Tax & Business Strategies Monthly Newsletter - January 2007

Tax Planning Strategies
Unusual Medical Considerations
Avoiding Tax Audits

Business & Management Practices
Are You Required to File 1099s?

General Information
Additional Vehicles Qualify for the Tax Credit
Eleventh Hour Tax Changes Passed
Recent Tax Law Changes May Affect People Giving to Charity

Briefs
Recordkeeping Requirements for Charitable Contributions Made By Payroll Deductions
IRS Announces Simplified Method for Computing Business Telephone Excise Tax Rebate

TAX PLANNING STRATEGIES

Unusual Medical Considerations

Taxpayers can only deduct medical expenses if they itemize their deductions. In addition, medical expenses are only deductible if they exceed 7.5% of a taxpayer’s income (AGI), and then only the amount that exceeds that income limit is actually deductible. The income limit is a higher 10% for those taxpayers subject to the alternative minimum tax (AMT).

Once a taxpayer’s expenses exceed the income limits, every additional dollar spent on medical for the year becomes deductible. Therefore, once the minimum is met, it is important to utilize every legal expense. In addition, if you only marginally qualify for medical each year, it may be appropriate, when possible, to “bunch” medical deductions in one year to maximize the benefit.

Taxpayers whose medical expenses do exceed the income limitation should also make sure they do not overlook any deductible medical expense. The following represent infrequent or unusual medical expenses and how they are treated for the medical expense deduction.

Adoption Expenses Paid by Adopting Parent - Medical expense payments made by an adopting parent for medical services rendered to a child, even before the child was placed in the parent's home, are deductible if:

• The child is a dependent of the adopting parent when services are rendered or paid; and
• The expenses are paid by the parent or agent for the medical care of the child; and
• They are not reimbursement for expenses by the adoption agency prior to adoption negotiations; and
• The expenses are shown to be directly attributable to the medical care of the child.
The adoptive parents cannot deduct the natural mother's childbirth expenses.

Birth Control Pills – A taxpayer can include in medical expenses the amount paid for birth control pills, provided they were prescribed by a doctor.

Chiropractor - The amounts paid to chiropractors for medical care can be included in medical expenses.

Christian Science Practitioner - The amounts paid to Christian Science practitioners for medical care can be included in medical expenses.

Cosmetic Surgery – This is defined as any procedure, which is directed at improving the patient's appearance and does not meaningfully promote the proper function of the body or prevent or treat illness or disease. Cosmetic surgery or other similar procedures can't be taken into account as a medical expense deduction, unless the surgery or procedure is necessary to ameliorate a deformity arising from (or directly-related to) a (1) congenital abnormality, (2) personal injury resulting from an accident or trauma, or (3) disfiguring disease. IRS specifically ruled that breast reconstruction surgery paid for by a breast cancer patient who had a mastectomy as part of her cancer treatment was a deductible medical expense.

IRS allowed the cost of eye surgery to correct defective vision, including laser procedures such as LASIK and radial keratotomy, since these procedures are performed to correct a dysfunction of the body.

Payments to a dentist to perform a teeth-whitening procedure on a patient whose teeth had discolored as a result of age were not deductible because the discoloration was not a deformity, was not caused by a disfiguring disease or treatment, and was done so as to improve appearance.

Decedent’s Medical Expenses - Medical expenses paid before death is claimed by the decedent as an itemized deduction in the usual manner on the decedent’s final return. Medical expenses paid after the decedent’s death becomes the liability of the decedent’s estate, and they are claimed on the estate tax return (Form 706). However, expenses that were paid out of estate funds within one year after death can be treated as if paid by the decedent and claimed on the decedent’s final return instead. Consult with the executor. Assuming the decedent will itemize, total medical expenses will exceed the 7½% (10% if taxed by the AMT) of AGI floor and no 706 is required; it is clear that making the election and deducting the medical expenses on the 1040 are appropriate.

Egg Donor Expenses - IRS has ruled privately that a woman who can't conceive children using her own eggs may claim a medical expense deduction for the costs of obtaining an egg donor, including associated legal costs. IRS said that a procedure facilitating pregnancy by overcoming infertility similarly affects a structure or function of the body and also may be medical care. Expenses that prepare for and are directly related to a medical care procedure may also constitute medical care, according to the IRS. For example, an IRS ruling holds that a kidney recipient who pays a kidney donor's surgical, hospital, and transportation expenses may deduct these costs as medical expenses. The ruling concludes that the costs of obtaining an egg donor, including the donor's expenses, are directly related and preparatory to her receiving the donated egg or embryo and may be deducted as medical expenses. IRS said that like other preparatory expenses, legal expenses may be deductible medical expenses if they bear a direct or proximate relationship to the provision of medical care to a taxpayer.

