Make the Most of New Tax Incentives with Year-End Planning

The end of the year has historically been the time for tax planning and making strategic year-end adjustments to reduce your tax bite.  2008 adds a whole new meaning to year-end tax planning.  Because of the downturn in the economy, falling home prices, failing financial institutions and the huge losses on Wall Street, Congress has provided a number of tax incentives in an effort to get the economy back on track.   The following articles include details about the most significant changes and those that require action by year's end.

Year-End Tax Tips and Planning Strategies

Year-End Tax Strategies for Stock Investors

Tax-Free IRA to Charity Distribution Reinstated

First-Time Homebuyer Credit

Summary of Economic Stability Legislation Tax Changes

Almost everyone will benefit in one way or another from at least one of the many tax changes implemented by Congress.  However, taxpayers who have one or more of the following conditions apply to them will probably benefit the most from some year-end tax planning.

• Large investment losses
• Home foreclosed upon or anticipating foreclosure
• Forgiven debt
• Over age 70½ and regularly contributing substantial amounts to charity
• Small business owners
• Disaster losses
• Abnormally high or low incomes for the year
• In the process of or planning for the installation of home energy-efficient or energy-generating improvements
• Substantial business losses
• Considering buying your first home
  
If you would like a year-end tax tune-up or need some multi-year strategizing, we encourage you to call for an appointment soon.  As we get closer to the end of the year, there will be less time to implement strategies that could provide you with significant tax savings on your 2008 return.

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Acquiring a New Business Vehicle? Maximize Your Deductions!

If, in 2008, you purchased and placed in service an automobile used in your business, you have two choices for deducting expenses related to the vehicle: (1) use a standard mileage rate (50.5 cents for each business mile driven in the first half of 2008 and 58.5 cents for each business mile driven in the last half of 2008), or (2) deduct actual expenses, including depreciation.  The standard mileage deduction is relatively easy to compute. Simply multiply the number of miles the vehicle was driven for business for each half of the year by the appropriate mileage rate for that period.

Determining actual expenses requires more work but may provide a larger deduction.  All expenses for the vehicle, for example, insurance, gas, repairs, garage rent, etc., must be recorded for the year.  In addition, a depreciation deduction is allowable under the actual expense method (the standard mileage rate has an amount for depreciation built into it).  The situation in 2008 is unique because the first-year depreciation limit for vehicles weighing 6,000 pounds or less is more than three times as much as in the previous year by virtue of the 50% bonus depreciation — which applies in 2008 only.  Thus, a passenger car used 100% for business has a first-year depreciation limit of $10,960; for light trucks and vans, the limit is $11,160.  Both of these limits include $8,000 of the new 50% bonus depreciation allowance.   If a vehicle is used less than 100% for business, these expenses are prorated based on the business use compared with the total miles for the year.  When the cost of fuel and the higher depreciation amounts for 2008 are considered, using the actual method for a vehicle placed in service during 2008 might be the right call.

Even though Congress is promoting energy efficiency, it still has not reined in the very large first-year deduction for heavy SUVs weighing more than 6,000 pounds.  By combining the $25,000 Sec. 179 expense deduction available for these SUVs, the new 50% bonus depreciation, and the regular depreciation on the remaining balance of the purchase cost, an SUV bought in 2008 can provide a huge first-year write-off.   The following is a representative example (assuming 100% business use):

Finally, if you acquire a qualified hybrid vehicle, you can take advantage of the Alternative Motor Vehicle Credit, and the business-use portion of the credit becomes a general business credit.  If all of the general business credit is not used in the current year, the unused portion is carried back one year and then forward for up to twenty years.

As you can see, there are several options and substantial write-offs to consider when purchasing a new vehicle.  Future years’ business use of the vehicle also needs to be looked at because the method chosen in the first year affects the way auto deductions are claimed in later years.  If you need assistance in developing a plan that is best suited to your unique tax situation, please call for an appointment.

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Tax Breaks for the Self-Employed and Small Business Owners

The following is a compilation of a number of tax breaks available to self-employed individuals and/or small business owners.  Some can be implemented before year’s end, providing benefits for your 2008 return, while others will provide planning opportunities for 2009.

• Little or No Profit This Year — Beginning in 2008, the farm and nonfarm optional methods for computing net earnings from self-employment are modified so that electing taxpayers may pay more in optional self-employment taxes and thus become eligible for Social Security benefits.

• The Work Opportunity Tax Credit — The work opportunity tax credit allows employers tax credits (as much as $4,800) for hiring individuals from one or more of nine targeted groups (such as recipients of public assistance, qualified veterans on assistance and “high-risk youth”).

• Elect to Deduct Start-Up Costs — Taxpayers can elect to deduct up to $5,000 of start-up and $5,000 of organizational expenses in the first year of a business.  Each of the $5,000 amounts is reduced by the amount by which the total start-up expense or organizational expense exceeds $50,000.  Expenses not deductible in the first year of the business must be amortized over 15 years. 

• Deduct a Home Office — If you work from an office in your home, perform management or administrative tasks from a home office, or store product samples or inventory at home, you may be entitled to deduct an allocable portion of certain costs of maintaining your home. This would include allocated maintenance, utilities, etc.

• Business Travel Break — If you maintain your office in your home and it is your principal place of business, you may be entitled to a special tax break on your commuting costs.
 
• Establish an Employee Pension Plan — Establishing a pension plan for your employees can help you retain better employees.  If you start a pension plan, you can take a credit of up to $500 a year for each of the first three years of the plan. The credit is for 50% of certain start-up costs incurred in each of those years.

• Deduct Vehicle Interest, Tax and License — Normally if you purchase a vehicle, the interest on the loan is treated as nondeductible consumer interest.  However, if the vehicle is used partially for business (other than as an employee), then the business portion of the interest can be deducted on your business schedule.  The business portions of the personal property tax and license fee can also be deducted on your business schedule.  The business portion of the sales tax is added to your vehicle’s basis and depreciated if the actual expense method is used. 

