refund returns and no refunds will be issued for returns filed after the statute has expired.

If tax is owed as a result of amending the return, file it as soon as possible to limit the interest and penalties that can accrue.

If you have unreported income from 1099s, W-2s, K-1s, etc., and wait for the inevitable notice from the IRS, you are taking the risk that they will not consider all the factors that might weigh in your favor since you have allowed the interest and penalties to build up. It may take the IRS one or two years to make the match between you and the missing income.

Does Amending Increase the Audit Liability? The fact that you amend a return does not in itself increase your chances of being selected for an audit. In fact, it might actually reduce your chances, especially if you are fixing something they will find later anyway. What concerns many about amending returns is that an IRS employee must compare the amended return changes with the original. If back-up documentation cannot be provided, the IRS may want to dig deeper.

That is why it is so important to provide proof or back-up documents to justify the changes being made. Let’s say you forgot to claim a $2,000 church donation. In this scenario, you definitely want to include documentation supporting the increased deduction.

If you have questions about amending your returns, please call us to discuss what steps need to be taken.

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Important Considerations When Selecting a Trustee

When it comes time to selecting a trustee, you need to be aware of several issues! To start off, a trustee must manage and oversee all the assets of the trust. That might require a significant amount of effort, depending on how complex your trust is and the number of assets involved. In some cases, it could become almost a full-time job.

The trustee can be a relative, a trusted friend, a professional trustee, a bank or corporate trustee.

The duties of a trustee are complex and involve among other things:

• Reviewing the trust documents and insuring the terms of the trust are followed,
• Managing the investments of the trust,
• Being responsible to the trust’s tax reporting and related tax issues,
• Trust recordkeeping,
• Overseeing the distribution of assets to the beneficiaries, and
• Ensuring each beneficiary receives their proper share of the distributions.

If a trustee is also a beneficiary, there are built-in conflicts of interest between the interests of the trust and the beneficiary trustee’s personal interests. This is also true if the potential trustee has any financial interests that could possibly be in conflict with the interests of the trust. If you plan on placing this responsibility on a friend or relative, are they really willing to take on the responsibility and spend the time it takes to correctly perform the duties of the trustee? Does the potential trustee have the knowledge, ethics and abilities to handle the responsibility? These are all things you must carefully consider before selecting a trustee.

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When to Throw Out Tax Records

Are you doing your spring cleaning and wondering if you can throw out some of those old tax records? If you are like most taxpayers, you have records from years ago that you are afraid to throw away. It would be helpful to understand why you keep the records in the first place.

Generally, we keep “tax” records for two basic reasons: (1) we need to keep the records in case the IRS or a state agency decides to question the information reported on our tax returns, and (2) we need to keep track of the tax basis of our capital assets so when we actually dispose of them we can minimize the tax liability.

With certain exceptions, the statute for assessing additional tax is three years from the return due date or the date the return was filed, whichever is later. However, the statute of limitations for many states is one year longer than the federal. In addition to lengthened state statutes clouding the recordkeeping issue, the federal three-year assessment period is extended to six years if a taxpayer omits from gross income an amount that is more than 25 percent of the income reported on a tax return. And of course, the statutes don’t begin running until a return has been filed. There is no limit where a taxpayer files a false or fraudulent return in order to evade tax.

If an exception does not apply to you, for federal purposes, you can probably discard most of your tax records that are more than three years old; add a year or so to that if you live in a state with a longer statute.

Examples - Sue filed her 2004 tax return before the due date of April 15, 2005. She will be able to dispose of most of her records safely after April 15, 2008. On the other hand, Don filed his 2004 return on June 2, 2005. He needs to keep his records at least until June 2, 2008. In both cases, the taxpayers may opt to keep their records a year or two longer if their states have a statute of limitations longer than three years. Note: If a due date falls on a Saturday, Sunday or holiday, the due date becomes the next business day.

The big problem! The problem with the carte blanche discarding of records for a particular year because the statute of limitations has expired is that many taxpayers combine their normal tax records and the records needed to substantiate the basis of capital assets. They need to be separated and the basis records should not be discarded before the statute expires for the year in which the asset is disposed. Thus, it makes more sense to keep those records separated by asset. The following are examples of records that fall into that category:

• Stock acquisition data - If you own stock in a corporation, keep the purchase records for at least four years after the year the stock is sold. This data will be needed in order to prove the amount of profit (or loss) you had on the sale.

