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Tax Tips

Following please find some year-end tax planning items which can save you serious federal income tax dollars.

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Tax Articles

Tax Law Enacted to Spur U.S. Economy

The Economic Stimulus Package Act of 2008 is designed to boost the U.S. economy by providing tax rebates to individuals and tax incentives for businesses.

Recovery Rebates
To encourage spending that stimulates economic recovery, eligible individuals will begin receiving rebate checks sometime soon after the April 15 tax filing deadline. You can’t use the rebate to offset a balance due with your tax return, and extending your 2007 tax return will delay the refund.

The amount of the rebate will generally be either $600 ($1,200 if filing jointly) or the taxpayer’s 2007 income tax liability after credits, whichever is less. But even if that liability is less than $300 ($600 if filing jointly), the rebate will be $300 ($600 if filing jointly) — as long as the taxpayer has either:

In addition, the rebate for taxpayers with dependent children will be increased by $300 per qualifying child. A qualifying child must not have reached the age of 17 before the end of 2007 and must have a Social Security number.

However, the rebate begins to phase out for taxpayers with a 2007 adjusted gross income (AGI) of at least $75,000 ($150,000 for a joint return). Under the phaseout, the rebate is reduced by 5% of the amount by which a taxpayer’s AGI exceeds the applicable limit. So filers without qualifying children will receive no rebate if their AGI is $87,000 or more ($174,000 for joint filers). Remember, AGI is your income after certain adjustments, such as retirement plan contributions, but before personal exemptions and itemized deductions, such as mortgage interest, state and local taxes, and charitable contributions.

Other factors may also impact taxpayer eligibility. Here are some examples of how the rebates will work:

Example 1
Joe and Tanya file jointly and have a 2007 AGI of $125,000 and a 2007 net income tax liability of $10,000. They have two dependent children under age 17. They can expect a recovery rebate of $1,800.

Example 2
Suppose, instead, that Joe and Tanya’s 2007 AGI is $200,000. The $1,800 calculated amount is reduced (but not below zero) by 5% of the amount by which their AGI exceeds $150,000. Thus, once their AGI exceeds $186,000, they are completely phased out (5% of $36,000 is $1,800) and won’t get any recovery rebate.

Example 3
Tanya’s widowed mother is retired and has no income other than her Social Security of $12,000. She pays no income tax, but because her Social Security income is $3,000 or more and is therefore considered qualifying income, she is eligible for a recovery rebate of $300 even though her income tax liability is not at least $1.

Note that the recovery rebates, while based on your 2007 tax return, are technically an advance on your income tax liability for 2008. Thus, when filing their 2008 tax return in 2009, those who didn’t receive the maximum possible rebate because their income was too low or too high get a second chance based on the figures on their 2008 return. For example, if a single person had no tax liability in 2007 and therefore received only a $300 rebate, but he or she has a $1,000 tax liability on the 2008 tax return, that person would receive an additional $300 credit on the 2008 return. No one will be required to give back any rebate received.

Incentives for Business Investment
To spur additional investment, the act increases the Section 179 limit for initial year expensing to $250,000 (from $128,000). The Sec. 179 expensing election allows a current deduction for newly acquired assets that otherwise would have to be depreciated over a number of years. Because this tax break is designed to benefit primarily smaller businesses, the expensing election begins to phase out dollar for dollar when total asset acquisitions for the tax year exceed $800,000 (up from $510,000 before the act). The new higher limit applies for calendar year 2008 or a business’s fiscal year that begins in 2008. As in the past, a business can claim the expensing election currently only to offset its net income, not to reduce net income below zero.

Another depreciation-related provision offers a special allowance for certain property, generally if acquired this year. This is in addition to any such property that qualifies for Sec. 179 expensing. For eligible property, the special depreciation amount is equal to 50% of its adjusted basis. The following types of property are qualified for this special depreciation:

Because both the Sec. 179 limit increases and the 50% depreciation allowance can provide large 2008 deductions, you may want to consider making major asset purchases this year.

Temporary Loan Limit Increases for Fannie Mae, Freddie Mac and FHA
In response to the mortgage crisis, the act increases from $417,000 to $729,750 the dollar limit on loans that may be issued by the FHA and that Fannie Mae and Freddie Mac can purchase. This is designed to reduce predatory lending practices on borrowers seeking loans in excess of the current limits, often referred to as “jumbo mortgages.” The increases are in effect for loans made or approved for origination through the end of 2008, after which the previous loan limits will apply once again.

Please consult us to find out exactly how the Economic Stimulus Package Act of 2008 will affect your personal and business taxes in 2008.

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Questions & Answers with Marcia Geltman - By Marcia Geltman

Whether the receipt of non statutory stock options impacts on social security benefits?

Until an individual reaches full retirement age, earnings received may reduce social security benefits. For tax year 2008, earnings received in excess of $13,560 will reduce social security benefits by $1 dollar for every $2 dollars earned. The question, therefore, becomes what constitutes earnings. For this purpose, earnings are the payments received for services rendered. In calculating this amount earnings include gross wages before any payroll deductions for income tax, Social Security tax, dues, insurance, or other deductions by the employer. For a self employed individual all net earnings (reduced by any net losses) from self-employment are considered as earnings.

