As the end of the year approaches, it is a good time for you to engage in tax planning. You know your tax picture from earlier in the year and you have a pretty good idea of what it will be for the rest of the year. With that knowledge in hand, you are now in a position to take various actions that may save taxes for this year, next year, or both years.
Those individuals who have attained age 70-1/2 may exclude up to $100,000 a year (for 2006 and 2007) for otherwise taxable distributions from an IRA (or a Roth IRA) that are paid directly to a qualifying charitable organization by the IRA trustee. Additionally, there are new tax credits for making certain energy-saving improvements around the house, a new tax credit for buying hybrid vehicles and another new credit for buying an alternative fuel vehicle.
Year-end planning also may turn out to be more of a "last minute" challenge this year than most because many deductions that were to expire at the end of 2005 have been retroactively extended by Congress in time for you to capitalize on them before year-end. These tax breaks include the above-the-line deduction for educators, the above-the-line deduction for higher education expenses, and the election to deduct state and local general sales taxes instead of state and local income taxes.
We have compiled a checklist of actions that may help you to save taxes if you act before year-end. Not all actions will apply in your particular situation, but you will likely benefit from many of them. We can narrow down the specific actions that you can take once we meet with you to tailor a particular plan. In the meantime, please review the following list and contact us at your earliest convenience so that we can advise you on which tax-saving moves to make:
- Increase the amount you set aside for next year in your employer's health flexible spending account if you set aside too little for this year. Don't forget you can set aside amounts to get tax-free reimbursements for over-the -counter drugs, such as aspirin and antacids. Also, new rules allow your plan to permit a grace period after year-end for using remaining amounts.
- 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 for us to meet to 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.
- It may be advantageous to try to arrange with your employer to defer your bonus until 2007.
- If you own an interest in a partnership or a corporation you may need to increase your basis in the entity so you can deduct a loss from it for this year.
- Consider using a credit card to prepay expenses that can generate deductions for this year.
- Consider making credit-eligible energy saving improvements to your home, or, if youÕre thinking of buying a hybrid vehicle eligible for the credit, purchase it before year-end.
- You may want to pay contested taxes to be able to deduct them this year while continuing to contest them next year.
- Business clients also should consider making expenditures that qualify for the $108,000 business property expensing option.
- You may want to settle an insurance or damage claim in order to maximize your casualty loss deduction this year.
- You may be able to save taxes this year and next year by applying a bunching strategy to "miscellaneous" itemized deductions, medical expenses and other itemized deductions.
- Those facing a penalty for underpayment of estimated tax may be able to eliminate or reduce it by increasing their withholding.
- Self-employed individuals should consider setting up a self-employed retirement plan.
- 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 2006 to an unlimited number of individuals but you can't carry over unused exclusions from one year to the next.
- If you're thinking of donating a used auto to charity, you may want to inquire whether the charity plans to sell the car or use it in its charitable activities; the latter may yield a bigger deduction for you.
- If you are contemplating marriage or divorce consider how marriage penalties could affect you. Marriage penalty relief has been extended for the 15% tax bracket and the standard deduction but other marriage penalties remain.
- If you are receiving Social Security benefits, there are a number of steps you can take to reduce or eliminate tax on your benefits.
- Consider asking your employer to increase withholding of state and local taxes to pull the deduction of those taxes into this year (but only if doing so won't cause an AMT problem).
- Consider extending your subscriptions to professional journals, paying union or professional dues, enrolling in (and paying tuition for) job-related courses, etc., to bunch into 2006 miscellaneous itemized deductions subject to the 2%-of-AGI floor.
- Depending on your particular situation, you may also want to consider deferring a debt-cancellation event until 2007, electing to deduct investment interest against capital gains, and disposing of a passive activity to allow you to deduct suspended losses.
These are just some of the year-end steps that can be taken to save taxes. Again, by contacting us, we can tailor a particular plan that will work best for you.
Tax Relief and Health Care Act of 2006
As one of its last official acts, the 109th Congress recently passed the Tax Relief and Health Care Act of 2006, a wide-ranging measure that preserves a variety of popular tax breaks for families and businesses, and includes new tax breaks as well. The new law is almost overwhelming "good news" for taxpayers, particularly because it retroactively restores and extends key tax breaks that went off the books at the end of 2005. These include the election to deduct state and local general sales tax, the deductions for higher education expenses and for schoolteachers' books and supplies, and the research credit.
