Matthew Accounting, PLLC

No matter what the season or your unique circumstances, when it comes to your taxes, planning usually pays off in a lower tax bill. The following is provided so that you may have a basic understanding of taxes before you discuss filing options and strategies.

• Filing Status - Except for a surviving spouse, or married individuals who have lived apart for the entire year, your filing status depends on your marital status at the end of the tax year. Generally, if you are married at the end of the tax year, you have three possible filing status options: Married Filing Jointly, Married Filing Separate, or if you qualify, Head of Household. If you were unmarried at the end of the year, you would file as Single status, unless you qualify for the more beneficial Head of Household status.
  
  Head of Household is the most complicated filing status to qualify for and is frequently overlooked as well as incorrectly claimed. Generally, the taxpayer must be unmarried AND:
  
  • Pay more than one half of the cost of maintaining as his or her home a household which is the principal place of abode for more than one half the year of a qualifying child, or an individual for whom the taxpayer may claim a dependency exemption, or
  
  • Pay more than half the cost of maintaining a separate household that was the main home for a dependent parent for the entire year.
  
  A married taxpayer may be considered unmarried for the purpose of qualifying for the Head of Household status if the spouses were separated for at least the last six months of the year, provided the taxpayer maintained a home for a dependent child for over half the year.
  
  Surviving Spouse is a rarely used status for taxpayers whose spouse died in one of the prior two years and who has a dependent child at home. The joint rates are used, but no exemption is claimed for the deceased spouse. In the year the spouse passed away, the surviving spouse would file jointly with the deceased spouse if not remarried by the end of the year.
  
  
• Adjusted Gross Income (AGI) - AGI is the acronym for Adjusted Gross Income. AGI is generally the sum of a taxpayer's income less specific subtractions called adjustments (but before the standard or itemized deductions and exemptions). Many tax benefits and allowances, such as credits, deductions, exemptions, etc., are limited by a taxpayer's AGI.
  
  
• Taxable Income - Taxable income is your AGI less deductions (either standard or itemized) and your exemptions. Your taxable income is what your regular tax is based upon using either the IRS tax tables or the rate schedule.
  
  
• Marginal Tax Rate - Not all of your income is taxed at the same rate. The amount equal to the sum of your deductions and exemptions is not taxed at all. The next increment is taxed at 10%, then 15%, etc., until you reach the maximum tax rate. When you hear people discussing tax bracket, they are referring to the marginal tax rate. Knowing your marginal rate is important, because any increase or decrease in your taxable income will affect your tax at the marginal rate. For example, suppose your
  marginal rate is 25% and you are able to reduce your income $1,000 by contributing to a deductible retirement plan. You would save $250 in Federal tax ($1,000 x 25%). Your marginal tax bracket depends upon your filing status and taxable income. Find your marginal tax rate using the table below.
  
  When using this table, keep in mind that the marginal rates are step functions and that the taxable incomes shown in the filing status column are the top value for that marginal rate range.
  
  

  2007 MARGINAL TAX RATES
  TAXABLE INCOME BY FILING STATUS
  Marginal Tax Rate	Single	Head of Household	Joint*	Married Filing Separately
  10.0%	7,825	11,200	15,650	7,825
  15.0%	31,850	42,650	63,700	31,850
  25.0%	77,100	110,100	128,500	64,250
  28.0%	160,850	178,350	195,850	97,925
  33.0%	349,700	349,700	349,700	174,850
  35.0%	Over 349,700			Over 174,850

  * Also used by taxpayers filing as Surviving Spouse
  
  
  
• Taxpayer & Dependent Exemptions - You are allowed to claim a personal exemption for yourself, your spouse (if filing jointly) and each individual who qualifies as your dependent. The amount you are allowed to deduct is adjusted for inflation annually; the amount for 2007 is $3,400. However, these deductible amounts phase out for individuals with higher incomes. The exemption amounts are reduced by 2% for each $2,500, or part of $2,500 ($1,250 for married filing separately), that the taxpayer's AGI exceeds the amount shown in the table below for the taxpayer's filing status. If the AGI exceeds the amount shown by more than $122,500 ($61,250 if Married Filing Separately), the amount allowed for exemptions is reduced to zero. Use the table below to determine if your exemption deduction will be limited or eliminated.
  
  

  PERSONAL EXEMPTION PHASE OUT
  	PHASE-OUT INCOME (AGI)
  FILING STATUS	THRESHOLD	TOTAL PHASE OUT
  Single	$156,400	$278,900
  Head of Household	$195,500	$318,000
  Married Filing Jointly	$234,600	$357,100
  Married Filing Separately	$112,300	$173,550

  
  Dependents - To qualify as your dependent, an individual must be the taxpayer’s qualified child or pass all five dependency qualifications: (1) Member of the Household or Relationship Test, (2) Gross Income Test, (3) Joint Return Test, (4) Citizenship or Residency Test, and (5) Support Test. The gross income test limits the amount a dependent can make if he or she is over 18 and does not qualify for an exception for certain full-time students. The support test generally requires that you pay over half of the dependent’s support, although there are special rules for divorced parents and situations where several individuals together provide over half of the support.
  
  Qualified Child - A qualified child is one that meets the following three tests:
  
  (1) Has the same principal place of abode as the taxpayer for more than half of the tax year except for temporary absences.
  
  (2) Is the taxpayer's son, daughter, stepson, stepdaughter, brother, sister, stepbrother, stepsister, or a descendant of any such individual.
  
  (3) The child must be under age 19 or under age 24 in the case of a full-time student.
  
  
• Deductions - Taxpayers can choose between itemizing their deductions or using the standard deduction. The standard deductions, which are inflation adjusted annually, are illustrated below for 2007.
  
