WELCOME Welcome to the inaugural issue of Tax Beat. Tax Beat was created to inform our clients of tax changes, planning opportunities, and information that you might find relevant to your business’ or family’s future. If you have questions on any of these articles and how they might apply to you, please give us a call. Our success is your success.
Tax Beat does not have a regular schedule; it will be sent as seen relevant. If you would prefer to receive further issues via e-mail, please let us know by sending a quick e-mail to tax-beat@komisarbrady.com. In order to read the newsletter on your computer, you will need to have Adobe Acrobat Reader installed on your computer, which you can download free-ofcharge at www.adobe.com.
HEALTH SAVINGS ACCOUNTS
HSAs offer new opportunities to lower out-of-pocket costs for health care -
Health Saving Accounts (HSAs) were established in 2004 and will allow eligible individuals to cut their federal income tax bills and lower their out-of-pocket costs for health care. HSAs operate somewhat like the flexible spending accounts (FSAs) that some employers currently offer to their employees who want to defer part of their own money into an account on a pretax basis to be used later to reimburse themselves for out-of-pocket medical expenses. Unlike an FSA, however, whatever’s left in the HSA at year-end can be carried over to the next year. In addition, HSAs can be set up by the self employed or even a nonworking spouse.
HSAs are only available to individuals whose only health insurance coverage has a relatively high annual deductible. By that, we mean their health insurance coverage must come with at least a $1,000 deductible for single coverage or $2,000 for family coverage. However, for many self-employed individuals, small business owners, and employees of smaller companies, these thresholds will not be a problem. Eligible individuals can not be eligible for Medicare benefits or claimed as a dependant on another person’s tax return.
Individuals meeting those requirements can make a tax deductible contribution that is limited to the lesser of: 1) their insurance plan’s deductible amount (which must exceed the $1,000 single or $2,000 family coverage), or 2) $2,600 for single coverage or $5,150 for family coverage. These amounts will be adjusted for inflation and eligible individuals who are 55 or over can make a “catch up” contribution of $500. These contributions will need to be prorated when the high deductible policy is not owned the full year.
An HSA can be set up at a bank, insurance company, mutual fund company, or a brokerage house, and it does not need to be set up at the same company that offers the high deductible policy. The HSA must be established exclusively for the purpose of paying the account beneficiary’s qualified medical expenses. These include uninsured medical costs incurred for the account beneficiary, spouse, and dependants. However, for HSA purposes, health insurance premiums do not count as medical expenses.
The tax rules for HSAs are quite similar to IRAs. For example, individuals can make HSA contributions for a particular year as late as April 15th of the following year. In addition, federal-income-taxfree rollovers from one HSA to another are permitted (limited to one such rollover per 12month period.
This is just a quick overview of the HSA rules. If you’d like to know more about whether HSAs are right for you, please feel free to give us a call.
The HSA must be established exclusively for the purpose of paying the account beneficiary’s qualified medical expenses.
OPTIONS FOR SAVING FOR COLLEGE If you are planning to or are already saving for the cost of college for your children, a couple of alternatives to the traditional taxable accounts are becoming popular options, and a combination of the two might be the best option for you. Cover-dell Education Savings Accounts (Coverdell’s—they were formally known as Education IRA’s until they were renamed for the late Senator Paul Coverdell) and Section 529 Qualified Tuition Plans (529 plans) have been available for a few years now and their major advantage over the traditional taxable amounts is the tax free growth of the accounts.
Coverdell’s are funded with after tax dollars that grow tax free and can be withdrawn tax free to pay for higher education costs, as well as private elementary or high school or even for other “educational” expenses, such as a computer or camp. The Coverdell is self directed and can be opened at any financial institution in the US. Just like a regular IRA, you have until April 15th of the following year to make contributions, as opposed to 529 accounts in which you only have until December 31st.
Beginning in 2004, Coverdell’s and 529 plans are now both treated as parental assets and not student assets when determining financial aid.
The largest drawbacks of the Coverdell is that contributions are limited to $2,000 per year per beneficiary, no matter how many accounts are established in the beneficiary’s name. The other drawback is that you cannot contribute to a Coverdell account if your income is above $190,000 as a married couple or more than $95,000 if you are unmarried. This drawback, though, should not be factored into your decision, as you can give anyone whose income falls below the income limit (including your child) $2,000 and let them contribute to the account. The other drawbacks are that you can only contribute to the account as long as the beneficiary is under 18, and if the account is not used for education by the time the beneficiary is age 30, the proceeds are paid out to the beneficiary, subject to tax and 10% penalty.