• Deduct Health Insurance Off-the-Top — A self-employed individual may deduct the amount paid during the tax year for medical insurance for himself, his spouse, and his dependents.  There is no limit on the amount that may be deducted, except that the deduction cannot exceed net self-employment income.  For this deduction, health insurance includes medical, dental, vision, and long-term care premiums. The medical care insurance isn’t limited by the normal 7.5%-of-AGI floor on itemized medical expenses, and it isn’t a business schedule deduction. Instead, it’s an above-the-line deduction on page 1 of Form 1040.  

• Business Education Expense Options — Self-employed taxpayers can treat business education expenses for themselves either as a deduction on the business schedule or as an education tax credit.  If the deduction option is chosen, it reduces both self-employment tax liability and income tax liability.  How much is saved depends upon your tax bracket. 

• Employ Your Child — You can turn some of your high-taxed income into tax-free or low-taxed income by shifting some of your business earnings to a child as wages for services performed by him or her.  For your business to deduct the wages as a business expense, the work done by the child must be legitimate and the child's salary must be reasonable. 

• Trade-in vs. Sale — If you are purchasing a new vehicle or other equipment, you should carefully consider whether to trade in the old asset or sell it in an unrelated transaction.  The reason?  If the disposition of the old vehicle or equipment would result in a tax loss, you might want to sell it separately.  However, if the disposition would result in a tax gain, you would want to trade it in to avoid the gain and instead have it reduce the basis of the replacement asset.

• Avoid Underpayment Penalties — Taxpayers are expected to pay their taxes during the year through the payment of estimated taxes and/or withholding.  If you have not paid enough and do not meet one of the exceptions, you could be subject to an underpayment penalty along with an unpleasant tax bill when the tax return is filed.  Year-end increased estimates and withholding can mitigate those penalties. 

• Borrow to Pay Deductible Expenses Before Year’s End — If 2008 was a better than normal year for income, you might consider using a credit card to pay expenses that can generate deductions for this year.   
• Contribute to Your Retirement Plan — A variety of retirement plans are available to the small business owner or self-employed taxpayer.  Some plans must be set up before year’s end.

Please give this office a call if you have additional questions on any of the tax breaks mentioned above.  Most of these benefits require action before 2009 to gain any tax advantage for 2008.  However, that does not preclude you from planning in advance for 2009.

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Two Special Business Provisions for 2008

This is a reminder that the Economic Stimulus Package that passed earlier this year includes two major tax benefits for small to medium businesses that provide the opportunity to acquire business assets and write off all or a substantial portion of the cost in the first year.  As the end of the year approaches, you may wish to consider these two benefits as a means of reducing current-year profits while expanding your business capabilities.

The first provision increases the limit up to which a business can expense property purchased and placed in service during its 2008 tax year.  The second provision provides an additional 50% special depreciation allowance for property acquired and placed in service during calendar year 2008.

Unlike the economic stimulus payments that millions of individuals have already received, the tax benefits for businesses are not automatic; businesses must act to take advantage of the new provisions by purchasing qualifying property.

The Joint Committee on Taxation estimates that businesses stand to lower their 2008 tax bills by roughly $45 billion as a result of the two business provisions in the Economic Stimulus Act of 2008; these provisions accelerate into 2008 the tax benefits that otherwise would not have been available until future years.

The following are some details about these two key tax benefits:

Section 179 Expensing

• In general, Section 179 provides that, instead of depreciating property, a business with a sufficiently small amount of annual property purchases may choose to expense the cost of the property.  For taxable years beginning in 2008, the Economic Stimulus Act increased the Section 179 expensing limit, allowing more property to be currently expensed.

• The Economic Stimulus Act increased the maximum Section 179 expense deduction to $250,000 for qualified Section 179 property that is placed in service in tax years that begin in 2008.  This is a 95% increase from the previous limitation of $128,000.

• The Economic Stimulus Act also increased the total amount of qualifying property a taxpayer may purchase before the Section 179 expensing limit begins to be reduced.  Under the new law, the $250,000 deduction amount is reduced only when a business acquires more than $800,000 of qualifying property.  Prior to changes made by the Economic Stimulus Act, the reduction began when a business acquired more than $510,000 of qualifying property.

• The new law does not alter the Section 179 expense limit for sport utility vehicles, which remains at $25,000.

• More than 4.5 million small businesses claimed the Section 179 expense deduction for tax year 2005, the most recent year for which this information is available.  These businesses placed almost $44 billion of Section 179 property in service in 2005 and claimed related deductions of approximately $41 billion (data derived from Depreciation and Amortization forms filed with Forms 1040).

Special Depreciation Allowance

• The Economic Stimulus Act also provided a 50% special depreciation allowance for property acquired and placed in service during 2008.  Depreciation is an income tax deduction that allows a taxpayer to recover the cost or other basis of certain property over several years.  It is an annual allowance for the wear and tear, deterioration, or obsolescence of the property.

• Under the new law, a taxpayer is entitled to depreciate 50% of the adjusted basis (after subtracting any Section 179 deduction taken on that property) of qualified property during the year the property is placed in service. 

• The types of property that qualify for the 50% special depreciation allowance are Section 168 property with a recovery period of 20 years or less, off-the-shelf computer software, water utility property, and qualified leasehold improvement property.

• To qualify for the 50% special depreciation allowance, a taxpayer must meet all of the following tests:

o The taxpayer must have acquired the property after December 31, 2007, and before January 1, 2009.  If a binding contract to acquire the property existed before January 1, 2008, the property does not qualify for the special depreciation allowance.

o The property must be placed in service before January 1, 2009 (before January 1, 2010, for certain transportation property and certain property with a long production period).

o The original use of the property must begin with the taxpayer after December 31, 2007.  In other words, the property must be “new” property.

• Prior to the enactment of the Economic Stimulus Act, the total depreciation amount (including the Section 179 deduction) a business could deduct for a passenger automobile was $2,960.  The Economic Stimulus Act increased this limitation by $8,000.  Therefore, the maximum limit is increased to $10,960 for automobiles for which the special bonus depreciation allowance is claimed.

• Prior to the enactment of the Economic Stimulus Act, the total depreciation amount (including the Section 179 deduction) a business could deduct for a truck or van used in a business and first placed in service in 2008 was $3,160.  The Economic Stimulus Act increased this limitation by $8,000.  The new maximum limit is increased to $11,160 for trucks and vans for which the special bonus depreciation is claimed.

