2007 Year-End Tax Planning

Checklist – Actions to Be Taken by December 31, 2007

Note: Be sure to include both regular tax and AMT tax projections in your planning.

• Make final state and local estimated tax payments (unless in AMT posture) early rather than waiting until January 2008
• Consider making January mortgage payment early
• Ensure all charitable gifts are made before year-end, consider gifting low cost basis, appreciated securities
• Realize capital gains or losses as appropriate
• Make family gifts (up to $12,000 per recipient, gift tax free), try to ensure checks are cashed by year-end
• Consider additional contributions to 401(k) and other qualified retirement plans or IRAs to maximize allowed deferrals – including catch-up contributions allowed for taxpayers aged 50 years or older by end of year
• Make contributions to Code Section 529 education savings plans for potential state tax savings and to Coverdell Education Savings Accounts (ESAs) - deadline for Coverdell ESA contributions is April 15, 2008
• Consider making payments toward 2008 tuition and expenses
• Ensure medical and dependent care expenses are sufficient to exhaust health and dependent care flexible spending account balances – if not, consider scheduling routine medical, dental, and eye exam appointments. You have until the end of March, 2008 to finish getting treatment and submitting those bills through your reimbursement account at work.
• Purchase big ticket depreciable business equipment (including off-the-shelf computer software) to take advantage of increased Code Section 179 expensing
• Purchase vehicles to be used in trade or business
• Be generous.- Charitable contributions must be made by December 31 in order to claim a tax deduction for 2007. A few strategies for charitable giving:
  • Be aware of changes in car donations: The rules on donating an automobile to a qualified charity changed in 2005. In the past, you could often deduct the full market value of the car, regardless of whether or not the charity resold the car. Now, however, you may only do so if the charity you select actually uses the car. If they resell it, as many organizations do, your deduction should be limited to the amount the charity receives for your car. Stricter recordkeeping requirements are also required to claim a deduction for donated cars, so be sure to ask the charity for appropriate documentation. It also pays to ask what will be done with your vehicle before you donate.
  • Documentation requirement for small cash gifts, Current IRS provisions require you to have documented evidence, such as a canceled check or a receipt from the charity, for contributions of any amount. Previously, you needed proof of your donation only for amounts of $250 or more.
  • Consider donating appreciated securities: If you own shares of stock, or other securities that have appreciated in value, you can potentially save taxes in several ways by donating them to qualified charities. Provided certain requirements are met, you may be able to take an income tax deduction equal to the fair market value of the securities at the time they are donated, rather than the amount you originally paid. And by donating appreciated securities, rather than selling them and donating the proceeds, you should not owe taxes on the appreciation.
  • Consider a donor-advised fund: By contributing to a donor-advised fund (DAF), you are eligible to take an immediate tax deduction (provided certain requirements are met) and then recommend grants to IRS-qualified public charities now or even several years later.
  • Donations from IRAs - Taxpayers who are 70½ or older to give away as much as $100,000 a year from their IRA directly to qualified charities without triggering federal income taxes. Here's how it works: In a typical case, a taxpayer can get an exclusion from gross income for otherwise taxable distributions of as much as $100,000 from an IRA -- as long as the money is paid directly to a qualified charity. This money counts toward taxpayers' required minimum distributions for that year. This new break is available only for distributions in 2006 and 2007. 

    The House recently voted to extend the provision through the end of 2008.  It would still require Senate approval and President Bush to sign to be effective for 2008.

Taxpayers who run the risk of incurring AMT should consider the following before the end of the year:

Because Code Section 6654(f) requires that estimated tax payments must include a taxpayer’s estimated AMT liability, adjustments to withholding or an additional one-time withholding contribution should be made. Even large one-time contributions made through withholding against wages are treated as though they were made throughout the year and, will, thus, avoid underpayment of estimated tax penalties and interest.

• Avoid paying estimated state and local taxes until January 2008. Contrary to the usual advice to make the last estimated payment slightly early, i.e., by December 31, 2007, in order to maximize the state and local tax deduction for 2007, taxpayers who are in an AMT posture for the year will receive no benefit from the acceleration of the payment and may be better off making their last estimated payment on time in January 2008, thereby allowing them to potentially benefit from the corresponding deduction on their 2008 income tax returns.
• Avoid exercising qualified stock options for which the difference between the exercise price and the fair market value of the option on the date of exercise will be subject to AMT as ordinary income to the exerciser /purchaser subject to AMT.
• Given that the AMT exemption amounts are scheduled to dramatically decrease after 2007, taxpayers may want to consider incurring the AMT currently, rather than to put it off, if it seems as though the taxpayer’s exposure to AMT is inevitable because the higher exemption amounts will operate to shield more income from the AMT. Moreover, AMT paid now can be carried forward and used to offset regular tax to the extent a taxpayer’s regular tax exceeds his minimum tax in future years. In particular, taxpayers with incentive stock options may have the flexibility to control the year in which they expose themselves to an AMT liability.