  

  Filing Status	Standard Deduction
  Single	$5,350
  Head of Household	$7,850
  Married Filing Jointly	$10,700
  Married Filing Separately	$5,350

  
  
  The standard deduction is increased by multiples of $1,300 for unmarried taxpayers who are over age 64 and/or blind. For married taxpayers, the additional amount is $1,050. Those with large deductible expenses can itemize their deductions in lieu of claiming the standard deduction.
  
  Itemized deductions include:
  
  (1) Medical expenses (limited to those that exceed 71/2% of your AGI for the year);
  
  (2) Taxes consisting primarily of real property taxes, state income tax and personal property taxes;
  
  (3) Interest on qualified home debt and investments; the latter is limited to net investment income (i.e. the interest cannot exceed your investment income after deducting investment expenses);
  
  (4) Charitable contributions are generally limited to 50% of your AGI, but in certain circumstances the limit can be as little as 20% or 30% of AGI,
  
  (5) Miscellaneous employee business expenses and investment expenses, but only to the extent that they exceed 2% of your AGI;
  
  (6) Casualty losses in excess of 10% of your AGI; and
  
  (7) Gambling losses to the extent of gambling income, and certain other rarely encountered deductions.
  
  For higher-income taxpayers, the itemized deductions are reduced by the smaller of 3% of the amount by which the AGI exceeds $156,400 ($78,200 if married filing separately), or 80% of itemized deductions that are affected by the limit, which generally include taxes, home mortgage interest, charitable contributions, investment expenses and employee business expenses.
  
  
• Alternative Minimum Tax (AMT) - The Alternative Minimum Tax is another way of being taxed that taxpayers frequently overlook. An increasing number of taxpayers are being hit with AMT. The Alternative Minimum Tax (AMT) is a tax that was originally intended to ensure that wealthier taxpayers with large write-offs and tax-sheltered investments paid at least a minimum tax. However, unlike the regular tax computation, the AMT is not adjusted for inflation, and years of inflation have driven everyone’s income up to the point where more taxpayers are being affected by the AMT. Your tax must be computed by the regular method and by the alternative method. The tax that is higher must be paid. The following are some of the more frequently encountered factors and differences that contribute to making the AMT greater than the regular tax.
  
  - Personal and dependent exemptions - are not allowed for the AMT. Therefore, separated or divorced parents should be careful not to claim the exemption if they are subject to the AMT and instead allow the other parent to claim the exemption. This strategy can also be applied to taxpayers who are claiming an exemption under a multiple support agreement.
  
  - The standard deduction – is not allowed for the AMT and a person subject to the AMT cannot itemize for AMT purposes unless they also itemize for regular tax purposes. Therefore, it is important to make every effort to itemize if subject to the AMT.
  
  - Itemized deductions:
  Medical deductions – only allowed in excess of 10% of AGI (71/2% normally).
  Taxes – are not allowed at all for the AMT.
  Interest – Home equity debt interest and interest on debt for non-conventional homes such as motor homes and boats are not allowed as AMT deductions.
  Miscellaneous deductions subject to the 2% of AGI reduction are not allowed against the AMT.
  
  - Nontaxable interest from Private Activity Bonds – is tax-free for regular tax purposes but taxable for the AMT.
  
  - Statutory Stock Options (Incentive Stock Options) when exercised produce no income for regular tax purposes. However, the bargain element (difference between grant price and exercise price) is income for AMT purposes in the year the option is exercised.
  
  - Depletion Allowance – in excess of a taxpayer’s basis in the property is not allowed for AMT purposes.
  
  For years 2001 through 2006, the exemption amounts were temporarily increased. However, without further intervention by Congress, the 2007 exemption rates will revert to the 2000 levels.
  
  

  AMT EXEMPTION PHASE OUT
  Filing Status	Exemption Amount	Income Where Exemption Is Totally Phased Out
  Married Filing Jointly	$45,000	$330,000
  Married Filing Separate	$22,500	$165,000
  Unmarried	$33,750	$247,500

  
  
  

  AMT TAX RATES
  AMT Taxable Income	Tax Rate
  0 – $175,000 (1)	26%
  Over $175,000 (1)	28%

  
  (1) $87,500 for married taxpayers filing separately
  
  Your tax will be the higher of the tax computed the regular way or the Alternative Minimum Tax. Anticipating when the AMT will affect you is difficult, because it is usually the result of a combination of circumstances. In addition to those items listed above, watch out for transactions involving limited partnerships, depreciation and business tax credits only allowed against the regular tax. All of these can strongly impact your bottom line tax and raise a question of possible AMT. Tax Tip: If you were subject to the AMT in the prior year and had a state tax refund in that year, part or all of your state income tax refund from that year may not be includable in the regular tax computation. To the extent you received no tax benefit from the state tax deduction because of the AMT, that portion of the refund is not includable in the subsequent year’s income.
  
  
• Tax Credits - Once your tax is computed, tax credits can reduce the tax further. Credits are divided into two categories: those that are nonrefundable and can only offset the tax, and those that are refundable. In addition, some credits are not deductible against the AMT, and some credits, when not fully used in a specific tax year, can carry over to the succeeding years. Although most credits are a result of some action taken by the taxpayer, there are two commonly encountered credits that are based simply on the number of your dependents or your income.
  
  
  Child Tax Credit - Under provisions of the 2004 tax-cut extension bill, the child tax credit remains at $1,000 per child through 2010. After 2010, without Congressional action, the credit drops to $500. The credit is generally nonrefundable except for certain taxpayers with three or more qualifying dependent children. For 2007, a credit is allowed against both the regular tax and the AMT for each dependent under age 17. The credit begins to phase out at incomes (AGI) of $110,000 for married joint filers, $75,000 for single taxpayers and $55,000 for married individuals filing separate returns. The credit is reduced by $50 for each $1,000 (or fraction of $1,000) of modified AGI over the thresholds.
  