Sometimes an individual receives Special Payments. Special Payments are amounts received which relate to prior work performed (work not performed in the current tax year). Examples of Special Payments include bonuses, accumulated vacation or sick pay, severance pay, back pay, standby pay, sales commissions and retirement payments or deferred compensation relating to work performed in a previous year. Non-statutory stock options are a type of deferred payment and should not affect the social security benefits received. The Social Security Administration makes the final decision on Special Payment items, but it appears that these payments would qualify as Special Payments.

The Social Security Administration has an excellent publication entitled "How Work Affects Your Benefits," publication number 05-10069, which is available on  at: www.socialsecurity.gov/pubs/10069.html.

I live in NJ and work in NY. I file tax return as NJ resident and NY Non-resident. My question is if I need to report my income from interest in dividend to both states? What state is considered the source of income? Interest and dividend income is only reported in the state of residence.

The company I worked for was sold. My position was eliminated and I left collecting a rather large "non-compete" payment and then moved out of NJ. I did not work for the payment, and it was not taxed. I plan to file a 'non-resident' NJ return. How can I determine if that income is considered "earned income" or "un-earned income"? The Company has other facilities around the US, but their accounting dept. is in the main NJ office. The determinative factors as to whether the payment is subject to tax in NJ are found in the wording of the severance agreement. If the payments are for past services, they are taxable to NJ. If the payments are for future services, or in this case, future non services, the payments are not taxable to NJ.

My employer is based out of NY but I live and work in NJ. The company reported my wages to NY and withheld NY state disability. If I fill out a NY IT-203, I owe NY additional money. Can this be accurate despite that I never lived nor worked in NY? The wages are taxed in the state where they are earned. Whether the wages are earned in New Jersey or New York is based on circumstances. If the job requires you to work in New Jersey then the wages earned would be New Jersey wages. However, if you work in New Jersey for your own convenience, then the wages are presumed to be earned in New York, (where the employer is located). If the wages are earned in both New York and New Jersey then you need to allocate them between the two states. Since you are a New Jersey resident, all income is reported to New Jersey. The wages allocated to New York are then also reported a second time to New York. You would then claim a credit on your New Jersey return for taxes paid to New York. By doing this, you do not pay double tax on the same dollars.

Can you claim your child as a dependent in the year they graduate college and begin working? You can claim your child as a dependent even if they earn more than the allowable amount as long as they are under age 24 and are a full time student. A child is considered a full time student if they are in school for at leasti 5 months. Therefore, if graduation is before May 30th, you lose the exemption.

Is there still a deduction for tuition expense? The deduction for tuition expense was extended by congress at the last minute after the forms were printed. Therefore, although you can claim a deduction for tuition, assuming income levels are not exceeded, there is no line on the form to do so. The amount should be put on page 1 line 36 with a letter "T" to reflect Tuition expense.

Are tax rebates taxable? Only if you claimed a deduction for the real estate taxes paid in the year before. If you received a deduction, you need to report the income from the rebate.

Are all proceeds from an IRA account taxable? If you received a deduction for the amount you contributed to the IRA than all proceeds are taxable. However, when IRAs first came about, there was no deduction allowed. Returns of non deductible contributions are not taxable. In addition, New Jersey doesn't allow a deduction for IRA contributions. Therefore, the amount taxable to New Jersey may be less than the taxable amount reported for federal purposes. Unfortunately you need to have kept records of the non deductible contributions.

How are prior year pension contributions treated upon distribution from the plan? The federal government treats every dollar of distribution as coming from both contribution and earnings. In year one of receiving distributions, a percentage is calculated. The top of the fraction is the amount of total non deductible contributions over the years. The bottom of the fraction is the total expected return. A life expectancy table is needed for this. After this fraction is determined it is applied against all future distributions from the plan. New Jersey has a simpler rule. It is called the 3 year rule. If you will recover your contributions within 3 years, then nothing is taxable until your contribution is recovered. After that point everything is taxable. As a result the taxable pension may be different for federal and state purposes.

How is the basis of mutual funds determined? While the government requires you to either use the specific identification method or the "first in - first out" method for determining costs of stock sales, for mutual funds you are allowed to use an average cost. In recent years, many of the mutual funds have been kind enough to calculate this information for you.

Is there any portion of assisted living expenses which are deductible as medical expense? If there is a portion of the bill which can be identified as medical expense, it is deductible. The assisted living home should be able to provide a detailed breakdown of the charges.

Are Medigap premiums deductible? Yes. Part B of Medicare is also a deductible medical expense.

An individual called who always owes money to NJ but gets money back from the IRS. How do they correct this problem? There is a separate New Jersey W-4 form which can be completed in addition to the federal W-4 form. This will allow you to claim different exemptions for federal and state. Alternatively you can request a specific amount to be withheld in addition to the calculated amount per the withholding tables.

Are social security benefits taxable? Depending on other income a portion of the social security benefits may be taxable. A single individual with income exceeding $25,000, some amount of the social security will be subject to tax. The income includes both taxable and some non taxable income, such as municipal bonds. Therefore, even though municipal bonds are non taxable, they can increase your tax liability.

Does a tax refund have to be included in income if you received no benefit of it in the prior year due to Alternative Minimum Tax? No. However, you need to recalculate the prior year return with and without the tax deduction to see if any benefit was received.