Equipment and Supplies – IRS has ruled that the prohibition against deductibility of nonprescription medicine or drugs does not apply to such items as crutches, bandages, and diagnostic devices (e.g., blood sugar kits used by diabetics). The costs of such equipment and supplies are deductible if they otherwise meet the general requirement of being paid for the diagnosis, cure, mitigation, treatment, or prevention of disease.

Guide Dog or Other Animal - The cost of a guide dog or other animal to be used by a visually-impaired or hearing-impaired person can be included in medical expenses. This includes the cost of a dog or other animal trained to assist persons with other physical disabilities. The amounts paid for the care of these specially-trained animals are also medical expenses.

Household Help as a Medical Expense - The cost of household help cannot be included in medical expenses, even if such help is recommended by a doctor. This is a personal expense that is not deductible. However, certain expenses paid to a person providing nursing-type services may be included. See Nursing Services below. Also, certain maintenance or personal care services provided for qualified long-term care can be included in medical expenses.

Impairment-Related Expenses - Capital Expenses - Amounts paid for special equipment installed in the home, or for improvements may be included in medical expenses, if their main purpose is medical care for the taxpayer, the spouse, or a dependent. The cost of permanent improvements that increase the value of the property may be partly included as a medical expense. The cost of the improvement is reduced by the increase in the value of the property. The difference is a medical expense. If the value of the property is not increased by the improvement, the entire cost is included as a medical expense.

Certain improvements made to accommodate a home to a taxpayer’s disabled condition, or that of the spouse or dependents that live with the taxpayer, do not usually increase the value of the home and the cost can be included in full as medical expenses. These improvements include, but are not limited to, the following items:

• Constructing entrance or exit ramps for the home,
• Widening doorways at entrances or exits to the home,
• Widening or otherwise modifying hallways and interior doorways,
• Installing railings, support bars, or other modifications,
• Lowering or modifying kitchen cabinets and equipment,
• Moving or modifying electrical outlets and fixtures,
• Installing porch lifts and other forms of lifts but generally not elevators,
• Modifying fire alarms, smoke detectors, and other warning systems,
• Modifying stairways,
• Adding handrails or grab bars anywhere (whether or not in bathrooms),
• Modifying hardware on doors,
• Modifying areas in front of entrance and exit doorways, and
• Grading the ground to provide access to the residence.

Only reasonable costs to accommodate a home to a disabled condition are considered medical care. Additional costs for personal motives, such as for architectural or aesthetic reasons, are not medical expenses.

Invitro Fertilization - Although not specifically addressed in tax law, it would appear that this procedure would be deductible if performed on the taxpayer claiming the expense. The Code specifically allows procedures that affect the structure or function of the body. It also would be allowed under discretionary surgery performed on the taxpayer. Discretionary medical costs are generally deductible where they are not illegal under Federal law. For example, abortions, vasectomies, and procedures to render the taxpayer incapable of getting pregnant have been held deductible.

Lead-Based Paint Removal - The cost of removing lead-based paints from surfaces in a taxpayer’s home to prevent a child who has or has had lead poisoning from eating the paint can be included in medical expenses. These surfaces must be in poor repair (peeling or cracking) or within the child’s reach. The cost of repainting the scraped area is not a medical expense. If, instead of removing the paint, the area is covered with wallboard or paneling, treat these items as capital expenses. Do not include the cost of painting the wallboard as a medical expense.

Learning Disability - Tuition fees paid to a special school for a child who has severe learning disabilities caused by mental or physical impairments, including nervous system disorders can be included in medical expenses. A doctor must recommend that the child attend the school. Tutoring fees recommended by a doctor for the child’s tutoring by a teacher who is specially trained and qualified to work with children who have severe learning disabilities may also be included.

Legal Fees – A taxpayer can include in medical expenses legal fees paid that are necessary to authorize treatment for mental illness. However, do not include in medical expenses fees for the management of a guardianship estate, fees for conducting the affairs of the person being treated, or other fees that are not necessary for medical care.

Long-Term Care Insurance – Amounts paid for certain premiums for long-term care insurance are deductible as medical expenses. However, the deductible amount of the premiums is limited to a prescribed amount based on the insured’s age and is inflation-indexed annually.

Meals - Medical expenses may include the cost of meals at a hospital or similar institution if the main purpose for being there is to get medical care. The cost of meals that are not part of inpatient care are not deductible.

Medical Conferences - IRS has ruled that a taxpayer may deduct the cost of attending a conference relating to a dependent’s disease. In this ruling, the taxpayer was allowed to deduct the cost of the conference registration fee and travel to the conference, because those costs were primarily for a dependent's medical care and the taxpayer's attendance was essential for that care. The cost of meals and lodging were not deductible, because the dependent did not receive medical care at a licensed facility (a prerequisite for medical deduction of meals and lodging).