New Law Changes Affecting Individuals
- The tax deduction for qualified higher education expenses is restored for 2006 and extended through 2007. It allows individuals to deduct up to $4,000 (depending on their income) of higher education expenses instead of claiming the Hope or Lifetime Learning tax credits. The deduction is taken "above-the-line" (that is, it is subtracted to arrive at adjusted gross income), so it may be claimed by all individuals regardless of whether they itemize their deductions.
- The tax break allowing individual taxpayers to elect to take an itemized deduction for state and local general sales taxes instead of the itemized deduction permitted for state and local income taxes is restored for 2006 and extended through 2007. You have two options for determining deductible sales tax: (1) actual sales tax paid if receipts are maintained for IRS verification; or (2) approximate sales tax paid as estimated in tables provided by the IRS plus sales tax on certain additional items (such as a boat or car) that may be added to the table amount. The IRS said it will be issuing a separate publication carrying optional sales tax tables for the 2006 tax year; these tables will not be in the Form 1040 instructions.
- The tax break permitting elementary and secondary school teachers and certain other school professionals to deduct up to $250 of out-of-pocket costs incurred to purchase books, supplies and other classroom equipment is restored for 2006 and extended through 2007. This deduction is claimed "above the line."
- The 30% tax credit for the purchase of residential solar water heating, solar electric equipment and fuel cell property is extended through December 31, 2008. The maximum credit depends on the type of energy efficient property that you buy.
- The election to have excluded combat pay counted as income for purposes of calculating the earned income tax credit (EIC) is extended through 2007. This election could result in an otherwise eligible taxpayer claiming the EIC, a refundable credit, even if he or she doesn't have any other earned income.
- The tax break allowing first-time homebuyers in the District of Columbia to claim a tax credit of up to $5,000 on the purchase price of the home is restored for 2006 and extended through 2007.
- New contributions to Archer medical savings accounts (Archer MSAs) may be made through 2007. New contributions may be made after 2007 only by or for individuals who previously had Archer MSAs, and employees who are employed by a participating employer. Individuals may make tax-deductible contributions to an Archer MSA to pay for health care expenses. The distributions are tax-free if used to pay for eligible medical expenses.
- For the 2007 tax year only, thereÕs a new itemized deduction for the cost of premiums for mortgage insurance on a qualified residence. The deduction is phased-out for taxpayers whose adjusted gross income exceeds $100,000.
- After 2006, a limited relief provision helps individuals who wound up with AMT (alternative minimum tax) problems because of their exercise of incentive stock options. The relief provision, which is complex, allows individuals to take advantage of a refundable credit with respect to certain long-term unused alternative minimum tax (AMT) credits existing before January 1, 2013.
- The new law includes many changes for health savings accounts (HSAs), including: allowing one-time rollovers from health flexible spending accounts (FSAs) and health reimbursement arrangements (HRAs) into HSAs (after the enactment date of the new law and before 2012); repeal of the annual plan deductible limit on HSA contributions (after 2006); expanded contributions limit for part year coverage (after 2006); and allowing one-time rollovers from IRAs into HSAs (after 2006).
New Law Changes Affecting Businesses
- The research and development (R&D) credit is restored for 2006 and extended for 2007. In addition, for tax years ending after 2006, the new law enhances the credit by (1) increasing the rates of the alternative incremental credit and (2) creating a new alternative simplified credit that does not use gross receipts as a factor (so that newer businesses can access the credit).
- The work opportunity tax credit (WOTC), which is a credit for wages paid by employers who hire individuals from certain targeted groups, and the welfare-to-work tax credit, which is a credit for wages paid by employers who hire long-term family assistance recipients, are extended in their current form for workers hired in 2006 and combined and modified for those hired after 2006 and before 2008.
- The election to expense (currently deduct) environmental remediation costs associated with cleaning up certain hazardous sites is restored for 2006 and extended for 2007, and for post-2005 expenses, the definition of an eligible contaminated site is expanded to include sites contaminated by petroleum products.
- The accelerated writeoff for certain leasehold improvements and restaurant property (depreciation over 15 years instead of 39 years) is restored for 2006 and extended through 2007.
- The bonus 50% first-year depreciation break that was included in the Gulf Opportunity Zone Act of 2005 is modified by extending the placed-in-service deadline for certain property used in certain highly damaged areas within the Gulf Opportunity Zone.
- The tax credit for builders of new energy efficient homes is extended through 2008. The credit applies to manufactured homes meeting a 30% energy reduction standard and other homes meeting a 50% standard.
- The deduction for energy efficient commercial buildings meeting a 50% energy reduction standard is extended through Dec. 31, 2008.
Please keep in mind that these are only the highlights of the most important changes in the new law.
If you would like to schedule a planning meeting or have questions please contact us.