What are the substantiation requirements for charitable contributions? For 2006 and prior, cancelled checks or receipts from the organization supporting the contribution are sufficient. Beginning in 2007, the IRS is tightening the substantiation requirements. All contributions need to be supported by a canceled check or cash receipt.

What tax benefits are there for having a child in college? There are several tax deductions as well as tax credits. The IRS has a wonderful publication available to explain these amounts (Pub 970). Go to the IRS website at www. IRS.gov or stop into the local IRS office in Parsippany.

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401k Distribution - By Marcia Geltman

Contributions made to a 401K plan prior to 1984 were not excluded from wages for New Jersey purposes. It follows then that the distribution of those amounts should not be included in income. Sounds easy, but it is not. There are two methods of excluding the non taxable distributions from income when received. The first method is called the 3 year rule. If the non deductible contributions (those made prior to 1984) will be returned within 3 years, then for New Jersey purposes, nothing is taxable until those amounts are returned. Everything is taxable after that. If the non deductible contributions will not be recovered within 3 years, then a second method applies. In this case New Jersey follows federal law. A portion of every dollar received represents a return of the non deductible contribution and a return of the taxable proceeds. The state provides a worksheet in order to calculate the percentage for each. The percentage is calculated in year 1 only and then remains the same for all subsequent 401k distributions. Just a note, the worksheet calculates a percentage based on a fraction. The top of the fraction is the non deductible contributions. The bottom of the fraction is the total expected return. This amount is based on life expectancy tables. Therefore, if you live longer than expected you will have excluded from income more than you actually paid. If you live less than expected you will have included in income part of your contribution. Not necessarily fair, but that is the tax law.

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2006 Tax Law Changes - By Marcia Geltman

The New Year brings new tax law changes. Here are a few of the more notable items:

If you hire construction contractors - Beginning in 2007 the State of New Jersey is requiring businesses paying construction contractors to withhold 7% income tax on work performed in the state. This rule does not apply, however, if the contractor is registered with the state. Therefore, it is important to verify that a contractor is registered before payments for services are made.

Per diem allowances - Employers often pay employees a fixed per diem allowance for travel overnight away from home. The IRS has set guidelines for standard per diem allowances. An employer who pays employees more than the IRS guideline is required to obtain substantiation from the employee. Beginning in 2007, if an employer fails to obtain substantiation from even one employee, all employee per diem allowances company wide will be taxable to the employees as additional compensation.

Excise Tax refund on telephone bills - Recent newspaper headlines touted the refund of federal excise taxes for individuals. Businesses and non profits also have the ability to claim the credit. However, the calculation is slightly more difficult. First, find the percentage of excise tax claimed on your April 2006 phone bill. Next find the percentage of excise tax claimed on your September 2006 phone bill. Subtract the calculated September amount from the calculated April amount. This represents the refundable federal excise tax percentage. (However, there is a cap of 2% for businesses with less than 250 employees and 1% for larger companies.) Multiply this percentage times the total telephone bills for the 41 month period from March 1, 2003 through July 31, 2006. This is the amount for which you can claim a refund. For individuals owning their own business and reporting the income on Schedule C, Schedule E (rental property), or Schedule F (farm income) of their personal income tax return, the credit can be calculated for each entity and claimed in addition to the safe harbor credit for individuals. (This additional credit for self employed individuals, however, is limited to businesses having more than $25,000 of gross receipts in 2006.) To claim the credit, the entity must file a claim using Form 8913.

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Changes in Charitable Contribution Rules - By Marcia Geltman

There appears to be a perception by the government that not all contributions claimed as an income tax deduction have actually been made. As a result, several years ago, the IRS began cracking down on some types of charitable contributions. Recent tax legislation has continued to focus on this area. Beginning in 2007 all cash contributions, including those made by check, must be supported by a bank record or written receipt from the charity. This will clearly impact on organizations receiving “out of pocket” cash donations. Not only is the IRS clamping down on cash contributions but on donations of clothing and household items as well. Beginning in 2007 non cash contributions can be claimed only in instances where the items donated are in reasonably good condition. The IRS has not defined "good condition" and clearly has a daunting task ahead in verifying charitable contributions based on these new laws.

It should be noted that the law does not change the current substantiation requirements. Receipts are still required for all non cash contributions. Acknowledgements must be made by the charities for gifts over $250 and appraisals are needed for all items over $5,000.

However, on the flip side, there are now opportunities for giving which didn’t exist in the past. For a limited time only, 2006 and 2007 individuals may choose to make contributions directly from their IRA (or Roth IRA) accounts. By doing so, the IRA distribution is not reported in income and the contribution deduction is not claimed. There are several advantages to making contributions in this manner.

First, for those individuals who do not itemize on their tax return, a tax benefit from making a charitable contribution can now be received. Prior to this new law change, under the same scenario, the IRA distribution would have been included in income without the ability to deduct the charitable contribution.

A second advantage is that there are many items on a tax return for which a deduction is subject to limitations based on adjusted gross income. Deductions for items such as medical expenses, miscellaneous deductions, and casualty losses are reduced as adjusted gross income increases. By not claiming the IRA distribution in income, the adjusted gross income amount is not affected.