Non-Hospital Institutions - The following are examples of when non-hospital institutions are deductible:

• All amounts paid by the taxpayer to maintain his mentally retarded son in a specially-selected private home (which qualified as an “institution”) in accordance with the recommendation of the psychiatrist in charge of the son's case, to help the son adjust to life in the community after living in a mental hospital.

• Amounts paid to maintain a child at a halfway house, including room and board. Admission to the halfway house required the recommendation of a psychiatrist and continued psychiatric supervision during the stay. The house staff included a psychiatrist and mental health counselor.

Nursing Home - Medical expenses include amounts paid for the cost of inpatient care at a hospital or similar institution if the main reason for being there is to receive medical care. This includes amounts paid for meals and lodging.

Nursing Services - Wages and other amounts paid for nursing services can be included in medical expenses. Services need not be performed by a nurse as long as the services are of a kind generally performed by a nurse. This includes services connected with caring for the patient's condition, such as giving medication or changing dressings, as well as bathing and grooming the patient. These services can be provided in the home or another care facility.

Generally, only the amount spent for nursing services is a medical expense. If the attendant also provides personal and household services, these amounts must be divided between the time spent performing household and personal services and the time spent for nursing services. However, certain maintenance or personal care services provided for qualified long-term care can be included in medical expenses.

Additionally, certain expenses for household services or for the care of a qualifying individual incurred to allow the taxpayer to work may qualify for the child and dependent care credit. Part of the amounts paid for that attendant's meals are also included in medical expenses. Divide the food expense among the household members to find the cost of the attendant's food. If additional amounts for household upkeep were paid because of the attendant, include the extra amounts with the medical expenses. This includes extra rent or utilities paid, because a larger apartment was needed to provide space for the attendant.

Over-the-Counter Drugs Paid for by Health Care Flexible Spending Accounts - The costs of over-the-counter drugs are not allowed as a medical deduction. However, over-the-counter drugs can be paid for with pre-tax dollars through health care flexible spending accounts. An IRS Revenue Ruling clarifies that reimbursements for nonprescription drugs by an employer health plan are excluded from income. Thus, reimbursements by health flexible spending arrangements (FSAs) and other employer health plans for the cost of over-the-counter drugs available without prescription are not subject to tax if properly substantiated by the employee.

However, amounts paid by an employee for dietary supplements that are merely beneficial to the general health of the employee or the employee's spouse or dependents, are not reimbursable by a flexible spending plan, nor excludable from gross income.

Smoke-Cessation Programs - IRS has ruled that uncompensated amounts paid by taxpayers for participation in smoking-cessation programs and for prescribed drugs designed to alleviate nicotine withdrawal are expenses for medical care that are deductible under Code Sec. 213, subject to the percentage-of-AGI limitation. However, because of the prohibition of deductions for most nonprescription drugs, no deductions are permitted for the costs of non-prescription nicotine gum and certain nicotine patches.

Social Security Taxes for Household Employees - If a domestic employee, such as a nurse, is paid cash wages of $1,500 (for 2006) or more during the year, Social Security and Medicare taxes are required from the employee and the household employer. If all (or a portion of the household services) are for nursing services (even if provided by someone other than a licensed practitioner), the Social Security and Medicare taxes applicable to the nursing services portion of the wages are also deductible as a medical expense.

Sterilization - The cost of a legal sterilization (a legally performed operation to make a person unable to have children) can be included in medical expenses.

Surrogate Mother Expenses - As with invitro fertilization, this issue is not specifically addressed in tax regulations. The Code does tell us that medical expenses are only deductible for the taxpayer, spouse and dependents. The definition of a dependent for medical purposes ignores the gross income and joint return tests. Therefore, it appears that a surrogate mother’s medical expenses can only be deducted if she qualifies as a “medical dependent.” The unborn fetus is not a dependent until actually born.

Weight-Loss Programs - The IRS has concluded that expenses for certain weight-loss programs may be deducted as a medical expense. To be deductible, the program must be undertaken as treatment for a specific disease or diseases (including obesity) diagnosed by a physician. The costs are not deductible by taxpayers who participate in weight-loss programs to improve their general health or appearance. Further, the cost of purchasing diet food items is not deductible. However, you cannot include membership dues in a gym, health club, or spa.

Wig – A taxpayer can include in medical expenses the cost of a wig purchased upon the advice of a physician for the mental health of a patient who has lost all of his or her hair from disease.

If you have questions regarding these or other questionable medical expenses, or wish to plan the payment of your medical expenses for the maximum tax benefit, please call this office for an appointment.

