Earl H. Cohen, Attorney at Law
Timely Tax Issues and Moves for 2008
Most of us have not yet filed our 2007 tax returns and yet now is the time to begin thinking about tax moves for 2008 as well as your 2007 filing. This includes minimizing taxes for the current year and considering moves that may have a positive long term effect on your tax bill and financial security.
As a matter of background, with the current tax reductions set to expire, Congress will likely be addressing income and estate taxes in the next fifteen months. Given the continued financial demands of the war in Iraq, the financial issues raised with Social Security and Medicare as well as the nation's infrastructure issues that must be addressed, taxes are likely to increase. In this article we will discuss some planning issues and opportunities that should be addressed with your tax advisors.
Capital Gains and Dividends-The Tax Act of 2003 reduced the rates on net long-term capital gains to 5% and 15%, respectively, for sales and exchanges on or after May 6, 2003 and originally through December 31, 2008. The lowest rate for 2008 is actually 0% and applies to long-term gain that would otherwise be taxed at an ordinary rate less than 25%. This applies to both regular tax and AMT. If you are holding appreciated assets that would qualify for long term capital gain treatment and your taxable income is below the top of the 15% ordinary income bracket you may be wise to sell in 2008. Immediately repurchasing the assets would increase the tax basis with no tax cost. Retirees need to be careful not to allow this planning to result in added tax on their Social Security benefits.
Kiddie Tax Changes-What has become known as the Kiddie Tax is the tax on the unearned income (interest, dividends, rents and capital gains) of those individuals under the age of 14. That income was taxed at the top marginal bracket of the parents of the child. It could be declared on the child's return or on the parents'. The Kiddie tax was intended, in part, to address income splitting within families seeking to push income into lower tax brackets. The Tax Increase Prevention and Reconciliation Act of 2006 (TIPRA) rose the age of application from 14 to 18 beginning in the 2006 tax year. The 2007 Small Business Act expanded the Kiddie Tax, effective in 2008, and thereafter, to reach two groups of individuals who have reached 18 before the end of the year: those that have not attained age 19 by the end of the tax year; and those who are full-time students at an educational organization during at least 5 months of the year and have not attained the age of 24. In addition, a child between 18-23 years of age must have earned income that does not exceed ½ of the amount of the individual's support for the year without taking into account scholarships. This may even affect children who are officially emancipated. Families who have children under 24 holding stock interests, partnership interests or limited liability company (LLC) membership interests in family businesses will be affected and need to work with their advisors to avoid unintended tax consequences. There are solutions including having children perform services that convert some of their unearned income to earned income and considering the use of 529 plans for education instead of gifting family business interests to younger children.
Tax Free IRA Transfers to Charity-The 2006 tax act made provision for direct transfers to charity from IRAs without taxation of the withdrawal and allowing the transfer to count towards your annual required distribution. The provision expired at the end of 2007. However, there is good reason to believe that the provision will be extended into 2008 and beyond. If you are over 72 years of age and considering a gift to charity this year this provision may be useful to you, we would recommend holding off until 4th quarter of 2008 before taking your required minimum distribution.
Amt Relief- Among the late tax changes enacted by Congress in 2007 was AMT relief for middle-income taxpayers. Provisions for AMT were originally enacted to make sure that wealthy individuals did not completely escape income tax; however, AMT has ended up applying to more middle-income taxpayers each year. This has resulted in part because the figures used to calculate AMT are not adjusted annually by inflation while other tax figures used for tax calculation are. The new law provides some relief for 2007 by increasing the maximum AMT exemption amount over its 2006 level by $3,700 for married taxpayers filing joint returns, and by $1,850 for unmarried individuals and married persons filing separately. However, after 2007, the maximum AMT exemption amount will drop to its 2000 level unless Congress provides another fix. Another provision in the new law provides AMT relief for those individuals claiming certain "nonrefundable" personal tax credits (such as the credit for dependent care and the Scholarship and Lifetime Learning credits). For 2007, these credits may offset an individual's regular tax and AMT. After 2007, unless Congress acts, these credits will be allowed only to the extent that an individual has regular income tax liability in excess of the tentative minimum tax, which has the effect of disallowing these credits against AMT. Discuss with your tax advisor how you may be affected by this change.
