Tax & Business Strategies Monthly Newsletter - February 2007

Tax Planning Strategies
Tip for Recently-Married or Divorced Taxpayers
Medicare-B Premiums Increased This Year
Some Home Energy Credits Extended - Others Expire at the End of 2007

Business & Management Practices
Starting Up a Pension Plan – You May Get a Tax Credit!
Is it a Repair or an Improvement?
Business Vehicles and the Hybrid Credit

General Information
Research and Development (R&D) Credit Extended
Nissan Altima Hybrid Qualifies for the Hybrid Tax Credit
April Due Date Extended to April 17
Clean Out Old Tax Records!
Plan Your Withholding & Estimates for 2007

Briefs
Is It Too Late to Establish a Pension Plan for Last Year?
IRS Sets Maximum Values For Cents-Per-Mile Valuation
Don’t Overlook Your Employer’s 401(k) Roth Option

TAX PLANNING STRATEGIES

Tip for Recently-Married or Divorced Taxpayers

Newlyweds and the recently divorced should ensure that the name on their tax return matches the name registered with the Social Security Administration (SSA). A mismatch could unexpectedly increase a tax bill or reduce the size of any refund.

For recently-married taxpayers, the tax scenario begins when the bride says "I do." If she takes her husband's last name, but doesn't tell the SSA about the name change, a complication may result. If the couple files a joint tax return with her new name, the IRS computers will not be able to match the new name with the Social Security Number.

After a divorce, a woman who had taken her husband’s name and made that change known to the SSA should contact the SSA if she reassumes a previous name.


It is easy to inform the SSA of a name change by filing Form SS-5 at a local SSA office. It usually takes two weeks to have the change verified. The form is available on the agency's web site, www.socialsecurity.gov, by calling 800-772-1213 and at local offices. The SSA web site provides the addresses of local offices.

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Medicare-B Premiums Increased This Year

Don’t be surprised if you notice an increase in your Medicare-B premium. The Federal Government has been supplementing the Medicare-B insurance premiums for some years, as the costs have exceeded the funds generated from the premiums. Beginning in 2007, the premiums will be increased for higher-income individuals based upon their modified AGI for the year two years prior. Thus, for 2007, the modified AGI for 2005 will be used. Apparently, your modified AGI exceeded the threshold for increases, which is $80,000 for unmarried individuals and $160,000 for individuals filing jointly. The following are the amounts of the increase based on the 2005 AGI. The tables below represent the adjustments for 2007 based on filing status.

Inflation Adjustments - The $80,000 and $160,000 thresholds will be adjusted annually, in $1,000 increments, based on the Consumer Price Index.

Subsidy Phase-Out – Think the 2007 increase is bad? The government’s subsidy of the Medicare-B premium for the affected higher-income taxpayers is being phased out over a three-year period.

Thus, in 2008, the monthly adjustments will double the 2005 increase based on the 2006 AGI, and the 2009 increase will be triple based on the 2007 AGI.



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Some Home Energy Credits Extended - Others Expire at the End of 2007

2007 may be your last opportunity to take advantage of the tax credit for residential energy improvements, which will expire at the end of 2007. However, you have an additional year to use the residential solar and fuel cell credits, because they were extended through 2008 by legislation passed last December. Here are the rundowns on these two tax credits.

Tax Credit for Residential Energy Improvements - Energy improvements to a principal residence located in the United States and placed in service before the end of 2007 qualify for the residential energy improvements credit. Generally, the credit is the cost of qualifying heat pumps, boilers, water heaters and fans, plus 10% of the cost of qualifying insulation, exterior windows including skylights, exterior doors, and metal roofs coated with heat-reduction pigments.

However, the total credit is limited to $500, of which no more than $200 can be for window components, $50 for an advanced main air circulating fan, $150 for a qualified furnace or hot water boiler, or $300 for any qualified central air conditioner, heat pump, or water heater. Installation expenses do not count as part of the cost.

