The IRS has reversed its position (announced in January 2007) regarding non-spouse beneficiary rollovers. Effective for 2008, all plans MUST now offer non-spouse beneficiary rollovers. This change offers all beneficiaries of the “Inherited IRA” the ability to stretch the required distributions over the life expectancy of that individual. This change effectively eliminates the older rule that forced certain beneficiaries to take lump sum distributions or payouts over a much shorter period thus accelerating income taxes while losing the wonderful benefit of tax deferred investing.

There are a few tax provisions set to expire at the end of 2007. I honestly believe some of these will be extended beyond the end of 2007, but let’s not chance it. If any of these should apply to your situation, I would encourage you to consider them now. Set to expire are the following:

IRA Distribution to Charity. Up to $100,000 of current year minimum required distributions can be directed to your favorite charities and be excluded from current year income. This strategy usually provides the greatest benefit to taxpayers who don’t normally itemize their deductions and/or live in states that don’t take itemized deductions into consideration to arrive at state taxable income. “Expanded Details Follow”

Residential Energy Credit. If you are planning to make some qualifying energy efficiency improvements to your principal residence, doing so by the end of 2007 can provide you with tax credits that you will otherwise forfeit.

Tuition and Fees Deduction. I am aware that most full-time students and/or parents of full-time students s spend well in excess of the $4,000 maximum deduction for qualifying tuition cost in a given year, and there is no need to spend additional amounts prior to the end of the year. However, if you or your child is not a full-time student or is just enrolled for a few classes, review your situation to make sure you max out before the end of 2007.

Other expiring provisions:

Educator Deduction
State and Local Sales Tax Deduction
Mortgage Insurance Premiums

Transferring Assets to Roth IRAs Will Be Easier in 2008

In 2008, taxpayers who are making Roth conversions will now be able to roll over qualified plan assets directly to a Roth IRA account. Previously, those same qualified plan assets needed to be rolled over into a traditional IRA and then converted to the Roth IRA.

If you are currently making contributions to a qualified employer plan that has a Roth feature such as a Roth 401(k), Roth 403(b), etc., please take note. For tax years 2008 and 2009, you will not be eligible to roll over the Roth 401(k), Roth 403(b), etc. directly into a Roth IRA if your modified adjusted gross income is $100,000 or greater. Those individuals in this situation will have to wait until 2010 to qualify for the rollover when the $100,000 modified AGI restrictions no longer apply.

If you own an IRA and your current year tax deductions and/or business losses will exceed your taxable income items, please consider doing a Roth conversion. With proper planning, you can convert that taxable IRA into a tax-free Roth IRA without paying any income taxes. Even converting a portion of the IRA and paying a small tax at the lowest marginal tax rates may certainly prove to be a very wise tax decision over the long haul.

Roth IRA conversions have been a valuable tool for many of our clients in maximizing financial security for their families. While each case will benefit from an individualized analysis on the merits of the conversion, the critical feature of the Roth is that once the initial taxes are paid on the conversion, income taxes will never be due on the growth, capital gains, dividends, interest, etc.

Remember, to qualify for a Roth conversion, your modified adjusted gross income (MAGI) must be under $100,000; so many higher income taxpayers are prohibited from making them. Income from an owner’s minimum required distribution from an IRA is not considered part of this income, while minimum required distribution from a pension plan is. This presents a multi-year planning opportunity for retirees in order to qualify for a conversion. If you receive income from a retirement plan that causes your MAGI to be over $100,000, plan to roll-over your retirement plan into an IRA account before year end so that in the next year, the minimum distribution does not count as part of MAGI so you can do a conversion. If you currently cannot even make Roth IRA contributions because your income is over $160,000 for joint filers or $110,000 for a single filer, consider making nondeductible traditional IRA contributions now and convert them to Roth IRAs in 2010. If those are your only IRAs, you may pay much less in tax on the conversion since you will have basis equal to the amounts contributed.

The new TIPRA law will permit all taxpayers to make Roth conversions beginning in year 2010, regardless of their income level. For the family, the long-term benefit of a Roth IRA conversion is simply phenomenal. This will be of particular benefit to high-income taxpayers who have not had the opportunity to grow significant amount of funds tax-free in a Roth account. The high-income taxpayers are most likely to have the longest time horizon to grow the funds tax-free and may not have to pay a higher marginal tax rate on the conversion income.

