Income Tax Planning

2007 Year-End Tax Planning for Individuals

As 2007 draws to a close, there is still time to reduce your 2007 tax bill and plan ahead for 2008. This letter highlights several potential tax-saving opportunities for you to consider.

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).

IRA, Retirement Savings Rules for 2007

More tax-saving opportunities continue for retirement planning in 2007 than in previous years due to changes in traditional IRAs, Roth IRAs, 401(k)s, and other retirement savings incentives.

Traditional IRAs: Individuals who are not active participants in an employer pension plan may make deductible contributions to an IRA. The annual deductible contribution limit for an IRA for 2007 is $4,000. Individuals who are active participants in a plan may also make deductible contributions to an IRA, but limited in amount depending on their AGI. For 2007, the AGI phase-out range for deductibility of IRA contributions is between $52,000 and $62,000 of modified AGI for single persons (including heads of households), and between $83,000 and $103,000 of modified AGI for married filing jointly. Above these ranges, no deduction is allowed.

For 2007, a $1,000 "catch-up" contribution deduction is allowed for taxpayers age 50 or older by the close of the taxable year who meet the other qualifications for IRA deductions. Thus, the total deductible limit for these individuals may be as high as $5,000.

In addition, an individual will not be considered an "active participant" in an employer plan simply because the individual's spouse is an active participant for part of a plan year. Thus, you may be able to take the full deduction for an IRA contribution regardless of whether your spouse is covered by a plan at work, subject to a phase-out if your joint modified AGI is $156,000 to $166,000. Above this range, no deduction is allowed.

Roth IRAs: This type of IRA permits nondeductible contributions of up to $4,000 a year. Earnings grow tax-free, and distributions are tax-free provided no distributions are made until more than five years after the first contribution and the individual has reached age 59 ½ . Distributions may be made earlier on account of the individual's disability or death. The maximum contribution is phased out for persons with AGI above certain amounts: $156,000 to $166,000 for joint filers, and $99,000 to $114,000 for single filers (including heads of households). For 2007, a $1,000 "catch-up" contribution is allowed for taxpayers age 50 or older by the close of the taxable year, making the total limit $5,000 for these individuals.

Roth IRA Conversion Rule: Funds in a traditional IRA may be rolled over into a Roth IRA. Such a rollover, however, is treated as a taxable event, and you will pay tax on the amount converted. No penalties will apply if all the requirements for such a transfer are satisfied. A taxpayer's AGI (whether married filing jointly or single) is limited to $100,000 to make such a conversion and the taxpayer must not be a married individual filing a separate return.

401(k) Contribution: The 401(k) elective deferral limit is $15,500 for 2007, up from $15,000 in 2006. If your 401(k) plan has been amended to allow for catch-up contributions for 2007 and you will be 50 years old by December 31, 2007, you may contribute an additional $5,000 to your 401(k) account, for a total maximum contribution of $20,500 ($15,500 in regular contributions plus $5,000 in catch-up contributions).

For the self-employed: If you are self-employed, your business is allowed to contribute up to a 25% match of your salary. The maximum of all contributions for a self-employed person to a 401(k) plan is $45,000 after both employee and business contributions. For example, if you are over 50, your salary is $100,000 for 2007 and you personally make a $20,500 contribution, you can reach the max contribution of $45,000 if your business contributes $24,500.

SIMPLE Plan Contribution: The SIMPLE plan deferral limit is $10,500 for 2007, up from $10,000 in 2006. If your SIMPLE plan has been amended to allow for catch-up contributions for 2007 and you will be 50 years old by December 31, 2007, you may contribute an additional $2,500.

Catch-Up Contributions for Other Plans: If you will be 50 years old by December 31, 2007, you may also contribute an additional $5,000 to your 403(b) plan or SEP.

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. 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, as discussed above.

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. 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.

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.

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.

Business Deductions

Self-Employed Health Insurance Premiums: Self-employed individuals are allowed to claim 100% of the amount paid during the taxable year for insurance that constitutes medical care for themselves, their spouses and dependents as an above-the-line deduction, without regard to the 7.5% of AGI floor.

Equipment Purchases: If you are in business and purchase equipment, you may make a "Section 179 Election," which allows you to expense (i.e., currently deduct) otherwise depreciable business property. In general, you may elect to expense up to $125,000 in 2007 of equipment costs (with a phase-out for purchases in excess of $500,000) if the asset was placed in service during 2007.

NOL Carryback Period: If your business suffers net operating losses in 2007, you may apply those losses against taxable income going back two tax years. Thus, for example, the loss could be used to reduce taxable income—and thus generate tax refunds—for tax years as far back as 2005.

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 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 amount will be adjusted for inflation in 2007. 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.

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.

Energy Incentives

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 2007.

Nonbusiness Energy Property Credit: Tax incentives are available to taxpayers who remodel their home and/or incorporate specific energy efficient property. 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.

Business Credits

Small Employer Pension Plan Startup Cost Credit: For 2007, certain small business employers that did not have a pension plan for the preceding three years may claim a nonrefundable income tax credit for expenses of establishing and administering a new retirement plan for employees. The credit applies to 50% of the first $1,000 in qualified administrative and retirement-education expenses for each of the first three plan years.

Employer-Provided Child Care Credit: For 2007, employers may claim a credit of up to $150,000 for supporting employee childcare or childcare resource and referral services. The credit is allowed for a percentage of "qualified child care expenditures" including for property to be used as part of a qualified child care facility, for operating costs of a qualified child care facility and for resource and referral expenditures.

Investment Planning

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).

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 includes dividends received from domestic and certain foreign corporations.

In 2008 through 2010, the net capital gains rate is zero percent for taxpayers in the 10 or 15 percent tax bracket. Thus, accelerating income into 2007 in order to qualify for the zero percent rate in 2008 and/or delaying the sale of long-term capital assets until 2008 if you are within the 15 percent bracket should be a consideration.

Gift-Giving

Take advantage of the 2007 annual and lifetime gift-giving limits to reduce your income and estate tax liabilities. For 2007 and 2008, you can transfer $12,000 per person, per year, without paying gift tax on the amounts transferred. Married couples can gift $24,000 per person, per year without tax liability on the amounts transferred.

Kiddie Tax

For 2007, a child under the age of 18 is subject to the "kiddie tax" (and thus pays tax at his or herhm parents' highest marginal tax rate on unearned income in excess of $1,700). But in 2008, courtesy of the Small Business and Work Opportunity Tax Act of 2007, the applicable age rises and the kiddie tax will apply to a child under the age of 19 and full-time students under the age of 24. In light of this development, parents should consider selling appreciated stock and other assets belonging to their children now, especially if their children will fall into the one of these age categories in 2008.

Alternative Minimum Tax

In 2007, the alternative minimum tax exemption amounts are: (1) $45,000 for married individuals filing jointly and for surviving spouses; and (2) $33,750 for unmarried individuals other than surviving spouses. Also, nonrefundable personal credits can offset an individual's regular and alternative minimum tax.