  
  Earned Income Credit - This is a refundable credit for low-income taxpayers with income from working, either as an employee or a self-employed individual. The credit is based on earned income, the taxpayer’s AGI and the number of qualifying children. A taxpayer who has investment income such as interest and dividends in excess of $2,900 (for 2007) is ineligible for this credit. The credit was established as an incentive for individuals to obtain employment. It increases with the amount of earned income until the maximum credit is achieved and then begins to phase out at higher incomes. The table below illustrates the phase-out ranges for the various combinations of filing status and earned income and the maximum credit available.
  
  
  

  2007 PHASE-OUT RANGE
  Number of Children	Joint Return	Others	Maximum Credit
  None	$9,000 - $14,590	$7,000 - $12,590	$428
  1	$17,390 - $37,241	$15,390 - $35,241	$2,853
  2	$17,390 - $39,783	$15,390 - $37,783	$4,716

  
  
  
• Home Energy Credits - There are two distinct categories of home energy credits: (1) Energy-saving improvements to an existing home (allowed in 2006 and 2007), and (2) Residential energy-efficient property (allowed in 2006 through 2008). The credits are not phased out at higher-income levels, but are not deductible against the Alternative Minimum Tax. Since the manufacturer will certify the materials that come with their products, the taxpayer does not have to determine whether a home improvement creates or saves energy.
  
  Energy-Saving Improvements Credit – For energy-efficient building envelope components installed in or on a taxpayer’s principal residence. The improvement’s original use must commence with the taxpayer and can reasonably be expected to remain in use for at least 5 years. The two sub-categories are:
  
  o Building envelope components – These include insulation material or system, exterior windows (including skylights), exterior doors, and metal roofs with appropriate pigmented coatings. These items qualify for a credit of 10% of their cost, subject to an overall lifetime maximum credit of $500, of which only $200 of the $500 limit can be from windows and skylights.
  
  o Qualified energy property – These items qualify for a 100% credit subject to the overall lifetime $500 credit limit and item limits noted below:
  - Electric heat pump water heater, electric heat pump, geothermal heat pump, central air conditioner, and natural gas, propane, or oil water heater meeting specific standards. Only $300 of the cost is credit-eligible.
  - A qualified natural gas, propane, or oil furnace or hot water boiler. Only $150 of the cost is credit-eligible; or
  - An advanced main air-circulating fan. Only $50 of the cost is credit-eligible.
  
  Solar Power or Fuel Cell Credit - This credit is available for the purchase of qualified solar power systems or fuel cells to create electricity.
  
  o Solar water heater - For use in the taxpayer’s main home or second residence and at least half of the energy used is derived from the sun. The credit is 30% of the qualified property’s cost, limited to a maximum credit of $2,000.
  
  o Solar energy electric generating equipment – For use in the taxpayer’s main home or second residence. The credit is also 30% of cost, limited to $2,000.
  
  o Qualified fuel cell property - A fuel cell power plant that generates electricity by electrochemical means and has a 30% generation efficiency that is installed on the taxpayer’s primary residence. The credit is $500 for each 0.5 kilowatt of capacity with no maximum.
  
  
• Withholding and Estimated Taxes - Our “pay-as-you-go” tax system requires that you make payments of your tax liability evenly throughout the year. If you don't, it's possible you could owe an underpayment penalty. Some taxpayers meet the “pay-as-you-go” requirements by making quarterly estimated payments. However, when your income is primarily from wages, you usually meet the requirements through wage withholding and rely on your employer's payroll department to take out the right amount of tax, based on the withholding allowances shown on the Form W-4 you filed with your employer. To avoid potential underpayment penalties, you are required to deposit by payroll withholding or estimated tax payments an amount equal to the lesser of:
  
  (1) 90% of the current year’s tax liability; or
  
  (2) 100% of the prior year’s tax liability or, if your AGI exceeds $150,000 ($75,000 for taxpayers filing Married Separate), 110% of the prior year’s tax liability.
  
  If you had a significant change in income during the year, we can assist you in projecting your tax liability to maximize the tax benefit and delay paying as much tax as possible before the filing due date.

Long-term capital gains tax rates will produce automatic tax savings by taxing the gain from capital assets at rates lower than the regular tax rate. To take advantage of the long-term rates, you need to hold the asset longer than one year. The long-term rate depends on two things: your marginal tax rate and how long you have held the asset.

• If your marginal rate is 15% or under - Your long-term capital gains rate for 2007* will be 5% for property held longer than one year.
  
  
• If your marginal rate is above 15% - Your long-term capital gains rate for 2007* will be 15% for property held longer than one year.

* These rates are in effect through 2010. After 2010 long term capital gains currently taxed at 5% (or zero percent as discussed below) will be taxed at a rate of 10% (8% for assets held over five years), and long-term capital gains now taxed at a rate of 15% will be taxed at a rate of 20% (18% for assets held over five years).

** The 5% rate becomes zero percent in 2008 through 2010.

Taxpayers in the 15% or less tax brackets with unrealized long-term capital gains should develop strategies to take advantage of the “zero” tax rates in 2008 through 2010, possibly cashing in on existing gains while avoiding any federal tax on the gains. However, this strategy is only applicable when there is no significant risk of value decline while waiting for the “zero tax” window. Also remember the gain itself adds to the taxpayer’s income, impacts income-based limitations, and possibly pushes the taxpayer into a higher regular tax bracket, so it is a balancing act to take advantage of this zero rate.

