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2007 Tax Planning Strategies
Updated 12/3/07
TAX LEGISLATION DELAYS WILL AFFECT ALL OF US: IRS needs 10 weeks to reprogram and test changes in tax law. If the tax relief bills pass first week in December, processing of tax returns will not start until mid-Feb at the earliest, delaying tax refunds for millions and causing end-of-season gridlock for tax preparers. Taxpayers will face higher preparation fees due to the added overhead of filing extensions. This is not the year to procrastinate
WHAT’S NEW: Pending legislation, we can be reasonably confident that the huge increase in AMT for 2007 will be reversed. Without this fix, millions of middle-class taxpayers could see as much as $6,000 added to their income tax. Same for excluding up to $2 million of forgiven acquisition debt on a primary home. Same for extending filing deadlines for fire victims. The additional standard deduction of real estate taxes for marrieds who don’t itemize is iffy. These breaks will be offset by higher penalties for businesses for filing late or incorrect tax returns, W-2s and 1099s.
REMINDERS: The standard mileage rate will remain at 48.5 cents per mile for business miles driven in 2007, but will increase to 50.5 cents for 2008. The mileage deduction for medical or moving expenses is 20 cents, but will drop to 19 cents in 2008. The rate for charitable miles remains at 14 cents both years. If you donate a vehicle to a charity and claim more than $500 deduction, you must attach to your return a statement from the charity that identifies you, the vehicle, date of donation, vehicle sale date, and sales proceeds. You need to get a receipt for each donation – not just those over $250. Instead of putting cash into the collection plate, you need to use a check or a card swipe so you and the organization have records. If you set up reimbursements for child care, be sure to use up the $5,000 limit (Need any year-end babysitting?) and be sure to submit all bills to your administrator.
Strategies for Individuals:
As always, the key to smart end-of-year tax planning is to look at two tax years – 2007 and 2008– as you study your options.
For most taxpayers, the best strategy is also the simplest: Defer income to the following year and accelerate deductions into the current year. This strategy takes advantage of the fact that income levels for tax brackets increase each year for inflation. But there are some exceptions: Taxpayers expecting to be in a higher tax bracket next year will maximize deductions next year, not this year.
If you find that, try as you might, your itemized deductions fall a little short of the standard deduction amount, you may be able to delay taking some of them so that you may itemize in 2008. This year, the standard deduction is marrieds: $10,700 plus $1,050 for each spouse age 65 or over, singles:$5,350, plus $1,300 if age 65+, and household heads: $7,850 plus $1,300 if age 65+. To maximize deductions in odd years (like 2007) you could prepay (in December) your January mortgage payment, 2nd installment property taxes, 4th-quarter estimated state taxes, and some portion of the following year’s alimony. See doctors, dentists accountants, etc. in the months of January and December, make two years’ worth of charitable gifts, and skip these in even years.
Consider getting and paying for elective medical procedures in 2007 if you are near the 7-1/2%-of-AGI threshhold. This does not include expenses for non-reconstructive cosmetic surgery. An even better option is available to taxpayers covered by high-deductible health insurance plans: the Health Savings Account, to which you may make tax-free contributions for non-reimbursed medical expenses, and which are not subject to the “use it or lose it” rules at the year end or upon changing jobs.
IRA contribution deductions of up to $4,000 are available to those who qualify, and the limit increases to $5,000 if you reach age 50 by 12/31/07. Tax-deferred employee retirement plans are an even better deal than IRAs. With tax rates so low right now, consider a Roth retirement plan. Contributions are not deductible, but earnings accumulate tax-free and distributions are tax-free upon retirement. For more info on IRA, 401(K), 403b, SEP and other tax-favored retirement planning see “Saving for Retirement” at MesaTaxes.com/resources.
Check your withholdingand estimated tax payments against your projected taxable income. Adjust as needed to avoid underpayment penalties. This goes for 2008, as well, since you may have modified your withholding in 2007 to accommodate over- or under-withholding during the beginning of the year.
The federal estate tax keeps shrinking. It will not affect you and your family unless the taxable estate exceeds $1.5 million. This increases to $3.5 million over the next 5 years, then goes back to $1 million in 2011, unless current law is extended. If these thresholds affect you, think about ways to gradually transfer your estate tax-free. Consider establishing a gift program or funding a 529 College Savings Plan for someone.
Consider charging contributions, medical expenses, business expenses, and some state tax payments, if you need the deductions this year, but don't have the ready cash. Deductions available to qualifying non-itemizers: IRAs, alimony, Keogh pay-ins, student loan interest (up to $2,500), job-related moving expenses, self-employed medical insurance and health savings accounts, college tuition & lab fees (up to $3,000). Teachers who do not itemize can write-off qualifying classroom expenses of up to $250 annually.
When strategies won’t work: If you are a high-incomer ($150,000+), chances are you may have to pay Alternative Minimum Tax (AMT). Or perhaps your deductions and credits are phasing out. Since you can’t use many deduction strategies, you may want to consider paying off your mortgage and equity loans to avoid non-deductible interest payments. Also, decrease your income with adjustments such as employee retirement plans and health savings accounts. See “Saving for Retirement” at MesaTaxes.com/resources
Determined at Tax Preparation Time:
In certain instances, it may be necessary to run calculations to determine if spouses should file separately, though this is not usually beneficial in community property states like California. How to claim education credits and deductions also depends on the situation. Hope credit is for college years 1-2 and is maximum $1500 for tuition & fees. Lifetime Learning Credit is maximum $2000 for tuition expenses not covered by Hope can be used for learning new skills or personal enrichment. For those who itemize, the Higher Education Expense deduction with its higher phase-out threshold may work better than the credit.
Business Strategies:
REMINDERS: If you are self-employed, you have until 12/31/07 to set up a Self-Employed 401(K) plan for tax year 2007. If a SEP-IRA is better for your needs, you have until you file your 2007 tax return to set it up. Self-employed taxpayers who employ their spouses in the business may deduct 100% of the health insurance premiums for the spouse and dependents. Make sure that you qualify for the home office deduction by not using the designated office space for personal activities at any time. See “Claiming Home Office and Vehicle Expenses” at MesaTaxes.com/resources.
Buy business supplies at the end of a profitable year and accelerate other expenditures like repairs and maintenance. Buy equipment before the end of the year to take advantage of your Section 179 expense. Realize, though, that depreciation of assets is reduced if 40% of purchases occur in the last quarter.
Investment Strategies
Tax rules for investors are complex and highly dependent on individual goals. Review your current holdings from an investment perspective first, then consider the tax issues. Don’t let taxes be the sole reason for switching investments. Capital losses may offset capital gains dollar-for-dollar and offset up to $3,000 of other income. Remember also that the wash-sale rule prevents your deducting a loss on securities purchased 30 days before or after their sale. Consider like-kind exchanges to defer gains on sale of business or investment property - but bear in mind that both taxes and capital gains rates are very low right now. You don’t want to end up having to sell property having a very low basis when capital gains taxes are high some time in the future. You may find that it is in your interest to take advantage of the low long-term capital gains rate, which is currently 10% for those in the 10% and 15% tax brackets, and 15% for everyone else. In 2008, the long term capital gains rate will become 0% for those in the 10% and 15% tax brackets.