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Avoiding Tax Audits

An IRS tax audit can come in a number of forms. The most demanding are the face-to-face audits, which require sitting down with an auditor and reconciling income and deductions. Others are the less demanding correspondence audits where the IRS has reason to believe that the taxpayer failed to include reported income or has overstated deductions.

Correspondence Audits – Employers, banks, lending institutions, schools, brokerage firms, escrow companies and others all feed data to the IRS, which the IRS, in turn, matches by computer the information reported on your tax return. If there is a significant discrepancy, the IRS will correspond with the taxpayer. Sometimes these discrepancies will result in additional tax liability, while other times a simple explanation will satisfy the IRS and make the problem go away. Here are some examples of typically-encountered discrepancies:

• Unreported Pension Income – Whenever a taxpayer takes money out of one IRA account and rolls it over within the 60-day statutory limit into another IRA or qualified plan, the income is not taxable. However, the financial institution from which the funds were withdrawn will issue a 1099R and report to the IRS that you made a withdrawal. To show the rollover, a taxpayer must report on their tax return that the distribution was in fact rolled over. All too frequently, taxpayers will fail to bring the distribution to their return preparer’s attention thinking that they have met the 60-day rollover requirement. Because the rollover is unreported, it will result in a correspondence audit. Generally, when moving an IRA from one institution to another, making arrangements for a direct transfer will avoid these types of audits. However, that is not universally true, because some institutions will still issue a 1099R, which must be reported on the tax return.

• Gross Proceeds of Sale – When real estate, stock or other securities is sold, the IRS computer knows what it sold for. Even if there is no gain or loss, it still needs to be reported on the tax return. Otherwise, the IRS will assume the entire sales price (gross proceeds of sale) is taxable profit. By reporting the sale on the return, the taxpayer is able to show what he or she paid for the sold investment, thus minimizing or even reporting a deductible loss.

• Alimony Paid or Received – A taxpayer who pays alimony is able to deduct the amount he or she paid. On the other hand, the recipient of that alimony must report that amount as taxable income. The IRS computer checks to make sure the amounts match; otherwise, a correspondence audit will be initiated by the IRS. This is an area of frequent mismatch because there is a lot of confusion with what constitutes alimony, child support and property settlements.

• Home Mortgage Interest – Each of your mortgage lenders will report to the IRS the interest paid on your mortgage for the year and issue you a 1098 for the same amount. If these amounts don’t reconcile, expect a correspondence audit. Where this frequently becomes an issue is when the loan is from a private party and the paying taxpayer must report on his or her tax return the name and social security number of the individual to which the interest was paid, thus allowing the IRS to make sure the private lender is reporting the income. Another frequently encountered area of mismatch is when two or more individuals are on the same loan, but lenders report the interest paid only under one of the borrower’s social security numbers. Here again, a notation must be made on the return showing the individual who actually received the income, so the IRS can make sure they are not claiming 100% of that interest and that the total reported paid by all parties does not exceed the total reported paid on the loan.

• Tuition Paid – Because of the Hope and Lifetime education tax credits that can be claimed for paying tuition to a qualified education institution, the IRS requires those institutions to report the tuition received to the IRS and issue the 1098-T to the taxpayers. Thus, the IRS has the ability to verify the tuition paid during the year, and any mismatch could result in a correspondence audit.

• Interest and Dividends – The IRS allows many financial institutions to issue substitute 1099s, i.e. forms that are not in the traditional standard 1099 format. These substitute forms can often be misinterpreted by an untrained eye with various types of interest and dividends reported separately and spread throughout lengthy annual account statements. To make matters worse, many brokerage firms have been issuing amended 1099 statements late in the tax filing season due to their errors in determining the allocation of a taxpayer’s earnings between dividends, qualified dividends, capital gains dividends, and original issue discount interest. Thus, if the taxpayer has already filed, the changes are significant, and if the taxpayer does file an amended return, they will probably receive a correspondence audit.

• Non-Taxable Interest Beginning in 2006 – Interest from municipal obligations are tax-free for purposes of computing federal tax. However, tax-free municipal interest income is added to income for purposes of computing taxable social security income. It is also counts as income for purposes of determining whether a taxpayer qualifies for earned income credit (EIC). Thus, beginning in 2006, payers of tax-free municipal interest must report the interest paid to the IRS and issue a 1099 to the taxpayer so that the IRS can match the tax-free income to the computation of taxable social security and EIC disallowance. Taxpayers should pay particular attention to this new matching program.

• Cash Contributions Beginning in 2007 – Beginning for the 2007 tax year, regardless of the amount of cash contributed, the contribution must be backed up with either a bank record or written communication from the donee organization showing the: (1) name of the donee organization, (2) date of the contribution, and (3) amount of the contribution. The recordkeeping requirements may not be satisfied by maintaining other written records.

