Tax & Business Strategies Monthly Newsletter - November 2007

Tax Planning Strategies
Credit for Retirement Savings Contributions
Avoiding the IRS Audit Net

Business & Management Practices
Say Hello and Say Goodbye to Business Tax Benefits
“Nanny Tax” Is Not Just For Nannies – Are You Liable?

General Information
President Designates Seven CA Counties as Disaster Areas
Purchasing Vehicles Can Provide Tax Benefits
IRS Announces Adjusted Rates for 2008

Briefs
Do Not Call List – Will it Expire?
Weight Loss Replacement Meals & Supplements Are Not Deductible

TAX PLANNING STRATEGIES

Credit for Retirement Savings Contributions

A few months back, we included an article about the credit for retirement savings contributions, frequently referred to as the “Saver’s Credit” in our newsletter. We are repeating that article, but would like to draw your attention to some interesting opportunities for parents, grandparents and others to help young, working adults get a head start on their retirement savings — something far too many individuals tend to put off until later in life when it is far more difficult to fund retirement. This often leads to inadequate financial resources when it comes time to retire in the future.

We encourage individuals with the financial resources to gift* the cash needed to fund a cash-strapped young adult’s IRA account for the year. And since IRAs can be set up and funded up to the April due date of the tax return, the contribution can be planned to maximize the tax benefit by analyzing the young adult’s tax situation after the close of the tax year. If the young adult you want to help fits into the parameters shown below, you can fund their retirement plan and at the same time increase their refund for the year.

How it works – A lower-income taxpayer 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. Contributions to regular IRAs, Roth IRAs and employer-sponsored plans, such as 401(k)s, qualify for the credit.

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, taxpayers who are on a tight budget, and counting on the full credit, might first make sure that 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 (other than qualified rollovers) you have 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.

Even if the young adult does not qualify for the credit, parents or others may still want to assist a young adult with their retirement savings contribution, so that there is no out-of-pocket cost to the young adult and thereby start them down the road to retirement savings.

*Gifts of cash or property to individuals may be subject to gift tax, payable by the person making the gift. However, up to $12,000 per donee may be gifted in each of 2007 and 2008, without the donor being subject to gift tax or having to file a gift tax return.

back to top

Avoiding the IRS Audit Net

The IRS recently announced that, after several years of heavy reliance on correspondence audits, they will be stepping up their tax return audits. Their mission is to help fill the tax gap. The areas of increased audits include Schedule Cs (sole proprietor businesses), where the Treasury Department estimates income is underreported by an estimated $68 billion.

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.

Face-to-Face Audits – Self-employed, high-income taxpayers, those who have omitted substantial income, or those who repeatedly fail to show income to support their lifestyles are more likely to be subject to these types of audits. Some are simply random to provide the IRS with statistics for targeting the most fruitful audit results.

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.

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 to the information reported on your tax return. If there is a significant discrepancy, the IRS will correspond that with the taxpayer. Sometimes these discrepancies will result in additional tax liability; at other times, a simple explanation will satisfy the IRS and make the problem go away. Here are some examples of typically-encountered discrepancies:

• Unreported Retirement 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. The IRS will know about the withdrawal but not the subsequent rollover. They will assume that it is a taxable distribution unless the rollover is reported on the tax return. So what would have been a simple entry on the tax return results in a correspondence audit. When moving an IRA from one institution to another, making arrangements for a direct transfer will generally avoid these types of audits.

• Gross Proceeds of Sale – Generally, when real estate, stock or marketable securities are sold, the IRS knows what you sold and for what price. Thus, you must account for the sale on the tax return and compute the gain or loss. If you neglect to report the transaction, the IRS will treat the entire sales price as profit, adjust your tax, and notify you via a correspondence audit.

• 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 checks to make sure the amounts match. If they don’t, expect a notice in the mail.

• Home Mortgage Interest – Each of your mortgage lenders will report to the IRS the interest paid on your mortgage for the year, and a Form 1098 will be issued to you for the same amount. If these amounts don’t reconcile, expect a notice or a request for an explanation. This is frequently an issue when the loan is from a private party not reporting the interest to the IRS or when more than one individual is on the loan, but the 1099 has space for only one Social Security number (SSN). In both cases, the IRS provides a procedure for dealing with these issues on your tax return. However, if the procedure is not followed, the IRS will not be able to verify the interest paid under your SSN and will issue a notice or request an explanation.

