CPE for Professionals Seminars Correspondence Online

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CPE for ProfessionalsSeminars ? Correspondence ?
Online
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40 Frequently Overlooked Tax Strategies

• Presented By
• Lee T. Reams, EA

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Designate Support
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• Supporting Two Parents
• Problem - Showing 50 support for both
• Solution - Designate support for only one
• Benefits
• Dependency for one if otherwise qualified
• Gross taxable income
• Head of Household
• Maintain a home that is parents principal abode.
• Taxpayer need not live there.

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Sales Tax State Income Tax
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• Problem State refund is taxable
• Solution Tax benefit rule
• Deduct sales tax
• No benefit from state tax deduction
• Requires careful analysis
• Current year benefit
• Subsequent year taxable income

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Example
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• State Tax Withholding 4,000
• Sales Tax Deduction 3,500
• Refund 1,500
• State Tax Deduction (4,000 _at_25) 1,000
• Tax on Refund (1,500 _at_25)
• Net Taxpayer Benefit 625
• Sales Tax Deduction (3,500 _at_25) 875
• No Tax on State Refund
• Net Taxpayer Benefit 875
• Be sure to look back!

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State Tax Refund AMT
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• Problem State refund is taxable
• Solution Tax benefit rule
• Limited to the extent of the AMT
• Be sure to look back
• Account for 1099G

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State Tax Refund AMT
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• Example
• State deduction 5,000
• Refund 2,000
• AMT 1,000 (26 Rate)

Zero Tax Benefit 1,000/.26 3,846 3,846
provided no tax benefit. So the 2,000 refund
is not taxable.
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Avoiding Taxable SS and Optimize IRA
Distributions
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• Problem
• SS Becomes Taxable as Income Increases
• 32,000 Jt Threshold (25,000 Others)
• IRA Distributions Increase Income
• Strategy Plan IRA Distributions
• Push SS Threshold
• Reduce IRA Value before 70½
• Alternate Years before 70½

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Example
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• Pension income 12,000 12,000
• Interest income 1,000 1,000
• IRA distribution - 0 - 10,000
• Total 13,000 23,000
• Standard deduction
  
• Exemptions
• Taxable - 0 -
  4,600
• Tax - 0 - 460

Client might even consider pushing the 10
envelope up to the taxable Social Security
threshold.
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Private Activity Bonds AMT
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• Problem Income for AMT Purposes
• Solution Eliminate PAB Investments

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ST CG LT CL
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• Problem
• ST capital gains are taxed at regular rates.
• LT capital losses if used to offset LT CG reduces
  10 or 15 income.
• Solution
• Attempt to arrange affairs so that long-term
  capital losses are used to offset short-term
  capital gains.

X
X
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Non-Stat Options Sales Costs
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• Problem
• Non-statutory option income included in W-2
• Stock shares sold by broker
• Sales costs overlooked
• Solution
• Dont overlook sales charges STCL
• Account for gross proceeds

Non-Stat Option (Gain in W-2) 7/1/06 7/1/06
50,000 50,300 -300
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Inherited Home Loss on Sale
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• Beneficiary
• Loss allowed if not personal-use property
• Living in home at time of death ok if out in
  reasonable period of time
• Life Estate
• If property is put up for sale immediately after
  the death
• Surviving Spouse
• Stops using the home as a residence soon after
  spouses death

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Section 1031 Carryovers
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• Passive loss carryovers
• Capital loss carryovers
• Investment interest carryovers
• Election to forego CG treatment
• Weigh exchange costs versus tax on a reduced gain
  before jumping into a 1031.