Tax Credit for Residential Solar and Fuel Cell Equipment - For property placed in service before the end of 2008, a credit is allowed for 30% of the cost of qualifying solar water heaters, up to $2,000 per year, and a credit subject to the same 30%/$2,000 limit also applies for photovoltaic (electricity-generating) solar panels. The foregoing apply to the taxpayer’s first or second homes.


In addition, a 30% credit is allowed for fuel cell property, up to $500 for each half-kilowatt of capacity installed per year on the taxpayer’s principal residence.

Labor costs for onsite installation and for piping and wiring connections are qualifying costs for all three credits. However, the credits do not apply to equipment used to heat swimming pools or hot tubs.

One cautionary note: the credits do not apply against the Alternative Minimum Tax (AMT), which means a taxpayer could lose all or a portion of the tax benefit from the credits. However, Congress is currently debating whether or not to eliminate the AMT effective beginning in 2007.

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BUSINESS & MANAGEMENT PRACTICES

Starting Up a Pension Plan – You May Get a Tax Credit!

If you are considering establishing a qualified pension plan for your business, you may be entitled to the “small employer pension start-up credit.” Eligible small employers that adopt a new plan, such as a 401(k), SIMPLE plan, or simplified employee pension plan (SEP), may claim a nonrefundable credit. The credit is equal to 50% of administrative and retirement-related education expenses for the plan for each of the first three plan years, with a maximum credit of $500 for each year.

The first credit year is the tax year that includes the date the plan becomes effective, or, electively, the preceding tax year. Examples of qualifying expenses include the costs relating to changing the employer’s payroll system, consulting fees, and set-up fees for investment vehicles.

There are some qualification rules, the most predominant being:

o The business did not employ, in the preceding year, more than 100 employees with compensation of at least $5,000.

o The plan must cover at least one non-highly compensated employee.

o The plan must be a new one – during the three prior years, the employer may not have had a qualified employer plan for which contributions were made or benefits accrued for substantially the same employees who are in the plan for which the credit is being claimed.

o If the credit is for the cost of a payroll-deduction IRA plan, the plan must be made available to all employees who have worked with the employer for at least three months.

No deduction is allowed for that portion of the qualified start-up costs paid or incurred for the tax year which is equal to the credit. However, an eligible employer may elect not to have the credit apply for any tax year.

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Is it a Repair or an Improvement?

One big issue that is frequently encountered in taxes is whether an expense is for a repair or a capital improvement to a business asset. The distinction for tax purposes is that a repair is immediately deductible in the year of the expense, where an improvement must be written off over time (i.e., depreciated). Of course, most taxpayers will prefer to immediately deduct any business expense they have. However, the tax code does not always permit that. How do you distinguish a repair from an improvement?

• Repairs - A repair keeps your property or equipment in good operating condition and does not materially add to the value of your property or substantially prolong its life. Let’s say you use a heavy duty truck in your business. You blow the engine and replace it with a new one. The new engine is not treated as a repair, because it substantially prolongs the useful life of the vehicle. If you own rental property, repainting your property inside or out, fixing gutters or floors, fixing leaks, and replacing broken windows are examples of repairs. However, if the repairs are part of an extensive remodeling or restoration of your property, the whole cost is an improvement.

• Improvements – An improvement will add to the value of the property, prolong its useful life, or adapt it to new uses. If you make an improvement to a property, the cost of the improvement must be capitalized. The capitalized cost can generally be depreciated as if the improvement were separate property. For a real estate rental, examples of improvements that must be depreciated include putting on a new roof, adding a room, paving a driveway and installing fencing.

Generally, the depreciable life of most business assets (other than real estate property) is 3, 5 or 7 years. In addition, for non-real estate business property, a taxpayer can utilize the Sec. 179 expense deduction that allows costs, which would otherwise be required to be depreciated, to be expensed in the first year of service.


For improvements to real estate property, the depreciable life is 27.5 years for residential and 39 years for commercial property.

If you would like to discuss how these issues may affect your business, please give our office a call.


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Business Vehicles and the Hybrid Credit

The allocation is based on miles driven between business and personal. If you have any questions, please call this office.