At this time, Congress has not passed the 2007 AMT “patch” with inflation adjusted amount increase for the AMT exemption. Although any amount helps, most of you that paid AMT in 2006 will most likely pay it again in 2007.

Because of the complexities of the AMT tax calculation, traditional tax planning to minimize taxes can backfire when you are subject to AMT. For example, if you are subject to AMT at all, paying additional state and local income taxes or non-reimbursed employee business expenses prior to year-end will waste these itemized deductions.

By the way, did the auto salesman who sold you that Hybrid auto and the tax credits that went with the car ask you if you are subject to AMT? Unfortunately, if you paid AMT you won’t get any tax credit for that Hybrid you purchased.

Taxpayers in higher income tax brackets commonly use tax-exempt bonds. Generally you have to accept a lower rate of interest in comparison with a comparable bond that pays taxable interest. If your tax bracket is high enough, however, the tax savings can more than make up for the lower earnings. Unfortunately, some bonds are exempt under the regular income tax but not under the AMT. These bonds generally fall under a category called private activity bonds. State or local governments issue them, but instead of funding something purely public, like roads and public schools, they provide funding for private enterprises. If you don't pay AMT, these bonds can be a good deal. They pay a slightly higher rate of interest to make up for their treatment under the AMT. That treatment doesn't matter if you don't pay AMT, so it's nice to have the higher yield. The increase in yield is minimal, though. It's nowhere near substantial enough to make up for the added tax cost if you end up paying AMT on the interest. Our advice is that anyone who pays AMT should stay away from private activity bonds. When investing in an exempt bond, check the prospectus to make sure it qualifies for exemption under the AMT as well as the regular income tax.

Due to the passing of the Small Business and Work Opportunity Tax Act of 2007, the kiddie tax rules will apply to certain children ages 18 or age 19 through 23 if that child is a full-time student. If your child will be subject to the rules next year, you still have one last opportunity to avoid the negative impact of the kiddie tax. Investment income recognized by these children in 2007 is not subject to the kiddie tax. Therefore, any long-term gains will be taxed at the child’s 5% capital gain rate versus the 15% rate that will apply in 2008 when the child’s parents’ rate will apply.

For example, a child age 19 has a custodial account (UGMA) with appreciated mutual fund assets that a parent may have established some time ago. If you wait until 2008 to sell the fund to pay for some of the college expenses, you will be paying a 15% long-term capital gains tax rate rather than 5% if you sell the shares before the end of 2007. For every $1,000 of gain, you will save $l00 in taxes. Always assess the impact this extra income might have on other areas, such as the amount of financial aid the student might stand to lose by recognizing additional income in 2007.

With recent tax law changes that are eliminating lower tax rates on child’s investment income, other college-saving avenues such as Section 529 plans are becoming increasingly popular. Come see us to discuss 529 Plans and other college planning strategies.

The Small Business and Work Opportunity Tax Act of 2007 increased the maximum dollar amount eligible for Section 179 expense to $125, 000 if certain other provisions are met. These rules allow taxpayers to reduce income taxes by fully expensing purchases of qualifying assets used in business (such as computers and other equipment) in the year of purchase. Multi-year plans can be made with knowledge that acquisitions 2-3 years from now can still use the higher deduction limits.

By reviewing your current year marginal rates and projecting next year rates, you can make sound decisions on whether to make a purchase before the end of this year or delay it into the next year.

If you are over age 70½, you can make a qualified charitable distribution directly from your IRA to the charity of your choice (subject to some restrictions). This provision applies to IRAs only and not qualified plans. The money transferred from the IRA does not count as income. You don’t get a charitable deduction, but for many taxpayers, this is a good trade. A key provision of this new law is that the IRA amount donated in this fashion counts toward your required minimum distribution (RMD). Also, if you have basis in your IRA, the donated part comes only out of the taxable part and does not diminish your basis. This may set you up for a more favorable Roth IRA conversion in future years since less of the conversion would be taxable. This provision is currently set to expire at the end of 2007, so you may want to make your contributions before year end.