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ISO Sales Basis
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• Regular Tax Basis Option Price
• AMT Basis Exercise Price
• Year of Sale
• Negative AMT Adjustment
• Lowers Tentative AMT
• AMT Credit

AMT Credit
AMT
REG TAX
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Self-Employed Medical
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• Above-the-line deduction
• Limited to net SE income
• Taxpayer, spouse and dependents
• Dont Overlook
• Long-term care premiums limits
• Medicare-B premiums

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Consumer Interest Sch C
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• Standard Mileage Rate
• Does not include vehicle interest or taxes
• Solution
• Deduct business portion on Schedule C
• Interest
• Personal Property Taxes License Fees

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Self-Employed Combo Plans
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• Elective Deferral no longer Subject to SEP and SE
  Plan limits.
• SE Plans limited to lesser of
• 20 of net from SE, or
• 42,000 (2005).
• Additional catch up of 4,000 (2005)

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Example - No Other Employer
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• SE Income ½ SE Taxes 10,000
• (1) Profit-sharing contribution (20 of
  10,000) 2,000
• (2) 401(k) arrangement - the lesser of
• (a) Net profits less PS (10,000 - 2,000)
  8,000
• (b) Max PS less allowable (42,000 - 2,000)
  40,000 or
• (c) Max deferral amount for the year (2005)
  14,000.
• The least of these three amounts
  is... 8,000
• Total combined allowable contribution is
  .... 10,000

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Example Full-Time Employer
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• SE Income ½ SE Taxes 10,000
• Contribution to Employers Plan 13,000
• (1) Profit-sharing contribution (20 of
  10,000) 2,000
• (2) 401(k) arrangement - the lesser of
• (a) Net profits less PS (10,000 - 2,000)
  8,000
• (b) Max PS less allowable (42,000 - 2,000)
  40,000 or
• (c) Max deferral amount (14,000 - 13,000)
  1,000.
• The least of these three amounts
  is... 1,000
• Total combined allowable contribution is
  .... 3,000

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Example Age 50
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• SE Income ½ SE Taxes 10,000
• Contribution to Employers Plan 13,000
• (1) Profit-sharing contribution (20 of
  10,000)2,000
• (2) 401(k) arrangement - the lesser of
• (a) Net profits less PS (10,000 - 2,000)
  8,000
• (b) Max PS less allowable (42,000 -
  2,000) 40,000 or
• (c) Max deferral amount (18,000 -
  13,000) 5,000.
• The least of these three amounts
  is... 5,000
• Total combined allowable contribution is
  .... 7,000

2006 401(k) Limit is 15,000 5,000 (age 50
extra)
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Hybrid Std Mileage
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• 2006 Hybrid Credit
• Nonrefundable
• No AMT deduction
• Std Mileage Rate
• Is adjusted for higher fuel prices
• Not currently adjusted for hybrid efficiency
• Strategy Use standard mileage rate

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Alimony IRA Contributions
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• To have an IRA, an individual must receive
  compensation.
• Compensation includes
• Wages, tips and bonuses
• Net SE Income
• Professional fees and commissions
• Alimony
• Combat Pay Hero Legislation (retro 04)

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IRA to Qualified Plan Rollover
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• Post-2001 Changes
• IRAs can be rolled into Qualified Plans.
• (If the plan allows not legally required
  to)
• Sec 401(k) plans
• Sec 403(a) annuity plans
• Sec 457 government plans
• Nontaxable amounts cannot be rolled to QP.
• Aggregation rule
• All considered one

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IRA to Qualified Plan Rollover
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• Strategies
• Separate taxable nontaxable amounts
• Tax-Free Roth Conversions
• Traditional nondeductible contributions
• AGI limitation issues
• Plan for 2010 no AGI limit Roth conversions
• Early Retirement
• Age 55 without strings

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Dividing an Inherited IRA
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• Problem
• Multiple beneficiaries
• Conflicting payout interests
• One beneficiary significantly older
• Divide the IRAs
• Separate or Sub-accounts
• Must be divided no later than last day of the
  year following the owners death.

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Home-Use Test Temp Absence
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• Short Temporary Absence Ok
• Generally if less than a year
• Even if rented while gone
• Own Home - Lives in a Disability Facility
• Physically lived in home at least one year
• Period in facility treated as living at home

Example 9-month vacation, rented home. Treated
as living in home even though rented while gone.
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Unsecured Election
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• Problem
• To the extent of Acquisition and Equity debt
  limits, home mortgage interest cannot be
  allocated to other uses.
• Solution
• Use the unsecured election which allows the
  interest to be allocated to the use of the funds.

