Tax Changes & Planning Opportunities Table of Contents Individual Income Taxes Capital Loss Carryforwards Education Expenses Retirement Planning Estate and Gift Taxes       INDIVIDUAL INCOME TAXES   Although tax rates remain at the lowest levels in years,  many more taxpayers continue are now subject to alternative minimum tax (AMT).  This makes tax planning more important than ever for 2008 and beyond.   Individual tax brackets continue to have six rates.  They are 10%, 15%, 25%, 28%, 33% and 35% for all income over $349,700.   Tax Rates on Long-Term Capital Gains The maximum tax rate on long-term capital gains remains at 15%.  The rate is further reduced to 5% for long-term capital gains in 2007 and 0% for 2008 as long as taxable income remains in the 10% or 15% brackets.  The holding period to qualify for long-term rates remains at one year.  These rates are scheduled to remain in effect through 2010.  Also, see the planning suggestions for capital loss carryforwards below.   Planning Tip: A tax strategy we have consistently recommended involves gifting appreciated stock to children in order that the stock can be sold when they are age 18 or older to fund college. The capital gain can then be taxed at the lower rate of the child.  This strategy is now even more beneficial because the rate reduction is now 15% to 0% in 2008.   However, beginning January 1, 2008, children under 24 that are full time students and can be claimed as a dependent on their parent's return are now taxed at their parent's tax rates.   Planning Tip: Because large long-term capital gains can result in Alternative Minimum Tax, consideration should be given to spreading large capital gains over multiple years to take advantage of the lower rates.   Reduction of Tax Rates on Qualified Dividends The maximum tax rate on qualified dividends continues at the relatively low 15% rate.  Like capital gains, the rate is further reduced to 5% for long-term capital gains as long as taxable income remains in the 10% or 15% brackets.  These rules are also scheduled to remain in effect through 2010.   Planning Tip: In order to qualify, the dividends must be "true" dividends, as opposed to interest from money market funds, bond funds or short-term capital gains from mutual funds characterized as dividends.  Stockholders must further insure that the underlying stock is held at least 60 days to result in a qualifying dividend.  Because of the large rate differential, investors should carefully scrutinize potential investments to determine whether dividend distributions will qualify for the reduced tax.   Deduction for State and Local Sales Tax For 2007, a deduction for sales tax on all purchases is allowed.  However, the deduction is only allowed if no deduction is claimed for state or local income tax.   Planning Tip:  Keep track of both state and local sales and income taxes paid in order to take the greatest possible deduction.  If no sales tax records are kept, the sales tax deduction will be limited to an amount shown in an IRS table.  An addition to the table is allowed for sales tax paid on major purchases such as cars, boats and home improvements.   Child Tax Credit The increased child tax credit of $1,000 continues through 2010.  This credit continues to be phased out for married taxpayers with income over $110,000 and single taxpayers with income over $75,000.   Dependent Care Credit Child care expenses eligible for the dependent care credit remain at $3,000 per child up to a maximum of $6,000 for two or more children. Expenses for overnight camp have now been specifically excluded from the definition of qualified expenses.   Planning Tip: Because the maximum tax free dependent care reimbursement from employers remains at $5,000 per tax return, taxpayers with two or more children and child care expenses in excess of $5,000 now can claim a credit even if they participate in a reimbursement plan at work.  Also, taxpayers with one child continue to save more taxes by participating in a plan at work than by claiming the credit.   Income Limits for Claiming Early Social Security Benefits Normal retirement age is defined for Social Security purposes as 65 years, ten months for those born in 1942 and 66 years for those born in 1943 through 1954.  Once this age is reached, full Social Security benefits can be claimed regardless of the amount of income earned.   However, benefits received before normal retirement age are reduced by one dollar in benefits for each two dollars earned above annual income of $13,560 in 2008.  In the year you reach normal retirement age, the deduction drops to one dollar for each three dollars earned above $36,120 in 2008 during the months before normal retirement age is reached.   Marriage Penalty Relief For many years, the tax on the combined income of a working married couple exceeded the sum of the taxes that would have been due if the spouses were single.  Through adjustments to the standard deduction and the tax brackets, this penalty has been significantly reduced through 2008.   Alternative Minimum Tax (AMT) Changes Although changes were made to the AMT by increasing the exemption amount for 2006 and 2007, the reduced tax rates on ordinary income, long-term capital gains and dividends will subject many taxpayers to the tax.  The government estimates that the 3.5 million taxpayers who paid AMT in 2006 will rise to over 23 million in the next year without additional legislation.   