Although on the surface, it may appear that reducing your income and your charitable deduction by the same amount should have no impact on you. It can save you money in many ways, such as:

If you use the standard deduction and make charitable contributions, this new rule is a windfall. Instead of contributing your after-tax funds, you can use pre-tax IRA funds and have no taxable income from the IRA.

If you take only the minimum distribution, you can reduce your adjusted gross income by the amount of the direct IRA donation because the direct IRA donation counts toward the RMD, and you only include as income the additional withdrawal needed to cover the RMD. There are several other potential tax advantages of lowering your adjusted gross income, even if you itemize deductions, such as lowering phase-outs of deductions and income limitations.

If you are in a somewhat lower income situation, less than the full 85% of your social security income is taxable. By lowering your income, less of your social security income is taxable.

If you donate large amounts to charity, you may find another potential tax advantage of donating your IRA directly to charity. You can only deduct up to 50% of your AGI amount to charity, and if the contribution is large enough, using this method will circumvent this limitation altogether.

Another potential advantage for lowering your AGI is that you may then qualify for Roth IRA contributions. If you have taken your RMD for the year, using the IRA to prevent a further increase in your AGI may also allow you to qualify for a Roth IRA conversion.

Please note that lowering your income using this method will not work if you have already withdrawn your RMD. If that is the case, and you itemize deductions, you may be better off donating after-tax funds like cash or appreciated securities.

The PPA also made a significant number of rule changes on the requirements of charities and individuals claiming non-cash contributions. Among other things, the IRS now will only allow donations of clothing and household items in “good used condition or better.” Although the IRS cannot define exactly what that means, it is an indication that they are cracking down on excessive write-offs. In order to better document your contributions, we suggest keeping a detailed list of what was donated, with values of individual items and original costs, if known. Taking a picture of donated items is also suggested.

For money denominated contributions, the IRS now requires a cancelled check or credit card statement as backup in addition to the letter from charities if the amount is over $250. Cash contributions that do not have this backup are no longer deductible. Therefore, we suggest using checks for all contributions instead of actual cash.

The PPA has also made permanent the laws allowing higher contributions to your retirement plans and the catch-up contributions for individuals over age 50. In 2007, individuals can contribute $15,500 per year ($20,500 per year if age 50 and older) to their retirement plans. If you have not, now is the time to review your 2007 year-to-date retirement plan contribution opportunities. In many instances, your employer plan will allow you to make changes for the remainder of 2007 to contribute more if you have not maximized your 2007 contributions to your desired level. These limits remain unchanged for tax year 2008. These elective deferrals can be made on a pre-tax basis or, if your employer offers them, through the new Roth 401(k) and 403(b) plans (see below).

Contributions to elective deferral retirement plans and self-employed retirement plans will reduce your adjusted gross income. See the partial list of tax deductions and tax credits above that are directly affected by adjusted gross income.

As most of you know, we are advocates of using Roth IRAs when possible, to take advantage of the tax-free growth of the account. The one drawback of a Roth IRA for many of our clients is the income limit to qualify for Roth IRA contributions. Well, that statement is old news since all taxpayers whose employers offer Roth 401(k) or Roth 403(b) plans are now eligible to make Roth 401(k) or 403(b) contributions to these plans regardless of income.

The differences between a Roth 401(k) and a traditional 401(k) are that with the Roth 401(k), you use after-tax dollars to fund your elective contributions and that the Roth 401(k) grows income tax free. For example, if your salary is $100,000, and you contribute $10,000 to your existing 401(k) or 403(b), you must pay taxes on $90,000 of wages. Keep in mind though that when you eventually withdraw those retirement funds, you will be taxed on the $10,000 in the retirement plan plus all the accumulated investment earnings. What happens if you contribute the same $10,000 to the Roth 401(k) or Roth 403(b)? Your taxable wages will be $100,000 for 2007, thus increasing your current year tax liability. The advantage, however, is that the Roth 401(k) and 403(b) will grow income tax free for your life, your spouse’s life, and the lives of your beneficiaries.