• Tuition Paid – Because of the education tax credits that can be claimed for paying tuition to a qualified higher education institution, the IRS requires those institutions to report the tuition received to the IRS and to issue Form 1098-T to the student. 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 standard 1099 format). These substitute forms—with various types of interest and dividends reported separately and spread throughout lengthy annual account statements—can often be misinterpreted by an untrained eye. To make matters worse, many brokerage firms have issued amended 1099 statements late in the tax filing season because of errors in allocating the investment income according to the proper type. Incorrectly reported, erroneously reported or omitted investment earnings can trigger correspondence from the IRS.

• Nontaxable Interest – Interest from municipal obligations is tax-free for purposes of computing federal tax. However, tax-free municipal interest income is added to income for the purpose of computing taxable Social Security income and determining whether a taxpayer qualifies for an earned income credit (EIC). Thus, all tax-free municipal interest must be reported on the tax return or you will risk a subsequent inquiry from the IRS.

• 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 (1) the name of the donee organization, (2) the date of the contribution, and (3) the 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 or 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 taxpayers’ charitable contributions via correspondence audits, since all contributions must be backed by written receipts or bank records.
Just because you receive a notice, don’t assume 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.

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


back to top

BUSINESS & MANAGEMENT PRACTICES

Say Hello and Say Goodbye to Business Tax Benefits

With Congress changing tax laws faster than a speeding bullet, it is sometimes difficult for taxpayers to keep up. In recent years, Congress has made a number of changes at the last minute, so there is a chance that some of these provisions might be extended or modified after this bulletin is sent out. Here is a brief overview (not all the details and limitations are included) of some of the extended and future business tax provisions:

o Section 179 Expense Deduction Increases Extended and Enhanced – For 2007, the amount that a taxpayer can deduct annually as a Sec. 179 expense (instead of depreciating) was increased to $125,000, and the phase-out threshold amount was upped to $500,000. Both values will be inflation-adjusted beginning in 2008. After 2010, the maximum deduction will revert back to $25,000. Extended through 2010 is the provision treating off-the-shelf computer software as eligible Sec. 179 property.

o Spouses May Elect Out of Partnership Rules – Effective for 2007 and later tax years, a husband and wife operating a business together who file a joint return may elect out of the partnership rules. Thus, a joint venture between them is not treated as a partnership for tax purposes. Instead, all items of income, gain, loss, deduction and credit are divided between the spouses according to their respective interests in the venture, and each spouse takes into account his or her respective share of these items as if they were attributable to a trade or business conducted by the spouse as a sole proprietor. Thus, each electing spouse will report his or her shares on the appropriate form, such as Schedule C.

o Domestic Production Deduction – For 2007 through 2009, the deduction percentage has been increased to 6% (from 3% in 2006 and 2005). Then, in 2010 and future years, the percentage will increase to 9%. The deduction is essentially equal to the lesser of the applicable percentage multiplied by the net income from eligible production activities or 50% of the W-2 wages paid to employees during the year properly allocated to the qualified production activity.

o Work Opportunity Tax Credit Extended and Expanded – The elective work opportunity tax credit (WOTC) provides a tax credit of as much as $2,400 per eligible employee hired from one or more of nine targeted groups (higher for certain veterans and special categories). The credit will now offset the alternative minimum tax (AMT) and has been extended by 44 months to August 31, 2011. The requirements were eased for “high-risk youths,” and the provisions for hiring certain veterans were enhanced. If you have questions regarding this credit, please give us a call.

o Research and Development Credit – The research and development credit (R&D), which expired at the end of 2005, was reinstated retroactively for 2006 and extended through 2007. In addition, for tax years ending after 2006, the new law enhances the credit by increasing the rates of the alternative incremental credit and creates an alternative simplified credit that does not use gross receipts as a factor, thus allowing newer businesses to qualify for the credit.

o Last Year for Sales Tax Deduction – Even though 2007 is the last year that taxpayers who itemize their deductions on their individual returns will be allowed to deduct the greater of the state income tax or state and local general sales tax, sales tax incurred as a business expense will continue to be deductible as part of the expense of the purchased item or capitalized as part of the item’s cost, as applicable.