Planning Tip:  AMT has generally been a problem only for those with large medical expenses, state and local taxes, real estate taxes, miscellaneous deductions or incentive stock options in relation to their income.  Now, add to that list dividend income and long-term capital gains.  Because of the complexities of AMT, once you are subject to the tax, decisions regarding investments and timing of deductions become more difficult.    Once in AMT, your marginal tax rate effectively becomes 28% on most income except long-term capital gains and qualified dividends.  Consideration should be given to accelerating ordinary income which would normally be taxable at 35% into an AMT year to reduce the tax to 28%.     CAPITAL LOSS CARRYFORWARDS   Planning Tip: Increased volatility in the stock market over the last few years has resulted in many taxpayers having substantial capital loss carryforwards. Capital losses generally can be offset only against capital gains and an additional $3,000 of ordinary income each year.  Although no other immediate tax benefit is available, several other planning opportunities exist for those with such carryforwards.   Mutual Fund Distributions - Even if you do not anticipate recognizing capital gains currently, a capital loss carryforward can be used to offset capital gain distributions from mutual funds.  Because we have seen improved market performance, many funds will again be making such distributions in December regardless of whether the value of the fund exceeds your cost.   Real Estate - Capital gains on sales of real estate can generally be offset against capital loss carryforwards.  This includes rental properties, raw land, vacation homes and principal residences.  The first $500,000 of capital gain for joint taxpayers ($250,000 single) on the sale of a principal residence is not taxable.  Because of the recent run up in real estate values, some sales are exceeding these limits.  The excess can be offset against capital losses.    Incentive Stock Options - If you hold stock acquired through exercise of incentive stock options granted by your employer for more than one year, long-term capital gains are recognized on the eventual sale of the stock.  Capital loss carryforwards can be offset against these gains and may reduce AMT.   Net Unrealized Appreciation (NUA) in Employer Securities - Employer provided retirement plans, such as 401(k)s, often allow investment in employer stock.  If you are in such a plan with low basis employer stock and if you have a capital loss carryforward, consideration should be given to taking a lump-sum distribution from the retirement plan.  The cost basis of the stock will generally be taxable at ordinary income rates, but the appreciation in the stock can be offset against the capital loss carryforward when the stock is sold.  Not all plans allow such a distribution, so check with your employer before considering such a strategy.   Collectibles - Capital gains on the sale of collectibles such as antiques, gems, stamps, coins and art work continue to be taxed at a maximum rate of 28%.  Losses used to offset such gains provide a significantly higher tax benefit than against 15% gains.    EDUCATION EXPENSES   Hope Scholarship Credit A maximum $1,650 credit (100% of the first $1,100 and 50% of the second $1,100) for qualified higher education expenses continues to be allowed.  Only tuition payments for freshman and sophomores in college qualify for this credit.  This credit is completely phased out for joint taxpayers with adjusted gross income over $114,000 ($57,000 for single taxpayers) in 2007.   Lifetime Learning Credit A maximum $2,000 credit (20% of the first $10,000) for qualified higher education expense continues to be allowed.  Unlike the Hope Credit, this credit is allowed for all tuition expenses above high school, including undergraduate and graduate tuition as well as course fees paid in a non-degree program such as a night school.  This credit is also completely phased out for joint taxpayers with adjusted gross income over $114,000 ($57,000 for single taxpayers) in 2007.   Tuition and Fees Deduction The adjustment to income for tuition and fees of $4,000 has been extended through 2007.  This deduction is completely phased out for joint taxpayers with adjusted gross income over $160,000 ($80,000 for single taxpayers).   Planning Tip:  Because of the higher phase out range for the tuition and fees deduction and the relative benefits of a 20% credit versus a deduction, we will make a determination whether the credit or the deduction will be more beneficial for you depending on your tax bracket and income level.   Section 529 Accounts Higher education savings (Section 529) accounts continue to be a tax free method for saving for college.  Although contributions are not deductible for Federal purposes, all qualified distributions for tuition, room, board and related supplies are tax free.  Contributions are generally limited to $12,000 per year without gift tax consequences.  Contributions are deductible for Pennsylvania state tax purposes up to an annual limit of $12,000 per beneficiary.    Planning Tip: A special election can be made once every five years to allow a contribution of up to $60,000 per donor without gift tax consequences.  However, Pennsylvania limits the amount of the deduction to $12,000 per beneficiary per year.   Student Loan Interest The first $2,500 of interest paid on student loans is deductible.  The deduction is phased out for joint taxpayers with adjusted gross income over $140,000 ($70,000 for single taxpayers).   