Tax Relief for Those Whose Home Mortgages Have Been Foreclosed-Congress also addressed the subprime lending crisis with late 2007 legislation to provide tax relief for homeowners whose mortgage was foreclosed and the debt deemed forgiven. Before passage of law, a homeowner would be taxed on the amount of forgiven mortgage debt in the case of a foreclosure of their mortgage or, in some cases, granting the lender a deed to the property in lieu of foreclosure. For example, before this law, an individual with a $100,000 mortgage whose lender foreclosed on the home and sold it for $80,000 would have had to report $20,000 of income from the forgiven debt if the borrower failed to pay the deficiency. The only way the borrower could escape the tax result would be proving he was insolvent or by filing bankruptcy. Under this newly enacted provision, a taxpayer does not have to pay federal income tax on up to $2 million of debt forgiven for a qualifying loan secured by a qualified principal residence (e.g., one to buy or renovate a residence). This change applies to debts that are discharged from January 1, 2007 through December 31, 2009. Keep in mind that this provision does not provide relief for foreclosures on secondary residences or property held for investment.
Homesale Exclusion Extended for a Surviving Spouse- Under prior law a qualifying taxpayer could exclude up to $250,000 ($500,000 for those filing a joint return) of gain from the sale or exchange of their principal residence. Married taxpayers filing jointly for the year of sale could exclude up to $500,000 of gain if: a. either spouse owned the home for at least 2 of the last 5 years before the sale; b. both spouses used the home as a principal residence for at least 2 of the last 5 years before the sale; and c. neither spouse is otherwise ineligible for the full exclusion. Before the change made in late 2007, the $500,000 exclusion was available only if a husband and wife filed a joint return for the year of sale. Thus, if the home was sold the next year after the year of a spouse's death, the surviving spouse could only get a maximum exclusion of $250,000. The new law provides relief for sales and exchanges after Dec. 31, 2007 by allowing a surviving spouse to qualify for the $500,000 exclusion if the sale occurs not later than 2 years after the spouse's death, provided the requirements for the $500,000 exclusion were met immediately before the spouse's death and the survivor has not remarried as of the date of the sale. This extension may necessitate careful planning for couples and their homestead in light of the expiration of the step up basis rules on December 31, 2009.
Taxation of Partners and Partnerships-Historically, the IRS has allowed spouses filing jointly to treat themselves as partners or as a single individual at their discretion. Thus, an LLC, usually taxed as a partnership when owned by 2 or more individuals, could be treated as a single member LLC and thus a disregarded entity with income declared on the Schedule C of their 1040 income tax return and no need to file a separate Partnership Return (Form 1065). But there was no real law on the subject. Now, spouses can elect to treat their business as a qualified joint venture and not as a partnership allowing each to declare their income as a sole proprietor. Taking advantage of this provision requires careful planning since the non tax issues, including liability, are extremely important.
Retirement Plans-Roth 401k plan provisions were enacted several years ago. Sponsors of 401k plans had to amend their plans to allow for the option. A Roth 401k plan operates like a Roth IRA. The contributions are not deductible, however, the earnings of the contributions are not taxable and withdrawals from the plan are not subject to income tax. Participants can elect what part of their contribution will be made pretax to the regular part of their 401k plan and what part of their contribution will be made post tax to the Roth 401k part of their plan. If you assume that income tax rates will increase in the future, it may be worthwhile to consider electing to contribute part of your 401k contribution on a post tax basis.
Self Employment Tax Issues for Participants in Disregarded Entities-A single member LLC or a qualified Sub S subsidiary are considered disregarded entities (DE) for tax purposes. Thus owners of a DE have been exempt from withholding for employment tax purposes. Beginning January 1, 2009 each DE will be responsible for withholding and the filing of employment returns and payment of employment taxes. This will likely be good for owners who will then be able to treat themselves as employees and not have to go through calculating and paying estimated taxes for earnings from their DE. Clients are advised to determine as soon as possible whether they will be subject to the new rules and begin reporting and withholding in 2008.
Estate Tax and the Need for Planning-In 2009 the Federal Estate Tax exemption will increase to $3.5 million for each person ($7 Million for a couple). This is far beyond the size of most estates. However, without careful planning for the proper use of the exemptions, many estates will needlessly pay Federal Estate Tax. There is still no indication that the Minnesota Estate Tax exemption will increase beyond the current $1 million. As with Federal Estate Tax, without careful planning, many estates will needlessly end up paying the state estate tax. The Plans for many other estates that will be well under the exemption limits in value need to be revised and simplified to avoid administrative issues.
As with all tax and legal issues it is important that you work carefully with your professional tax advisors before implementing any plan.