An additional advantage relates to the way IRA distributions are taxed. When an IRA account consists of both taxable and non taxable amounts, the regulations require a pro rata allocation of every dollar distributed. For example, if the IRA account totals $100,000 of which $20,000 is non taxable and $80,000 is taxable, then for every dollar withdrawn from the account 20% is non taxable and 80% is taxable. The new rules regarding IRA distributions going to charities, allows for the amount distributed to be treated as coming from the fully taxable portion. Therefore, in the example above, if $80,000 was distributed to a charity, then the entire $20,000 remaining could be distributed as non taxable.

Note, however, that the new federal rules do not impact New Jersey tax law. Therefore, taxable IRA distributions remain taxable even if given to charities.

In order to qualify for these new charitable giving rules, the individual donor must be at least 70 ½. The maximum amount of IRA distributions allowed to be distributed is $100,000 and must come from qualified distributions. For IRA accounts, qualified distributions are those which would normally be taxable distributions. In addition, the transfer needs to be a direct transfer from the IRA account to the charity and the charity must be a public charity exempt under IRS Code Section 501(C)(3) (rather than a private foundation).

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Telephone Excise Tax Refund - By Marcia Geltman

A surprising windfall for all taxpayers resulted this year from the repeal of the federal excise tax on long distance phone charges. The repeal of the 3% federal excise tax was announced last May for all long distance charges billed from March 1, 2003 through July 31, 2006. (The tax was no longer charged after July 2006.) The resulting refunds total approximately $13 billion.

Individuals can claim the refund when filing the 2006 Federal income tax return. If you can’t imagine trying to find all of your old telephone bills, not to worry, the IRS is providing a solution. There will be a safe harbor range for the refund of $30 to $60, depending on the number of exemptions claimed on your 2006 tax return.

Corporations and other businesses will have a slightly more difficult calculation. The calculation is based on the percentage excise tax determined for a sample period multiplied times the total telephone bills for the 41 month period from March 1, 2003 through July 31, 2006. As a general rule of thumb, for most businesses the credit will be limited to 2% of the total phone bill. For individuals owning their own business and reporting the income on Schedule C, Schedule E (rental property), or Schedule F (farm income) of their personal income tax return, the credit can be calculated for each entity and claimed in addition to the safe harbor credit for individuals. This additional credit for self employed individuals, however, is limited to businesses having more than $25,000 of gross receipts in 2006. To claim the credit, other than the safe harbor credit discussed above, businesses must file a claim using Form 8913.

There still remains a federal excise tax on local telephone service. Keep your eyes open. There are several bills being introduced to eliminate this tax as well.

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Social Security Benefits may be Taxable - By Marcia Geltman

Social Security benefits may be taxable. Depending on an individual's income level, up to 85% of the social security benefits may be included in income. If a married couple has income from other sources (referred to as modified adjusted gross income) in excess of $32,000 then the taxation of the benefits begins. For single individuals the triggering income level from other sources drops to $25,000. For married couples filing separately there is no minimum income level and therefore a portion of social security benefits will always be included in income.

Income from other sources (modified adjusted gross income) is calculated by starting with items generally included in income on the tax return,(used in arriving at adjusted gross income) and then adding back tax exempt interest, non taxable amounts paid through employer adoption assistance programs, qualified tuitiion expense, interest on education loans, and foreign earned income exclusion. It is this amount that determines the amount of includible social security benefits.

Therefore, since the percentage of social security benefits subject to tax is based on income level, it is easy to understand that the more income one has the more social security benefits become taxable. Even if all of the investments are in tax exempt bonds, an increase in tax can occur as a result of the taxable social security calculation.

Unfortunately, there is no way of avoiding the taxation of social security benefits. To add to the pain, ponder this thought. Amounts paid into social security are not deductible. Yet the benefits when received are taxed. Seems that we end up paying tax twice on the same dollars.

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Ways to Avoid an Audit - By Marcia Geltman

Ways to Avoid an Audit - There is no guarantee against an audit. Not only is the federal government looking for money, but the states and local governments are struggling as well to meet budgets. Even when every item on a return is reported correctly, an audit can still result. This is due to random audit testing for statistical purposes. However, there are certainly things to focus on which will minimize the chances of an audit.

1. Be average. The IRS scans tax returns for reasonability. The reasonability test is based on the results of random tax audits and statistics gathered from prior year tax return filings. Should amounts on a tax return fall outside the reasonability area, the return may be manually reviewed to determine if an audit is warranted. An example would be a large charitable contribution compared to the amount of income earned. It is important to retain documents to support deductions claimed, especially if the amount is large. The statistics from the prior tax year can be found on the IRS website at www.IRS.Gov - Statistics of Income Bulletin

2. Attach an explanation of unusual items. The IRS insists that they do not want documents or receipts attached to returns. However, a short explanation of an unusual item might help prevent an auditor from pursuing the issue further.

3. Avoid high audit risk areas. Certain areas by their nature attract the eyes of the IRS. Examinations of business expenses by the IRS have historically resulted in more changes than other areas. Therefore, a return which includes business expenses may have a higher risk of being audited than other returns. Avoiding high risk areas is easier said than done. If you are entitled to claim the deductions you should do so. However, it is important to ensure that proper substantiation is maintained.

4. Avoid "See Saw" issues. There are often items on one return which impact another return. For example, alimony. If one spouse deducts alimony and the other spouse does not report the income, or reports a different amount, an audit is almost certain. Exemptions is another area. If an individual is claimed by two people, as is often the case when parents are separated and both are contributing to the child's support, the IRS will question both returns. For business returns, an example of a "See Saw" issue is a buy and sell agreement where one party may treat a payment as goodwill while the other treats it as a covenant not to compete. The tax treatment is different for each of these and the IRS is looking for consistency. It is important that both parties agree to the tax treatment before filing returns.