Primarily because of this zero tax rate beginning in 2008, Congress raised the age for the “kiddie” tax to include full-time students under the age of 25 (See chapter 8.02 for the “kiddie” tax). Thus, Congress effectively nullified a popular strategy for funding college expenses by gifting appreciated stock to children who could then sell it with no or reduced tax liability.

Long-term capital losses offset long-term capital gains before they offset short-term capital gains. Similarly, short-term capital losses offset short-term capital gains before they offset long-term capital gains. Keep in mind that taxpayers may use up to $3,000 ($1,500 for taxpayers filing as married separate) of total capital losses in excess of total capital gains as a deduction against ordinary income in computing adjusted gross income or AGI. For 2007, individuals are subject to tax at a rate as high as 35% on short-term capital gains and ordinary income. But long-term capital gains are generally taxed at a maximum rate of 15%.

All of this means that having long-term capital losses offset long-term capital gains should be avoided, since those losses will be more valuable if they are used to offset short-term capital gains or ordinary income. Avoiding this requires making sure that the long-term capital losses are not taken in the same year as the long-term capital gains. However, this is not just a tax issue; investment factors also need to be considered. It would not be wise to defer recognizing gain until the following year if there is too much risk that the property’s value will decline before it can be sold. Similarly, one wouldn't want to risk increasing a loss on property that is expected to continue declining in value by deferring its sale until the following year.

To the extent that taking long-term capital losses in a different year than long-term capital gains is consistent with good investment planning, a taxpayer should take steps to prevent those losses from offsetting those gains.

Special Considerations - Some long-term gains are treated differently. Long-term gain attributable to depreciation recaptured on certain depreciable real estate is taxed at a maximum rate of 25%, and long-term gain attributable to collectibles (works of art, coins, stamps, antiques and similar property) is taxed at a maximum of 28%. If a taxpayer owns shares of the same stock purchased at different times and prices and can specifically identify those blocks of stock, it may be to his or her benefit to pick the block of shares to sell based on their cost and holding period. If the taxpayer cannot specifically identify them, then the first-in first-out rule applies. Shareholders of mutual funds may choose to average the cost basis of shares bought at different times; for holding period purposes, the mutual fund shares that are sold are considered to be the ones acquired first.

When deciding whether to take gain or hold for long-term rates, compare the savings associated with long-term rates to the financial risk of continuing to hold the investment. Careful handling of capital gains and losses can save substantial amounts of tax. Please contact this office to discuss year-end planning strategies that apply to your particular situation so as to maximize tax savings. Owners of luxury homes with gains exceeding the $250,000/$500,000 exclusion limits, and owners of second homes that do not qualify for the home sale gain exclusion, will especially benefit from the lower capital gain rates.


Dividends

Dividends received by an individual shareholder from domestic corporations (and certain foreign corporations) are treated as net capital gain for purposes of applying the capital gain tax rates. This means dividends are taxed at no more than 15% for taxpayers whose marginal rate is above 15% and 5%* for those in the 10% and 15% tax brackets. Capital losses cannot offset the dividend income. Dividends on stock held in a retirement plan or Traditional IRA do not benefit from the lower rates; distributions from these plans are taxed at ordinary income rates.

* The 5% rate becomes zero percent in 2008 through 2010.

Deferring or Avoiding Tax When Disposing of Assets

Depending on the type of asset, there are a number of strategies that can be employed to reduce, defer, or even avoid the tax upon the asset’s disposition.

• Tax-Free Exchange - Commonly referred to as a Sec 1031 exchange in reference to the tax code section covering exchanges, this type of strategy is frequently used to defer taxes in real estate held for business or investment purposes by deferring the gain into a replacement real estate property also held for business or investment purposes. Tax-free exchanges are also available for non-real estate business assets, but must conform to stringent like-for-like requirements. Tax-free exchanges do not apply to personal-use real estate holdings, such as your home or second home, and generally do not apply to publicly-traded stock. If the property is mixed-use property, such as a house that is used partially as a home, the business portion may qualify under the Sec 1031 exchange rules. Please call this office for additional details.
  
  
• Installment Sale - By carrying back the paper (loan) on the sale of an asset, you can spread the gain over a period of years. In these types of arrangements, the gain and nontaxable return of capital are taxed proportionally over the term of the sale agreement, thereby deferring the tax on the gain portion until actually received.
  
  
• Charitable Gift - Consider replacing cash charitable gifts with gifts of appreciated property. By giving the asset to a favorite charity, the taxpayer receives a charitable contribution deduction equal to the fair market value of the gift and at the same time avoids having to report the gain from the asset on his or her return. However, the maximum deduction for gifts of this type can be as low as 20% or 30% of AGI as compared to 50% for cash gifts. Caution: If the value of the stock a taxpayer is considering gifting is less than what was paid for it, he or she should sell it, take the loss on their return and then contribute the cash to the charity.
  
  
• Charitable Remainder Trust - This technique allows a taxpayer to contribute his or her asset(s) to a trust, which in turn pays an income during the remainder of the taxpayer's life and leaves the balance at death to the charity. The assets contributed to the trust can be sold within the trust without any tax consequences to the taxpayer. In addition, when the trust is formed, the taxpayer will receive a charitable deduction for the estimated amount that the trust will leave to charity upon death. The amount of income paid to the taxpayer each year is flexible (within some limitations) and provides annual funds, which can then supplement retirement needs.
  
  
• Gifts to Individuals - Giving a gift of appreciated property to an individual (donee) transfers the gain from that property to the donee. This can work to your advantage by gifting the appreciated asset rather than giving the donee cash. Let’s say that a taxpayer is paying for a child’s college education. Instead of selling some appreciated stock to pay for the schooling, the stock should be gifted to the student, who can sell it in a much lower tax bracket and pay for his or her own school expenses. The foregoing are abbreviated summaries of tax strategies that may have additional restrictions or other tax ramifications. Please consult with this office before attempting to employ any of these strategies.