Most people are likely to have accumulated the bulk of their retirement plan nest egg in fully taxable retirement plans such as 401(k)s and 403(b)s. Thus most of their withdrawals at retirement will be fully taxable. Having some of your retirement money in a Roth account provides a way of diversifying your tax exposure by giving you some flexibility in deciding which account to withdraw from to be most tax efficient. Though every case is different, in general, we prefer the Roth 401(k) to a traditional 401(k).

Younger people who are currently in lower tax brackets should always consider funding a Roth account. Running the numbers will prove this to be a long-term winning decision.

Hybrid Vehicle Credits Available

Beginning in 2006, there are tax credits available for purchases of Alternative Technology Vehicles, the most common of which are the hybrid vehicles that use both gas and electricity to propel the vehicle. These credits reduce federal tax bills on a dollar-for-dollar basis and replace the clean-fuel vehicle deduction allowed in prior years. Unlike many tax credits in the Internal Revenue Code, these energy tax credits are not phased out for higher-income individuals.

Caution is needed in quantifying the benefits, however, for two reasons. One is that the apparent benefit may be offset by AMT. The other is that the full credit is only available until the end of the first calendar quarter after the quarter in which the manufacturer records its sale of the 60,000th vehicle. The two quarters thereafter, you only get 50% of the full credit. The two quarters after that, you only get 25% of the full credit and after that, nothing.

Energy-Efficiency Credits Available

A tax credit is also available for the purchase of energy-efficient improvement to existing homes located in the United States. Qualifying items include insulation, windows, doors, furnaces, and hot water heaters. A qualifying purchase will be mainly based on manufacturer certifications in the materials that come with their products. The credit is based on a percentage of the cost of the qualifying item. For example, you will take 10% of the cost of qualifying windows up to a maximum credit of $200. There is a maximum lifetime credit of $500 for all of the qualifying purchases mentioned above.

Many taxpayers have some ability to reduce or increase their adjusted gross income. Projecting your current year adjusted gross income and taking steps before year-end to lower this amount can result in reducing your overall tax liability by thousands of dollars. Reducing your adjusted gross income helps preserve certain tax breaks you may otherwise lose and helps to avoid additional taxable income. Some examples include:

• Deductions for higher education expenses and student loan interest.
• Child tax credits for qualifying children.
• Hope and Lifetime learning education credits.
• Personal exemption amounts for you and your family.
• Avoiding phase-out of itemized deductions.
• Losses from certain rental real estate activities.
• The ability to make a deductible IRA or Roth IRA contribution or a Roth conversion.
• Reduced overall taxability of social security benefits
• Various other tax credits.

If you delay taking your first required minimum distribution during the year you turn age 70½ (which is permissible), you will be required to take two minimum distributions during the following year. Although this is a good strategy for delaying taxes if all other factors are equal, lower income taxpayers may discover that taking two distributions in the same year pushes them into a higher tax bracket, or even worse, increases the taxable amount of their social security benefits. For higher income taxpayers, the delaying process may be more prudent.

Analyze your situation to see which strategy benefits you the most. For help in determining how much your minimum distributions are, please see our Minimum Distribution Calculator on our web site, http://paytaxeslater.com/calculator/index.htm.

Many readers will have capital loss carry-forwards to use in 2007 and possibly beyond. Using losses to reduce taxable gains by offsetting the losses against the gains is referred to as “tax-loss harvesting or tax-loss selling.” Now is the time to review your investment portfolio and make some decisions that will generate tax savings.

It is required for income tax purposes to match your short-term gains with short-term losses and your long-term gains with long-term losses. You should always make sure that you never end up with short-term taxable gains by failing to sell securities that will create a loss to offset these short-term gains prior to year-end. Any remaining short-term gains are taxed at ordinary income rates that are as high as 35% in 2007. It may not always be the best decision to recognize losses in the current year. For example, let’s say you have a net long-term gain that is going to be taxed at 15% and you also have unrecognized long-term losses in your portfolio. You are advised to sell the stock and offset the long-term gain with the loss and pay no income taxes. What if you knew prior to the end of the year that in January of the following year, you were about to recognize a nice short-term profit on a stock? By harvesting those losses in the same year as taking the short-term gain, you may save income taxes of up to 20%. If you do have excess losses in any tax year, you can deduct up to $3,000 of losses against ordinary income. That adds up to an $840 tax savings for an individual who is in a 28% tax bracket. However, you must be careful to avoid a “wash sale,” that is buying the same security within 30 days of the time you sell the shares—the tax rules will disallow the loss.