5. "Non tax" returns are not exempt from audit. Charitable organizations are required to file annual returns. Even though no tax is due (unless there is unrelated business income), the IRS may choose to audit these returns for compliance purposes. Is the charity functioning for the purpose for which they became exempt? Are disbursements appropriate? Often times these "non tax" returns are audited because information requested on the return has not been provided. Once a return is selected for audit, any items on the return can be examined. Therefore, it is important to make sure all questions are properly answered and no items left blank before the return is filed.

6. Avoid "Tax Shelter" items. If it is too good to be true, the IRS thinks so too. There are some very appealing investment tax shelters which are constantly being developed by creative investment counselors. They may be legal, but when the government is looking for ways to collect more taxes, these investment vehicles will be scrutinized very carefully.

7. Business Returns - Focus on the Balance Sheet - Make sure that the beginning balance sheet amounts tie in with the prior year ending balance sheet amounts. It is a simple task for the IRS to scan these two items and a miss match will almost certainly generate a question.

8. Ensure that S-Corporations pay salaries to shareholders. One way to avoid paying social security taxes is to not allocate any of the profits of an S-Corporation to officer's salaries when salaries would normally have been paid for the services provided. The IRS wants to make sure that social security taxes are paid when applicable and therefore, makes a point of verifying that a reasonable salary is paid to shareholders. This is an easy item for the IRS to scan and if they find no salary or a small salary deducted on the return an audit is more likely.

9. Focus further on the Balance Sheet - Unusual items would raise the eyebrows of an experienced IRS auditor. Examples are negative cash accounts, large shareholder loans, little or no inventory for a business which should normally maintain an inventory.

10. Be sure to keep proper documentation for items reported on the return. - If you are audited and the audit results in a no change, the chances of an audit in the subsequent year are slim, assuming the income and expense items are similar. Alternatively, an audit which resulted in changes will in most instances result in the expansion of the audit to the next year.

Remember audits may not always be bad. The purpose of an audit is to ascertain that the correct tax has been paid. Although most audits result in additional assessments, an audit can also result in a no change or a refund. The best way for that to happen is to keep documentation for all items reported.

Marcia Geltman CPA - Principal with Nisivoccia & Co LLP with 18 years of public experience specializing in Income Tax, and Estate and Gift Tax. Prior experience includes 15 years as a Revenue Agent with the Internal Revenue Service auditing business tax returns, and working as an IRS instructor and a member of the IRS Speaker's Panel.

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Tax Tips - By Marcia Geltman

I am often asked as to the best tax planning tip. My response is simple. Do a tax projection before the end of the year. It doesn't have to be anything fancy. Use the prior year as your guide. One of the main reasons for doing so is that some of the best tax planning techniques can be undermined by Alternative Minimum Tax (AMT). For example, you might be considering paying your state income tax in December rather than waiting until next year in order to get a current year deduction? It sounds like a good idea, but if you are subject to AMT you may actually be doing yourself a disservice.

AMT has become a real problem for too many people. The tax began in the 1960s. It was a time when wealthy individuals were investing in so called "tax shelters" and reducing their income tax liability to very low amounts. Congress decided to stop this abuse by instituting a minimum tax. This would be a small tax on shelter items, also known as tax preference items.

Here we are 45 years later and the tax still exists, with very few modifications. The so called "wealthy" people in the 60s earned over $100,000. Today in New Jersey, there are many more people with earnings in this range. Tax preference items, (items subject to the tax) include deductions such as accelerated depreciation, intangible drilling costs and state and local taxes. It is the state and local tax deduction that creates much of the problem for the average taxpayer. In New Jersey, where we have higher than average income levels, we pay more state income tax. In addition, our real estate taxes are fairly high and combined with the income tax; these two times often push individuals into an AMT situation. A list of tax preference items can be found on IRS Form 6251. The form can be obtained by going onto the IRS website at www.irs.gov.

As more and more congressmen fall under the curse of AMT, we are hearing about a push to eliminate the tax. Most recently, congress has agreed to revisit the issue next year with the hope of some change in 2007. Of course, the tax brings in significant dollars into the federal coffers and elimination of the tax may be tough. The best we can do this year is plan ahead. Do a tax projection. Make sure your best tax planning ideas are not undermined by the Alternative Minimum Tax.

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Sales Tax Deduction is Back - By Marcia Geltman

The headlines read: “Sales tax deduction is back”. “Oh no, say it’s not so!” the accountants cry. The picture of clients walking in with bags of sales tax receipts is too much to bear. But alas, it is true, well sort of. The new tax law allows for a sales tax deduction should you choose to claim one in lieu of a state income tax deduction. There are two options for calculating the sales tax deduction. You can base the deduction on actual receipts (the old shopping bag method), or you can base the deduction on IRS tables. Sales tax on major purchases, such as cars, can be added to the table amount. The tables have yet to be created and hopefully will be completed by this coming tax season.