The foregoing are abbreviated summaries of tax strategies that may have additional restrictions or other tax ramifications. Please consult with this office before attempting to employ any of these strategies.


Take Investment Losses

If a taxpayer has investments that are worth less than what was paid for them, he or she can use the losses to offset other gains and in certain circumstances other types of income.

• Capital Losses - Tax law allows you as an investor to offset capital gains with capital losses, and if the losses exceed the gains, one can deduct losses up to a maximum of $3,000 ($1,500 if filing married separate) for the tax year. Any additional losses carry over to future years. For this reason, review your securities portfolio at year’s end and search for stocks and other securities whose sales will result in a capital loss. This will help minimize your gains or maximize your losses for the year. When planning this strategy, keep in mind that under the wash sale rules, a loss is disallowed if the security sold at a loss is repurchased within 30 days. A loss will also be disallowed if the investor buys the same security 30 days before the sale.
  
  Another planning strategy is to avoid having long-term capital losses offset long-term capital gains, since those losses will be more valuable if they are used to offset short-term capital gains or ordinary income. Avoiding this requires making sure that the long-term capital losses are not taken in the same year as the long-term capital gains. However, this is not just a tax issue; investment factors also need to be considered.
  

• Variable Annuity Losses - If a taxpayer has a variable annuity that is worth less than what was paid for it, consider surrendering it before year’s end so that a deductible loss can be realized. Usually, the amount that is deductible will be the surrender value less the tax basis in the annuity. The tax basis is generally the amount originally invested less any amounts previously received from the annuity that were excludable from income. Before making a decision to surrender, consider any possible surrender penalties and the potential for the annuity to recover. Please call this office if we can assist you with your decision.

Invest in Tax-Exempt Securities

• Municipal Bonds - Interest received on obligations of states and their municipalities is exempt from Federal tax and may also be free from state taxation. Although these bonds generally pay a lower interest rate, their “after-tax” return (yield) can be higher than other similar investments such as corporate bonds, CDs, etc. Taxpayers in higher tax brackets and children subject to the “kiddie tax” frequently use this investment. Taxpayers drawing Social Security benefits should be reminded that even though municipal bond income may be tax-free, it is still used as income for purposes of determining the taxable portion of Social Security income. In addition, interest on certain “private activity bonds” is not exempt for AMT purposes.
  
  
  

  EQUIVALENT TAXABLE YIELD
  Tax Exempt	Tax Equivalent Taxable Yield Marginal Tax Rate
  10	15	27	30	35	38.6
  2.0	2.2	2.4	2.7	2.9	3.1	3.3
  2.5	2.8	2.9	3.4	3.6	3.8	4.1
  3.0	3.3	3.5	4.1	4.3	4.6	4.9
  3.5	3.9	4.1	4.8	5.0	5.4	5.7
  4.0	4.4	4.7	5.5	5.7	6.2	6.5
  4.5	5.0	5.3	6.2	6.4	6.9	7.3
  5.0	5.6	5.9	6.8	7.1	7.7	8.1
  5.5	6.1	6.5	7.5	7.9	8.5	9.0
  6.0	6.7	7.1	8.2	8.6	9.2	9.8

  
  
  
• Direct U.S. Government Obligations - Interest from U.S. Savings Bonds, T-Bills, H Bonds, etc. is taxable only for Federal purposes. Federal law prohibits states from taking a bite out of this income. In addition, interest from U.S. Savings Bonds may be deferred until the year the bond is cashed, providing a vehicle for deferral strategies.

• Dependent Care Benefits - If a taxpayer works and incurs child care expenses, he or she should check to see if their employer has a dependent care program. If the employer does provide dependent care benefits under a qualified plan, the taxpayer may be able to exclude up to $5,000 ($2,500 if Married Filing Separately) of child care expenses from his or her wages, which generally provides a greater tax benefit than the child care credit.
  
  
• 401(k) or Similar Retirement Plans - If an employer has a 401(k) plan, the employee can elect to defer (pre-tax) a maximum of $15,500 for 2007. If age 50 or older, the maximum is increased to $20,500. These plans are especially beneficial when the employer provides a matching contribution.
  
  
• Flexible Spending Accounts - Some employers provide flexible spending accounts, which allow an employee to make contributions on a pre-tax salary reduction basis to provide coverage for medical and dental expenses. If the plan permits, even nonprescription drugs that are not allowed as a medical deduction are covered. However, the participant must use the contributed amounts for the qualified expenses, or else forfeit any amounts remaining in the account at the end of the plan year.
  
  
• Education Assistance Programs - If you are receiving educational assistance benefits through an educational assistance program provided by your employer, up to $5,250 of those benefits can be excluded from income each year.
  
  
• Stock Purchase and Option Plans - A variety of plans available to employers are designed to allow the employees to invest in the employer’s stock. The most commonly encountered are:

  (1) Employee stock ownership plan (ESOP);

  (2) Nonqualified stock option; and
  
  (3) Incentive Stock Options (ISOs). Note: Because of the tax ramifications, it may be prudent for you to consult with this office prior to exercising a stock option, especially an ISO.

Each individual taxpayer, regardless of age, is allowed to exclude up to $250,000 of gain from the sale of their main home if certain requirements are met. A married couple that meets the requirements can exclude up to $500,000. To qualify for the exclusion, a taxpayer must own and live in the home as their main home for two of the prior five years immediately before the sale (under certain circumstances the five-year period extended military personnel). Short temporary absences, such as for vacation or other seasonal absence (even though accompanied with rental of the residence), are counted as periods of use.

