Start Planning Now for Your 2007 Taxes
The spring tax-filing season for 2006 has arrived, but planning now for your 2007 corporate and individual tax positions could be an effective strategy to reduce your overall tax bill. Effective tax planning also can help increase your company’s cash flow and enhance your shareholder value.
Tax planning can be a year-long task, so it’s never too early to give your taxes a once-over, especially regarding two new provisions which Congress passed and President Bush recently signed: the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) and the Pension Protection Act of 2006 (PPA).
TIPRA affects a broad cross-section of taxpayers. It extends the controversial dividend and capital-gains tax-rate cuts for two years beyond 2008, gives taxpayers immediate relief from the alternative minimum tax (AMT), extends small-business expensing thresholds and gives high-income taxpayers the opportunity to convert retirement savings to Roth individual retirement accounts (IRAs).
Lawmakers intended PPA to fix outdated pension laws that present risks to taxpayers, workers and retirees. It also encourages greater participation in 401(k) and other defined-contribution retirement plans and makes permanent several other reforms to those plans that were set to expire over the next several years.
For a more detailed account of recent tax changes and their effect on your business and personal tax liabilities, consult a tax advisor.
Business Tax Tips
• Annual expensing election. Before claiming your company’s tax depreciation, check to see if you can write off certain qualified fixed-asset purchases—such as furniture, equipment, computers and off-the-shelf software—under the Section 179 annual expensing election rather than through depreciation over five or seven years. Since 2003, Congress has enhanced small-business expensing under Section 179 several times to encourage business investment. TIPRA continues this special treatment. The maximum amount a taxpayer may expense is $100,000 of the cost of qualifying property, less the amount by which the cost of qualifying property exceeds $400,000. For 2006, the maximum qualifying expenses are indexed to $108,000 and $430,000, respectively. Without the extension, the expensing limit would have dropped to $25,000 on a $200,000 cap after 2007.
• Cost-segregation study. If you constructed, acquired, expanded or remodeled a building in recent years, consider a costsegregation study, which can identify possible tax savings. Businesses typically depreciate buildings over 39 years, but they can depreciate certain costs, including those associated with parking, landscaping, signs and equipment, over shorter periods. The study will identify not only current-year costs you can depreciate over shorter periods but also the depreciation you should have taken on the assets you acquired in earlier years, with the cumulative adjustment allowed as a deduction in the current year. In one case, a $2.6 million manufacturing construction project could depreciate more than $1 million in costs early, resulting in a tax savings of $190,000.
• Corporate status. When it comes to taxes, some companies, especially startups, may find it beneficial to convert to an Scorporation. In general, an S-corporation does not pay income taxes. Instead, the income, losses, deductions and credits pass through to shareholders. S-corporations have other benefits as well. You may deduct interest you incur in order to purchase S-corporation stock as an investment interest expense. When it comes to selling your S-corporation, your taxable gain on the sale may be less than it would be if the business had been a Ccorporation. For your business to qualify as an S-corporation, it must be a U.S. company, offer just one class of stock and include no more than 100 shareholders who are all U.S. citizens or residents and are not partnerships or other corporations.
• Telephone excise-tax repeal. Thanks to a series of court cases, tax refunds may result from a 108-year-old tax on long-distance telephone service, originally created to fund the Spanish-American War. In addition, the federal government will refund about $13 billion in taxes collected on telephone bills over the past three years. The maximum refund taxpayers can claim without producing old telephone bills ranges from $30 for a single taxpayer to $60 for a family of four. Businesses willing and able to produce old telephone bills may be eligible for refunds worth hundreds of thousands of dollars.
• Excess inventory. To nail down a deduction for excess or slowmoving inventory, you must dispose of it or hold it for sale at a substantially reduced price within 30 days of year-end.
• Skillful accounting. Accounting methods deal with issues such as the recognition of income and expenses, valuation of yearend inventory, capitalization of certain expenses, treatment of prepaid expenses and much more. By modifying your company’s accounting methods, you might find opportunities for significant tax deferrals and current-year tax reductions. Some method changes are automatic, while others require prior IRS approval.