The question is whether we really benefit from this change. In New Jersey, where we have a relatively high cost of living and a state tax based on our income, most individuals will be better served by claiming the income tax deduction. Then there are those individuals who claim a standard deduction on their tax return and wouldn’t benefit from either an income tax deduction or a sales tax deduction. Of course we can’t forget about the alternative minimum tax which essentially negates the tax deduction for large numbers of individuals. So who benefits from this tax change? The real beneficiaries are those in states without income taxes. There are seven such states including Alaska, Nevada, South Dakota, Washington, Wyoming, Florida and Texas. Did I say Florida and Texas? Now there is a topic for another article.

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Year End Tax Planning Tips - By Marcia Geltman

Goals when tax planning:

Prepare a tax projection - Need to know your tax bracket
Recognize when you may be subject to alternative minimum tax (26%, $58,000 exemption) The reduced capital gains tax and reduced tax rates can throw you into an AMT. Don't forget state and local taxes are considered to be a "tax shelter" item which benefits the wealthy and effect AMT calculation.

Ways to postpone income:

Ways to deduct more expenses:

The Jobs and Growth Tax Relief Reconciliation Act of 2003 reduced capital gains rates for sales after May 6, 2003. 20% to 15%, 10% to 5%, 5% to 0%. This is only temporary and will expire in 2009. These reduced rates don't apply to sales of collectables(28%) and business property which has been depreciated. (The depreciation recapture amount is taxed at 25%.)

Don't let taxes rule your life. First decide your goals and then let the tax system work to help you meet your goals. Make knowledgeable decisions and be happy.

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A Hidden Tax on Non-Taxable Investments? - By Marcia Geltman

Since the percentage of social security benefits taxed is based on total income, including non taxable income, some think this unfairly causes individuals to pay a higher tax as a result of non taxable investments.

There are many tax calculations which are based on total income received by the taxpayer. Total income, for most purposes, includes both taxable and tax exempt income. Perhaps the logic to these types of calculations is to assess tax on "wealthier" individuals and, logically, wealth is determined by the amount earned rather than amount taxed.

The taxability of social security will be the same whether or not an individual invests in taxable or tax exempt securities. Therefore, the impact on social security should not be a factor in determining where to invest money. There is a formula available to help compare the net return on taxable verses tax exempt securities.

The formula is “Taxable Interest Rate less (Taxable Interest Rate times Tax Bracket Rate) equals Tax Exempt Interest Rate. Example: 6% taxable interest rate less 1.8 (6% times 30% tax bracket) equals 4.2% tax exempt interest rate.  Therefore, a 6% taxable yield equals a 4.2% tax exempt yield.

However, with all this stated, I am not sure that understanding the logic behind a tax law helps to make paying taxes on April 15th any less painful.

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Can you claim a parent as a dependent? Will this cause a tax audit? - By Marcia Geltman

There are 5 tests which must be met in order to claim someone as a dependent on your tax return.

  1. The individual must be a either a member of your household or a relative
  2. The individual must be a citizen or resident of the United States, Canada or Mexico
  3. The individual can not file a joint return with someone else
  4. The individual can not earn more than $3,300 (in 2006) unless he or she is a full time student under the age of 24
  5. You must furnish over 50% of the support for that person

As always with tax law there are exceptions to these five tests. The Internal Revenue Service explains the tests in more detail in Publication 17 which can be requested free of charge from the IRS either through their website at www.IRS.gov or at a local IRS office.

Claiming an exemption for a qualified dependent should not trigger an audit. Attaching unrequired schedules is not recommended since all returns are processed through data entry into a computer system. It is however, important to keep the support records available for three years from the date the return was filed or April 15th which ever is later. That is the time allowed by law for the IRS to audit the return. Even though the chances of an audit are slim, keeping the information available is always good planning.

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A Kinder and Gentler IRS? - By Marcia Geltman

Is the Internal Revenue Service really "kinder and gentler" as they profess? One area much touted is the Offer in Compromise. This is where an individual has the option to make a cash offer for less than the total liability due. Sounds great, but here are the details.

The Internal Revenue Service will consider compromises of liability based only upon the following 4 grounds: doubt as to liability, doubt as to collectibility, if the collection of the full liability would create economic hardship, or if because of exceptional circumstances, collection is detrimental to voluntary tax compliance and an acceptance of the compromise will not undermine over all tax compliance. (The last two grounds were added in 1999 to reflect a “kinder and gentler” IRS.)

Assuming there is no doubt as to the liability owed, then the other 3 grounds must be explored. The second option is Doubt as to Collectibility. This exists when the taxpayer’s assets and income are less than the liability. Assets include the value of a car, home, retirement plan and other miscellaneous items. Therefore, unless the liability is significant, chances are doubt as to collectibility will not apply.

The third ground for compromise would exist if collection of the full amount would result in economic hardship. This exists if the payment would cause the individual to be unable to pay reasonable basic living expenses. An example would be an individual who because of a long term illness is unable to work and is therefore having trouble meeting basic housing and food costs.

The fourth ground for compromise exists when there is compelling public policy or equity considerations which provide a sufficient basis for the compromise. One example would be if the taxpayer received misinformation regarding the tax laws and the use of this information resulted in the tax liability.

In order to apply for an offer in compromise the application, Form 656, must be submitted along with the applicable Form 433-A or B. These are financial statements which will allow the IRS to evaluate the need for a compromise.