If you have any questions regarding these tax issues and how they may impact your unique tax situation, please give us a call.


back to top

“Nanny Tax” Is Not Just For Nannies – Are You Liable?

If you employ someone who works in your home, you may be subject to household employment taxes. This tax is sometimes referred to as the “Nanny Tax,” which is misleading because it also applies to a nurse, caregiver, maid, gardener, etc. This is the same tax that you have read about where some politicians and people in high places have been brought to task for avoiding.

Not all those hired to work in a taxpayer’s home are considered household employees. For example, an individual may hire a self-employed gardener who handles the yard work for a taxpayer and other residents in the neighborhood. The gardener supplies all the tools and brings in other helpers needed to do the job. Under these circumstances, the gardener isn’t an employee, and the person hiring him/her isn’t responsible for paying employment taxes. Another example of a worker who is not considered a taxpayer’s employee is one who comes from an agency (if the agency is responsible for the work and how it is done).

It depends greatly on the circumstances, and the amount of control that the hiring person has over the job and the hired person, on whether or not a household worker is considered an employee. Ordinarily, when someone has the authority to tell a worker what needs to be done and how the job should be done, that worker is considered an employee. Having a right to discharge the worker, supplying tools and providing the place to perform a job are primary factors that show control.

Contrast the following example to the self-employed gardener described earlier. The Smith family hired Lynn to clean their home and care for their three-year old daughter, Lori, while they are at work. Mrs. Smith gave Lynn instructions about the job to be done and how to do the various tasks; she, rather than Lynn, had control over the job. Under these circumstances, Lynn is a household employee, and the Smiths are responsible for withholding and paying certain employment taxes for her. It would not matter whether Lynn worked full- or part-time, nor whether the job was paid on an hourly, daily, weekly or per-job basis. Lynn would still be the Smiths’ employee.

You are not required to withhold federal income taxes if you employ someone who is subject to the “Nanny Tax.” However, income taxes can be withheld if your employee asks you to do so and you are willing to do the additional paperwork and make the required payroll deposits.

You are required to withhold and pay FICA (social security and Medicare) taxes if your household worker earns cash wages of $1,500 or more (excluding the value of food and lodging) during the calendar year 2007 (the withholding threshold is $1,600 for 2008). If you reach the threshold, the entire wages (not just the excess) will be subject to FICA. However, if your employee is under age 18 and the services are not the employee’s principal occupation, you don't have to withhold FICA taxes. For example, there is no FICA tax liability for the services of an employee, who is a student younger than 18 years old and babysits or mows the lawn on part-time basis. On the other hand, if the employee is under age 18, and the job is the employee’s principal occupation, you must withhold and pay FICA taxes.

If there is some uncertainty as to whether your household employee’s earnings will be under the withholding threshold, you should withhold the FICA from the beginning of the employment. If it turns out that the threshold is not met, then the withholding can later be refunded to the employee. On the other hand, if you did not withhold initially and the employee’s wages do reach the threshold, make up amounts can be withheld from the pay later on. This may create a problem in that the employee won’t appreciate large unexpected withholding amounts from his or her subsequent pay. You have the option of paying the FICA withholding yourself, but it must be imputed as part of the employee’s payroll.

In addition to withholding the employee’s share of the FICA, you, as an employer, are responsible for paying a matching amount. The FICA tax is divided between social security and Medicare. The social security tax rate is 6.2%, and the Medicare tax rate is 1.45%. These rates apply to both the employee and employer for a total tax rate of 15.3%.

Example: You pay your employee $500 a week and do not withhold income tax. You must withhold a total of $38.25 ($500 x 6.2% plus $500 x 1.45%) for your employee’s share of FICA. Thus, your employee’s net paycheck would be $461.75 ($500 - $38.25). In addition, you must match the $38.25 for a total FICA tax of $76.50.

As an employer, you are also required to pay FUTA (federal unemployment) taxes if a total of $1,000 or more in cash wages (excluding the value of food and lodging) is paid to your employees in any calendar quarter of the year. This tax (maximum rate is 6.2%) applies to the first $7,000 of wages paid.