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Unsecured Election
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• Strategies
• Business Use
• Investment Use
• Higher Education
• Pitfalls
• Irrevocable without IRS consent
• None can be allocated back to the home

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Rental Partial Exclusion
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• House Sold while Used as a Rental
• Previously was used as a home
• 13 months of the 60-Month look-back
• Exclusion applies to any sale of a principal
  residence.
• (13/24) x 250K 135,425 Exclusion or
• (396/730) x 250K 135,625 (200)
• Section 1031 could also apply.

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Employment Health Reduced Exclusion
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• Due to Change of Employment or Health Reasons of
  a Qualified Individual
• Qualified Individual
• Employment Health
• Taxpayer X X
• Spouse X X
• Co-Owner X X
• Home Resident X X
• Family Members No X
• Descendents No X

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Who Gets Education Credits?
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• The taxpayer who claims the exemption for the
  student gets the credit no matter who actually
  paid the tuition.
• Non-custodial parent
• Grandparents
• AGI Limitations
• AMT after 2006?

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Higher Education Interest
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Not Limited to Government Loans

• Cannot be
• Related party loans
• Mixed-use loans

• Can be
• Home equity loan
• use unsecured election
• Credit card debt
• Consumer loan

• Strategies
• Convert nondeductible interest
• AGI adjustment Avoids AMT issues
• Lower interest loans

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Electing Out of Hope Credit
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• The Hope credit cannot be claimed for more than
  two tax years, whether or not consecutive.
• Taxpayers can elect not to claim the credit in a
  particular year for a student.
• Whether or not a student has completed the first
  two years of post-secondary education for the
  year is determined on the first day of the year.
• Tuition can be prepaid for the first 3 months of
  the next year.
• Typical 4-Year Student

Tax Years
Academic Years
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Electing Out of Hope Credit
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First Year Generally only a part of the year
and tuition less than a full year. Solution A
Elect out for 1st year, wait for 2nd 3rd Years
Solution B Prepay the 1st three months of
the next year to increase amount available for
credit. Repeat pre-pays in 2nd year.
1
2

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Electing Out of Hope Credit
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AGI Phased Out Solution A Phase-out
automatically elects out, preserved for another
post-secondary year. Solution B Prepay the 1st
three months of the current year in the prior
year if possible and if AGI is below
phase-out. Low-Cost Local College First
Year Solution Elect out 1st Year take credit
in 2nd two years.
2

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Electing Out of Hope Credit
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• Divorced Parents
• Solution
• Alternate years claiming student.
• Elect out of Hope for the year non-paying spouse
  is claiming exemption.
• Lifetime credit can be claimed in the year
  electing out of Hope.
• Possibilities are endless just think them
  through!

2

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Coverdell or Sec 529?
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Coverdell
529 Plan Use Kindergarten Up
Post-Secondary Phase-out Yes
No Earnings Taxable No No
through 2009 Limits 2,000
200,000 Control
Limited Yes
Strategy - It may be to a taxpayers advantage to
place the first 2,000 contributed toward a
students education fund in a Coverdell and then
any additional amount can be set aside in a
Section 529 plan.
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AMT Itemizing
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Regular Tax
AMT Medical 7 AGI
10 AGI Taxes Yes
No Acquisition Debt Interest
Yes Yes Investment Interest
Yes Yes Equity Debt Interest Yes
No Charity Yes
Yes Tier I Misc Yes
Yes Tier II Misc
Yes No
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AMT Itemizing
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• If you take the standard deduction for regular
  tax, you cant itemize for AMT.
• You can elect to itemize even if the deductions
  are less than the standard.
• Strategy - Balancing act

Regular Tax increases when itemized deductions
are forced.
AMT decreases by being able to utilize itemized
deductions.
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Deductions Jointly-Owned Property
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• When two or more persons are jointly and
  severally liable for a debt, each is primarily
  liable for that debt, and each is entitled to a
  deduction for the interest on that debt that he
  or she pays (similar rule applies to property
  taxes).
• Strategies
• Parents and children
• Home ownership by unmarried individuals
• Same sex couples with joint home ownership where
  one works and the other does not or there is
  disproportionate contribution to household income

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IRD Estate Tax Deduction
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• Recognizing The Possibility
• IRD Income
• Estate Tax Paid
• Determining The Deduction
• Other Issues
• Tier 1 No 2 reduction OK for AMT
• Amortized deduction

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Capitalize Taxes - AMT
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.

