Volume 4, No. 1

Happy New Year! The start of a new year brings plenty of tax planning opportunities. Here are eight considerations for tax planning as 2008 begins.

#1. Foreclosure Help
Every practitioner knows clients caught in the subprime mortgage crisis. The high-flying housing market of recent years is in serious trouble in many localities. Homeowners who took advantage of "low teaser" interest rates are suddenly looking at foreclosure when they cannot make their payments.

When a lender forecloses on property, sells the home for less than the borrower's outstanding mortgage and forgives part or all of the unpaid mortgage debt, the Tax Code had considered the cancelled debt to be taxable income to the homeowner. Congress passed some relief for distressed homeowners late in 2007.

The Mortgage Forgiveness Debt Relief Act of 2007excludes discharges of up to $2 million of indebtedness from taxation ($1 million for a married taxpayer filing a separate return) if the debt is secured by a principal residence and if it was incurred in the acquisition, construction or substantial improvement of the principal residence. This special relief is temporary and is available for three years, retroactively applied for discharges from Jan. 1, 2007, through Dec. 31, 2009. The new law also addresses mortgage workouts.

#2. Kiddie Tax
Until recently, the kiddie tax kicked in at 14. The Small Business and Work Opportunity Tax Act of 2007 (2007 Small Business Tax Act) raised the age to 19, 24 if a student, under which the unearned income of minors who provide less than half their support is taxed at their parents' tax rate for tax years beginning after May 25, 2007 (2008 for most calendar year taxpayers). Congress decided that it was time to lessen the effectiveness of intra-family transfers of income-producing property, which shift income produced from such property from the parents' high marginal tax rate to the child's generally lower tax bracket, thereby reducing a family's overall income tax liability.

Key figures. Generally, the kiddie tax applies when a child's income exceeds $1,800 for 2008. For tax years beginning in 2008, the inflation-adjusted amount used to reduce the net unearned income reported on a child's return that is subject to the kiddie tax is $900. For tax years beginning in 2008, the amount of a dependent's standard deduction is the greater of $900, as adjusted for inflation, or the sum of $300 and the dependent's earned income.

Reminder. For purposes of the kiddie tax, the source of the income-producing property is irrelevant. For example, the property may have been transferred to the child, by gift from the child's parents, grandparents or anyone else, in any type of trust, by gift under the Uniform Gift to Minors Act, by inheritance.

#3. Life Changes
Change is the only constant in life, so the saying goes. Many clients may be undergoing a life-changing event now or are anticipating one, such as marriage or the birth of a child, starting a new job or business venture, retiring, or closing a business. Almost every event has tax implications and consequences. The sooner a taxpayer addresses the tax consequences, the easier it is to focus on the event itself.

Most clients plan for post-death distributions. The one-year repeal of the federal estate tax, set for 2010, is fast approaching. In 2001, Congress repealed the federal estate tax, but only for one year (2010) and replaced it with a carry-over basis regime. However, for 2008, the maximum estate tax rate is 45 percent and the estate tax exclusion amount is $2 million.

#4. Hybrid Vehicles
With gasoline selling at all-time record highs, consumer interest in hybrid vehicles is also at an all-time high. Not only will taxpayers save on fuel costs, they also may qualify for a tax break. However, be careful; not all models of hybrid vehicles qualify for the same tax credits. Moreover, the tax break has expired for others. Legislation has been introduced in Congress to remove the vehicle-production cap that gradually phases out the credit for certain manufacturers.

#5. Child Care and Education
A married couple with a combined annual income of $100,000 can expect to spend nearly $300,000 on rearing a child until age 18, according to the U.S. Department of Agriculture. Child care and education are a large chunk of these costs. Fortunately, there are some tax-friendly savings strategies, such as Coverdell Educational Savings Accounts (ESAs) and qualified tuition plans, also known as "529" plans.

Contributions to a Coverdell ESA are not tax deductible. However, earnings are not currently taxed and withdrawals from Coverdell ESAs are tax-free when used to pay for qualified educational expenses. Funds saved in a Coverdell ESA can be used for kindergarten through twelfth grade as well as post-secondary education expenses. Contributions to a 529 plan are also not tax deductible, but the amounts earned by the funds invested in the plan grow tax-free and the original investment and earnings are tax-free when withdrawn if they are used for qualified education expenses.

#6. Roth IRAs
The Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) eliminated the $100,000 adjusted gross income ceiling for converting a regular IRA to a Roth IRA for tax years after 2009. A conversion is treated as a taxable distribution, but is not subject to the 10 percent early withdrawal penalty. Taxpayers who convert in 2010 can elect to recognize the conversion income in 2010 or average it over the next two years.

Although this provision in TIPRA does not extend to 401(k) plans, nothing would apparently prevent Roth IRA conversions of traditional IRAs that have received proceeds of 401(k) balances when an individual leaves employment. Nor does the new law prevent high-income taxpayers from contributing to nondeductible traditional IRAs now in anticipation of converting to Roth IRAs in 2010. Additionally, 2010 is also the last year before the lower individual marginal tax rates in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) sunset.

#7. Lower Capital Gains and Dividends Tax Rates
The taxpayer-friendly lower capital gains and dividend tax rates in recent legislation are temporary. The maximum rate of 15 percent will disappear after 2010 as will the zero-percent rate for individuals in the 10- or 15-percent tax brackets.

• Caution: The capital gains and dividend tax rates have been changed so often in recent years that practitioners need a scorecard to keep up with them all. For tax years ending on or after May 6, 2003, and through the end of 2010, up to four different rates could apply to long-term capital gains: 28 percent for collectible gain and gain on qualified small business stock, 25 percent for unrecaptured gain from the sale of certain depreciable realty, 15 percent for other gain, or five percent for other gain for taxpayers in the 10- or 15-percent income tax rate brackets. For tax years beginning after 2007, the five percent rate is reduced to zero.

Reminder. For small business owners, capital gains have another advantage. Unlike the money a small business owner earns in his or her business, capital gains are not subject to the 15.3 percent self-employment tax.

#8. Small Business Expensing
Generous small business expensing under Code Sec. 179 is also temporary. The enhanced amounts in the 2007 Small Business Tax Act will sunset after 2010. For 2008, the maximum expense amount is $128,000. The $128,000 amount is reduced, but not below zero, by the amount by which the cost of qualifying property placed in service exceeds $510,000.

The timing of purchases is always an important consideration. As long as the taxpayer starts using the newly purchased business equipment before the end of the tax year, the taxpayer receives the entire expensing deduction for that year, whether it started using the equipment in January or on Dec. 31. The amount that can be expensed depends upon the date the qualifying property is placed in service, not when it's purchased or paid for.