Tips for Individual Taxes
• Protection from the alternative minimum tax. Through Dec. 31, 2006, Congress lifted the curse of the alternative minimum tax (AMT) from some 15 million taxpayers, many of them middle class. The AMT exemption amount increases to $62,550 from $58,000 for joint tax filers and to $42,500 from $40,250 for single taxpayers. Additionally, the law also offers these taxpayers protection from the AMT if they also claim several nonrefundable personal credits, including the dependent-care credit, the credit for the elderly and disabled, the credit for interest on certain home mortgages, the Hope credit for certain college expenses and the Lifetime Learning credit.
• Reduced rates on long-term capital gains and qualified dividends. Long-term capital gains and dividend income are taxed at a maximum rate of 15 percent through 2008. For taxpayers in the 10 percent and 15 percent tax brackets, the tax rate is 5 percent through 2007 and zero in 2008. TIPRA extends the rates effective in 2008 through 2010. Without action, these rates would have increased after 2008.
• Retirement plans. One way to effectively lower your taxable income is to contribute to or open a retirement plan, such as a 401(k), 403(b), deductible IRA, SIMPLE IRA or simplified employee pension (SEP). Make contributions until Dec. 31st for 401(k)s and 403(b)s. With some plans, you have until tax-filing day, April 17, to contribute, or later if you extend your return. Check with a tax professional to determine the best move for you. The 2006 limits are: up to $15,000 for 401(k)s; up to $10,000 for SIMPLE IRAs; up to $5,000 for 401(k) catch-up contributions (for those older than 50); up to $4,000 for traditional and Roth IRAs; and up to $1,000 for traditional and Roth IRA catch-ups (for those older than 50). If you participate in a 401(k) plan, you should verify whether that plan provides for Roth 401(k) savings. If so, you need to decide whether you would be best served by making pre-tax contributions that will be taxable upon withdrawal from a traditional 401(k) plan or after-tax contributions that you can withdraw tax-free from a Roth 401(k).
• Direct rollovers from retirement plans into Roth IRAs. Beginning in 2008, you can make a direct rollover from your retirement plan into a Roth IRA. This new Roth conversion privilege will be available for money coming out of qualified retirement plans, such as 401(k)s, Section 403(b) tax-sheltered annuity arrangements and governmental Section 457 plans. Under the current Roth conversion rules (which will continue to apply through 2007), it takes a two-step procedure to convert from a retirement plan to Roth status. You must first roll over the funds into a traditional IRA. You then convert the traditional account into a Roth account. Of course, you’ll have to pay any taxes on funds you convert to Roth status, but that will be the last time you pay taxes on those Roth funds, assuming you follow the rules. And there’s another fly in the ointment: For 2008 and 2009, you’ll be ineligible for the Roth conversion privilege if your modified adjusted gross income exceeds $100,000. Starting in 2010, however, the $100,000 limitation is scheduled to disappear. So everyone will eventually qualify for Roth conversions, regardless of income.
• Donations directly out of IRAs for seniors. If you’re 70 1/2 or older, you can contribute otherwise taxable amounts you withdraw from a traditional IRA or Roth IRA directly to tax-exempt charities. These “qualified charitable distributions” are free from federal income tax. However, since tax-free treatment equates to a 100 percent write-off, you can’t claim any itemized deduction for a qualified charitable distribution. A qualified charitable distribution means your IRA trustee makes a payment directly to a qualified public charity; the money cannot pass through your hands. The new rule applies for 2006 and 2007, but you cannot donate more than $100,000 in one year.
• Direct deposit of tax refund into IRA. Starting with 2007 Form 1040, you can directly deposit all or part of your federal income-tax refund into your IRA, or your spouse’s IRA if you file jointly.
• Charitable contributions. People who wish to make a charitable donation and who own stock that has risen in value should consider donating appreciated property rather than cash. The full fair-market value of the stock will be deductible as a charitable contribution on Schedule A. In addition to enjoying the improved cash flow and tax deduction, you will avoid paying tax on the unrealized stock gain.