As a household employer, you generally are not required to file any of the usual employment tax returns that a business must file. Instead, obtain an employer identification number (EIN) from the IRS and include payment with your individual tax return (1040) using a Schedule H. However, if you own a business as a sole proprietor in which you have employees, you may include the taxes for your household worker(s) on the FICA and FUTA forms (Forms 940 and 941) that is filed for your business. In that case, the EIN from your sole proprietorship is used to report the taxes for your household employee(s).

You are also required to provide your employee with a Form W-2, if the employee’s wages are subject to FICA or income tax withholding, and file the W-2 with the Social Security Administration. It is also your responsibility to file the appropriate employment-related forms for your state of residence. And while not a tax matter, those individuals hiring a household worker must verify that the employee can legally work in the U.S., and then complete and retain the U.S. Citizenship and Immigration Services’ Form I-9.

Generally, a deduction is not allowed on your income tax return for the household employment taxes paid. However, if the wages paid to a household worker are for qualifying medical care of yourself, your spouse or dependents, or if the payments are eligible for the credit for child and dependent care expenses, you may include your portion of the employment taxes (in addition to the wages) when figuring the medical deduction or child/dependent care credit.

The reporting requirements for the “Nanny Tax” can be complicated. Please contact us if you need assistance or have questions.


back to top

GENERAL INFORMATION

President Designates Seven CA Counties as Disaster Areas

The President has declared the following California counties as disaster areas:

o Los Angeles
o Orange
o Riverside
o San Bernardino
o San Diego
o Santa Barbara
o Ventura

Individuals affected by the wildfires in those counties will qualify for certain disaster financial assistance and tax relief.

Tax Relief – Because these counties were declared as Federal disaster areas, taxpayers who incurred a casualty loss can elect to claim the loss on either their 2006 or 2007 tax returns. The election to claim the loss on the prior year is irrevocable 90 days after the election is made. Electing to claim the loss on the prior year’s return provides immediate tax relief. However, it is late in the year; by the time the taxpayer is able to assess the loss and file an amended return, it will probably be close to filing the 2007 returns, where electronic filing can provide almost instant relief.
If the casualty loss exceeds a taxpayer’s income for the year the loss is claimed, it creates an NOL which can be carried to other years. So, it may be more important to determine which year provides the best overall tax relief, taking into account the size of the loss.

Disaster Assistance – In addition to the tax relief, financial assistance is available to help pay for temporary housing, home repairs and other serious disaster-related expenses through the Federal Emergency Management Agency (FEMA). The U.S. Small Business Administration (SBA) will be providing low-interest loans to cover residential and business losses not fully compensated by insurance.

For more information regarding the financial benefits available from these two agencies, please consult their websites:

o FEMA: http://www.fema.gov/
o SBA: http://sba.gov/

If you were affected by the wildfires and have questions about documenting your losses for tax purposes, or which year is most appropriate to claim the loss, please call this office for assistance.


back to top

Purchasing Vehicles Can Provide Tax Benefits

If you plan on purchasing a 2008 vehicle or taking advantage of a year-end 2007 vehicle clearance, there are some tax aspects to be considered.

Unless Congress extends the sales tax deduction (an extension is currently being considered), 2007 will be the last year for that deduction. So, you might want to purchase that new car before the year-end just to make sure that the personal portion of the sales tax can be deducted. However, taxes are not deductible as an itemized deduction for alternative minimum tax (AMT) purposes; so to the extent that you are subject to the AMT, the tax will not be deductible. That is not true for the business portion of the sales tax. When vehicles are used partially for business, the business portion of the sales tax is capitalized into the business basis of the vehicle and is deducted as depreciation on the business schedule.

A second tax benefit can be gained through the purchase of a hybrid vehicle. Depending upon its fuel-efficiency, a vehicle can qualify for a credit as high as $3,400. Thus, you can determine by the amount of the credit which vehicle has the greatest efficiency. To date, no vehicle has qualified for the full $3,400 credit. The credit is divided into two parts: the personal and the business portion. The personal portion can only be used to reduce income tax for the year to zero; any excess is lost. To make matters worse, the credit does not offset the AMT. To the extent to which you are subject to the AMT for the year, there is no benefit from the personal portion of the credit. The business portion of the credit is a general business credit, of which any amount not used in the current year can be carried back one year and forward for up to twenty years and is deductible against the AMT.
Taxpayers may claim the full amount of the credit up to the end of the first calendar quarter after the quarter in which the manufacturer records its sale of the 60,000th qualified vehicle. For the second and third calendar quarters after the quarter in which the 60,000th vehicle is sold, taxpayers may claim 50 percent of the credit. For the fourth and fifth calendar quarters, taxpayers may claim 25 percent of the credit. No credit is allowed after the fifth quarter.