What this means is that unless the charitable organization provides a written communication, cash donations put into a “Christmas kettle,” church collection plate, and pass-the-hat collections at youth sporting events will not be deductible. Donations by debit or credit card can be substantiated by bank records. These new rules will give the IRS the ability to audit taxpayer’s charitable contributions via correspondence audits since all contributions must be backed by written receipt or bank record.

Don’t assume that just because you received a notice that the IRS is correct. They are frequently wrong. Please call this office before responding to any IRS notice. Tax laws are complicated, and the notices are not always easily understood.

Face-to-Face Audits – The more demanding face-to-face audit is rarely encountered by wage-earning taxpayers who report all their income and have deductions that are within the general norms. Self-employed, high-income taxpayers, those who have omitted substantial income, or those who repeatedly fail to show income to support their lifestyle are more likely to be subject to these types of audits.


You can appear for the audit yourself, but that is probably a bad idea since you are not trained in the rules and regulations regarding audit procedures and what limits the IRS’s incursion into your private life. You can authorize your tax professional to handle it without you. Often, this is the best way to prevent the audit from escalating beyond the original areas that attracted the IRS's interest in the first place. Practitioners experienced with IRS audits are less likely to become emotional or to make statements that would lead to additional IRS questioning.

Caution: It is strongly recommended that you contact this office immediately upon receipt of any inquiry from the IRS. Don’t procrastinate, because that only leads to further action on the part of the IRS.



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BUSINESS & MANAGEMENT PRACTICES

Are You Required to File 1099s?

If you use independent contractors to perform services for your business or rental and you pay them more than $600 for the year, you are required to issue them a Form 1099 after the end of the year to avoid facing the loss of the deduction for their labor and expenses. The 1099 must be provided to the independent contractor no later than January 31st following the close of the tax year in which the services were rendered.

It is not uncommon to have a repairman out early in the year, pay him less than $600, then use his services again later and have the total for the year exceed the $600 limit. As a result, you overlook getting the information needed to file the 1099s for the year. Therefore, it is good practice to always have individuals who are not incorporated complete and sign the IRS Form W-9 the first time you use their services. Having a properly completed and signed Form W-9 for all independent contractors and service providers eliminates any oversights and protects you against IRS penalties and conflicts.

IRS Form (W-9, Request for Taxpayer Identification Number and Certification) is provided by the government as a means for you to obtain the data required to file the 1099s from your vendors. It also provides you with verification that you complied with the law should the vendor provide you with incorrect information. We highly recommend that you have a potential vendor complete the Form W-9 prior to engaging in business with them. The form, available from this site, can either be printed out or filled onscreen and then printed out. The W-9 is for your use only and is not submitted to the IRS.

In order to avoid a penalty, copies of the 1099s need to be sent to the IRS by the last day of February. They must be submitted on magnetic media or on optically scannable forms (OCR forms). This firm prepares 1099s in OCR format for submission to the IRS with the 1098 submittal form. This service provides recipient and file copies for your records. Use the worksheet to provide us with the information we need to prepare your 1099s.

Please attempt to have the information to this office by January 20th, so that the 1099s can be provided to the service providers by the January 31st due date.

If you have questions, please call.



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GENERAL INFORMATION

Additional Vehicles Qualify for the Tax Credit

The Internal Revenue Service announced the addition of certain Honda vehicles to the list of vehicles qualifying for the Alternative Motor Vehicle and Alternative Fuels Credit.

The following is a list of vehicles qualifying for the credit. Note that Toyota reached the 60,000 vehicle limit in the third quarter of 2006. Thus, beginning in the fourth quarter of 2006, the credit will be reduced by 50% for vehicles purchased from 10/1/06 to 3/31/07. From then onwards, the credit will only be 25% of the otherwise allowable amount between 4/1/07 through 9/30/07. No credit will be given for Toyota vehicles purchased 10/1/07 and later.

Note: The credit is allocated between the personal and business portions of the credit. The business portion of the credit is treated as part of the General Business Credit.

Please call if you have further questions.



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Eleventh Hour Tax Changes Passed

Congress has been procrastinating for months on extending certain tax benefits that otherwise expired in 2005. Finally, as one of its last official acts for the year, Congress has passed the Tax Relief and Health Care Act of 2006 (the fourth tax legislation passed this year. However, the legislation is not limited to extending old benefits and includes some new benefits as well.

Preparing returns to accommodate these changes can be a challenge, since the IRS has already sent the forms and publication to print and has indicated they will not reprint them. Instead, they will issue supplemental instruction on how to accommodate the extended items on the returns.


The following is a summary of the most widely applicable tax changes included in the legislation that will affect individuals and small businesses.