Teacher's Classroom Expenses The special $250 adjustment to income for classroom supplies by a teacher has been extended through 2007.  The IRS has clarified that this deduction is not available to college and graduate school professors.       RETIREMENT PLANNING    Individual Retirement Account (IRA) Contribution Limitation The maximum annual contribution to an IRA is $4,000 for 2007 and $5,000 for 2008.  Taxpayers age 50 and over can make additional "catch-up" contributions.  The catch-up amount is $1,000.  Both the regular and catch-up contribution increases apply to Traditional and Roth IRAs.   401(k) Contribution Limitations The maximum annual contribution to a 401(k) is $15,500 for 2007 and 2008.  Taxpayers age 50 and over can make additional catch-up contributions of $5,000 for 2007 and 2008.   Planning Tip:  Self employed taxpayers with no employees wishing to maximize their pension contribution may wish to consider a single person 401(k) which may allow for both a 401(k) deferral and a profit sharing contribution.  Although a higher contribution may be allowable, it should be balanced against higher administration costs and annual filing requirements.   SIMPLE IRA Contribution Limitations The maximum annual contribution to a SIMPLE IRA is $10,500 for 2007 and 2008.  Taxpayers age 50 and over can make additional catch-up contributions of $2,500 for 2007 and 2008.   Planning Tip: Because SIMPLE IRA contributions can be made up to 100% of net income, businesses with income less than $52,500 should seriously consider this alternative.  Keep in mind that new SIMPLE IRAs must be set up by September 30th of the tax year.  Funding can be delayed as far as April 15th of the next year.    SEP Contribution Limitations The maximum annual compensation limit for a SEP account is $225,000 for 2007 and $230,000 for 2008.  The annual contribution limit for SEP accounts is $45,000 for 2007 and $46,000 for 2008.   Planning Tip: Because SEP contributions can be made up to 25% of net income, businesses with net income more than $42,000 should seriously consider these alternatives.  New SEP plans must be set up by the later of April 15th or the extended due date of the tax return.  Funding can be delayed as far as September 15th of the following year for corporations and October 15th for others.   Roth 401(k) Many 401(k) plans offer an option for employees to designate a portion of their contributions to go to a Roth account.   Planning Tip:  Roth contributions are not currently deductible, but generate tax-free growth as long as certain requirements are met.  Although the current deduction is lost, the tax benefit is realized through tax-free withdrawals versus regular 401(k) withdrawals which are taxable.  Also, Roth contributions are normally only allowed for joint taxpayers with income below $166,000 and single taxpayers with income below $114,000.  No income limits apply to Roth 401(k) contributions.   Planning Tip:  Traditional IRAs can currently be rolled over into Roth IRAs only by taxpayers with adjusted gross income below $100,000.  Beginning in 2010, this income limit is removed and all taxpayers may convert traditional IRAs to Roth IRAs.  Taxable income from a 2010 conversion is not included in gross income until 2011 and 2012.  Instead taxpayers can elect to include the income from the conversion in 2010.  These alternatives allow for significant planning opportunities for IRA conversions.      ESTATE AND GIFT TAXES    Estate Tax Credit Increase and Rate Decreases The Federal estate tax credit for 2007 and 2008 is $780,800.  This generally means no Federal estate tax is due on estates less than $2,000,000.  The gift tax credit remains at $1,000,000 so that lifetime gifts in excess of $1,000,000 will be subject to a gift tax.  The top marginal Federal estate and gift tax rate is 45% in 2007 through 2009.  Scheduled increases in the estate limit and reduction of the top marginal rate through 2011 are shown below:                                                                                 Top                                             Estate Tax               Marginal                    Year                     Limit                       Rate                    2007                  2,000,000                  45%                    2008                  2,000,000                  45%                    2009                  3,500,000                  45%                    2010                     Repeal                       0%                    2011                  1,000,000                  50%   Annual Gift Tax Exclusion The annual federal gift tax exclusion remains at $12,000 for 2007 and 2008.  This means annual gifts of this amount can be given to any individual(s) without any gift tax impact or any utilization of your unified credit.  Married couples can give up to $24,000 per beneficiary for 2007 and 2008.   Planning Tip: Taxpayers whose estates exceed the credit listed above should seriously consider annual gifts to family members to take advantage of the annual exclusion.  Although these gifts are not deductible for income taxes, they can save significant Federal estate taxes.  Also, annual exclusion gifts may save state inheritance taxes even for those with estates below the federal credit limit.   Planning Tip:  Leverage of the annual gift tax exclusion can be accomplished by purchasing life insurance in an irrevocable trust and gifting the annual premiums.