Toyota hybrids have been by far the most popular hybrids, and Toyota Motor Corp. recorded the sale of their 60,000th qualified vehicle in the quarter ending June 30, 2006. Therefore, for qualifying vehicles purchased between Oct. 1, 2006 and March 31, 2007, consumers may claim 50% of the credit amount. Consumers who purchase qualifying vehicles between April 1, 2007 and Sept. 30, 2007 may only claim 25% of the credit amount. Thus, Toyota (and Lexus) vehicles purchased after Sept, 30, 2007 no longer qualify for the hybrid credit.

Vehicles periodically receive IRS credit certification, so the following list only includes those certified through the end of September 2007 for both 2007 and 2008 models. Toyota and Lexus vehicles are excluded from the list, since they no longer provide any credit.

The portion of the vehicle that is used for business can also be taken as a business deduction. However, the basis of the vehicle must be reduced by the amount of the credit allowable. A taxpayer can depreciate the vehicle over a number of years, but the depreciation each year is generally limited to “Luxury Auto Limits.” For passenger automobiles acquired in 2007, these limits are:

For certain qualified trucks and vans, the limit amounts increase for Years 1 and 3 by $200, Year 2 by $300 and other years by $100.

In addition to the depreciation, the business portion of the vehicle operating expenses can also be deducted, including fuel, oil, insurance, maintenance, license, etc. In lieu of taking depreciation and keeping track of expenses, the mileage rate can be used (which is 48.5 cents per mile for 2007). The depreciation limits and the mileage rate are annually adjusted by the IRS. The rates for 2008 should be similar to those for 2007.

Taxpayers who purchase a hybrid for business use should consider using the standard mileage rate, which is based on the cost to operate a conventional vehicle. Thus, the deduction using the mileage rate may exceed the actual expenses of operating the vehicle and can provide a rare opportunity to deduct more than was actually spent.

Business users of “heavy” SUVs, rated at 14,000 pounds gross vehicle weight or less, are allowed to take a first-year Section 179 expense deduction for up to a maximum of $25,000 of the cost of the vehicle, subject to all the normal Sec. 179 limitations. This provides a significant first-year deduction that is allowed for both the regular and alternative minimum taxes. At press time, Congress was considering eliminating this special SUV provision.

Tax rules associated with vehicles, especially those used in business, are very complicated. If you have any questions about how the purchase of a vehicle will impact your particular situation, please give us a call. Also, if your new purchase will replace an existing business vehicle, it can make a tax difference whether the old vehicle is being sold or traded in.

back to top

IRS Announces Adjusted Rates for 2008

Each year, certain tax deductions, rates, and limits are adjusted for current costs or inflation adjustments. The following are some of the more notable adjustments for 2008.

o Standard Deduction – For single individuals, the standard rose by $100 to $5,450. The amount for joint-filing taxpayers and surviving spouses will be $10,900, up by $200. It is up by $150 to $8,000 for taxpayers filing as head of household. The standard deduction for a dependent increased from $850 to $900 or the dependent’s earned income plus $300 (but no more than the regular standard deduction amount).

o Itemized Deduction Phase Out - A higher-income taxpayer's itemized deductions (other than those for medical expenses, investment interest, non-business casualty and theft losses and gambling losses) are reduced if his adjusted gross income (AGI) exceeds an inflation-adjusted amount. The 2008 reduction is equal to one-third of the lesser of three percent of AGI over the threshold amount or 80 percent of itemized deductions otherwise allowable. For 2008, the threshold amount at which the three-percent itemized deduction limitation takes effect will increase by $3,550, to AGI of $159,950 for married taxpayers filing jointly, single taxpayers and heads of household, and will increase by $1,775, to AGI of $79,975 for married taxpayers filing separately.

o Personal Exemptions – Personal exemptions for taxpayers and dependents rose by $100 to $3,500.