The current interest rate charged by the IRS is 7%. In addition, a failure to pay penalty of 1/2% per month can be assessed. Effectively this equals 13% per year. Therefore, a taxpayer’s liability is not a bad investment for the IRS. Even the “kinder and gentler” IRS may be reluctant to compromise on a liability unless the circumstances are overwhelming. Since the IRS has the ultimate authority to accept or reject an offer, it is no wonder the acceptance rate has historically been very low.

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New Changes to Section 529 Plans - By Marcia Geltman

I am one of those people who likes to read tax law. I am always searching through lots of not so hot topics to find something really special. I recently reviewed the new changes to Section 529 plans. These plans are now so hot that they sizzle.

A section 529 plan is a type of education savings plan. It has been primarily used as an estate tax planning tool because it allows one to remove up to $60,000 from their estate without any gift or estate tax implications. The money is placed in a state sponsored education savings plan. Almost every state has a plan and an individual can invest in any state’s plan and receive the benefits. When the money is withdrawn for qualified education expenses, the income which has been deferred since inception is taxed to the beneficiary. Therefore, not only is the money removed from the donor’s estate, the income is deferred and taxed to the beneficiary, who usually is in a lower tax bracket. One of the benefits of these plans is that the donor can change beneficiaries at any time. Therefore, if the account is set up for Suzy and Suzy chooses not to go to school, or for any other reason the donor chooses not to fund Suzy’s education, the donor can change the beneficiary. This allows the donor to retain control over the account without paying tax on the income. It should be noted that there are penalties if the money is withdrawn for other than education purposes. Section 529 plans were great.

Now they are fantastic. Here is what has changed. The income earned from these accounts is no longer deferred. The income is now non taxable for both federal and New Jersey State tax purposes. Another positive change, the law now allows for portability among plans, therefore if you are unhappy with a particular state’s plan, you can move the money into another plan. In addition, the new law allows private educational institutions to establish Section 529 plans. This makes for tough competition among plan sponsors and therefore provides the investors with greater investment opportunities. Just be aware that many of the large financial companies have affiliations with various state plans. Therefore, you may want to do some of your own homework in determining which plan is best for you. The internet offers ample information on the subject. When looking for ways to fund future education expenses Section 529 plans sizzle. Life is good.

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Hidden Taxes - By Doug Collins

There are numerous circumstances in life when we must consider the income tax consequences of our finances. Many financial transactions have a more significant tax consequence than just the gain or income multiplied by the marginal tax bracket. Tax planning must consider various “hidden taxes” that may affect the ultimate tax on any one or series of transactions. The tax brackets commonly used to project ordinary income are 15%, 28%, 36% and 39.6% while the capital gains rates are 10%, 20%, 25% and 28%.

Trying to use the correct tax brackets noted above may be difficult enough but what many taxpayers fail to incorporate in tax planning are the “phase outs.” “Phase outs” are gradual elimination of tax deductions, exemptions, credits or other tax benefits when a taxpayer’s adjusted gross income (or in certain cases modified adjusted gross income) rises above certain levels. When a taxpayer sees income rising he may be receiving less and less benefits from his current deductions and credits. Below are two examples that illustrate how hidden taxes can complicate an otherwise simple situation (all tax rates and brackets are based on 2000).

Example 1:

John Smith (married and one child) has a projected adjusted gross income of $80,000 and itemized deductions of $11,600. In 2000 his child starts attending college and John would like to take advantage of the Hope Scholarship tax credit after spending $20,000 on tuition. His projected income is as follows:

AGI (excluding capital gain) $80,000 
Itemized deductions (11,600)
Exemptions    (8,400)
            Taxable Income    60,000 
   
Tax 11,107 
Less: Education credit    (1,500)
            Net tax     9,607 

In order to pay the tuition John decides to sell a stock that yields a long-term capital gain of $20,000. He believes that the gain will cost him $4,000 in tax or 20%. A hidden tax on this transaction is the result of the phase out of the education credit with adjusted gross incomes between $80,000 and $100,000. With John’s AGI now at $100,000 he will not be able to avail himself of the education credit of $1,500. Thus the tax for the $20,000 gain is actually $5,500 or 27.5%. The hidden tax amounted to $1,500 or 7.5%.

(Note : under proposed regulations the taxpayer above could elect to forgo the credit and allow the child to use it in exchange for the parents not claiming the child as a dependent. Another tax planning technique might be to gift the stock to the child and have him or her sell it in order to pay the tuition. This may allow the 10% capital gain rate to be applied).

Example 2:

Jane Smith with a projected gross income of $75,000 started adoption proceedings for a child in 1999. In 2000 she finalized the adoption and would like to take advantage of the $5,000 adoption tax credit. Her projected taxes are as follows:

AGI $75,000 
Standard deduction (head of household) (6,450)
Exemptions     (5,600)
            Taxable Income     62,950 
   
Tax (head of household) 13,050
Less: Adoption credit     (5,000)
            Net tax      8,050 

In December of 2000 Jane’s employer pays an unexpected performance based bonus to Jane of $40,000. A quick look at Jane’s situation may lead to a tax increase of $11,571 or 29% (partially in 28% & 31% brackets). A hidden tax, however, is encountered due to the phase out of the adoption credit for taxpayers with AGI between $75,000 and $115,000. The true tax increase will be $16,571 or 41% of Jane’s bonus.

