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YEAR END TAX PLANNING AND PREPARATION FOR INDIVIDUALS - Tax Tips for 2007

Now is the best time to start thinking about your year-end tax planning. These tax strategies can be put into effect by the end of the year and some as late as when the tax return is due. Planning now will save you money and reduce your tax liability not only with your federal taxes but also with your state taxes. Here are tax tips that will help you accomplish your goal.

BASIC NUMBERS YOU NEED TO KNOW

Because many tax benefits are tied to or limited by adjusted gross income (AGI)—IRA deductions for example—a key aspect of tax planning is to estimate both your 2007 and 2008 AGI. Also when considering whether to accelerate or defer income or deductions you should be aware of the impact this action may have on your AGI and your ability to maximize itemized deductions that are tied to AGI. Your 2006 tax return and your 2007 pay stubs and other income- and deduction-related materials are a good starting point for estimating your AGI.

Another important number is your "tax bracket," i.e. the rate at which your last dollar of income is taxed. The tax rates for 2007 are 10% 15% 25% 28% 33% and 35%. Although tax brackets are indexed for inflation if your income increases faster than the inflation adjustment you may be pushed into a higher bracket. If so your potential benefit from any tax-saving opportunity is increased (as is the cost of overlooking that opportunity).

DEFERRING INCOME TO 2008

If you expect your AGI to be higher in 2007 than in 2008 or if you anticipate being in the same or a higher tax bracket in 2007, you may benefit by deferring income into 2008. Deferring income will be advantageous so long as the deferral does not bump your income to the next bracket. Deferring income could be disadvantageous if your deferred income is subject to §409A thus making the income includible in gross income and subject to a 20% additional tax. Some ways to defer income include:

Delay Billing: If you are self-employed, delay year-end billing to clients so that payments will not be received until 2008.

Interest and Dividends: Interest income earned on Treasury securities and bank certificates of deposit with maturities of one year or less is not includible in income until received. To defer interest income, consider buying short-term bonds or certificates that will not mature until next year. If you have control as to when dividends are paid, arrange to have them paid to you after the end of the year.

ACCELERATING INCOME INTO 2007

In limited circumstances you may benefit by accelerating income into 2007. For example you may anticipate being in a higher tax bracket in 2008 or perhaps you will need additional income in order to take advantage of an offsetting deduction or credit that will not be available to you in future tax years. Note however that accelerating income into 2007 will be disadvantageous if you expect to be in the same or lower tax bracket for 2008. In any event, before you decide to implement this strategy we should "crunch the numbers."

If accelerating income will be beneficial here are some ways to accomplish this: Accelerate Collection of Accounts Receivable: If you are self-employed and report income and expenses on a cash basis, issue bills and attempt collection before the end of 2007. Also see if some of your clients or customers might be willing to pay for January 2008 goods or services in advance. Any income received using these steps will shift income from 2008 to 2007.

Year-End Bonuses: If your employer generally pays year-end bonuses after the end of the current year ask to have your bonus paid to you before the beginning of 2008.

Retirement Plan Distributions: If you are over age 59 1/2 and you participate in an employer retirement plan or have an IRA, consider making any taxable withdrawals before 2008. You may also want to consider making a Roth IRA rollover distribution.

DEDUCTION PLANNING

Deduction timing is also an important element of year-end tax planning. Deduction planning is complex; however, due to factors such as AGI levels and filing status. If you are a cash-method taxpayer remember to keep the following in mind:

Deduction in Year Paid: An expense is only deductible in the year in which it is actually paid.

Payment by Check: Date checks before the end of the year and mail them before January 1 2008.

Promise to Pay: A promise to pay or providing a note does not permit you to deduct the expense. But you can take a deduction if you pay with money borrowed from a third party. Hence, if you pay by credit card in 2007, you can take the deduction even though you won't pay your credit card bill until 2008.

