Year End Tax Considerations

CONGRESSIONAL ACTIVITY

On November 12, 2007, the House passed the Temporary Tax Relief Bill of 2007 (HR 3996). This legislation would prevent an increase in the number of individuals subject to AMT to approximately 24 million. For 2006, approximately 4 million individuals were subject to AMT. The bill would increase the AMT exemption amount to $66,250 for taxpayers filing joint returns and to $44,350 for single taxpayers for 2007. The bill would also continue to allow non-refundable credits to offset AMT as well as regular tax. In addition, HR 3996 contains several other important provisions including an extension of more than 25 income tax provisions scheduled to expire at the end of 2007 and a provision eliminating debt forgiveness income upon home foreclosures where the debt forgiven is home acquisition debt. The Senate is scheduled to take up HR 3996 this week.

I am also following energy legislation currently before Congress. As mentioned in Fax No. 163, the renewable Energy and Energy Conservation Tax Act of 2007 cleared the House Ways and Means Committee on June 29, 2007. A provision in this legislation would treat SUVs as luxury autos. Under the legislation, SUVs (unless they have a GVW of more than 14,000 lbs) would have the same "luxury auto" depreciation limitations that currently apply to cars that have a GVW of 6,000 lbs or less (e.g. $3,060 for 2007). Pickup trucks and other vehicles weighing over 6,000 lbs that are currently exempt from the $25,000 limit on 179 depreciation as well as certain "special use" vehicles would not be subject to these new limitations. The proposed effective date of this change is for vehicles placed-in-service after 2007. Because of this proposal, clients thinking of buying a new business SUV during 2008 may wish to consider purchasing the SUV and placing it in service before 2008 in case this legislation becomes law.

I will continue to monitor these legislative proposals and keep you informed!

YEAR END PLANNING

The following are a few items that I feel deserve special attention as we near the end of 2007.

1. Estimated Taxes. If an individual client has failed to pay sufficient estimated taxes during 2007 and is facing a penalty for such under payments, withholding from a year-end bonus, a distribution from an IRA, etc., may solve the problem. Any income tax withholding (including withholdings at the end of 2007) is deemed paid 1/4 on April 17, 2007, June 15, 2007, September 15, 2007 and January 17, 2008. Therefore, amounts withheld on or before December 31, 2007 may reduce or eliminate a penalty for underpaying estimated taxes.

2. Converting Regular IRA To Roth. If a client has little or no taxable income for 2007, we may be able to save the client taxes in the long-run by converting a regular IRA or a portion of a regular IRA to a Roth. We should definitely consider converting amounts from a traditional IRA into a Roth IRA to the extent the amount required to be included in income from the conversion does not increase the client's Federal or State tax liability. This strategy, in essence, converts taxable retirement income into tax-free retirement income. The amount converted from a regular IRA to a Roth IRA is included in taxable income for the year of the conversion. Therefore, if we want the conversion amount included in income for 2007, we must transfer the amount from the regular IRA to the Roth IRA no later than December 31, 2007. Caution! We cannot convert a regular IRA or a portion of a regular IRA to a Roth if the client's modified AGI exceeds $100,000 (excluding the income from the conversion and any IRA distribution required because the client has reached age 70).

3. Planning For IRA Distributions. If a client reaches age 70 at any time during 2007, he or she must begin distributions from a traditional IRA account no later than April 1, 2008. A 50% penalty applies to the excess of the required minimum distribution over the amount actually distributed. If the client waits until 2008 to make the first distribution, then two distributions must be made for 2008 (one by April 1, 2008 for the 2007 year and one by December 31, 2008 for the 2008 year). Therefore, tax projections should be made for these clients for 2007 and 2008 in order to determine whether we should defer the required distribution for 2007 until 2008 or make the 2007 distribution in 2007.

In addition, if a client over age 70 dies during 2007, the sole beneficiary of the client's IRA or qualified plan is the surviving spouse, and the surviving spouse is over age 59, we should consider rolling the decedent's qualified plan amount or IRA amount into an IRA in the surviving spouse's name before 2008. If the decedent's retirement account is rolled into an IRA in the surviving spouse's name before 2008, then 1) if the surviving spouse is not at least age 70, no distributions are required in 2008 and 2) if the surviving spouse is at least 70, the required minimum distribution in 2008 will be determined using the Uniform Lifetime Distribution Table rather than the surviving spouse's single life expectancy. Therefore, converting the account into the surviving spouse's name on or before December 31, 2007, will substantially reduce the amount of the required minimum distribution for 2008 where the decedent was at least 70. Caution! In situations where the surviving spouse is not yet 59, we should probably leave the IRA or qualified plan amount in the name of the decedent if distributions are to be made to the spouse before age 59. For example, if we transfer the account into the spouse's name in 2007, and the spouse receives a distribution in 2008, the spouse will generally be subject to the 10% early distribution penalty unless the spouse is at least age 59 when the distribution is made or the distributions are determined using the surviving spouse's life expectancy.

4. Income Deferral By Non-Spouse Beneficiaries Of Retirement Plans. If a non-spouse beneficiary of a decedent's retirement plan, where the plan requires distributions to the beneficiary under the 5-year rule, wishes to make distributions over the beneficiary's life expectancy, the beneficiary should have the plan trustee transfer the decedent's account balance directly (using a trustee-to-trustee transfer) into an IRA for the benefit of the non-spouse beneficiary before the end of the year following the year of the decedent's death. In addition, IRS says the IRA must be established in a manner that identifies it as an IRA with respect to a deceased individual and also identifies the deceased individual and the beneficiary, for example, "Tom Smith as beneficiary of John Smith." Therefore, where the participant in a qualified plan died in 2006, the plan provides for a 5-year payout, and the beneficiary of the participant's account is a "non-spouse beneficiary", the IRA should be properly established and the trustee-to-trustee transfer from the plan to the IRA should be made during 2007 if the non-spouse beneficiary does not wish to take distributions under the 5-year rule.