To make the most of these provisions, we suggest that you take action soon.  It may not be possible or wise to make last-minute acquisitions near the end of the year.  If you would like to see how these special 2008 provisions might benefit your business, please call for an appointment.

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Alternative Minimum Tax (AMT) Patched Again!

For yet another year, Congress has applied a patch to the AMT by increasing the AMT exemption amount and continuing to allow nonrefundable credits, such as dependent care, child credit, education credits and others that most middle-income taxpayers use to avoid this punitive tax.  In addition, the amount of long-term unused AMT tax credit that can be applied in the current year was also substantially increased.  The following is an overview of these changes:

• AMT Exemption Amount for 2008 Increased - The AMT exemptions have been increased for 2008 to: $69,950 for married individuals filing jointly, $46,200 for unmarried individuals and $34,975 for married individuals filing separately.  The AMT phase-out rules remain unchanged.

• AMT Relief for Nonrefundable Personal Credits - Nonrefundable personal credits will offset the AMT for 2008.  Those credits include the dependent care credit, elderly and disabled credit, Hope and Lifetime Learning credits, adoption credit, child tax credit, mortgage credit, saver’s credit and certain residential and home energy credits.

• Increased AMT Refundable Long-Term Unused Credits - Prior to this change and for purposes of claiming the long-term unused minimum tax credit, the refundable credit amount was limited to the greatest of (1) $5,000, (2) 20% of the long-term carryover or (3) the AMT refundable credit amount (if any) for the prior year– before any reduction by reason of AGI.  Under the Act, the $5,000 limitation has been removed, and the 20% limit has been increased to 50%.  This effectively allows taxpayer with existing long-term unused credits to utilize the entire amount of the unused credit in 2008 and 2009.

In addition, the Act provides for abatement of any underpayment of tax outstanding on October 3, 2008, which is attributable to AMT on incentive stock options for any taxable year ending before January 1, 2008. The abatement extends to any related interest or penalty.

Originally conceived to combat taxpayers in the higher-income brackets who utilized legal tax shelters and tax preferences to avoid paying income tax, the AMT can be tricky and hit when you may not expect it.  The tax was supposed to inflict a “minimum” tax on those who were able to avoid the regular tax.  However, years of inflation have pushed many middle-income taxpayers into the reach of the AMT.  Although there is a long list of items that can trigger the AMT, for most individuals, the triggers include the following or combinations of the following:

• Preference income from exercising stock options from an employer’s qualified plan, sometimes referred to as incentive stock options (ISOs)
• Having large itemized tax deductions
• Having large miscellaneous itemized deductions
• Large medical itemized tax deductions
• Home equity debt interest deduction
• Interest income from private activity bonds  

There are planning techniques that can avoid or mitigate the effects of the AMT.  If you anticipate an AMT problem, you may wish to set up an appointment for a planning session before year’s end.

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Home Energy Credits Enhanced

As part of the recently enacted Economic Stabilization legislation, homeowners can continue to benefit from a tax credit for installing energy-generating systems into their homes.  The new law removed limitations and added wind and geothermal generating systems.  If you are thinking of going green, here is an overview of these credits.

• Residential solar equipment - For property placed in service before the end of 2016, 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 limits also applies for photovoltaic (electricity-generating) solar panels but the $2,000 per year limit no longer applies after 2008.  The foregoing applies to the taxpayer’s first or second homes.

• Fuel cell equipment - 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.

• Wind & Geothermal energy equipment - A 30% credit is allowed for qualified systems placed into service before 2016. The credit is limited to $500 for each half-kilowatt of capacity (maximum $4,000 for wind turbines and $2,000 for geothermal heat pumps).

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

Call this office first to verify the tax benefits before signing on with a contractor or salesperson. 

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Optional Medical Procedures

Deductible medical expenses are defined as the costs of diagnosis, cure, mitigation, treatment, or prevention of disease, and the costs for treatments affecting any part or function of the body including dental expenses. 

There has been some debate on whether certain out-of-pocket expenses for medical tests would be deductible even though an individual may not be experiencing any symptoms of illness.  

The IRS, in a recent notice, ruled that several medical procedures are deductible even though the individual was not experiencing any symptoms of illness.  It included an annual physical examination, self-administered pregnancy tests, and a full-body scan even though a physician had not recommended it.  Keep in mind that even though these expenses would be includable with other medical expenses, only medical expenses in excess of 7.5% of the taxpayer’s adjusted gross income (10% if taxed by the AMT) can be deducted. 

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Split Rate Mileage Recordkeeping

By now, most of us are probably aware that the business mileage rate for 2008 is 50.5 cents per mile for the first half of the year and 58.5 cents for the last half of the year.  The question that comes to mind is whether a taxpayer can simply use the average of 54.5 cents per mile for the whole year.

Unfortunately, the calculation cannot be simplified by averaging the two rates.  The IRS requires that a contemporaneous log of the total miles and business miles for the year is maintained.  This means that a taxpayer must record his or her business trips and the associated mileage on a daily basis in order to properly document any business travel.  Averages and estimates are not considered adequate records.  The mileage for the first half and last half of the year must be determined from the mileage record and the appropriate mileage rate applied to each.    

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Income Averaging for Exxon Valdez Litigation Amounts

Effective October 3, 2008, commercial fishermen and other individuals whose livelihoods were negatively impacted by the '89 Exxon Valdez oil spill are allowed to average any settlement or judgment-related income that they receive in connection with pending litigation in the federal courts over three years for federal tax purposes. It also allows them to use these funds to make contributions to retirement accounts. 

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Home Equity Debt Interest Deduction Limitations

One of the current IRS audit initiatives is checking to see if taxpayers are deducting too much equity debt interest.  Generally, taxpayers are allowed to deduct the interest on up to one million dollars of acquisition debt and the interest on up to $100,000 of equity debt.  Over the past few years, taxpayers have frequently exceeded the debt limits and have failed to adjust their interest deduction accordingly.