• Documentation of cash donations. In 2007, you’ll no longer be allowed to write-off contributions of cash, checks or other monetary gifts without a bank record (for example, a canceled check) or a written statement from the charity. The existing rule that requires you to obtain receipts for cash donations of $250 or more remains in force. Smaller cash donations will fall under the new rule. You won’t get any write-offs for undocumented cash contributions (such as money placed in church collection plates and cash dropped into Salvation Army pots).
• Planned wealth transfer. It’s also recommended that you plan well in advance how you intend to distribute your assets to your children, grandchildren or others. Current law allows individuals to make annual gifts up to $12,000 to each individual recipient without being subject to gift tax. A husband and wife can transfer up to $24,000 per recipient. To be eligible for this annual exclusion, the gift must constitute a present interest in an asset. An unlimited exemption is available for education or medical expenses paid on behalf of an individual—as long as the payments are made directly to the service provider. This allows you to minimize your taxable estate without incurring gift taxes. You could also consider establishing tax-free savings accounts, also known as qualified tuition programs or statesponsored Section 529 plans, to save for the college expenses of your children or grandchildren. Your contribution can qualify for the $12,000 annual gift-tax exclusion ($24,000 for gifts by married couples).
• Taxpayer-friendly rules for Section 529 plans. The taxpayerfriendly federal tax rules for Section 529 plans were enacted in 2001, but they were scheduled to expire after 2010. PPA makes the existing rules permanent, including federal-income-tax-free treatment for qualified Section 529 plan distributions. However, the new law also gives the IRS authority to issue “anti-abuse” rules to prevent taxpayers from using Section 529 plans in taxsaving strategies that go beyond what Congress intended. For example, the government doesn’t like that taxpayers use Section 529 accounts to avoid estate taxes while retaining control over how they use the funds.
• “Kiddie” tax. Under current law, children are taxed on their unearned income (such as interest, dividends and capital gains) at their parent’s tax rate, which is usually higher than what they would pay based solely on their income. The kiddie tax applies if the child is younger than 4, the child has net unearned income greater than $1,700 and the parent can claim the child as a dependent. TIPRA raises the age limit to 17. IBI
Tax planning can be a year-long task, so it’s never too early to give your taxes a once-over, especially regarding two new provisions which Congress passed and President Bush recently signed: the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) and the Pension Protection Act of 2006 (PPA).
TIPRA affects a broad cross-section of taxpayers. It extends the controversial dividend and capital-gains tax-rate cuts for two years beyond 2008, gives taxpayers immediate relief from the alternative minimum tax (AMT), extends small-business expensing thresholds and gives high-income taxpayers the opportunity to convert retirement savings to Roth individual retirement accounts (IRAs).
Lawmakers intended PPA to fix outdated pension laws that present risks to taxpayers, workers and retirees. It also encourages greater participation in 401(k) and other defined-contribution retirement plans and makes permanent several other reforms to those plans that were set to expire over the next several years.
For a more detailed account of recent tax changes and their effect on your business and personal tax liabilities, consult a tax advisor.
Business Tax Tips
• Annual expensing election. Before claiming your company’s tax depreciation, check to see if you can write off certain qualified fixed-asset purchases—such as furniture, equipment, computers and off-the-shelf software—under the Section 179 annual expensing election rather than through depreciation over five or seven years. Since 2003, Congress has enhanced small-business expensing under Section 179 several times to encourage business investment. TIPRA continues this special treatment. The maximum amount a taxpayer may expense is $100,000 of the cost of qualifying property, less the amount by which the cost of qualifying property exceeds $400,000. For 2006, the maximum qualifying expenses are indexed to $108,000 and $430,000, respectively. Without the extension, the expensing limit would have dropped to $25,000 on a $200,000 cap after 2007.