Effective for home sales after October 22, 2004, if the home was originally acquired via a Sec 1031 tax-free exchange, the home must be owned for a minimum of five years before a home-sale gain exclusion can be utilized, provided the taxpayer also meets the two-year use test. Any gain in excess of the excludable amount is taxable. The exclusion can be used over and over again, as long as two years have elapsed between sales and the taxpayer otherwise meets the ownership and use tests. If there is a loss from the sale of your home, that loss is not deductible. Even if the taxpayer doesn’t qualify for the full exclusion, he or she may still qualify for a partial exclusion if the home is sold due to a job-related move, health reasons, involuntary conversions, death, loss of employment, divorce, or other unforeseen circumstances. Also, in divorce situations where one spouse remains in the home for an extended period after the divorce, the spouse who no longer lives in the home may still qualify for the exclusion based on the other spouse’s use period. If claiming, or have previously claimed, a home office deduction for an office that is an integral part of your home, the IRS has taken a liberal approach and allows the gain from the office portion to also be excluded, except for home office depreciation claimed after May 6, 1997. That depreciation, to the extent of any home sale gain, is taxable at 25%. However, this liberal treatment is not extended to gain derived from a portion of the property that is separate from the dwelling and that was used for business. The exchange of a home can qualify for both the §121 home sale exclusion and §1031 like-kind exchange deferral treatment. This can occur where the property was used as a principal residence and a business consecutively (e.g., use as a principal residence followed by rental of the property) or concurrently (a portion of the home used as a principal residence and a portion used as a home office).

A beneficiary who inherits the residence of a decedent receives a step-up in basis, and since it is inherited property, it is treated as held for long-term. Generally, a beneficiary will sell the residence through a broker and will have substantial sales costs. These sales costs quite often translate into a loss on the sale (sales price – sales costs – inherited basis) if the beneficiary does not use the property for personal uses.

Shifting Income to Your Child - Children under the age of 18 in 2007 (under the age of 19 and full-time students under the age of 24 beginning in 2008) are subject to the so-called kiddie tax. This was enacted by Congress to restrict taxpayers from shifting large amounts of income to their children by taxing the child at the parent’s marginal tax rate. However, for children without earnings from working, there is no kiddie tax on the first $850 of investment income, and the next $850 is taxed at 10%. Once the child reaches age 14, all of their income is taxed at their own marginal rate. Once the child’s income reaches the point where it would be taxed at the parent’s rate, additional investments can be made through tax-deferred investment vehicles.

To avoid the negative effects of the Kiddie Tax, it has been a popular higher-education funding tax strategy for parents to transfer appreciated capital assets, such as stock, to a child to be sold after the child was out from under the Kiddie Tax rules at the age of 18. This strategy looked to be especially attractive for years 2008 through 2010 when the tax rate for long-term capital gains (and qualified dividends) drops to zero for taxpayers in the 15% or lower marginal rate. Parents of unmarried children age 18 to 23 who are full-time students expected that the children would also be able to enjoy the lower capital gains rates. However, Congress has essentially closed this loophole by subjecting children through age 18 and full-time students age 19 to 23 to the Kiddie Tax rules beginning in 2008. Another change to the rules may prevent some of these older children from falling into the Kiddie Tax trap; if the child’s earned income exceeds one-half of the child’s support, the Kiddie Tax rules won’t apply.

Because of these impending changes, a parent may want to reconsider any planned transfers of income-generating stocks, bonds, and other investments to children age 18, or those age 19-23 who are full-time students. However, placing or moving a child's funds into tax deferred or tax free investments such as U.S. Savings Bonds, tax-deferred annuities, municipal bonds, growth stocks, etc. that produce little or no current taxable income, can help avoid the Kiddie Tax, at least in the years until the investments need to be sold or redeemed to pay for the education expenses.

Investing in U.S. Savings Bonds - Interest income from U.S. Savings Bonds may be deferred until the bonds are cashed in. Thus, one can defer income for the life of the bonds.

Investing in Deferred Annuities - Because the interest earned on a deferred annuity is tax-deferred, your earnings are not taxed until withdrawn. This also allows the investment to compound faster.

Employing Your Child - Payments that you make to your child under the age of 18, who works for you in your trade or business that is a sole proprietorship or partnership in which each partner is a parent of the child, are not subject to Social Security and Medicare taxes. As long as the pay is reasonable for the necessary services to the business provided by the child, you can deduct that pay as a business expense. Assuming the child has no other income, he or she will not have any tax on the first $5,350 of wages from you in 2007. Your child may also make deductible contributions to an IRA of the lesser of earned income or $4,000. These contributions can offset income, so your child could receive $9,350 in gross income by combining the IRA deduction with the standard deduction and pay no tax.

IRA Contributions - For 2007, an individual may contribute the lesser of his or her compensation or $4,000 to their IRA accounts. The spouse can do the same even if he or she does not work, provided the joint compensation is at least $8,000 for the year. For individuals age 50 and over, the annual limit is increased by $1,000. Contributions to a Traditional IRA cannot be made once the taxpayer reaches age 70-1/2. For purposes of determining IRA deduction limits, individuals who receive taxable alimony and separate maintenance payments may treat the alimony as compensation even if it is the only income they have. This allows alimony recipients to save for their retirement by making either Traditional or Roth IRA contributions. Traditional IRA contributions are deductible if the taxpayer and spouse (if married) do not actively participate in another qualified retirement plan or if their AGI is below income phase-out levels. For married taxpayers where one spouse is an active participant in a qualified plan and the other is not, the IRA deduction is phased out when AGI is between $150,000 and $160,000 for the one who is not an active participant.

2007 TRADITIONAL IRA PHASE OUT AGI
Phase Out	Single & Head of Household	Joint* & Surviving Spouse	Married Separate
Threshold	$52,000	$83,000	$0
Complete	$62,000	$103,000	$10,000

*When both spouses are active participants in qualified plans.