5. Consider Selling ISO Stock Before 2008. If a client has exercised an incentive stock option during 2007, the difference in the value of the stock on the date of exercise and the amount paid for the stock is taxable for AMT purposes (but not for regular tax purposes). If the value of the stock has declined substantially since the date of exercise, the exercise of the ISO could create a large AMT tax bill even if the value of the stock has plummeted after the exercise. However, it may be possible to eliminate or reduce the AMT liability by selling the stock on or before December 31, 2007. Therefore, we should meet with the client to discuss the possibility of selling the stock before 2008. If the stock is sold before 2008 (i.e., sold in the same year the ISO was exercised), the AMT income from the exercise of the option cannot exceed the actual income from the sale. Caution! For this strategy to eliminate the AMT liability resulting from the exercise of the option, the client may not "buy back" the stock within the period beginning 30 days before the sale and ending 30 days after the sale. In addition, if we sell the stock received upon the exercise of the ISO in 2007, any gain will be ordinary income and the capital gain benefits are lost.

6. Children At Least 18 May Need To Cash Out Investments. Beginning in 2008, many college age students will no longer be able to sell off their appreciated investment accounts set up by their parents to cover tuition and pay tax at the student's lower tax rates. These individuals should consider selling these assets in 2007 if the student is at least age 18 or consider taking out student loans until the year the student turns 24. However, the maximum tax on capital gains might rise from 15 to 20 percent after 2010, possibly adding a price tag to postponing income recognition. In addition, accumulating assets in a child's name or selling those assets may adversely affect a child's college financial aid awards. See The Tax Advisor, January, 2007, Page 48, The Expanded "Kiddie Tax" And The Financial Aid Trap for an examination of the effects of decisions concerning a child's assets upon the receipt of financial aid.

7. Tax-Free IRA Distributions To Charities For Those At Least 70. Individuals at least age 70 who do not itemize deductions or whose itemized deductions are reduced as AGI increases, should consider having the IRA trustee make their charitable contributions for 2007 directly from the IRA (up to the minimum required distributions for the year) and reduce the IRA owner's minimum required distributions by the same amounts. Note! The maximum charitable contributions that may be made directly from an IRA cannot exceed $100,000 for 2007. Charitable contributions may not be made directly from IRAs after 2007, unless Congress extends this rule. Caution! If the client does not reduce his or her minimum required distribution for 2007 by the amount of the charitable contribution, the client will receive no current tax benefit for the charitable contribution.

8. $500 Lifetime Energy-Savings Home Improvement Tax Credit. This $500 energy credit is scheduled to expire for property placed-in-service after 2007. Therefore, individuals who have not already qualified for the maximum credit may wish to make qualifying energy-saving expenditures before 2008.

9. Conservation Easements. The increased limitations for contributions of conservation easements by individuals, farmers, and ranchers are scheduled to expire for tax years beginning after 2007. Therefore, clients considering granting a conservation easement should consider granting the easement in 2007.

10. Establishing A New Retirement Plan For 2007. Calendar-year clients wishing to establish a qualified retirement plan for 2007 (e.g. a profit-sharing, 401(k), or defined benefit plan), must adopt the plan no later than December 31, 2007. An exception to this general rule applies to SEP plans. An SEP may be established by the due date of the tax return (including extensions). A SIMPLE plan must have been established no later than October 1, 2007.

11. S Corporation With Losses. If we expect losses for a calendar-year S corporation for 2007 or if we wish to pass through deductions (e.g. 179 depreciation), then we should make certain the owners have basis in the S Corp stock and/or basis in loans by the shareholders directly to the S corporation at the end of 2007. The basis in the stock and loans should at least equal the expected losses and deductions. Otherwise the losses and deductions will not be allowed for 2007.

12. Qualified Leasehold Improvements And Qualified Restaurant Property. The recovery period for qualified leasehold improvements and qualified restaurant property is scheduled to increase to 39 years for property placed-in-service after 2007. Therefore, in case Congress does not extend the current 15-year recovery period for qualified leasehold improvements and qualified restaurant property, qualifying property under construction should be placed-in-service before 2008 to qualify for the 15-year write off. Note! A certificate of occupancy for the building normally indicates the building is "in service."

13. S Corporation Charitable Contributions Of Long-Term Capital Gain Property. The rule providing that a contribution of long-term capital gain property to charity by an S corporation will result in a reduction of a shareholder's basis in the S corporation stock equal to a pro-rata share of the basis of the property (not the property's fair market value) is scheduled to expire for tax years beginning after 2007. Therefore, S corps planning such contributions should consider making them in their 2007 tax year.

14. Other Benefits Scheduled To Expire After 2007. Congress is currently considering extending several other income tax benefits scheduled to expire after 2007, such as the deduction for higher education tuition and fees, the deduction for state and local sales taxes, and the $250 deduction for teachers' expenses. However, Congressional action is uncertain. Therefore, just in case these items are not extended beyond 2007, clients should consider accelerating the payment of higher education tuition and fees, sales taxes, and teachers' expenses into 2007 if these items will produce significant tax benefits for 2007.

Circular 230 Disclaimer: Any tax advice contained in the body of this material was not intended or written to be used, and cannot be used, by the recipient for the purpose of 1) avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions, or 2) promoting, marketing, or recommending to another party any transaction or matter addressed herein.