The best way to explain this interest deduction limitation is by example.  Let’s assume that you have never refinanced the original loan that was used to purchase the home and that the acquisition debt is less than one million dollars.  However, you have a line of credit on the home and the debt on that line of credit is treated as equity debt.  If the balance on that line of credit is $120,000, then you have exceeded the equity debt limitation and only 83.33% ($100,000/$120,000) of the equity line interest is deductible as home mortgage interest on Schedule A.  The balance is not deductible unless you can trace the use of the funds to either investment or business use.  If traceable to investments, the amount traceable would be deductible as investment interest, which is also deducted on Schedule A but is limited to an amount equal to your net investment income (investment income less investment expenses).  If the excess was used for business, you could deduct the excess on the appropriate business schedule.  Alternatively, you could elect to treat the equity line as not secured by the home, which would require the interest on the entire loan to be traced to its use and deducted on the appropriate schedule.  However, none could be traced back to the home itself. 

Using the unsecured election can have unexpected results in the current and future years.  You should use that election only after consulting with this office.

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Year-End Tax Strategies for Stock Investors

The volatile securities markets make year-end planning for investors especially challenging this year.  As December 31 approaches, the following moves should be considered to make the best tax use of both paper and actual losses from stock market investments.

• Sell Loser Stocks to Offset Gains — With the roller coaster stock market this year, there may be a mix of winners and losers in your non-retirement plan investment portfolio.  If you have a net gain for the year — from sales that were already made or capital gain distributions from investments — you should consider selling enough of the losers to offset the gain and produce a net loss of at least $3,000.  This will erase any tax liability from the gains and allow a $3,000 deduction against ordinary income.  Don’t worry about having exactly a $3,000 net loss; any unused losses will carry over to future years.  Be careful not to repurchase any of the stocks that were sold at a loss for 31 days.  Otherwise, the loss will not be allowed because of the “wash sale” rules.  (If a married separate return is filed, substitute $1,500 for $3,000 in this discussion.)

• Convert a Traditional IRA to a Roth IRA — When a Traditional IRA is converted to a Roth IRA, taxes are generally paid on the value of the Traditional IRA converted.  Therefore, the lower the value, the less it will cost to convert it to a Roth IRA.  If one or more IRA accounts are invested in stocks that have declined in value, this might be a good time to convert to a Roth IRA.

It generally makes sense to convert to a Roth if you have many years to go before the funds are withdrawn.  Another reason to convert to a Roth is to pass on money to your heirs.  Unlike a Traditional IRA, there are no mandatory withdrawals by the account owner while living, and although his or her heirs will be subject to the minimum distribution rules, they generally will not be liable for income taxes.
 
To convert, the annual income must be $100,000 or less for married couples filing jointly and singles, and taxes must be paid on the IRA contributions that were previously deducted and accumulated earnings in the same year.  It can be a hefty bill, but if you need to take money out of your IRA to pay the taxes and you are under age 59½, there will be a 10% penalty on the amount withdrawn.

• Take Advantage of the 2008 Zero Tax Rate — If you or a family member is thinking of selling appreciated stock or other capital assets held outside of an IRA or retirement plan, and your (or their) income isn't taxed at a rate higher than 15%, you might want to consider taking advantage of the zero tax rate available in 2008. To maximize this strategy, sell just enough profitable long-term holdings so that your income is approximately at the threshold of the 25% bracket.  Please call for further information. 

• Substantial Losses — Even if substantial losses from sales of stocks, mutual funds or other capital assets have been incurred, the loss deduction is still limited to $3,000 ($1,500 married separate) for the year, with the balance being carried over to future years.  This might be the time to sell other capital assets with built-in gains and use the losses that were already realized to offset the gains.    
 
If you wish to take advantage of any of these strategies, you will need to do so before the year’s end. 

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Tax Credit to Aid First-Time Homebuyers

First-time homebuyers may wish to take advantage of a new tax credit included in the Housing and Economic Recovery Act of 2008.
Available for a limited time only, the credit:

• Applies to home purchases after April 8, 2008, and before July 1, 2009.

• Reduces a taxpayer's tax bill or increases his or her refund, dollar for dollar.

• Is fully refundable, meaning that the credit will be paid out to eligible taxpayers, even if no tax is owed or the credit is more than the tax that is owed.

However, the credit operates much like an interest-free loan, because it must be repaid over a 15-year period. So, for example, an eligible taxpayer who buys a home today and properly claims the maximum available credit of $7,500 on his or her 2008 federal income tax return must begin repaying the credit by including one-fifteenth of this amount, or $500, as an additional tax on his or her 2010 return.

CAUTION: Taxpayers are cautioned that this credit is a loan, and except under some special circumstances noted in this article, it must be repaid.  Do not take this credit if you will be unable to meet the repayment requirements in the future.  The repayment is subject to the same penalties and interest and collection procedures as any other income tax when not paid on time.  In addition, your withholding or estimated payments may need to be adjusted to avoid the underpayment penalty.

Definition of a First-Time Homebuyer - A taxpayer is considered a first-time homebuyer if he (or spouse, if married) had no present ownership interest in a principal residence in the U.S. during the three-year period before the purchase of the home to which the credit applies. If the individual is married, neither the individual nor his spouse may have had a present ownership interest in a principal residence during that three-year period, even if they file as married taxpayers filing separately. Ownership of a home outside the U.S. during the three-year period will not disqualify the taxpayer.

When to Claim the Credit - If an eligible purchase is made in 2008, the first-time homebuyer credit can be claimed on your 2008 tax return. For an eligible purchase in 2009, the credit can be claimed on either your 2008 (or amended 2008 return) or 2009 return.

Homes That Qualify - Only the purchase of a main home located in the United States qualifies.  Vacation homes and rental property are not eligible. The home must be purchased after April 8, 2008, and before July 1, 2009. For a home that is constructed, the purchase date is the first date the home is occupied.

Amount of the Credit - The credit is 10 percent of the purchase price of the home, with a maximum available credit of $7,500 for either a single taxpayer or a married couple filing jointly. The limit is $3,750 for a married person filing a separate return. Unmarried taxpayers who purchase a home together are eligible to share the credit under an as-yet-to-be announced formula to be determined by the IRS.  In most cases, the full credit will be available for homes costing $75,000 or more. Whatever the size of the credit a taxpayer receives, the credit must be repaid over a 15-year period.