AGI Limits: The AGI limits on itemized deductions affect deduction planning. Normally overall itemized deductions are reduced by 3% of the AGI exceeding $156 400 ($78 200 if married filing separately). However for 2007, the reduction is itself reduced to two-thirds of what it otherwise would be. For 2008, the reduction is reduced by only one-third of what it otherwise would be thus allowing for more deductions than in 2007. Similarly certain deductions may be claimed only if they exceed a percentage of AGI: 7.5% for medical expenses 2% for miscellaneous itemized deductions and 10% for casualty losses.

Standard Deduction Planning: Deduction planning is also affected by the standard deduction. For 2007 returns, the standard deduction is $10,700 for married taxpayers filing jointly, $5,350 for single taxpayers, $7,850 for heads of households and $5,350 for married taxpayers filing separately. If your itemized deductions are relatively constant and are close to the standard deduction amount, you will obtain little or no benefit from itemizing your deductions each year. But simply taking the standard deduction each year means you lose the benefit of your itemized deductions. To maximize the benefits of both the standard deduction and itemized deductions consider adjusting the timing of your deductible expenses so that they are higher in one year and lower in the following year. You can do this by paying in 2007 deductible expenses such as mortgage interest (including for 2007 mortgage insurance premiums) due in January 2008.

Medical Expenses: Medical expenses including amounts paid as health insurance premiums are deductible only to the extent that they exceed 7.5% of AGI. Consider bunching medical expenses into years when your AGI is lower.

State Taxes: If you anticipate a state income tax liability for 2007 and plan to make an estimated payment, consider making the payment before the end of 2007. Note that in 2007 you can choose to deduct as an itemized deduction state and local sales taxes instead of state and local income taxes.

Charitable Contributions: Consider making your charitable contributions at the end of the year. This will give you use of the money during the year and simultaneously permit you to claim a deduction for that year. You can use a credit card to charge donations in 2007 even though you will not pay the bill until 2008. A mere pledge to make a donation is not deductible; however, unless it is paid by the end of the year. Note however for claimed donations of cars, boats, and airplanes of more than $500, the amount available as a deduction will significantly depend on what the charity does with the donated property not just the fair market value of the donated property. If the organization sells the property without any significant intervening use or material improvement to the property, the amount of the charitable contribution deduction cannot exceed the gross proceeds received from the sale.

To avoid capital gains you may want to consider giving appreciated property to charity. Individuals who are at least age 70 1/2 may exclude from gross income qualified charitable distributions of up to $100 000 per year from an IRA. Distributions from SEPs and SIMPLE accounts do not qualify. The distribution must be made directly by the IRA trustee to a public charity or to a private operating or flow-through foundation described in §170(b)(1)(F). Distributions to other types of private foundations to supporting organizations and to donor-advised funds are not eligible. The distribution qualifies for the income exclusion only to the extent that the distribution would have been includible in gross income but for this special treatment. Although no charitable contribution deduction is allowed for the distribution it is necessary that the entire amount of the distribution satisfy the requirements for a charitable contribution deduction without consideration of the percentage limitations. Thus, there can be no quid pro quo from the charity that would otherwise reduce the amount of the deduction. This exclusion is available only for distributions made before the end of 2007.

Additionally new restrictions on claiming charitable contributions that began in 2006 continue into 2007. These rules are the following: (1) no deduction is allowed for charitable contributions of clothing and household items if such items are not in good used condition or better; (2) the IRS may deny a deduction for any item with minimal monetary value; and (3) the restrictions in (1) and (2) do not apply to the contribution of any single clothing or household item for which a deduction of $500 or more is claimed if the taxpayer includes a qualified appraisal with his or her return. Effective January 1, 2007, charitable contributions of money regardless of the amount will be denied a deduction unless the donor maintains a cancelled check bank record or receipt from the donee organization showing the name of the donee organization and the date and amount of the contribution.

EDUCATION AND CHILD TAX BENEFITS

Child Tax Credit: A tax credit of $1,000 per qualifying child under the age of 17 is available on this year's return. The credit is phased out at a rate of $50 for each $1,000 (or fraction of $1,000) of modified AGI exceeding the following amounts: $110,000 for married filing jointly; $55,000 for married filing separately; and $75,000 for all other taxpayers. A portion of the credit may be refundable.