• Cost-segregation study. If you constructed, acquired, expanded or remodeled a building in recent years, consider a costsegregation study, which can identify possible tax savings. Businesses typically depreciate buildings over 39 years, but they can depreciate certain costs, including those associated with parking, landscaping, signs and equipment, over shorter periods. The study will identify not only current-year costs you can depreciate over shorter periods but also the depreciation you should have taken on the assets you acquired in earlier years, with the cumulative adjustment allowed as a deduction in the current year. In one case, a $2.6 million manufacturing construction project could depreciate more than $1 million in costs early, resulting in a tax savings of $190,000.
• Corporate status. When it comes to taxes, some companies, especially startups, may find it beneficial to convert to an Scorporation. In general, an S-corporation does not pay income taxes. Instead, the income, losses, deductions and credits pass through to shareholders. S-corporations have other benefits as well. You may deduct interest you incur in order to purchase S-corporation stock as an investment interest expense. When it comes to selling your S-corporation, your taxable gain on the sale may be less than it would be if the business had been a Ccorporation. For your business to qualify as an S-corporation, it must be a U.S. company, offer just one class of stock and include no more than 100 shareholders who are all U.S. citizens or residents and are not partnerships or other corporations.
• Telephone excise-tax repeal. Thanks to a series of court cases, tax refunds may result from a 108-year-old tax on long-distance telephone service, originally created to fund the Spanish-American War. In addition, the federal government will refund about $13 billion in taxes collected on telephone bills over the past three years. The maximum refund taxpayers can claim without producing old telephone bills ranges from $30 for a single taxpayer to $60 for a family of four. Businesses willing and able to produce old telephone bills may be eligible for refunds worth hundreds of thousands of dollars.
• Excess inventory. To nail down a deduction for excess or slowmoving inventory, you must dispose of it or hold it for sale at a substantially reduced price within 30 days of year-end.
• Skillful accounting. Accounting methods deal with issues such as the recognition of income and expenses, valuation of yearend inventory, capitalization of certain expenses, treatment of prepaid expenses and much more. By modifying your company’s accounting methods, you might find opportunities for significant tax deferrals and current-year tax reductions. Some method changes are automatic, while others require prior IRS approval.
Tips for Individual Taxes
• Protection from the alternative minimum tax. Through Dec. 31, 2006, Congress lifted the curse of the alternative minimum tax (AMT) from some 15 million taxpayers, many of them middle class. The AMT exemption amount increases to $62,550 from $58,000 for joint tax filers and to $42,500 from $40,250 for single taxpayers. Additionally, the law also offers these taxpayers protection from the AMT if they also claim several nonrefundable personal credits, including the dependent-care credit, the credit for the elderly and disabled, the credit for interest on certain home mortgages, the Hope credit for certain college expenses and the Lifetime Learning credit.
• Reduced rates on long-term capital gains and qualified dividends. Long-term capital gains and dividend income are taxed at a maximum rate of 15 percent through 2008. For taxpayers in the 10 percent and 15 percent tax brackets, the tax rate is 5 percent through 2007 and zero in 2008. TIPRA extends the rates effective in 2008 through 2010. Without action, these rates would have increased after 2008.
• Retirement plans. One way to effectively lower your taxable income is to contribute to or open a retirement plan, such as a 401(k), 403(b), deductible IRA, SIMPLE IRA or simplified employee pension (SEP). Make contributions until Dec. 31st for 401(k)s and 403(b)s. With some plans, you have until tax-filing day, April 17, to contribute, or later if you extend your return. Check with a tax professional to determine the best move for you. The 2006 limits are: up to $15,000 for 401(k)s; up to $10,000 for SIMPLE IRAs; up to $5,000 for 401(k) catch-up contributions (for those older than 50); up to $4,000 for traditional and Roth IRAs; and up to $1,000 for traditional and Roth IRA catch-ups (for those older than 50). If you participate in a 401(k) plan, you should verify whether that plan provides for Roth 401(k) savings. If so, you need to decide whether you would be best served by making pre-tax contributions that will be taxable upon withdrawal from a traditional 401(k) plan or after-tax contributions that you can withdraw tax-free from a Roth 401(k).