Energy Tax Breaks:

These include credits of up to $500 lifetime for energy-efficient improvements to your home. Other incentives apply to eligible solar water heaters and solar electricity equipment, and -- for many taxpayers -- the purchase of hybrid and other alternative-fuel vehicles.

If you installed any solar heating units or fuel cell equipment, you have a 30% credit coming with a $2,000 cap. In addition, any energy-saving improvements made to commercial realty can be expensed, with a cap on the deduction of $1.80 per square foot.

These provisions expire after this year.

Child Tax Credit

Earned income for purposes of the child tax credit includes excludable combat pay. In addition, the refundable portion of the credit is determined by using 15% of earned income rather than 10%. This provision applies to families with earned incomes in excess of $11,750 (2007). The additional child tax credit is the lower of (1) the unused child tax credit or (2) (taxable earned income - $11,750) x 15%. This will increase the child tax credit for many low-income families.

Kiddie Tax

Congress has increased the number of children whose income is subject to their parents' higher tax rate, by raising the age limit. If a child receives dividends, interest and other "unearned income," the first $850 typically is tax free and the next $850 is then taxed at the child's lower rate. Income above $1,700 is subject to the parents' top rate. Previously, the parental rate kicked in only for children under age 14, but now it affects kids under age 18.

Because of this change, upper-income investors should consider investments for their children that generate little or no current taxable income, such as U.S. savings bonds or index funds. Consider avoiding high-yielding corporate bonds, since the interest currently would be taxable as ordinary income.

Combat Pay

The law counts excludable combat pay as income when figuring the Child Tax Credit and gives the taxpayer the option of counting or ignoring combat pay as income when figuring the Earned Income Tax Credit. Counting combat pay as income when calculating these credits does not change the exclusion of combat pay from taxable income.

For more about the effect of excludable income on the EITC, see Q&A-37 in Miscellaneous Provisions - Combat Zone Service.

For more details on tax issues related to military service, see Publication 3, Armed Forces' Tax Guide.

Long-term Capital Gain and Dividend Income

The maximum tax rate for net capital gains is 15%. The tax rate is 5% for taxpayers whose ordinary income is taxed at the 10% or 15% rate. These reduced rates are currently scheduled to be in effect through 2010 (with the 5% rate going to zero in 2008). All of these changes are set to expire for tax years beginning after 2010.

An individual’s qualified dividend income is also taxed at the lower capital gains tax rates.

Note: Unlike the lower tax rates for ordinary income reduced capital gain and qualified dividend income rates do apply for AMT purposes and, therefore, will not cause otherwise exempt taxpayers to be subject to the AMT.

Exhaust health and other flexible spending accounts

Because taxpayers must either use or lose any pre-tax income deferred into their health and other flexible spending accounts, taxpayers should always make sure that they have fully utilized the dollars they elected to set aside before the end of the calendar year. Taxpayers who still have balances in their flexible spending accounts (FSAs) should accelerate their expenditures to avoid forfeiting any remaining balances. For example, by scheduling doctor and dentist visits and eye exams, filling prescriptions, and completing other types of medical care procedures prior to the end of the year, taxpayers can fully utilize their pre-tax deferrals and take care of expenditures they were going to make anyway.

Importantly, the IRS has ruled that the costs of even non-prescription drugs, such as pain-killers and cold medicines, are eligible to be reimbursed under a health FSA. As a result, taxpayers with excess funds in their health FSAs should consider locating receipts for these types of expenditures and submitting them for reimbursement. Note, however, that some health FSA plans might not allow reimbursement for non-prescription drugs. Amendments to these plans may only apply for 2004 and subsequent years. Finally, taxpayers should be aware that many reimbursement plans require only that the expense be incurred prior to the year-end. You have until the end of March, 2008 to finish getting treatment and submitting those bills through your reimbursement account at work.

Maximize Retirement Savings Contributions and Catch-up Contributions

Those taxpayers that have not fully funded their maximum retirement savings deferrals may want to be reminded that they can elect to make large year-end contributions to lower their taxable income for the year.

For 2007, the maximum elective deferral for a 401(k) plan is $15,500 and individuals who will reach their 50th birthdays on or before December 31, 2007, may defer an additional $5,000 of income to a 401(k) plan.

Similarly, eligible taxpayers can make tax-free contributions of up to $4,000 to an individual retirement account (IRA) for 2007. Taxpayers who are at least 50 years old by the end of 2007 may contribute an additional $1,000 to their IRAs. IRA contributions do not have to be made by December 31, 2007. Taxpayers have until April 15, 2008 (i.e., the due date of the return, without regard to extensions) to make their contributions for the calendar 2007 tax year.

For SIMPLE plans, the maximum allowed deferral is $10,500 ($13,000 for taxpayers age 50 or older) for 2007.