• Stock and mutual fund statements – Where you reinvest dividends. Many taxpayers use the dividends they receive from a stock or mutual fund to buy more shares of the same stock or fund. The reinvested amounts add to the basis in the property and reduce gain when it is finally sold. Keep statements at least four years after final sale.

• Tangible property purchase and improvement records - Keep records of home, investment, rental property, or business property acquisitions AND related capital improvements for at least four years after the underlying property is sold.

Please give this office a call if you have questions about whether or not to retain certain records. You don’t want to discard something that might be needed down the road.

For example, when the large $250,000 and $500,000 home exclusion was passed into law several years back, homeowners became lax in maintaining home improvement records and thought that the large exclusions would cover any potential appreciation in the home’s value. Then came the real estate boom and the exclusion was not always enough. Records can be important so please use caution when discarding them.

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BRIEFS

What Income Is Taxable and Nontaxable?

Generally, most of the income that is received is taxable. But there are some situations when certain types of income are partially taxed or not taxed at all. Some common examples of items that are not included in your income are:

• Adoption Expense Reimbursements for qualifying expenses,
• Child support payments,
• Gifts, bequests and inheritances,
• Workers' compensation benefits,
• Meals and Lodging for the convenience of your employer,
• Compensatory Damages awarded for physical injury or physical sickness,
• Welfare Benefits,
• Cash Rebates from a dealer or manufacturer, and
• Tax-Exempt Interest from municipal bonds and tax-exempt bond mutual funds. Although this interest is not taxable, it must be reported on your tax return.

Examples of items that may or may not be included in your income are:

• Life Insurance - If you surrender a life insurance policy for cash, you must include in income any proceeds that are more than the cost of the life insurance policy. Life insurance proceeds paid to you because of the death of the insured person are not taxable unless the policy was turned over to you for a price.

• Scholarship or Fellowship Grant - If you are a candidate for a degree, you can exclude amounts that were received as a qualified scholarship or fellowship. Amounts used for room and board do not qualify.

If you have questions about the taxability of an item of income, please give this office a call. If the income is significant and taxable, it might be appropriate to take action before the end of the year.

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When Should You Start Taking Social Security?

A question frequently asked by most when approaching the age of drawing Social Security benefits is, “At what age should I begin taking my benefits?” To make an informed decision, a number of issues need to be considered, including how it affects your benefits, what are the tax ramifications, your family's historical longevity, and your financial needs. But first, let’s review how the decision will impact your Social Security benefits based on when you decide to retire.

• Wait Until “Normal” Retirement Age – When an individual retires at the normal retirement age, they will receive the standard Social Security benefits based on their lifetime earnings. The “normal” retirement age is no longer age 65. “Normal” retirement age is now based on a sliding scale and varies by year of birth, as indicated in the table below.

• Take the Benefits Early – You can also begin taking benefits as early as age 62 if you are willing to take a reduced amount over your lifetime. The amount of the reduction is based on how early the benefits are taken. Here is an example of how the reduction works. If your full retirement age is 67, then the approximate reduction for taking the benefits at an earlier age is:

(1) Generally, a spouse whose Social Security benefit is based on the other spouse’s earnings receives 50% of what the other spouse receives. This column represents the spouse’s retirement benefit based on the retiree’s benefits.

• Take the Benefits Late – Some people decide to continue working full-time beyond retirement age. In that case, their Social Security benefits increase in two ways:

o Each additional year a person works adds another year of earnings to their Social Security record. Higher lifetime earnings may result in higher benefits when one retires.

o In addition, a person's benefit will be increased by a certain percentage (see table below) if he/she delays retirement. These increases, called delayed retirement credits, will be added in automatically from the time that individual reaches full retirement age until he or she starts taking benefits or reaches age 70.

You may also want to take your life expectancy into consideration. If your family history indicates a shorter than average life expectancy, you might want to take the benefits earlier than later.

Social Security is taxable once an individual’s income for the year, including one-half of the Social Security income, exceeds $25,000 ($32,000 for married taxpayers filing jointly). Thus, for very low-income taxpayers, the benefits are not taxable at all, and as the taxpayer’s income increases, a greater portion of the benefits become taxable. However, not more than 85% of the benefits are added to taxable income, so taxpayers who are still working or have substantial other income may not wish to utilize the “early” option, since that requires a reduced benefit which will be subject to taxation and further reduced.

Everyone’s situation is different and there are a number of issues to consider. If you would like to set up an appointment to discuss your specific circumstances, please give this office a call.


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