• Direct rollovers from retirement plans into Roth IRAs. Beginning in 2008, you can make a direct rollover from your retirement plan into a Roth IRA. This new Roth conversion privilege will be available for money coming out of qualified retirement plans, such as 401(k)s, Section 403(b) tax-sheltered annuity arrangements and governmental Section 457 plans. Under the current Roth conversion rules (which will continue to apply through 2007), it takes a two-step procedure to convert from a retirement plan to Roth status. You must first roll over the funds into a traditional IRA. You then convert the traditional account into a Roth account. Of course, you’ll have to pay any taxes on funds you convert to Roth status, but that will be the last time you pay taxes on those Roth funds, assuming you follow the rules. And there’s another fly in the ointment: For 2008 and 2009, you’ll be ineligible for the Roth conversion privilege if your modified adjusted gross income exceeds $100,000. Starting in 2010, however, the $100,000 limitation is scheduled to disappear. So everyone will eventually qualify for Roth conversions, regardless of income.
• Donations directly out of IRAs for seniors. If you’re 70 1/2 or older, you can contribute otherwise taxable amounts you withdraw from a traditional IRA or Roth IRA directly to tax-exempt charities. These “qualified charitable distributions” are free from federal income tax. However, since tax-free treatment equates to a 100 percent write-off, you can’t claim any itemized deduction for a qualified charitable distribution. A qualified charitable distribution means your IRA trustee makes a payment directly to a qualified public charity; the money cannot pass through your hands. The new rule applies for 2006 and 2007, but you cannot donate more than $100,000 in one year.
• Direct deposit of tax refund into IRA. Starting with 2007 Form 1040, you can directly deposit all or part of your federal income-tax refund into your IRA, or your spouse’s IRA if you file jointly.
• Charitable contributions. People who wish to make a charitable donation and who own stock that has risen in value should consider donating appreciated property rather than cash. The full fair-market value of the stock will be deductible as a charitable contribution on Schedule A. In addition to enjoying the improved cash flow and tax deduction, you will avoid paying tax on the unrealized stock gain.
• Documentation of cash donations. In 2007, you’ll no longer be allowed to write-off contributions of cash, checks or other monetary gifts without a bank record (for example, a canceled check) or a written statement from the charity. The existing rule that requires you to obtain receipts for cash donations of $250 or more remains in force. Smaller cash donations will fall under the new rule. You won’t get any write-offs for undocumented cash contributions (such as money placed in church collection plates and cash dropped into Salvation Army pots).
• Planned wealth transfer. It’s also recommended that you plan well in advance how you intend to distribute your assets to your children, grandchildren or others. Current law allows individuals to make annual gifts up to $12,000 to each individual recipient without being subject to gift tax. A husband and wife can transfer up to $24,000 per recipient. To be eligible for this annual exclusion, the gift must constitute a present interest in an asset. An unlimited exemption is available for education or medical expenses paid on behalf of an individual—as long as the payments are made directly to the service provider. This allows you to minimize your taxable estate without incurring gift taxes. You could also consider establishing tax-free savings accounts, also known as qualified tuition programs or statesponsored Section 529 plans, to save for the college expenses of your children or grandchildren. Your contribution can qualify for the $12,000 annual gift-tax exclusion ($24,000 for gifts by married couples).
• Taxpayer-friendly rules for Section 529 plans. The taxpayerfriendly federal tax rules for Section 529 plans were enacted in 2001, but they were scheduled to expire after 2010. PPA makes the existing rules permanent, including federal-income-tax-free treatment for qualified Section 529 plan distributions. However, the new law also gives the IRS authority to issue “anti-abuse” rules to prevent taxpayers from using Section 529 plans in taxsaving strategies that go beyond what Congress intended. For example, the government doesn’t like that taxpayers use Section 529 accounts to avoid estate taxes while retaining control over how they use the funds.
• “Kiddie” tax. Under current law, children are taxed on their unearned income (such as interest, dividends and capital gains) at their parent’s tax rate, which is usually higher than what they would pay based solely on their income. The kiddie tax applies if the child is younger than 4, the child has net unearned income greater than $1,700 and the parent can claim the child as a dependent. TIPRA raises the age limit to 17. IBI