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GENERAL INFORMATION

Research and Development (R&D) Credit Extended

As part of the Tax Relief and Health Care Act of 2006 passed in late December 2006, the research and development (R&D) credit, which expired at the end of 2005 is reinstated retroactively for 2006 and extended through 2007. In addition, for tax years ending after 2006, the new law enhances the credit by:

(1) Increasing the rates of the alternative incremental credit, and

(2) Creates an alternative simplified credit that does not use gross receipts as a factor, thus allowing newer businesses to qualify for the credit.

Although the computation can be more complicated, generally a taxpayer can claim a research credit equal to 20 percent of the business’s incremental increases in qualified research expenses.

Expenses qualifying for this credit generally include: (1) in-house wages and supplies attributable to qualified research; (2) certain time-sharing costs for computer use in qualified research; and (3) sixty-five percent of expenses of research contracted out to others.

New alternative simplified credit - The alternative simplified credit available in tax years after 2006 is equal to 12 percent of qualified research expenses that exceed 50 percent of the average qualified research expenses for three preceding taxable years. The rate is reduced to 6 percent if a taxpayer has no qualified research expenses in any one of the three preceding taxable years.

Option to deduct R&D expenses – As an alternative, a taxpayer may elect to deduct R&D expenses that do not create an asset or extend an asset’s useful life. Where an asset is created, or the life is extended, the expenses must be capitalized. However, deductions allowed to a taxpayer must be reduced by an amount equal to 100 percent of the taxpayer’s research tax credit for the taxable year. Taxpayers can alternatively elect to claim a reduced research tax credit amount (13 percent) in lieu of reducing deductions otherwise allowed.

If you have questions regarding this tax credit, please give this office a call.



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Nissan Altima Hybrid Qualifies for the Hybrid Tax Credit

The Internal Revenue Service has acknowledged the certification by Nissan North America, Inc., that its 2007 Nissan Altima Hybrid vehicle meets the requirements of the Alternative Motor Vehicle Credit as a qualified hybrid motor vehicle. The credit amount for the hybrid vehicle certification of the 2007 Nissan Altima Hybrid is $2,350.

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April Due Date Extended to April 17

Generally, the filing and payment due date for the preceding year’s tax return is April 15. However, when the due date falls on a Saturday, Sunday or legal holiday, the due date is extended to the next business day. In addition, legal holidays in the District of Columbia are also treated as legal holidays for purposes of the federal filing and payment deadline.

For 2007, April 15 falls on a Sunday, and since April 16 is a legal holiday in the District of Columbia (Emancipation Day), the filing and payment due date for 2006 returns is extended to April 17.


For most individual taxpayers, this extends the following due dates:
• Filing the 2006 individual return,
• Paying any remaining 2006 tax liability,
• Filing for an extension for filing the 2006 individual tax return,
• Making the first installment of the 2007 estimated tax,
• Filing individual claims for refund from the 2003 tax year, and
• Making contributions to IRA accounts for the 2006 tax year.

Although this provides one additional day to meet the filing due date for 2007, clients are encouraged to file as early as possible and not put off filing until the last minute.

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Clean Out Old 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 period. 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 2005 tax return before the due date of April 17, 2006. She will be able to dispose of most of her records safely after April 17, 2009. On the other hand, Don filed his 2005 return on June 2, 2006. He needs to keep his records at least until June 2, 2009. In both cases, the taxpayers may need 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.

• Individual retirement arrangements (IRAs) – Copies of the following forms or records should be kept at least four years beyond the year when all distributions have been made from your IRA:
o Form 5498 (IRA Contribution Information) or a similar statement you receive each year that shows the contributions you made, distributions you received and the IRA’s value;
o Form 8606 (Nondeductible IRAs) for each year you made a nondeductible contribution to your IRA or received IRA distributions if you ever made a nondeductible contribution; and
o Form 1099-R (Distributions) for each year you received a distribution from your IRA.

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Plan Your Withholding & Estimates for 2007

You may not realize it but taking a few minutes to plan your estimated tax payments and/or proper withholding amounts for the year can actually protect you from underpayment penalties in 2008.