Income Limits – The purpose of the credit is to assist lower-income individuals in acquiring their own home. Thus, the credit is reduced or eliminated for higher-income taxpayers. The credit is phased out based on the modified adjusted gross income (MAGI). MAGI is the adjusted gross income plus various amounts excluded from income-for example, certain foreign income. For a married couple filing a joint return, the phase-out range is $150,000 to $170,000. For other taxpayers, the phase-out range is $75,000 to $95,000.  This means that the full credit is available for married couples filing a joint return whose MAGI is $150,000 or less and for other taxpayers whose MAGI is $75,000 or less.

Who Cannot Take the Credit – In addition to the other qualifications and limitations discussed above, a taxpayer cannot take the credit if the:

• Home is purchased from a close relative. This includes a spouse, parent, grandparent, child or grandchild.

• Home is no longer used as the main home.

• Home is sold before the end of the year in which it was purchased.

• Taxpayer is a nonresident alien.

• Taxpayer is, or was, eligible to claim the District of Columbia first-time homebuyer credit for any taxable year.

• Home financing comes from tax-exempt mortgage revenue bonds.

How and When is the Credit Repaid - The first-time homebuyer credit is similar to a 15-year interest-free loan. Normally, it is repaid in 15 equal annual installments beginning with the second tax year after the year the credit is claimed. The repayment amount is included as an additional tax on the taxpayer's income tax return for that year. For example, if a $7,500 first-time homebuyer credit is properly claimed on the 2008 return, the taxpayer will begin paying it back on his or her 2010 tax return. Normally, $500 will be due each year from 2010 to 2024.

A taxpayer may need to adjust his or her withholding or make quarterly estimated tax payments to ensure that they are not under-withheld.

However, some exceptions apply to the repayment rule. They include:

• Taxpayer’s Death - If a taxpayer dies, any remaining annual installments are not due. If a joint return was filed and the taxpayer passes away, the surviving spouse would be required to repay his or her half of the remaining repayment amount.

• Ceases Being Main Home - If a taxpayer stops using a home as the main home, all remaining annual installments become due on the return for the year that happens. This includes situations where the main home becomes a vacation home or is converted to business or rental property. There are special rules for involuntary conversions.  

• Home Sold - If a home is sold, all remaining annual installments become due on the return for the year of sale. The repayment is limited to the amount of gain on the sale, if the home is sold to an unrelated taxpayer. If there is no gain or if there is a loss on the sale, the remaining annual installments may be reduced or even eliminated. For example, a home is purchased for $200,000 and the credit of $7,500 is claimed.  Assume that no improvements are made on the home and it is sold for $195,000 after repaying $500 of the credit.  The gain or loss would be measured for purposes of the accelerated credit recapture from $193,000 (the original cost of $200,000 less the $7,500 credit plus the $500 repayment).  In this case, there would be a gain of $2,000 on the sale ($195,000 - $193,000).   Thus, the taxpayer would only be liable for repaying $2,000 of the credit when the home is sold.  Had the home sold for $193,000 or less, there would be no repayment required.

• Divorce - If a home is transferred to a spouse, or, as part of a divorce settlement, to a former spouse, that person is responsible for making all subsequent installment payments.

• Involuntary Conversion - If the home is involuntarily converted (e.g., it's destroyed in a storm), and the taxpayer buys a new principal residence within a two-year period beginning on the date of the disposition or the date the home ceases to be the principal residence, the accelerated recapture rule does not apply.  However, the regular recapture rule applies to the replacement principal residence during the recapture period in the same way as if the replacement principal residence were the converted residence. 

It may be appropriate to consult with this office in advance of a home purchase where you or a family member are contemplating on utilizing this credit.  

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Tax-Free IRA to Charity Distributions Reinstated

The provision that permits taxpayers age 70½ and over to make direct distributions (up to $100,000) from their IRA account to a charity has been reinstated for 2008 and 2009.  The distribution is tax-free, but there is no charitable deduction.  This provision can be very beneficial to taxpayers who have social security income and/or do not itemize their deductions.

IMPORTANT! If you are over 70½, you must act quickly to take advantage of this provision for 2008.  This provision can substantially benefit low-income taxpayers, as well as the more wealthy individuals.  Please call if you are contemplating a cash charitable contribution between now and the end of the year to see if it would benefit you to make a direct contribution from your IRA.

The key benefits of this provision lie in the fact that the distribution;

(1) Is not included in the taxpayer’s income for the year,

(2) Counts toward the taxpayer’s minimum required distribution for the year, and

(3) Does count as a charitable contribution for the year. 

How does a taxpayer benefit from this provision?

• By making a contribution directly from the IRA, taxpayers are able to exclude the amount that was contributed from their income for the year, which is essentially the same as deducting the contribution without itemizing their deductions.
• This technique also lowers a taxpayer’s adjusted gross income (AGI) for other tax breaks pegged at various AGI levels, such as medical expenses, passive losses, etc., allowing them greater benefits from the AGI limited deductions.
• For taxpayers receiving Social Security (SS), the taxability of the SS is also based on income.  Thus, excluding the portion of the IRA distribution directly distributed to the charity can reduce the taxable portion of the SS.
• Taxpayers who wish to make very large contributions (up to the 100,000 limit) can do so with IRA funds that would have otherwise been taxable to them.

Example: Retired couple (both over 70½) file a joint return.  Their income consists primarily of RMD from their IRA accounts totaling $35,500, both of their SS incomes totaling $28,000, and $2,000 of investment income.  They are very active with their church and make a $14,000 contribution each year. They have no other income or deductions.  Compare the 2006 results with and without a qualified charitable distribution:

 

In this example, instead of making a charitable contribution, the taxpayer made a qualified charitable distribution of $14,000, lowering their AGI, reducing their taxable SS, and then using the standard deduction.  Result: Tax savings of $2,901. 

Caution – It is important to stress that a qualified charitable IRA contribution must be directly distributed to the qualified charity. Otherwise, the distribution is taxable as income and the charitable deduction would be taken on the taxpayer’s itemized deductions subject to all the normal limitations.  Please call this office before attempting to execute this strategy.

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Year-End Tax Tips and Planning Strategies

The end of the year is traditionally a time to celebrate the holidays, and your 2008 taxes may be the farthest thing from your mind.  However, with a few exceptions, it is your last opportunity to alter the results of your 2008 taxes.  The following are some of the many possible strategies that can be employed before year’s end.