o Exemption Phase Out - For higher-income taxpayers, the otherwise allowable exemption amounts must be reduced by 2% for each $2,500, or part of $2,500 ($1,250 for married filing separately), that the taxpayer's AGI exceeds a threshold amount for the year. However, for 2008, the exemption reduction is reduced to one-third of the calculated amount. If the AGI exceeds the phase-out threshold by more than $122,500 ($61,250 if married filing separately), the amount allowed for exemptions is reduced to $2,333. For 2008, the threshold for married taxpayers filing jointly will increase by $5,350 to $239,950; for single taxpayers, the threshold will increase by $3,550 to $159,950; for heads of households, the increase is $4,450 to $199,950; and for married taxpayers filing separately, the increase is $2,675 to $119,975.

o Kiddie Tax – The threshold where a child’s investment income is taxed at the parent’s rates has increased to $1,800, up from $1,700 for 2006 and 2007. In addition, due to a recent law change, and beginning in 2008, the Kiddie Tax will apply to children under the age of 19 as well as full-time students under the age of 24 whose earned income is less than 50% of their total support.

o Education Credit – For 2008, the Hope education credit has been inflation adjusted so that the maximum credit for the year is $1,800, up from $1,650 in 2007. The credit for 2008 is based on 100% of the first $1,200 of qualified tuition expenses plus 50% of the next $1,200 of expenses. For 2007, the credit was based on 100% of the first $1,100 of qualified tuition expenses plus 50% of the next $1,100 of expenses.

o Individual Retirement Accounts (IRA) – For 2008, the contribution limits for traditional and Roth IRA accounts were statutorily increased by $1,000 to $5,000 ($6,000 age 50 and over). After 2008, they will be inflation adjusted.

o Traditional IRA Phase Out - For traditional IRA accounts, the deductibility of IRA contributions for taxpayers who are also active participants in an employer’s retirement plan are ratably phased out for higher-income taxpayers. This phase-out occurs for jointly-filing taxpayers with AGI (incomes) between $85,000 and $105,000 (up $2,000 from 2007) and $53,000 and $63,000 (up $1,000 from 2007) for single taxpayers. For married taxpayers filing separately, the phase-out range remains $0 to $10,000.

The phase-out threshold is higher for a married taxpayer who is not an active participant in an employer-provided plan who is married to a taxpayer who is an active participant in an employer’s plan. In this situation, the phase-out range for the nonparticipant spouse has been increased to AGI between $159,000 and $169,000.

o Roth IRA Deductibility Phase Out – The ability to make contributions to a Roth IRA is phased out for higher-income taxpayers. This phase out occurs when married filing joint taxpayers’ AGI (income) is between $159,000 and $169,000. For others, except married taxpayers filing separately, the phase-out range is between $101,000 and $116,000. For married taxpayers filing separately, the phase-out range remains $0 to $10,000.

o Per Diem Rates –The meals and incidental expenses (M & IE) per diem rates in effect since October 1, 2007 are $58 and $45, respectively, for the high-low cost localities. These amounts are unchanged from the prior year. The lodging and M & IE rates decreased to $237 for high-cost areas and increased to $152 for low-cost areas.

o Social Security Administration Rates (2008)
1. Maximum taxable earnings for Old-Age, Survivors and Disability Insurance (OASDI) will increase to $102,000, up from the 2007 maximum of $97,500. Note: There is no maximum earning for purposes of the Medicare tax.
2. The amount a retiree under full retirement age can earn before being required to repay a portion of their SS benefits is $13,560 ($1,130 per month) up from $12,960 ($1,080 per month) in 2007.
3. The amount of earnings required to obtain one quarter of coverage has increased to $1,050 up from $1,000 in 2007.

o Tax Brackets – The various tax brackets are inflation adjusted annually. The table below shows the top end of each tax bracket for the 2008 year, as well as the rates for 2007 for inflation comparison purposes.

o Annual Gift Tax Exemption - The gift tax annual exemption remains unchanged for 2008 at $12,000.

o Sec. 179 Expensing Amounts – Are inflation adjusted for 2008 to $128,000, up from $125,000 in 2007. The threshold for phasing out the Sec. 179 expensing amount was also increased – to $510,000, up from $500,000 in 2007.

o Standard Mileage Rates – To date, the IRS has not released the business vehicle, moving or medical standard mileage rates for 2008.

o AMT Exception Amounts – The Alternative Minimum Tax (AMT) exemption amounts are in limbo with Congress promising some AMT reform for 2008 and a temporary patch for 2007. Thus, even the 2007 amounts are still in question late in 2007. Without a patch or subsequent 2008 reform legislation, the amounts for 2008 could be as low as $33,750 for individuals and $45,000 for married couples filing jointly.