Many investors fail to maximize the benefits by specific lot selling. Keeping track of your stock purchases at lot levels (instead of the First-In, First-Out default method) allows for greater control when instructing your broker to sell shares.

Harvesting your investment losses can reduce your capital gain income to zero. It’s a great way to increase the after-tax rate-of-return on your portfolio without the risks of active trading. In combination with a good asset allocation and reallocation strategy, you can add value to your investment portfolio without increasing your investment risk.

Contributions to qualified tuition programs (as defined in Section 529) are deductible from taxable income. A separate deduction up to $12,000 for each beneficiary (the annual gift tax exclusion limit) is available to all such plans, including plans offered by other states. As the funds grow and when the funds are used for qualified higher education expenses, they are not taxable. If subsequent distributions are not used for qualified higher education expenses, they will be taxed.

HSA and MSA accounts will be taxed for Pennsylvania purposes following federal rules. Allowable contributions will be deductible from income and any distributions not used for qualified medical expenses will be taxable as interest income.

There are several new Pennsylvania income tax rules that favorably impact businesses including:

• Pennsylvania Subchapter S status will be automatic if the business elects Sub-S for federal purposes.
• Beginning in 2007, the capital stock and franchise tax is lowered to 3.89 mills and is lowered by a mill each year thereafter until it is phased out in 2011.
• Beginning in 2007, the capital stock and franchise tax fixed formula deduction will increase from $125,000 to $150,000.
• Small businesses may receive a research and development tax credit equal to 20% of the qualified research and development expense for credits awarded after June 30, 2007.

Make or Increase IRA and Self-Employed Retirement Plan Contributions: Business owners can reduce AGI by increasing contributions to pre-existing retirement plans or establishing new plans such as 401(k) plans, SIMPLE pension plans, SEPs, Keogh plans, or regular (deductible) IRAs. Most self-employed retirement plans allow for deductions in tax year 2007 even for contributions which are made after year-end but before the extended due date for filing the return. In other words, payment of 2007 deductible retirement plan contributions can be postponed until October 15, 2008, with an automatic extension. But remember, there is no extension of time for making IRA contributions. The deadline is April 15, 2008.

Maximize Loss Situations: If you are experiencing an unusual tax year where you may be in a much lower tax bracket than usual or even in jeopardy of wasting itemized deductions and personal exemptions, careful tax planning can be more crucial than ever. Make sure you project your taxable income before the end of the year and examine all of your alternatives. There may be steps you can take to avoid wasting deductions so your taxes can be lowered in future years.

Enroll in a Cafeteria or Flexible Spending Plan: Be sure to take advantage of employer provided Cafeteria or Flexible Spending Plans. This strategy allows you to pay for medical, child-care and other qualified expenses with pre-tax dollars. Medical expenses are rarely fully deductible on Schedule A due to the 7.5% of AGI limitation. Medical costs paid for through your company’s cafeteria plan will allow you to fully deduct your medical expenses from your taxable W-2 federal and social security wages. The key here is to make a good estimate of your projected qualified expenses for the year. If you set aside more pre-tax dollars than you will be able to claim, the unused portion is forfeited subject to the IRS rule described further below. But, don’t let the forfeiture risk deter you from participating, just be a little more conservative in your estimate. If you are currently enrolled in a program, review your outstanding balance, and if necessary, schedule a dentist, doctor, optometrist, chiropractor, etc. appointment before December 31st.

The IRS previously extended the deadline by which participants in an Internal Revenue Code Section 125 cafeteria plan must incur medical expenses to receive reimbursement under the plan. Contributions that cannot be applied to expenses incurred by 2 ½ months after the calendar year end are forfeited under the IRS “use it or lose it” rule. For example, a participant in a calendar year plan may pay for medical expenses incurred by March 15, 2008 and expenses submitted by April 30, 2008 with health care flexible spending account contributions made in 2007.