Congress considers our tax system as a "pay-as-you-go" system. To facilitate that concept, the government has provided several means of assisting taxpayers in meeting the "pay-as-you-go" requirement. These include:

• Payroll withholding for employers;
• Pension withholding for retirees; and
• Estimated tax payments for self-employed individuals and those with other sources of income not covered by withholding.

When a taxpayer fails to prepay a safe harbor (minimum) amount, they can be subject to the underpayment penalty. This nondeductible interest penalty is higher than what you might earn from a bank and is computed on a quarter-by-quarter basis.

Safe Harbor Payments – Federal law and most states have safe harbor rules. There are two Federal safe harbor amounts that apply when the payments are made evenly throughout the year:

1. The first safe harbor is based on the tax you owe in the current year. If your payments equal or exceed 90% of your current year tax liability, you can escape a penalty.

2. The second safe harbor – and the one taxpayers rely on most often – is based on your tax in the immediately preceding tax year. If your current year payments equal or exceed 100% of the amount of your prior year’s tax, you can escape a penalty. If your prior year’s adjusted gross income was more than $150,000 ($75,000 if you file married separate status), then your payments for the current year must be 110% of the prior year’s tax to meet the safe harbor amount.

Where taxpayers get into trouble is when their income goes up or their withholding goes down for the current year versus the prior year. Examples are having a substantial increase in income, such as when investments are cashed in, thereby increasing income but without any corresponding withholding or estimated payments. Another frequently encountered situation is when a taxpayer retires and his payroll income is replaced with pension and Social Security income without adequate withholding. Taxpayers who don’t recognize these types of situations often find themselves substantially underpaid and subject to the underpayment penalty when tax time comes around.

Bottom line, 100% (or 110% for upper-income taxpayers) of your prior year’s total tax is the only true safe harbor because it is based on the prior year’s tax (a known amount), whereas the 90% of the current year’s tax amount is a variable based on the income for the current year, and often that amount isn’t determined until it is too late to adjust the prepayment amounts.


Therefore, it is very important that you bring any potential tax events to our attention, so that we might suggest adjustments to your withholding or provide you with estimated payment vouchers.

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BRIEFS

Is It Too Late to Establish a Pension Plan for Last Year?

A Keogh plan must be established before the close of the 2006 tax year if you want to make a contribution for 2006. However, a Simplified Employee Pension Plan (SEP) can be established after the close of the year allowing you to make retroactive tax-deductible retirement contributions, provided they are made before the extended due date of your return. Actually, the SEP provides for the same contribution amounts as a Keogh plan. In addition, a SEP does not have the separate pension plan reporting requirements of a Keogh plan (e.g., Form 5500-EZ due July 31 if covering only one person under a Keogh). Nonetheless, the SEP is probably your better choice.

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IRS Sets Maximum Values For Cents-Per-Mile Valuation

The IRS has set forth the maximum allowable values of employer-provided automobiles, including trucks and vans, first made available to employees for personal use in calendar year 2007 for which:

(1) The vehicle cents-per-mile valuation rule, and

(2) The fleet-average valuation rule may be applicable.

The maximum value for use of the vehicle cents-per-mile valuation rule is $15,100 for a passenger automobile and $16,100 for a truck or van. The maximum value for use of the fleet-average valuation rule is $20,100 for a passenger automobile and $21,100 for a truck or van.

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Don’t Overlook Your Employer’s 401(k) Roth Option

Beginning in 2006, employer’s 401(k) plans could be modified to accept Roth-type contributions, provided the designated Roth 401(k) contributions are held in a separate account within the plan. If your employer offers a 401(k) plan and you are interested in Roth-type pension contributions, you might inquire to see if that is an option.

As under regular Roth IRA rules, tax-free Roth distributions would be allowed after a five-year waiting period if you are at least age 59 ½ when the distributions are made. This gives you the option to choose the immediate tax benefit of pre-tax regular 401(k) contributions or the future tax-free distribution benefits of a Roth account. This provision also applies to 403(b) plans (so-called tax sheltered annuities).

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