INDIVIDUAL PROVISIONS

Deduction for Higher Education Expenses - The tax deduction for qualified higher education expenses is retroactively restored for 2006 and extended through 2007. Thus, individual taxpayers will be allowed to deduct up to $4,000 of higher education expenses instead of claiming the Hope or Lifetime Learning tax credits. The deduction is taken “above-the-line” so that it is deductible even for those taxpayers who do not itemize their deductions.

Caution: This deduction phases out for higher-income individuals. Married taxpayers filing jointly with an Adjusted Gross Income (AGI) of $130,000 or less are allowed to deduct up to $4,000 of expenses. The limit drops to $2,000 for taxpayers with an AGI of $160,000 or less and no deduction at all if the AGI exceeds $160,000. For other taxpayers, the equivalent AGI limits are $65,000 and $85,000. In addition, taxpayers filing as Married Separate, Dependent of Another or Non-Resident Alien are not allowed to take this deduction.

State and Local Sales Tax Deduction - The tax break allowing individual taxpayers to choose between deducting state income tax or sales tax, whichever provides them the best benefit, is retroactively restored for 2006 and extended through 2007.

To determine the deductible amount of sales tax, taxpayers may use their total sales tax for the year backed up with receipts or use the amount predetermined by the IRS for their income, plus the sales tax for motor vehicles and boats. Those that live in states with no state income tax simply benefit from the additional deduction for the year. Non-itemizers may also find that the addition of the sales tax deduction might allow them to itemize. Because of this last minute law change, the sales tax tables were not included in the 1040 instructions and instead will appear in a special, yet-to-be-numbered IRS publication.

Teacher's Expenses - The $250 tax deduction for out-of-pocket costs incurred to purchase books, supplies and other classroom equipment by elementary and secondary school teachers and certain other school professionals is retroactively restored for 2006 and extended through 2007. The deduction is taken "above-the-line" so that it is deductible even for those taxpayers who do not itemize their deductions.

Solar Credit Extended - The personal 30% tax credit for the purchase of residential solar water heating, solar electric equipment and fuel cell property, which originally applied only to 2006 and 2007, has been extended through 2008.

The credit is limited to an annual maximum of $2,000. Qualifying solar water heating property is property to heat water for use in a dwelling unit located in the U.S., and used as a main or second residence by the taxpayer, and at least half of the energy used by the property for such purpose is derived from the sun. The property must be certified for performance by the Solar Rating Certification Corporation or a comparable entity endorsed by the state government where the property is installed

Combat Pay EIC Election - The election to have excluded combat pay counted as income for purposes of calculating the earned income tax credit (EIC) is extended through 2007. Thus, for tax years 2004 through 2007, a taxpayer may elect to treat combat pay that is otherwise excluded from gross income as earned income for purposes of the EIC.

Caution: Making this election for EIC purposes may or may not be advantageous. If the taxpayer has earned income below the maximum amount of earned income on which the credit is calculated, including the combat pay will increase the credit amount. On the other hand, if the taxpayer’s earned income is already in the phase-out range, electing to include combat pay as earned income will decrease the amount of credit that can be claimed.

DC First-Time Homebuyer Credit - The tax break allowing first-time homebuyers in the District of Columbia to claim a tax credit of up to $5,000 on the purchase price of the home is retroactively restored for 2006 and extended through 2007.

Archer Medical Savings Accounts (Archer MSA) - The Act provides that no new contributions may be made to Archer MSAs after Dec. 31, 2007, except by or on behalf of individuals who previously had Archer MSA contributions and employees who are employed by a participating employer. Under pre-Act law, the cutoff date for such new contributions was Dec. 31, 2005.

In general, Archer MSAs allow favorable tax treatment of money saved for medical expenses by certain taxpayers covered by high-deductible health plans. Within limits, contributions to an Archer MSA are deductible in determining adjusted gross income if made by an eligible individual and are excludable from gross income and wages for employment tax purposes if made by the employer of an eligible individual. Earnings on amounts in an Archer MSA aren't currently taxed. Distributions for medical expenses aren't taxed, but those used for other purposes are taxed and are subject to a 15% penalty tax unless made after age 65, death, or disability.

Mortgage Insurance Premiums - For the 2007 tax year only, the Act establishes an itemized deduction for the cost of premiums for mortgage insurance on a qualified personal residence for amounts paid or accrued after Dec. 31, 2006 and before Jan. 1, 2008. The deduction is phased-out ratably by 10% for each $1,000 by which the taxpayer's adjusted gross income exceeds $100,000.

Incentive Stock Option AMT Provisions - Beginning in 2007, the Act provides that if an individual has a “long-term unused minimum tax credit” for any tax year beginning before Jan. 1, 2013, the amount determined under the Code Sec. 53(c) limit on the minimum tax credit for the tax year can't be less than “the AMT refundable credit” amount for that tax year. The annual refundable credit amount, subject to a phase-out, is the greater of (i) the lesser of $5,000 or the amount of the long-term unused AMT credit, or (ii) 20 percent of the amount of the long-term unused AMT credit. Thus, the minimum tax credit allowable for the tax year is the greater of the AMT refundable credit amount or the amount of the credit otherwise allowable. This credit is subject to a phase-out and is refundable.