Credit for Adoption Expenses: For 2007, the adoption credit limitation is $11,390 of aggregate expenditures for each child except that the credit for an adoption of a child with special needs is deemed to be $11,390 regardless of the amount of expenses. The credit ratably phases out for taxpayers whose income is between $170,820 and $210,820 HOPE Credit and Lifetime Learning Credit: The maximum HOPE credit for 2007 is $1,650 (100% on the first $1,100 plus 50% of the next $1,100) for qualified tuition and fees paid on behalf of a student (i.e. the taxpayer the taxpayer's spouse or a dependent) who is enrolled on at least a half-time basis. The credit is available for only the first two years of the student's post-secondary education.

The Lifetime Learning credit maximum in 2007 is $2,000 (20% of qualified tuition and fees up to $10,000). A student need not be enrolled on at least a half-time basis so long as he or she is taking post-secondary classes to acquire or improve job skills. As with the HOPE credit eligible students include the taxpayer, the taxpayer's spouse or a dependent.

For 2007, both the HOPE credit and the Lifetime Learning credit are phased out at modified AGI levels between $94,000 and $114,000 for joint filers and between $47,000 and $57,000 for single taxpayers.

Coverdell Education Savings Account: For 2007, the aggregate annual contribution limit to a Coverdell education savings account is $2,000 per designated beneficiary of the account. This limit is phased out for individual contributors with modified AGI between $95,000 and $110,000 and joint filers with modified AGI between $190,000 and $220,000. The contributions to the account are nondeductible but the earnings grow tax-free.

Student Loan Interest: You may be eligible for an above-the-line deduction for student loan interest paid on any "qualified education loan." The maximum deduction is $2,500. The deduction for 2007 is phased out at a modified AGI level between $110,000 and $140,000 for joint filers and between $55,000 and $70,000 for individual taxpayers.

Rules are in effect to coordinate education provisions such as the qualified higher education expense deduction, the Hope and Lifetime Learning credits, Coverdell education savings accounts, and qualified tuition plans to prevent double benefits.

Kiddie Tax: 2007 is the last year that you can avoid the kiddie tax rules for your dependent children who are age 18 or over by year end. Beginning in 2008, the kiddie tax will apply to 18-year old children who have unearned income in excess of the threshold amount do not file a joint return and who have earned income if any that does not exceed one-half of the amount of the child's support. The tax also may apply to children between the ages of 19 and 23 and if in addition to the above rules they are full-time students. For 2007, the kiddie tax threshold amount is $1,700.

ENERGY INCENTIVES

Alternative Motor Vehicle Credit: For 2007, a credit is available for purchases of motor vehicles powered by certain alternative fuels. The dollar amount of the credit depends on fuel savings and weight of the vehicle. The most popular vehicles subject to the credit are hybrids. However, when a particular manufacturer sells in the United States its 60,000th of the particular hybrid a phaseout period kicks in. The phaseout will reduce the credit from fully available to nothing being available. The phaseout begins in the second calendar quarter following the calendar quarter where the manufacturer sold its 60,000th hybrid vehicle following December 31,2005. Credits are also available for lean-burn technology vehicles (subject to the same phaseout) qualified fuel cell motor vehicles and qualified alternative fuel motor vehicles. If you have an interest in purchasing a hybrid vehicle before the end of 2007, please be sure that you calculate correctly the allowable credit. The amount of the credit could affect your decision on which vehicle to purchase.

Residential Energy Efficient Property Credit: Tax incentives are available to taxpayers who install certain energy efficient property such as photovoltaic solar water heating or fuel cell property. In 2007 a credit is available for the expenditures incurred for such property up to a specific dollar limitation. The property purchased cannot be used to heat swimming pools or hot tubs. The credit is set to expire for property placed in service after 2008.

Nonbusiness Energy Property Credit: Tax incentives are available to taxpayers who remodel their home and/or incorporate specific energy efficient property. In 2007 a credit is allowed for the purchase of qualified energy efficiency improvements. Such property includes advanced main air circulating fans natural gas propane oil furnace or hot water boiler windows insulation material exterior doors etc. that meet certain energy efficiency standards. The credit is capped in dollar amounts per item of property. The credit is set to expire for property placed in service after 2007.