Pre-pay Tuition and Expenses and Fund Education Savings

For education expenses incurred in 2007 for academic periods that began in 2007, taxpayers may be eligible for the lifetime learning credit and/or the Hope Scholarship Credit. The maximum lifetime learning credit is $2,000 (i.e., an amount equal to 20% of so much of the qualified tuition and related expenses paid during the year as do not exceed $10,000), and the Hope Scholarship Credit is $1,650 (i.e., 100% of qualified tuition and related expenses not in excess of $1,000 and 50% of such expenses in excess of $1,000).

The MAGI (Modified Adjusted Gross Income) limitation under which both the Hope and the lifetime learning credits are reduced is $55,000 ($110,000 for joint returns) in 2007.

Taxpayers have until April 15, 2008, to make contributions to Coverdell Education Savings Accounts of up to $2,000 per beneficiary. While contributions to Coverdell ESAs are not deductible, the contributions are allowed to grow on a tax-deferred basis (so long as the proceeds are used for qualified education expenses). Qualified education expenses include elementary and secondary education expenses.

Time Year-End Income and Expenses for Tax-Saving Results

Most small businesses operate as pass-through entities (meaning S corporations, partnerships, and LLCs). These outfits pass their business income and deduction items through to their individual owners, who then report them on their personal 1040s. Most small businesses also use the cash method of accounting for tax purposes.

If that sounds like your situation, and you expect to be in the same or lower tax bracket next year, it's a smart move to defer taxable income into 2008 and accelerate deductible expenditures. Here are some suggestions on how to do that:

• Charge deductible business expenses on credit cards before year end. That way, you'll create 2007 tax writeoffs even though the actual credit-card bills won't be paid until 2008. Beware: this taxpayer-friendly rule doesn't apply to store revolving charge accounts. So if you charge expenses on your Home Depot credit card, you can't claim any deductions until you actually pay the bill.
• Cut checks before year end to pay other deductible expenses. You can claim 2007 deductions even though the checks might not be cashed or deposited until early next year. To fail-safe your writeoffs against an IRS challenge, send large year-end checks via registered or certified mail. That proves you shipped the checks off this year.
• On the income side of the equation, consider deferring some of your billings until right at the end of the year. That way, you'll be paid — and taxed — next year instead of this year. Of course, you should never defer billings when there's any chance that would decrease the odds of collecting your money.

Vehicle Depreciation Limitations

The American Jobs Creation Act of 2004 imposed a $25,000 limit on Section 179 deductions for heavy SUVs, but it's still a great deal. Why? Because the tax law allows you to claim the following writeoffs on your 2007 return: (1) a $25,000 Section 179 deduction, (2) regular first-year depreciation on the cost left after the first deduction.

For example, say you spend $60,000 on a new Cadillac Escalade that will be used 100% in your business. As long as you make the purchase before the year's over and use the new vehicle for business before then, you can generally claim the following deductions on your business's 2007 federal return: the $25,000 Section 179 deduction plus $17,500 of bonus depreciation plus another $7,000 of regular depreciation. These first-year deductions add up to a whopping $32,000, or about 53% of your new Escalade's cost, all in Year One.

Better Yet: Buy a Heavy Non-SUV
The full $108,000 Section 179 deduction is still available for heavy business vehicles (those with GVWRs above 6,000 pounds) that are not considered to be SUVs under the tax law. Both new and used vehicles can qualify for this important exception. Non-SUVs include:

• Vehicles with a cargo area of at least six feet in interior length that's not easily accessible directly from the passenger compartment. Many pickups with full-size beds will fit this description. Beware: some "quad cab" and "extended cab" pickups might have cargo beds that are too short to qualify.
• Vehicles designed to seat more than nine passengers behind the driver's seat. Many hotel shuttle vans will fit this description.
• Vehicles with: (1) a fully enclosed driver's compartment and cargo area, (2) no seating behind the driver's seat, and (3) no body section protruding more than 30 inches ahead of the leading edge of the windshield. This sounds pretty weird, but many delivery vans will meet this description.

Bottom Line: Heavy vehicles that fall under these three exceptions remain eligible for the full Section 179 instant writeoff of $125,000 for tax years beginning in 2007.

Standard Mileage Rates

Code Section 179 Expensing

Code Section 179 allows a taxpayer to elect to treat the cost or a portion of the cost of certain property (now including computer software) acquired by purchase for use in the active conduct of a trade or business as a currently deductible expense.

For taxable years beginning in 2007, the aggregate cost limitation on Code Section 179 expensing is increased to $125,000 and this limitation is reduced, but not below zero, by the amount by which the eligible property exceeds $500,000.

Domestic Production Activities Deduction

For tax years beginning after December 31, 2006, the domestic production activities deduction percentage increases from 3% to 6%. For more information on this deduction, see Form 8903, Domestic Production Activities Deduction, and its instructions.