New Health Savings Account Provisions - The new law includes many changes for health savings accounts (HSAs), including:

-Allowing one-time rollovers from health flexible spending accounts (FSAs) and health reimbursement arrangements (HRAs) into HSAs (after the enactment date of the new law and before 2012);

-Repeal of the annual plan deductible limit on HSA contributions (after 2006);

-Expanded contributions limit for part-year coverage (after 2006); and

-Allowing one-time rollovers from IRAs into HSAs (after 2006).

BUSINESS PROVISIONS

Here's a summary of the most widely applicable business-related tax provisions that have been restored and/or modified and extended, and for how long:

Research and Development (R&D) Credit - The research and development (R&D) credit is restored for 2006 and extended for 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) creating a new alternative simplified credit that does not use gross receipts as a factor (so that newer businesses can access the credit).

Work Opportunity Tax Credit (WOTC) - The work opportunity tax credit (WOTC), which is a credit for wages paid by employers who hire individuals from certain targeted groups, and the welfare-to-work tax credit, which is a credit for wages paid by employers who hire long-term family assistance recipients, are extended in their current form for workers hired in 2006 and combined and modified for those hired after 2006 and before 2008.

Environmental Remediation Costs - The election to expense (currently deduct) environmental remediation costs associated with cleaning up certain hazardous sites is restored for 2006 and extended for 2007, and for post-2005 expenses, the definition of an eligible contaminated site is expanded to include sites contaminated by petroleum products.

Leasehold Improvements and Restaurant Property - The accelerated write-off for certain leasehold improvements and restaurant property (depreciation over 15 years instead of 39 years) is restored for 2006 and extended through 2007.

GO Zone Bonus 50% First-Year Depreciation - The bonus 50% first-year depreciation break that was included in the Gulf Opportunity Zone (GO Zone) Act of 2005 is modified by extending the placed-in-service deadline for certain property used in certain highly damaged areas within the Gulf Opportunity Zone.

New Energy-Efficient Homes Tax Credit - The tax credit for builders of new energy efficient homes is extended through 2008. The credit applies to manufactured homes meeting a 30% energy reduction standard and other homes meeting a 50% standard.

Energy-Efficient Commercial Buildings - The deduction for energy efficient commercial buildings meeting a 50% energy reduction standard is extended through Dec. 31, 2008.



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Recent Tax Law Changes May Affect People Giving to Charity

Individuals and businesses making contributions to charity should keep in mind several important tax law changes made last summer by the Pension Protection Act.

The new law offers older owners of individual retirement accounts a new way to give to charity. It also includes rules designed to provide both taxpayers and the government greater certainty in determining what may be deducted as a charitable contribution. Some of these changes include the following:

New Tax Break for IRA Owners

An IRA owner, age 70 ½ or over, can directly transfer tax-free, up to $100,000 per year to an eligible charitable organization. This option is available in tax years 2006 and 2007. Eligible IRA owners can take advantage of this provision, regardless of whether they itemize their deductions. Distributions from employer-sponsored retirement plans, including SIMPLE IRAs and simplified employee pension (SEP) plans are not eligible.

To qualify, the funds must be contributed directly by the IRA trustee to the eligible charity. Amounts so transferred are not taxable and no deduction is available for the amount given to the charity.

Not all charities are eligible under this provision. For example, donor-advised funds and supporting organizations are not eligible recipients.

Transferred amounts are counted in determining whether the owner has met the IRA’s required minimum distribution rules. Where individuals have made nondeductible contributions to their traditional IRAs, a special rule treats transferred amounts as coming first from taxable funds, instead of proportionately from taxable and nontaxable funds, as would be the case with regular distributions.

Rules for Clothing and Household Items

To be deductible, clothing and household items donated to charity after Aug. 17, 2006, must be in good used condition or better. However, a taxpayer may claim a deduction of more than $500 for any single item, regardless of its condition, if the taxpayer includes a qualified appraisal of the item with the return. Household items include furniture, furnishings, electronics, appliances and linens.

Guidelines for Monetary Donations

To deduct any charitable donation of money, a taxpayer must have a bank record or a written communication from the charity showing the name of the charity and the date and amount of the contribution. A bank record includes canceled checks, bank or credit union statements and credit card statements. Bank or credit union statements should show the name of the charity and the date and amount paid. Credit card statements should show the name of the charity and the transaction posting date.