INVESTMENT PLANNING

The following rules apply for most capital assets in 2007:

Capital gains on property held one year or less are taxed at an individual's ordinary income tax rate.

Capital gains on property held for more than one year are taxed at a maximum rate of 15% (5% if an individual is in the 10% or 15% marginal tax bracket).

Review your capital gains and losses for the year including taxable investment accounts and taxable real estate sales. If you have net capital gains, you may want to sell some of your investments that have a loss to offset the gain. You should also check your 2006 tax return for any loss carry forwards to 2007.

Timing of Sales: You may want to time the sale of assets so as to have offsetting capital losses and gains. Capital losses may be fully deducted against capital gains and also may offset up to $3,000 of ordinary income ($1,500 for married filing separately). In general, when you take losses you must first match your long-term losses against your long-term gains and short-term losses against short-term gains. If there are any remaining losses you may use them to offset any remaining long-term or short-term gains or up to $3,000 (or $1,500) of ordinary income. When and whether to recognize such losses should be analyzed in light of the changes in the capital gains rates applicable to your specific investments.

Dividends: Qualifying dividends received in 2007 are subject to rates similar to the capital gains rates. Therefore qualifying dividends are taxed at a maximum rate of 15%. Qualifying dividends include dividends received from domestic and certain foreign corporations.

SALES TAX DEDUCTION

Taxpayers who itemize deductions can choose between claiming the state income tax or sales tax as a deduction. The IRS will provide optional tables for use in determining this sales tax deduction if tax payers do not keep their receipts throughout the year. Sales tax paid on motor vehicles and boats may be added to the table amount up to the general sales tax rate. This can really benefit the states that do not have individual income tax-Alaska, Florida, Nevada, New Hampshire, South Dakota, Texas, Washington and Wyoming.

EDUCATOR'S DEDUCTION

Eligible educators are permitted an "above-the-line" deduction up to $250 per year for non-reimbursed expenses incurred in connection with books, supplies, computer equipment and supplementary materials used in the classroom with an amount over the $250 deductible on Schedule A.

OPEN AN INDIVIDUAL RETIREMENT PLAN ACCOUNT (IRA)

See IRA and Retirement Savings Rules for an example of what you can do to defer income until retirement. You can open your 2007 IRA as late as April 15th of 2008. You may want to consider a Roth IRA. They are not tax deductible but also are not taxable when withdrawn at retirement.

GET ORGANIZED

Clients always ask me what I need in order to do their taxes. For 90% of the population, with a little organization, your tax preparation doesn't have to be overwhelming and can cost less if you submit organized documents to your tax professional. First, when you receive tax documents in the mail, have a folder ready to drop them in and forget about them until tax time. Most tax documents are required to be mailed by January 31st so you should have almost everything by the first week of February. If not, call to have them send a duplicate. Next, go through your check book, credit card statements and cash payouts for the basic deductible items. This would include your medical expenses including eye glasses, taxes paid, donations and any employer expenses that were not reimbursed. Don't forget day care expenses, student loan interest and tuition if any of those apply to you.

TAX PLANNING FOR YOUR BUSINESS

Go to YEAR END TAX PLANNING FOR BUSINESSES for what you can do to prepare your business for year end.

These are just some tax tips you should consider when thinking about your year-end tax planning.

This article was intended to provide general information about year-end tax planning. It does not contain all the rules and exceptions that may apply to your situation. If you have further questions regarding year-end tax planning, I can be reached at www.dgoodmancpa.com.

About the Author

Dianne Goodman, CPA, FCPA - Specializes in servicing Small Businesses and Individuals. Visit www.dgoodmancpa.com for relevant and current information on a variety of financial and tax issues focusing on small businesses and individuals or call at 1-888-851-1975.

CONTACT INFORMATION:

Dianne Goodman, CPA, FCPA
Comprehensive Small Business Solutions, PC
505 323-2307
1 888-851-1975 toll free
www.dgoodmancpa.com