Take Advantage of Pre-Tax Parking Breaks: If your employer offers pre-tax dollars to be used for parking, mass transit or van pools, take advantage of the tax savings. Many individuals are not afforded the luxury of being able to deduct personal parking costs. Using this fringe as a component of employee compensation can create tax savings for both parties.

Preserve the Student Loan Interest Deduction: If you have college-age children, consider obtaining student college loans in the student’s name instead of your name. Deferring the payment of student loan interest until after graduation may preserve the deduction for payment of interest on student loans. Most college grads start out with salaries that would allow a full deduction for the interest paid. Conversely, if the loan is in your name, there is a higher possibility that the interest would be non-deductible. You can always make monetary gifts to help repay the loan interest.

Make a Roth IRA Contribution: If you qualify, making an annual $4,000 Roth IRA contribution for 2007 (up to $5,000 if you are over the age of 50 by the end of 2007) both for you and your spouse will help you accumulate tax-free wealth. You have until April 15, 2008 to fund a 2007 Roth IRA.

Donate Appreciated Stock Instead of Cash to your Favorite Charity: If you hold appreciated publicly traded stock for more than one year, you can donate the stock and get a charitable deduction for the full market value of the stock and avoid paying any capital gains tax. You must give the stock directly to the charity. The opposite is true for stocks that have gone down in value. Never donate stocks that have declined in value, but rather sell the stock at a loss and donate the cash to charity.

Self-Employed Individuals Should Consider Employing their Child(ren): Employing your child (age permitting) offers great tax-saving opportunities. Assuming your child has no unearned income, you could pay your child wages up to $5,350 in 2007, and the child would not have to pay any federal income taxes. The next $7,825 would be subject to a 10% tax rate. If your marginal income tax bracket was 28%, the $13,175 wage deduction would generate $2,906 in federal income tax savings. Furthermore, when you employ a child under 18-years-old, neither the employer nor the employee is subject to social security tax on the child’s wages. The wages your child earns will qualify as earned income for the purpose of establishing a Roth IRA. A Roth IRA will provide your child with an exceptional opportunity to accumulate money with tax-free growth.

Self-Employed Individuals with No Employees Should Consider Employing Their Spouse: A self-employed individual may be able to deduct all of his or her health insurance premiums and medical expenses by setting up a medical reimbursement plan with his/her spouse as the only employee of his/her business. Self-employment taxes could then be saved on all the deductions under the medical reimbursement plan. But make sure it’s legitimate--your spouse must become a bona fide employee of your business. Theoretically, that means your spouse will be working under your control. (Good luck.)

We hope you found this information helpful in planning your year-end tax savings strategies. Please don’t hesitate to come see us if you have specific questions or want to discuss your investment portfolio, estate plan or college savings plan. If you want personal attention for income tax planning, I urge you to schedule to meet with whoever prepares your tax return. If you are not currently an income tax preparation client and are considering using our firm for tax preparation, I would recommend setting up a meeting with one of our preparers before year-end. Call us if you have questions or need assistance establishing or updating your wills or trusts, converting to a Roth IRA, or securing adequate life insurance. We are here to help with all of your financial planning needs.

I wish you and your family a joyful holiday season and a healthy, prosperous new year.

Warmest personal regards,

James Lange
Certified Public Accountant
Attorney at Law

P.S. If you need to see either me or your tax preparer, please don’t put it off. Simply call our receptionist, Alice Davis, at 412-521-2732. Alice will be happy to schedule an appointment for you.

Disclaimer: Material provided is general in nature and does not, nor is it intended as a rendering of formal legal advice. Reading of this document does not establish an attorney/client relationship. James Lange Law Offices is not responsible for the results obtained from using the contents, nor any errors or omissions. Do not act upon information contained herein without a thorough evaluation of the facts relating to your specific circumstances. Any tax advice included in this written or electronic communication was not intended or written to be used, and it cannot be used by the taxpayer, for the purpose of avoiding any penalties that may be imposed on the taxpayer by any governmental taxing authority or agency. Readers should consult with professionals from James Lange & Associates or James Lange Law Offices or other legal, tax or financial advisors.