As the end of the year approaches, your opportunities to reduce your 2007 tax liability diminish. If you have questions or would like to set up a fall tax planning appointment, please give us a call.


back to top

BRIEFS

Do Not Call List – Will it Expire?

There has been some press about the phone numbers on the “Do-Not-Call” list being expunged after five years, which makes it necessary for consumers to re-enter their number at the end of that period. The Federal Trade Commission (FTC) began building the list in 2003, making 2008 the fifth year.

During October, in testimony before the U.S. House of Representatives’ Subcommittee on Commerce, Trade and Consumer Protection, the Consumer Protection Director, Lydia Parnes, indicated “the Commission now commits that it will not drop any telephone numbers from the Registry based on the five-year expiration period pending final Congressional or agency action on whether to make registration permanent.”

According to the testimony, when the Registry was developed, the Commission adopted a five-year re-registration mechanism and said that the list – which now contains more than 145 million phone numbers – would be periodically purged of disconnected or reassigned numbers. This was done to ensure that the Registry was as accurate as possible. The goal was “to adequately balance the need to maintain a high level of accuracy in the Registry, with the imposition on consumers to periodically re-register their telephone numbers.”

Since the Registry has been in place, however, several changes have occurred, the testimony continued, including the increased use of cell phones and the popularity of telephone number portability. In addition, the legal landscape surrounding the Registry has become clearer, and the Commission has more information about how the courts view consumer privacy in this context.

Also, the Registry has been implemented successfully for five years and has included a scrubbing program that has removed disconnected and reassigned numbers each month. Finally, “the Registry has enjoyed unprecedented popularity and helped enhance the privacy of the American public in a tangible way.”

If you have not registered a number and would like to do so, you can either visit the Do-Not-Call website at www.DoNotCall.gov or call 1-888-382-1222.

back to top

Weight Loss Replacement Meals & Supplements Are Not Deductible

With the current emphasis on weight loss by the medical profession and government, it is appropriate to review the tax implications associated with obesity. The tax code treats obesity as a disease; thus, you can include in medical expenses amounts paid to lose weight if it is a treatment for a specific disease diagnosed by a physician. This includes fees you pay for membership in a weight reduction group and attendance at periodic meetings.

However, you cannot deduct the cost of diet food or beverages in medical expenses, because the diet food and beverages substitute for what is normally consumed to satisfy nutritional needs. You can include the cost of special food in medical expenses only if:

1. The food does not satisfy normal nutritional needs,
2. The food alleviates or treats an illness, and
3. The need for the food is substantiated by a physician.

The amount you can include in medical expenses is limited to the amount by which the cost of the special food exceeds the cost of a normal diet.

The question always arises; why is not the cost of the dietary meals and supplements deductible? Recently, an individual who sells dietary meals and supplements wrote to his representative in Congress asking that very question. The Congressman raised this question with the IRS Office of Chief Counsel. The Chief Counsels office responded with the following:

The tax code provides a deduction for expenses paid for medical care of the taxpayer, his spouse, or a dependent; to the extent such expenses exceed 7.5 percent of adjusted gross income. The tax code defines the term “medical care” as amounts paid for the diagnosis, cure, mitigation, treatment, or prevention of disease, or for the purpose of affecting any structure or function of the body. The code provides that no deduction shall be allowed for personal, living, or family expenses. Food is a personal item. Therefore, the cost of food is nondeductible. Meal replacements, diet foods, and supplements are substitutes for the food individuals normally consume. The costs of these items are nondeductible personal expenses under the tax code.

Based on the tax code, as outlined in the response above, IRS publications and rulings generally take a very restrictive view of this deduction. Thus, no portion of membership dues paid to a gym, health club or spa qualifies as a deductible medical expense in any case—even if the individual joined on the advice of a physician to lose weight to combat a disease.

If you have a question regarding this or other possible medical deductions, please give this office a call.



back to top