Donations of money include those made in cash or by check, electronic funds transfer, credit card and payroll deduction. For payroll deductions, the taxpayer should retain a pay stub, Form W-2 wage statement or other document furnished by the employer showing the total amount withheld for charity, along with the pledge card showing the name of the charity.

Prior law allowed taxpayers to back up their donations of money with personal bank registers, diaries or notes made around the time of the donation. Those types of records are no longer sufficient.

This provision applies to contributions made in taxable years beginning after Aug. 17, 2006. For taxpayers that file returns on a calendar-year basis, including most individuals, the new provision applies to contributions made beginning in 2007.

The new law does not change the prior-law requirement that a taxpayer obtain an acknowledgement from a charity for each deductible donation (either money or property) of $250 or more. However, one statement containing all of the required information may meet the requirements of both provisions.

To help taxpayers plan their holiday-season and year-end donations, the IRS offers the following additional reminders:

• Contributions are deductible in the year made. Thus, donations charged to a credit card before the end of the year count for 2006. This is true even if the credit card bill isn’t paid until next year. Also, checks count for 2006 as long as they are mailed this year.

• Check that the organization is qualified. Only donations to qualified organizations are tax-deductible. IRS Publication 78, available online and at many public libraries, lists most organizations that are qualified to receive deductible contributions. The searchable online version can be found on IRS.gov under “Search for Charities.” In addition, churches, synagogues, temples, mosques and government agencies are eligible to receive deductible donations, even though they often are not listed in Publication 78.

• For individuals, only taxpayers who itemize their deductions on Schedule A can claim a deduction for charitable contributions. This deduction is not available to people who choose the standard deduction, including anyone who files a short form (1040A or 1040EZ).

• For all donations of property, including clothing and household items, obtain from the charity, if possible, a receipt that includes a description of the donated property. If a donation is left at a charity’s unattended drop site, keep a written record of the donation that includes a description of the property and its condition.

• The deduction for a motor vehicle, boat or airplane donated to charity is usually limited to the gross proceeds from its sale. This rule applies if the claimed value of the vehicle is more than $500. Form 1098-C, or a similar statement, must be provided to the donor by the organization and attached to the donor’s tax return.

Please call if you have questions or concerns.

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BRIEFS

Recordkeeping Requirements for Charitable Contributions Made By Payroll Deductions

The Pension Protection Act of 2006 added Code Sec. 170(f)(17), which subjects taxpayers claiming a charitable contribution deduction for cash, check or other monetary gifts made in tax years beginning after August 17, 2006 to new recordkeeping requirements. Thus, to substantiate a deduction in 2007, a taxpayer is required to maintain a bank record or a written communication from the donee showing the name of the donee organization, the date of the contribution and the amount of the contribution. This replaces the former contemporaneous requirements for contributions of $250 or more.

The IRS has provided guidance (IR-2006-186; Notice 2006-110) for charitable contributions made by payroll deductions under these rules. The requirements are satisfied if the taxpayer retains a pay stub, Form W-2 or other employer-furnished document that indicates the amount withheld for payment to the donee organization, along with a pledge card or other document prepared by or at the direction of the donee organization that shows the name of the donee organization. To substantiate a contribution of $250 or more made by payroll deduction, the pledge card or other document prepared by the donee organization also must include a statement to the effect that the organization does not provide goods or services in whole or partial consideration of any contributions made to the organization by payroll deduction.

Taxpayers may rely on the notice until revised regulations incorporating the recordkeeping requirements of Code Sec. 170(f)(17) are issued and effective.

If you have questions regarding charitable recordkeeping requirements, please call this office.


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IRS Announces Simplified Method for Computing Business Telephone Excise Tax Rebate

Businesses and tax-exempt entities may either claim the actual amount of long-distance phone excise tax paid from March 2003 through July 2006, as determined from actual phone bills for that period, or they may elect to use a simplified method established by the IRS.

Business Simplified Method - Businesses and tax-exempt organizations can figure their refund amounts by comparing two telephone bills to determine the percentage of their telephone expenses attributable to the long-distance excise tax. The bills with statement dates in April and September 2006 should be used. They must first figure the telephone tax as a percentage of their April 2006 telephone bills (which included the excise tax for both local and long-distance service) and their September 2006 telephone bills (which included only the tax on local service). The difference between these two percentages should then be applied to the quarterly or annual telephone expenses to determine the amount of their refunds. The refund is capped at 2% of the total telephone expenses for businesses and tax-exempt organizations with 250 or fewer employees. The refund is capped at 1% for those with more than 250 employees.

Worksheets – Business clients should prepare for this issue prior to tax season, by gathering the documentation needed to determine the amount of the business rebate due. Clients may find it easier to use the simplified method. Either way, worksheets for both the actual method and business simplified method are provided for your use.


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