• Required Minimum Distributions (RMD) — If you are 70½ or older, make sure that the minimum distribution amount is withdrawn from your IRA or other qualified plans to avoid the 50% penalty for under-withdrawals.  

• IRA and Qualified Plan Withdrawals — If you are retired and taking IRA distributions, make sure that you are maximizing your withdrawal with respect to your tax bracket.  It may be tax-effective to actually withdraw more than the minimum required by law.  If you receive Social Security benefits, IRA distributions can sometimes be planned to minimize the taxability of this income.

• Avoid Underpayment Penalties — Taxpayers are expected to pay their taxes during the year through withholding and/or the payment of estimated taxes.  If you have not paid enough and do not meet one of the exceptions, you could be subject to an underpayment penalty, along with an unpleasant tax bill when the tax return is filed.  Year-end increased withholding and estimates can mitigate those penalties. 

• Capital Gains and Losses — If you have any capital gains or losses from sales of stock or other capital assets, or you have stock or other capital assets that are ripe for sale, it may be advisable to meet and discuss how you can best coordinate timing your gains and losses to minimize tax on your gains and maximize the tax benefit from your losses.

• Zero Tax Rate — If you or a family member are thinking of selling appreciated stock or other capital assets, and your (or their) income isn't taxed at a rate higher than 15%, you can take advantage of the zero tax rate available in 2008.

• Expecting a Year-End Bonus — It may be advantageous to arrange with your employer to defer a bonus until after the end of the year, thereby deferring the taxes on it until 2009.

• Fuel-Efficient Vehicle — If you are thinking of buying a hybrid or advanced lean-burn vehicle eligible for a tax credit,(1) be sure to confirm that the particular model still qualifies for the credit.  

• Bunch Deductions — If you are marginally able to itemize each year, it may be appropriate to “bunch” deductions in one year and then claim the standard deduction in the alternate year. 

• State Estimated Tax Payments — Although the deadline for most states is January 15, 2009, for the fourth quarter 2008 state estimated tax payment, if that payment is made before the end of December 2008, the payment will count as a tax deduction(1) on federal Schedule A for 2008.   

• Property Taxes — Generally, your property taxes(1) are billed in installments, and that is how most people pay them.  However, the tax can be paid all at once if it provides a greater tax benefit for the current year.

• Charitable Contributions — If you have been planning to contribute used clothing and household goods to a charity, doing so before the year’s end can increase your itemized deductions.  But keep in mind that under the stringent rules for charitable donations, the items must generally be in good or better condition, and your contribution will need to be substantiated. 

• Annual Gift Tax Exclusion — You can save gift and estate taxes by making gifts sheltered by the annual gift tax exclusion before the end of the year.  You can give $12,000 in 2008 to an unlimited number of individuals, but you can't carry over unused exclusions from one year to the next.

• Roth IRA Conversions — If your taxable income is low or a negative amount for the year, it may be appropriate to convert some or all of your taxable traditional IRA to a Roth IRA for little or no tax cost.  Roth IRAs provide the benefit of tax-free income for retirement.

• Education Credits — If you qualify for one of the higher education tax credits and have not paid enough tuition during the year to achieve the maximum credit, the law allows you to prepay tuition for an academic period beginning within the first three months of the next year and claim the tuition for the current year’s credit.

If you would like to discuss other possible strategies or how any of the ones listed above apply to you, please call this office.

(1)  Caution: These credits and/or deductions do not benefit taxpayers who are subject to the alternative minimum tax (AMT). 

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Economic Stabilization Legislation

On October 3, 2008, Congress passed and the President signed into law the “Economic Stabilization” legislation, which included numerous tax law changes that are mostly pro-taxpayer. These changes will impact just about everyone, and you are encouraged to review them below. Please call this office if you have questions about any of the provisions or need additional details.

Additional Standard Deduction for State and Local Property Taxes - The tax provision that allows taxpayers who claim the standard deduction instead of itemizing deductions to claim an additional standard deduction for State and local property taxes paid, originally slated for 2008 only, has been extended through 2009. The deduction cannot exceed the lesser of state and local property taxes actually paid or $500 ($1,000 for joint return filers). No taxes deductible in computing adjusted gross income are taken into account in computing the increased standard deduction.

Refundable Child Tax Credit Eased - Currently, taxpayers receive a $1,000 tax credit for each child under the age of 17. The credit is used to reduce the taxpayer’s tax liability. If the credit is larger than the tax liability, the excess is eligible for a refundable credit called the “additional child tax credit.” The additional child tax credit is equal to 15% of earned income in excess of a threshold dollar amount. For 2008, the threshold amount has been reduced to $8,500 from $12,050, thus increasing the refundable amount for low-income taxpayers.

Income Averaging for Exxon Valdez Litigation Amounts - Effective October 3, 2008, commercial fishermen and other individuals whose livelihoods were negatively impacted by the '89 Exxon Valdez oil spill are allowed to average any settlement or judgment-related income that they receive in connection with pending litigation in the federal courts over three years for federal tax purposes. It also allows them to use these funds to make contributions to retirement accounts.

Qualifying Child - The “uniform definition of a child” is used in taxes to determine when an individual qualifies for certain tax benefits including the dependency exemption, child tax credit and earned income tax credit. Acting to close some of the loopholes in various applications of the uniform definition of a child, Congress has made several changes to the qualifying child rules effective beginning in 2009. The new law:

• Requires that a qualifying child be younger than the claimant;

• Requires that a qualifying child be unmarried;

• Restricts qualifying child tax benefits to the child's parents in certain cases; and

• Denies the child tax credit to taxpayers who are dependents.

Home Mortgage Debt Forgiveness Relief - When a taxpayer defaults on their home loan through foreclosure, short sale or voluntary reconveyance, the amount of the debt forgiven becomes income for tax purposes. Thus, a taxpayer who has just lost their home is also straddled with an additional tax burden created by the debt relief income. Trying to soften the foreclosure problems, Congress, last year, added a provision that allows taxpayers to exclude up to $2 million ($1 million for married individuals filing separately) of home mortgage acquisition debt relief income from a taxpayer’s principal residence. This provision has been extended through 2012.