The above cases are just two examples of how a tax bracket tax may be increased dramatically for taxpayers in different situations. The IRS has many different phase out rules for taxpayers that can add to their tax burden. It is very important to provide all aspects of income and deductions as well as any other pertinent information to your tax preparer when doing income tax planning.

Remember many hidden taxes can be reduced or eliminated with proper planning prior to consummating taxable events or prior to the tax year ending. Once the tax year is closed taxpayer options are limited when trying to reduce the tax burden.

The new tax law just signed may affect the above phase outs over time but the immediate impact will be very little.

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Most Commonly Overlooked Deductions - By Marcia Geltman

There is always good news and bad news when you sell stock. If you sell it a gain, that's good news, but you have to pay taxes on the gain, that's bad news. If you sell stock at a loss, that's bad news, but you can claim up to $3,000 of losses on your current tax return, and that's good news. How do you change good news/bad news into all good news?  Try and have your gains equal your losses.  Now is the perfect time to evaluate your stock portfolio.  If you have sold stock at a loss during the year, now may be the time to sell some stock at a gain.  If on the other hand, you have sold appreciated stock during the year, now consider weeding out some of those loss stocks.  Just remember, when selling stocks at a loss, no deduction can be claimed if you buy the stock back within 30 days.

The tax laws just seem to get more and more complicated each year.  Even the professionals have a hard time keeping track of all of the deductions.  Here are some really neat ones that might just work for you.

Do you own your own business?  If so, consider these ideas.  Purchase any long needed business assets by December 31st.  The IRS allows you to treat the asset as if you purchased it on July 1st and therefore half a year's depreciation can be deducted.  You can even charge the cost and pay for it next year.  Just remember to place the asset in service by December 31st.

Hire your children to work for you.  You can pay them a reasonable salary, then open up an IRA or Roth account for them.  They can contribute to their IRA account up to $4,000 ($5,000 age 50 and over.)  If it is a regular IRA account, the contribution deduction offsets their income.  Either way, you get the deduction for salary and your child begins a retirement plan.

While we are on the subject of children, don't forget the interest expense paid on college loans.  This interest is deductible in arriving at adjusted gross income and therefore, you are not required to itemize your deductions in order to reap the benefit.   Just remember that the interest has to be on a loan used for qualified education expenses by someone who can be claimed as your dependent at the time the debt was incurred.  Also be aware that there is a phase out of the benefit if your income is higher than $40,000.

If you have heard about the education credits, such as the Hope and Lifetime learning credits, you probably also heard that many of us do not qualify for the credits because of income limitations. The IRS now allows the child to claim themselves as a dependent on their own return in lieu of the parents claiming the dependency exemption on the parent's return.  By doing so, the child can now benefit from the credits previously lost on the parents' returns. Just make sure that the benefit of claiming the credits to the child exceeds the cost of not claiming the exemption to the parents.

One more great idea. The IRS requires you to pay taxes as you earn the income. This is usually done through payroll withholding or through estimated tax payments. If the estimated tax payments are not made in the period where the income was earned the IRS assesses a penalty for underpayment of estimated taxes. If you find yourself in that position, consider increasing your tax withholding from your final wage payment. The IRS treats payroll withholding as if it was withheld equally throughout the year. Therefore, you may be able to minimize or even eliminate any potential penalties.

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Top Tax Tips - By Marcia Geltman

  1. Prepare a tax projection before the end of the year You can't make any good decisions until you know the facts.
  2. Make charitable contributions by December 31 A good idea would be to donate appreciated assets, like stock, rather than cash in order to avoid paying tax on the capital gains from the sale of the stock.
  3. Pay state and local taxes, such as real estate taxes Generally this is a good idea; however, in certain circumstances you may not benefit from the deduction in one year due to Alternative Minimum Tax rules and may want to wait until next year to pay the taxes.
  4. Don't invest in mutual funds until after the end of the year Mutual funds report the gains to the investors of the funds as of December 31st whether or not they were the investors when the dividends were issued.
  5. Evaluate your portfolio Try and offset gains on stock sales with stock losses.
  6. Buy business assets at year end The law allows you to treat the assets as if purchased on July 1st even if you buy them on December 31st. You can even charge the cost on your charge card. Just remember to place the asset in use by the end of the year.
  7. If you underpaid estimated taxes during the year, adjust for it through withholding, in order to avoid underpayment penalty
  8. Open a pension plan Most plans require you to establish the account by the end of the year, although funding usually isn't required until the return is filed. Exceptions to this rule include IRA accounts, Roth IRA accounts and Simplified Employee Plans. You have until the filing date of your return to open and fund these types of accounts.
  9. Make gifts to friends and relatives If you are trying to reduce the value of your estate, an easy way to do so is through gifting. $12,000 per year per donee, per donor is allowed. Therefore, a married couple with two children could gift up to $48,000 per year. By gifting amounts prior to December 31st, you can gift another $12,000 per person next year.
  10. Calculate the balance in your flexible spending account The law requires you to use it or lose it.
  11. Don't let taxes rule your life First decide your goals then let the tax system work to help you meet the goals. There are always decisions to be made. Just make sure you know the implications before making the decisions. The best plan is one you feel comfortable with after making a knowledgeable decision.

Good luck and happy filing!

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Nisivoccia and Company Nisivoccia & Company LLP
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