Section 529 plans are established and run by states. They are also funded with after tax dollars that grow tax free. Withdrawals for qualified expenses – tuition, fees, room and board, books, and supplies are tax free, but the tax free status expires after 2010. Even though it is expected that Congress will extend or make tax free qualified distributions permanent, right now as of 2010, earnings will be taxed to the beneficiary when withdrawn.
The greatest benefits of 529 plans is the ability for anyone to put large amounts into the account as there is no income limitation and contribution limits for most states are in excess of $200,000, and the state tax deductions that a number of states including Wisconsin offers for contributions (Wisconsin offers a $3,000 deduction per year, per beneficiary for contributions to Wisconsin’s 529 plan). Besides no guarantee that the qualified distributions will be tax free after 2010, there are some other downsides to 529 plans. The states establish 529 plans and hire sponsors (mutual fund companies) to run them. States can change sponsors whenever they want and you will not be able to invest with that mutual fund company in the state’s 529 plan. Another downside is that your investment choices are limited to what is offered by the plan. With a Coverdell, you can choose any mutual fund company, brokerage house, bank, or other financial institution to invest with. The last downside is that expenses are usually higher in most 529 plans than in the equivalent mutual fund.
An option that might work for you is a combination of a Coverdell and a 529 plan where the first $2,000 per year is contributed into the Coverdell account and the rest into a 529 plan. You used to be forced to choose between a private tax-deferred savings account and a state-administered one; now they can be used in conjunction with one another. This combination will allow you to choose the investment you want for the first $2,000 per year, but will not limit your contribution to $2,000 per year. This approach might limit the amount you can take as a state tax deduction, but that needs to be weighed with the possible lower fees and the more choices and control that you would have.
Taxable custodial accounts in the child’s name are still an option, especially with the lower income and capital gain rates, but there are a few points to consider. At a certain age, your son or daughter gains control of the account and can spend it on anything they want (think back to when you were 21 and what you would have spent it on). For financial aid purposes, Uniform Transfers to Minors Act (UTMA) accounts are considered student accounts, and are weighted more heavily in the financial aid formula. Next, the lower tax rates are set to expire in 2010, increasing the tax on the earnings. Finally, if the child is under the age of 14 and makes over $1,400 of income, that income is subject to “kiddie tax” and will be taxed at the parent’s tax rate.
This is a small sampling of the factors that should be considered in determining what the right plan is for you. If you want further help to decide what might be best for you, please give us a call. At a minimum, choose one of the options, as saving something is always better than not saving at all.
NEW TAX LAW CHANGES President Bush signed the Working Families Tax Relief Act of 2004 and the American Jobs Creation Act of 2004. The Working Families Tax Relief Act extends some of the prior tax law changes that were set to expire after 2004 to 2010, and extends some business credits that were set to expire as well. Among the highlights of this bill are:
Child tax credit will remain at $1,000 per child
The 15% married filing joint tax bracket and the married filing joint standard deduction will remain at twice the single amount
The larger 10% bracket will remain
A larger Alternative Minimum Tax exemption was extended thru 2005
Educators can continue to deduct $250 of qualified expenses from their income thru 2005.
The largest portion of the American Jobs Creation Act is to correct an illegal trade subsidy written into the tax law and replace it with a new tax deduction for manufacturing and production activities which will effectively reduce the manufacturers top tax rate, but there are many other provisions in this act. Among the highlights of this bill are:
Extension of the increased first year Section 179 expensing ($100,000 plus adjustment for inflation) through 2007
Effective after the date of enactment (which is October 22, 2004), the amount of Section 179 first year expensing on a SUV or any vehicle weighing less than 14,000 lbs is capped at $25,000.
Qualified leasehold improvements to nonresidential real estate can be depreciated over 15 years through 2006. The old law depreciated qualified leasehold improvements over 39 years.
Individuals in 2004 – 2006 will have the option of deducting state sales tax instead of state and local income taxes as part of their itemized deductions. This will primarily benefit those who live in a state which does not have a state income tax.
Beginning in 2005, if you donate a vehicle to a charity that sells the vehicle without improving or using it, the charity is required to inform you of the proceeds from the sale, and the charitable contribution that you can take is limited to that amount. The “blue book” value can no longer be used to determine the fair market value of the donation.