• A taxpayer can annually elect to capitalize taxes
  for unimproved and unproductive real estate.
• Problem Taxpayer is subject to the AMT and gets
  no deduction for taxes.
• Solution Capitalize the taxes.
• Secondary Issue Investment interest limitations

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Deduct IRA Losses
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When a Traditional IRA has been totally
distributed and amounts received are less than
the individuals unrecovered basis in the
account, a loss is recognized. Example 6
annual nondeductible contributions of
2,000 Basis 12,000 Total Distribution
10,000 Loss 2,000 Other Issue Tier 2 Misc
Deduction (2 AMT)
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Medical Dependents
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• For medical purposes, an individual may be a
  dependent
• Meets all the requirements of dependency except
  the gross income test, or
• In the case of divorced or separated parents,
  even if the other parent claims the exemption.

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Decedents Unrecovered Basis
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• Problem Taxpayer dies before recovering entire
  basis in pension or annuity.
• Solution Unrecovered basis is deductible.
• Taken on final return
• Tier I Itemized No 2 and is OK for AMT
• Joint lives final return of last to die

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Variable Annuity Losses
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• If a nonqualified annuity and is cash-out, the
  loss from the annuity can be claimed as Tier 2
  miscellaneous deduction.
• Note
• Subject to the 2 of AGI limit.
• Thus, not deductible against the AMT.

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IRA Pension Fees
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• IRA and pension fees
• Taken out of pension funds no deduction
• Paid directly Tier 2 miscellaneous deduction
• Maximize IRA or pension strategy
• Miscellaneous deductions
• Subject to 2 limitation
• Not deductible against AMT

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Spousal Buy-Out Debt
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• Problem During a divorce, one spouse may exceed
  the acquisition and equity debt limits when
  buying out the other spouse.
• Creates interest deductibility problems
• Creates AMT problems with equity debt
• Solution Rev Ruling 88-74 Acquisition debt
• Secured debt
• Buy out spouses interest

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Refinanced Acquisition Debt
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• Problem Refinancing existing acquisition debt
  and extending the term of the debt.
• Solution Continues to be acquisition debt even
  though term has been extended and interest rate
  changed.
• Any additional debt is equity debt.

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Effect of Refinancing
2/2
Refinance
Represents Excess Debt
300K 200K 100K
Represents allowable Equity Debt
Both represent allowable Acquisition Debt
0 5 10 15 20 25 30
35 40 45
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Investment Interest Expenses
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• Problem
• Investment interest is deductible to the extent
  of net investment income (NII).
• Investment interest is deductible for both
  regular tax and AMT.
• Investment taxes and investment expenses are not
  deductible against the AMT.
• Solution
• If in the AMT (or even under the 2 misc floor
  for investment expenses), dont deduct the
  expenses or the taxes.

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Excess Accumulation Penalty
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• Problem Taxpayers forget to take their RMD.
• Trustee doesnt always provide reminders.
• 50 Penalty
• Solution
• Pay the penalty
• Request abatement
• Bottlenecks
• E-filing cant attach the abatement request
• Paper getting the IRS to notice the request

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Premature Distribution Medical Exception
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• Medical Exception
• Distributions that are equal or less then the
  un-reimbursed medical expenses that exceed 7.5
  of the taxpayer's AGI are exempt from penalty.
• Applies whether or not the taxpayer itemizes.
• No requirement that the distribution be made
  specifically to pay the medical expenses.

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True Safe-Harbor Payments
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• Only Real Safe Harbor
• 110 of the Prior Years Tax
• Requires evenly paid estimates
• Withholding treated as received evenly throughout
  the year. Can be used to make up for uneven
  estimates in earlier part of year.

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• Thank You For Having Me.
• Lee