Deduction for State and Local Sales Taxes - The provision whereby a taxpayer may elect to claim an itemized deduction for state and local general sales taxes instead of deducting state and local income taxes has been retroactively reinstated for 2008 and extended through 2009.

Deduction of Qualified Tuition & Related Expenses -The above-the-line deduction for qualified tuition and related expenses has been retroactively reinstated for 2008 and extended through 2009. This provision allows a taxpayer to claim an above-the-line deduction for qualified tuition and related expenses for higher (post-secondary) education. The maximum deduction is $4,000 for an individual whose adjusted gross income (AGI) for the tax year does not exceed $65,000 ($130,000 in the case of a joint return), or $2,000 for other individuals whose AGI does not exceed $80,000 ($160,000 in the case of a joint return). No deduction is allowed for an individual whose AGI exceeds the relevant AGI limits, for a married individual who does not file a joint return, or for an individual whose personal exemption deduction may be claimed by another taxpayer for the tax year.

Educator Above-the-Line Expenses - The above-the-line deduction for teachers (kindergarten through 12th grade) has been retroactively reinstated for 2008 and extended through 2009. Eligible teachers may claim an above-the-line deduction for up to $250 annually of expenses paid or incurred for books, supplies (other than nonathletic supplies for courses of instruction in health or physical education), computer equipment (including related software and services) and other equipment, and supplementary materials used by the eligible educator in the classroom. To be eligible for this deduction, the expenses must be otherwise deductible as a trade or business expense.

Tax-Free IRA to Charity Distributions - The provision that permits taxpayers age 70½ and over to make direct distributions (up to $100,000) from their IRA account to a charity has been reinstated for 2008 and 2009. The distribution is tax-free, but there is no charitable deduction. This provision can be very beneficial to taxpayers who have social security income and/or do not itemize their deductions. 

IMPORTANT: You must act quickly to take advantage of this provision for 2008.  If you are over 70½ and are contemplating any size of cash charitable contribution between now and the end of the year, please call to see if making a direct contribution from your IRA can provide you any significant tax benefit for 2008.

Alternative Minimum Tax Relief - For yet another year, Congress has applied a patch to the AMT by increasing the AMT exemption amount and continuing to allow nonrefundable credits, such as dependent care, child credit, education credits and others that most middle-income taxpayers use to avoid this punitive tax. In addition, the amount of long-term unused AMT tax credit that can be applied in the current year was also substantially increased. The following is an overview of these changes:

• AMT Exemption Amount for 2008 Increased - The AMT exemptions have been increased for 2008 to: $69,950 for married individuals filing jointly, $46,200 for unmarried individuals and $34,975 for married individuals filing separately. The AMT phase-out rules remain unchanged.

• AMT Relief for Nonrefundable Personal Credits - Nonrefundable personal credits will offset the AMT for 2008. Those credits include the dependent care credit, elderly and disabled credit, Hope and Lifetime Learning credits, adoption credit, child tax credit, mortgage credit, saver’s credit and certain residential and home energy credits.

• Increased AMT Refundable Long-Term Unused Credits - Prior to this change and for purposes of claiming the long-term unused minimum tax credit, the refundable credit amount was limited to the greatest of (1) $5,000, (2) 20% of the long-term carryover or (3) the AMT refundable credit amount (if any) for the prior year - before any reduction by reason of AGI. Under the Act, the $5,000 limitation has been removed, and the 20% limit has been increased to 50%.

In addition, the Act provides for abatement of any underpayment of tax outstanding on October 3, 2008, which is attributable to AMT on incentive stock options for any taxable year ending before January 1, 2008. The abatement extends to any related interest or penalty.

Home Energy Credit - The credit for certain energy-efficient property installed on the taxpayer’s principal residence that originally expired in 2007 has been reinstated for 2009 only. This provision allows a nonrefundable $500 credit for the installation of qualified windows, skylights, air circulation systems, hot water boilers and other energy-efficient equipment. Biomass fuel stoves that heat the residence or heat water for the residence, and asphalt roofs which include appropriate cooling granuals have been added to the list of qualifying property.

Residential Energy-Efficient Property (REEP) Credit - This credit, which was scheduled to expire after 2008, has been extended through 2016 and includes credit for the installation of solar water heating systems (excluding swimming pools) and qualified fuel cell property. The $2,000 cap on the solar systems credit is removed as of 2009, wind property and geothermal heat pumps are eligible as of 2008, and the credit can now be claimed against the AMT.

Certain Farming Machinery & Equipment Treated as 5-Year Property - For 2009 only, new machinery or equipment (other than any grain bin, cotton ginning asset, fence, or other land improvement) which is used in a farming business after December 31, 2008, and which is placed in service before January 1, 2010, is treated as 5-year property.

Plug-In Electric Drive Vehicle Credit - A tax credit for “new qualified plug-in electric drive motor vehicles” purchased before January 1, 2015 has been added. The credit, which is subject to a limit based on weight, is the sum of: (1) $2,500 plus (2) $417 for each kilowatt hour of traction battery capacity in excess of 6 kilowatt hours. The maximum credit for vehicles weighing 10,000 pounds or less is $7,500. Larger maximums apply to heavier vehicles. When the vehicle is used partially for business, the credit is allocated between personal and business credits. This credit has a phase-out provision similar to the hybrid vehicle credit and will begin to phase out after 250,000 units are sold. Watch for more on this when the vehicles become available.

Bicycle Reimbursements Added to Employer Fringe Benefits - Employers are able to provide certain tax-free “fringe benefits” to their employees. “Qualified bicycle commuting reimbursement” has been added to the list of qualified transportation fringe benefits. Up to $20 per month of employer tax-free reimbursement is allowed for reasonable expenses incurred by the employee during that calendar year for the purchase of a bicycle and bicycle improvements, repair and storage if the bicycle is regularly used for travel between the employee's residence and place of employment.

Contractor Efficient Home Credit - An eligible contractor may claim a business credit for each qualified new energy-efficient home that the contractor constructs and which is acquired by a person from the contractor for use as a residence. The credit is either $2,000 (for a 50% energy reduction in energy usage) or $1,000 (for a 30% energy reduction in energy usage). This credit has been extended through 2009.