Both of these summaries hit only the highlights, if you have further questions, or want to know how these tax law changes might affect you or your business, please give our office a call.
YEAR END TAX PLANNING As the end of the year gets closer, people think more about tax planning. A little bit of tax planning can often help you reduce the amount of tax you owe this year, but everyone needs to be aware of the potential “side effects” of tax planning actions.
Timing Income & Deductions
Timing Income & Deductions The most basic form of tax planning involves deferring income into the next year and accelerating deductions into the current year to lower your income in the current year. Examples of this technique involve postponing an IRA withdrawal, or prepaying your January mortgage payment in December of the current year. Lowering your income in the current year usually means increasing your income in the following year. The possible “side effect” of this type of tax planning is whether the increase in the following year’s income could increase the amount of social security that will be taxed, if you are receiving social security, and whether part or all of your child tax credit, college tuition credit, or the ability to make deductible IRA or Roth IRA contributions will be phased out. Tax planning needs to consider both the effect on the current year and the next so you can determine if you are ahead over the two year period.
Making the Most of Year End Selling If you have a portfolio of stocks and securities, a review of your portfolio should be undertaken. If you have some loser stocks that you would not mind unloading, the loss realized on the sale can benetted against capital gains, plus another $3,000. You need to be careful and not repurchase the same stock within 30 days before or after you sell the shares. That is called a wash sale, and this action will disallow the loss on the sale. There are no wash sale rules that deal with gains, so if you want to sell and take some of the profit out of a stock you hold; you can rebuy the stock right away.
If you have a stock that you want to sell at a gain, be sure to determine how long you have owned the shares. If you have owned them longer than a year, the gain is taxed at capital gain rates, a maximum of 15%. If you owned the shares for less than one year, the gain will be taxed at the ordinary income rates, a maximum of 35%. That 20% difference might be worth the risk net you a larger charitable contribution.
Donating Your Car
I am sure you have income and real estate taxes, heard many advertise-among other things and more ments asking you to donate your car to charity and get a charitable donation for the fair market value of the car. To determine the fair market value of the car, taxpayers generally refer to the blue book value of the car. Beginning in 2005, the IRS will not allow that method for cars that are donated to a charity and are not used or improved by the charity. Your charitable contribution will be limited to the proceeds that they receive on the sale of the vehicle. If you were thinking about donating your car to a charity that is going to sell the car and keep the proceeds, a donation in 2004 will probably net you a larger charitable contribution.
AMT & Other Tax Planning
AMT Other Tax Plannin Two other important parts of tax planning are to make sure that you have enough tax paid in using withholding and estimated tax payments, and to see if you are going to be subject to the Alternative Minimum Tax (AMT). Determining if you need to adjust your withholding or estimates up or down to avoid or limit an underpayment penalty is part of year end tax planning. We can help you. Having enough tax paid in is based upon what your tax was last year and what your projected tax will be this year.
AMT disallows deductions for income and real estate taxes, among other things and more and more people are being subjected to it. If you are going to be subject to the AMT, you might want to defer paying some real estate and income taxes until the following year, since you will receive no benefit by paying them in the current year. Sometimes this will make no difference if you are subject to AMT in the following year; however, if you can defer the payment to a year you are not subject to AMT, you will get a tax benefit from the deduction of these expenses.
Year End Tax Planning (continued from page 5) Capital Expenditure Planning for Your Trade or Business Above and beyond the Section 179 deduction, you can also claim first-year bonus depreciation equal to 50% of the cost of most new (not used) equipment and software acquired and placed into service by December 31, 2004. This first-year bonus depreciation deduction will expire at year’s end; it was not extended by either of the recently enacted tax law changes. Therefore, if you are planning new business related equipment or software purchases in 2005, you should consider accelerating the purchase into 2004 so the new equipment can be placed in service before December 31, 2004. There are other rules involved with both the Section 179 deduction and the 50% bonus depreciation. Please contact our office if you would like to learn more.
If you have any questions about year end tax planning, or think that you need a projection run to estimate you 2004 tax situation, please give us a call. We have the ability to project your tax under many different scenarios to help you decide the best course of action.
To ensure compliance with Treasury Circular 230, we are required to inform you that any advice concerning U.S. federal tax issues contained on this website is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code and was not written to support the promotion or marketing of any transaction or matter discussed herein. Application of tax regulations is specific to the individual or business and we recommend that you consult a qualified Komisar Brady tax professional for how the above information may apply to you.