If you cannot deduct your IRA contribution or you simply wish to generate tax-free retirement funds, you can contribute to a Roth IRA instead of the Traditional IRA, provided the owner’s AGI is below the phase-out levels shown in the table below. Roth IRA distributions are tax-free after a five-year waiting period and the owner has reached age 59-1/2 or becomes disabled.

ROTH IRA PHASE OUT AGI
Phase Out	Single & Head of Household	Joint & Surviving Spouse	Married Separate
Threshold	$ 99,000	$156,000	$0
Complete	$114,000	$166,000	$10,000

An individual can convert all or any portion of his or her Traditional IRA to a Roth IRA, provided their AGI does not exceed $100,000 in the year of conversion. Since income tax must be paid on the conversion amount, it makes sense to convert if there are many years to go before the individual plans to withdraw the funds. This allows the IRA to accumulate tax-free earnings and appreciation. If an individual has one or more IRA accounts invested in stocks or mutual funds that have declined in value, this might be an opportune time to convert it to a Roth IRA. Another reason to convert to a Roth IRA is to pass on money to your heirs. Unlike a Regular IRA, there are no mandatory withdrawals for the Roth IRA owner, and the heirs will not be liable for income taxes when the Roth IRA is distributed to them.

Beginning in 2010, new legislation: (1) Eliminates the $100,000 modified AGI limit on conversions of traditional IRAs to Roth IRAs, and (2)Permits married taxpayers filing a separate return to convert amounts in a traditional IRA into a Roth IRA. Under prior law, married taxpayers who filed separate returns were restricted from making conversions.

Roth 2010 Rollover Strategies - Looking ahead, there are some interesting strategies a taxpayer can employ to convert nondeductible traditional IRA contributions to a Roth IRA, thereby funding the more favorable Roth IRA. Taxpayers who have employer plans and are restricted from making deductible traditional IRA contributions because of income level can make nondeductible traditional IRA contributions in the tax years leading up to 2010 and then convert those nondeductible traditional IRAs to Roth IRAs with virtually no tax since they were nondeductible. Only the earnings would be taxable. Taxpayers who are prohibited from making Roth IRA contributions because their income exceeds the limit may also benefit from this strategy. Using the same strategy, even a taxpayer who can make a deductible contribution can elect to make it nondeductible, providing the same result as above.

Self-Employed Retirement Plans - The maximum deduction for a self-employed individual’s contribution on their own behalf to a profit-sharing or SEP plan for 2007 is the lesser of 20% of net self-employment earnings (after the deduction for one-half of self-employment taxes) or $45,000. In addition, a self-employed individual who is age 50 or older can make an additional catch-up contribution of $5,000 for 2007. Self-employed individuals are also allowed a 401(k)-style elective deferral of the lesser of the annual maximum ($15,000 in 2007) or the net profit from the self-employed business less the profit-sharing or SEP contrib

An individual may begin withdrawing, without penalty, from his or her qualified pension plans at the age of 59-1/2. There are several exceptions that will allow earlier withdrawal without penalty. Upon reaching age 70-1/2, you are required to take distributions from your plans or face a substantial penalty for failing to do so.

• Impact of Your Marginal Rate - If you are able to plan your withdrawals, you can save considerable tax dollars. This is not always possible, but the basic premise is to take distributions and pay the resulting tax in years when your marginal rate is low. Also watch for years when, for a variety of reasons, your taxable income is negative and some amount of distributions could be taken tax-free if age 59-1/2 and over. The penalty only applies to those under 59-1/2.
  
  
• Impact on Social Security - For retired individuals receiving Social Security benefits, planning IRA distributions can also be beneficial. Social Security itself is only taxable when the total of one-half of the taxpayer’s Social Security benefits plus the taxpayer’s other income exceeds $25,000 ($32,000 for a married couple filing jointly). Once this threshold is reached, every additional dollar of other income will cause 50% to 85% of the Social Security benefits to also become taxable. Therefore, if a taxpayer’s other income is under the threshold, it is generally good practice to withdraw just enough taxable IRA funds to bring the income up to the threshold amount, even if the funds are not needed in that year. They can be set aside for a future year when they might be used for some unplanned need or large purchase. However, this strategy may not work if IRA distributions are required to be made (see next section).
  
  
• Minimum Distribution Requirements - The IRS does not allow taxpayers to keep funds in qualified plans indefinitely. Eventually, assets must be distributed and taxes paid. If there are no distributions, or if the distributions are not large enough, the owner may have to pay a 50% penalty of the amount not distributed as required. Generally, distributions must begin in the year the plan owner reaches the age of 70-1/2.
  
  
  

  UNIFORM LIFETIME TABLE
  Age	Life	Age	Life	Age	Life	Age	Life	Age	Life
  70	27.4	80	18.7	90	11.4	100	6.3	110	3.1
  71	26.5	81	17.9	91	10.8	101	5.9	111	2.9
  72	25.6	82	17.1	92	10.2	102	5.5	112	2.6
  73	24.7	83	16.3	93	9.6	103	5.2	113	2.4
  74	23.8	84	15.5	94	9.1	104	4.9	114	2.1
  75	22.9	85	14.8	95	8.6	105	4.5	115	1.9
  76	22.0	86	14.1	96	8.1	106	4.2
  77	21.2	87	13.4	97	7.6	107	3.9
  78	20.3	88	12.7	98	7.1	108	3.7
  79	19.5	89	12.0	99	6.7	109	3.4

Congress, in recent years, has provided a variety of tax incentives to help defray the cost of education. Some require long-term planning to become beneficial, while others provide current tax deductions or credits.