Energy-Efficient Commercial Building Property - A deduction is allowed in an amount equal to the cost of “energy-efficient commercial building property” placed in service during the tax year. The maximum deduction for any building for any tax year is the excess (if any) of $1.80 multiplied by the square footage of the building, less the aggregate amount of the deduction for the building for all earlier tax years. This credit is extended through 2013.

Casualty Losses - The $100 floor for personal-use property has been increased to $500 for 2009 only. The 10% of AGI limit on personal casualty losses is waived in federally declared disasters in 2008 and 2009. The 2008 Extenders Act introduces the new definition of a “federally declared disaster,” allows certain casualty losses to be tacked on to the standard deduction, and modifies provisions related to federally declared disaster areas.

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First Look: QuickBooks 2009

QuickBooks 2009 has just been released and you’ll find a number of improvements that are sure to be helpful. Of course, the introduction of a new release also means the discontinuation of support for an old release—QuickBooks will end support for QuickBooks 2006 as of May 31, 2009. This means that after that date you’ll no longer able to request technical assistance from Intuit, and services such as payroll, merchant service, online banking, and so on will no longer be accessible. With that background in mind, let’s explore what’s new!

Three long awaited improvements

Some users have been stymied by the fact that QuickBooks would not allow numbers of $100 million or above to be entered. QuickBooks 2009 extends this limit to numbers just shy of $100 billion. So, instead of being limited to 8-figure numbers, you’re now limited to 11-figure numbers. This increased limit is particularly helpful now that QuickBooks supports multiple currencies. As shown in Figure 1, you can configure QuickBooks to process transactions in just about any currency. Records will show both the foreign and converted amounts, plus Intuit now offers an international payment service that allows you to initiate wires and drafts for more than 100 foreign currencies from within QuickBooks.

 

Figure 1: QuickBooks 2009 supports multiple currencies.

A more universal improvement that you’ll appreciate involves the Bank Reconciliation window. Until now you couldn’t sort transactions, which meant you could spend a lot of time looking for a specific item when combined with the seemingly arbitrary grouping of transactions. As shown in Figure 2, you can now click on any column heading and sort the bank reconciliation columns any way you wish.



Figure 2: You can click and sort based on any column heading in the Bank Reconciliation window.

Multiple User Improvements

You may also have been frustrated in the past that you had to switch QuickBooks into single-user mode in order to back-up your company. For many offices, this involves tracking everyone down, getting them to log out of QuickBooks, and then letting them know when to get back in. Or, because of the hassle, some users just wouldn’t get around to backing up their data. QuickBooks 2009 addresses both of these issues:

• You’re now able to back-up QuickBooks while other users are logged into the company.

• The new Messenger feature allows you to instantly communicate with other users currently logged into the software.

The multi-user improvements don’t stop there: now one user can create an invoice while another is running a report. 

Accountants Copy Improvements

You’ll also be glad to know that you can now reconcile your bank account at any time while the accountant’s copy is out. Previously you couldn’t carryout reconciliations after the dividing date until the accountant’s copy had been returned. In addition, accountant’s copy users can now map Form 1099 fields, as well as modify and merge classes. Further, accountant’s copy users can access both QuickBooks 2008 and 2009 companies, which simplifies the review process.

Other new features

QuickBooks 2009 also includes a potpourri of other new features:

• The new Company Snapshot provides an instant overview of your business, as shown in Figure 3.



Figure 3: The new Company Snapshot serves as an executive dashboard.

• Online banking has been improved, meaning that QuickBooks should automatically match more transactions, resulting in less work for you to do by hand.

• The Item List window has a new search feature that makes it easier to find inventory items, as shown in Figure 4.

• A new Duplicate command allows you to replicate existing inventory items and certain transactions. As shown in Figure 4, this command appears when you right-click on an inventory item. It also appears when you right-click anywhere in a transaction window, as shown in Figure 5. Although QuickBooks enables you to duplicate existing transactions, the Memorized Transaction feature is a much safer way to do so. Duplicating a transaction means an exact duplicate, including invoice or check numbers and dates.



Figure 4: A new search feature helps locate items, while the new Duplicate command eliminates redundant keying.



Figure 5: It’s possible to duplicate transactions, but use this feature with care.

• QuickBooks 2009 users can have a free business web site—comprised of three pages—hosted for twelve months.

• QuickBooks 2009 is Windows Vista-certified by Microsoft, although previous versions should also work within without issue in Windows Vista.

• Converting from Peachtree 2008 and Microsoft Office Accounting 2008 to QuickBooks is easy via the free QuickBooks Conversion Tool available at www.quickbooks.com/converttoquickbooks.

• Adobe Acrobat Form templates can be imported into QuickBooks. Keep in mind that this requires that you purchase Adobe Acrobat Pro in order to do so, but this allows other employees or sales reps to generate invoices, sales orders, or estimates that can be imported into QuickBooks. This allows you to push accounting tasks out to the field, without granting direct access to QuickBooks.

• QuickBooks Enterprise Edition now supports up to 30 users, so you can stay with QuickBooks as your business grows.

• The Administrator password now uses stronger, 2048-bit encryption. Make sure that you don’t lose this password, as you’ll have a much tougher time revealing it through password recovery tools.

• A new Live Community feature allows you to see questions and answers posted by other QuickBooks users, as shown in Figure 6. You can even post questions on your own for free, but keep in mind that there’s no guarantee of a response to your question. If you find that Live Community takes up too much screen space, you can turn off the feature by choosing Edit, Preferences, and then clear the checkbox for Show Live Community in the Desktop view, as shown in
Figure 7. You can then activate Live Community at any time by choosing Help, and then Live Community.



Figure 6: The Live Community feature allows you to see what questions others are asking about QuickBooks.



Figure 7: You can disable Live Community if you don’t find it helpful.

A worthy upgrade

Quickbooks 2009 offers solid improvement over previous versions. With new features like 11-digit number support, multiple currency support, and advanced sorting options, you’re sure to increase your productivity enough to more than offset the cost of the upgrade. Add usability features like enhanced security and multi-user support and Quickbooks 2009 looks like a winner.

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