• Section 529 Plans - Section 529 Plans (named after the section of the IRS Code that created them) are plans established to help families save and pay for college in a tax-advantaged way and are available to everyone, regardless of income. These state-sponsored plans allow you to gift large sums of money for a family member’s college education while maintaining control of the funds. The earnings from these accounts grow tax-deferred and are tax-free, if used to pay for qualified higher education expenses. They can be used as an estate-planning tool as well, providing a means to transfer large amounts of money without gift tax. With all these tax benefits, 529 Plans are an excellent vehicle for college funding. Section 529 Plans come in two types, allowing you to either save funds in a tax-free account to be used later for higher education costs, or to prepay tuition for qualified universities. You can contribute $12,000 ($24,000 for married couples who agree to split their gift) a year without gift tax implications. The annual amount is subject to inflation-adjustment. There is also a special gift provision allowing to prepay five years of gifts up front without gift tax.
  
  
• Coverdell Education Savings Account - These accounts are actually education trusts that allow nondeductible contributions to be invested for a child’s education. Tax on earnings from these accounts is deferred until the funds are withdrawn, and if used for qualified education purposes, the entire withdrawal can be tax-free. Qualified use of these funds includes elementary and secondary education expenses in addition to post-secondary schools (colleges). A total of $2,000 per year can be contributed for each beneficiary under the age of 18. The ability to contribute to these plans phases out between $190,000 and $220,000 for married taxpayers filing jointly and between $95,000 and $110,000 for all others.
  
  
• Education Tax Credits - Two nonrefundable tax credits, the Hope Scholarship and the Lifetime Learning Credit, are available for qualified post-secondary education for a taxpayer, spouse and eligible dependents. Both credits will reduce one’s tax liability dollar for dollar until the tax reaches zero. Any credit in excess of the tax liability is lost. The credit is not allowed for taxpayers who file Married Separate returns. The allowable credits phase out when a taxpayer’s modified 2007 AGI is between $47,000 and $57,000 for single taxpayers and between $94,000 and $114,000 for joint return filers.
  
  The Hope Scholarship Credit is a credit of up to $1,650 per student per year, covering the first two years of qualified post-secondary education. The credit is 100% of the first $1,100 of qualifying expenses plus 50% of the next $1,100 for a student attending college on at least a half-time basis. The Lifetime Learning Credit is a credit of up to 20% of the first $10,000 of qualifying higher education expenses. Unlike the Hope Credit, which is on a per-student basis, this credit is per taxpayer. In addition to the postsecondary education allowed for the Hope Credit, the Lifetime Credit applies to any course of instruction at an eligible institution taken to acquire or improve job skills. Qualifying expenses for these credits is generally limited to tuition. However, student activity fees and fees for course-related books, supplies and equipment qualify if they must be paid directly to the educational institution for the enrollment or attendance of the student. You may qualify for this credit even if you did not pay the tuition.
  
  If a third party (someone other than the taxpayer or a claimed dependent) makes a payment directly to an eligible educational institution for a student’s qualified tuition and related expenses, the student would be treated as receiving the payment from the third party, and, in turn, paying the qualified tuition and related expenses. Furthermore, qualified tuition and related expenses paid by a student would be treated as paid by the taxpayer if the student is a claimed dependent of the taxpayer.
  
  
• Education Loan Interest - You can deduct qualified interest of $2,500 per year in computing AGI. This is not limited to government student loans and could be home equity loans, credit card debt, etc., provided the debt was incurred solely to pay qualified higher education expenses. This deduction phases out for married taxpayers with an AGI between $110,000 and $140,000 and for unmarried taxpayers between $55,000 and $70,000. This deduction is not allowed for taxpayers who file married separate returns.
  
  
• Gift Appreciated Stock to the Student - You might want to consider gifting stock that has appreciated in value to your children to help pay for their education. By doing this, you shift the tax liability for the gain from the sale to the child who, with proper planning, will pay a lower tax on the profits. Each parent can gift up to $12,000 per year to each child without gift tax liability.

As you plan for your tax year, keep in mind that some tax deductions are “above-the-line” and are available whether deductions are itemized or not. In addition to the educational “above-the-line” deductions mentioned earlier, the following deductions are noteworthy.

• Hybrid Vehicle Tax Incentives - Purchasing a hybrid vehicle can provide you with a tax credit ranging from $250 to $3,400.
  
  This tax credit directly offsets the regular income tax. However, it cannot be used to offset the Alternative Minimum Tax (AMT). In addition, each manufacturer is limited to producing 60,000 vehicles on which these credits are available. Thus, before purchasing a hybrid vehicle, consider the following:
  
  (1) Make sure you are not in the AMT and can benefit from the credit,
  (2) Verify the amount of credit available for the vehicle being purchased, and
  (3) Make sure the credit is not limited because the manufacturer has exceeded the 60,000 car limit.
  (Note:Toyota and Lexus have already exceeded the 60,000 car limit and therefore no credit will be available for those vehicles purchased after September 31, 2007).
  
  Additionally, one should evaluate whether the extra cost usually commanded for hybrid vehicles can be recouped by a combination of the tax benefit and anticipated fuel cost savings over the period the vehicle is expected to be driven.
  

• Health Savings Acounts - A Health Savings Account is a trust account into which tax-deductible contributions may be made by qualified taxpayers who have high deductible medical insurance plans. Interest earned on the HSA balance is tax-free. The funds from these accounts are then used to pay qualified medical expenses not covered by the medical insurance for an eligible individual. If these funds are not used, they roll over year to year. Once the taxpayer turns 65, the funds can be used as a retirement plan (taxable when withdrawn, but not subject to a withdrawal penalty) or saved for future medical expenses. Since the contribut