Tax Beat

June 2006 | Download

Welcome to another year of Tax Beat. As in the past, a new piece of tax legislation seems to be passed right around the time we are ready to put out a new issue, and this is no exception. Inside, we have highlighted some of the tax law changes that might affect you, both currently and in future years. Some of these changes could fundamentally change the way you plan for retirement or save for your children’s education.

As always, previous issues of Tax Beat can be found on our website, along with other helpful information. If you would rather receive further issues via e-mail, or if you have any other comments about the newsletter, please let us know at taxbeat@komisarbrady.com.

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NEW TAX LAW CHANGES
by Stephen Bjork, CPA

In May 17th, the Tax Increase Prevention and Reconciliation Act (TIPRA) was signed into law. This bill, among other things, extends some current tax provisions, stops some taxpayers from being subject to the alternative minimum tax, raises the age for which children are subject to the “kiddie tax”, and creates an important planning opportunity with regards to Roth IRA rollovers. This is more than likely not the last piece of tax legislation of the year, as some research and development and targeted employee credits along with other tax provisions are scheduled to expire at the end of this year. TIPRA extends the lower qualified dividend and capital gain tax rates through 2010, where their expiration date is aligned with the sunset of the tax cuts that originally took place in 2001. The rates will remain at 15% until 2010, with rates being 5% for those in the lowest tax brackets (in 2008 the rate falls to 0% for those in the lowest brackets).

Another provision that was extended for two years is the small business §179 expensing which was set to expire in 2007, but has been extended through 2009. This provision extends the inflation adjusted $100,000 first year expensing for purchases of certain business property. For 2006 the maximum amount is $108,000 which is decreased if a company places over $430,000 of certain business property into service in that year. If the provision expires in the future, the expensing limit will drop to $25,000. This provision allows small businesses more time to plan and to purchase business assets that they can expense in the current year. As in the past, the state of Wisconsin still caps its business expensing limit at $25,000.

On of the most publicized parts of TIPRA is the Alternative Minimum Tax (AMT) relief. The tax law change does not have the tax relief many people hoped for. A few years ago, the tax law was changed to adjust the AMT exemption amount for inflation. That inflation adjustment was set to expire in 2006, but with passage of TIPRA, the expiration date is pushed back to 2007. For 2006, those subject to AMT in 2005 will probably still be subject to roughly the same amount of AMT. For those who were not subject to AMT in 2005, unless items on your tax return significantly change in 2006, you still should probably not be subject to AMT. This “band-aid” solution only addresses 2006, so we can expect additional legislation in the next year.

One of the tax increases of TIPRA is the raised age of children subject to “kiddie tax”. Currently children under age 14 who have unearned income (i.e. interest, dividends, and capital gains) over $1,700 are taxed at their parent’s tax rate on amounts exceeding $1,700. TIPRA immediately raises the limit to age 18 retroactive to the beginning of 2006, meaning that children who were thought to be done with the kiddie tax could be subject to it again. Additionally, parents who had invested money in custodial accounts may not be able to take full advantage of the child’s lower tax rates. This change makes Coverdell Education IRAs and state sponsored §529 plans even more attractive to save for college as opposed to custodial accounts in the child’s name.

The part of the TIPRA that could have the largest impact is the waiving of the income limitation on Roth IRA rollovers in 2010. Currently higher income taxpayers can not contribute to or roll over a traditional IRA into a Roth IRA due to income limitations. Beginning in 2010, all taxpayers will also be able to convert a regular IRA into a Roth IRA. The new law also permits taxpayers who convert in 2010 to spread the income and resulting tax payments on the converted funds over two years-2011 and 2012. If you believe tax rates will be higher in the future than they are currently (all the tax cuts which began in 2001 are set to expire after 2010), this conversion will allow you to lock in current tax rates, and eliminate uncertainty about the taxation of your retirement assets. Another benefit of a Roth IRA is that, during your lifetime, you are not required to withdraw money out of a it, as opposed to other retirement accounts which have required minimum distributions when you reach a certain age. Amounts can only be converted from a traditional IRA (not an employer sponsored retirement plan such as a 401(k), SEP, or pension plan), and generally you should not use funds from the IRA to pay the tax. Otherwise, you may subject yourself to premature distribution penalties.

If you are currently phased out of a Roth IRA, and would like to take advantage of the conversion, but do not have a traditional IRA account, or you would like to increase the amount that could be converted to a Roth IRA, a strategy you could use would be to make nondeductible IRA contributions for 2006 through 2009 (if you are under age 50, you can contribute a maximum of $18,000 over the 4 years, if you are age 50 or older, you can contribute a maximum of $22,000). In 2010, you can convert your nondeductible IRA and pay the tax on the difference between the value of the account on the day of conversion and the amount contributed to the account (since contributions to a nondeductible IRA uses after tax dollars, only the appreciation and income earned is taxable upon conversion). The tax on the conversion can be spread over two years, and by paying the tax on the income and appreciation of 4 years, you will own a Roth IRA on which you will never pay another dollar of tax. If you are married, your spouse can also take advantage of this technique.

There are many other provisions of TIPRA, and this summary addresses only the highlights. If you have further questions, or want to know how the tax law changes might affect you or your business, please give our office a call.

YOU CAN END THOSE CREDIT CARD SOLICITATIONS!
If you are like most of us, you probably receive several credit card solicitations offering pre-approved lines of credit every week. These solicitations are called “firm offers of credit,” and under the Fair Credit Reporting Act (FCRA) the Consumer Credit Reporting Companies (Equifax, Experian, Innovis, and TransUnion) are permitted to include your name on lists used by creditors and insurers to make firm offers of credit or offers of insurance to you. You, as also provided by the FCRA, have the ability to “opt out” (either permanently or for 5 years) and have your name removed from these lists.

There are several benefits of receiving these prescreened offers (you are provided with product choices, learn about and have the opportunity to take advantage of offers that may or may not be available to the general public, and you can “comparison shop” offers which may increase your buying power), but if you are worried about possible identity theft as a result of receiving these offers, or are just tired of receiving them day after day, you can request to “opt out” of these offers either at www.optoutprescreen.com or by calling 1-888-567-8688.

www.optoutprescreen.com is the official Consumer Credit Reporting Industry’s website created to accept these “opt-out” requests. Signing up will not increase or decrease your credit score, nor will it affect your ability to apply for credit or insurance. “Opting Out” will also not prevent companies that you authorized from looking at your credit information and receiving the information they need.

SOLO 401(k) PLANS - ARE THEY FOR YOU?
“What is the best way for me to save money for my retirement?” asked a client. We as CPAs are asked this question many times and the answer is, “It depends.” There are many factors to consider before recommending a type of retirement savings plan for someone. For many self-employed people the retirement plans of choice have been the Simplified Employee Pension (SEP) or SIMPLE IRA. A recent tax law change created a new opportunity for the self-employed to save more money for retirement using a variant of the popular 401 (k) plan.

Commonly called an Individual 401(k) or Solo 401(k), the plan is designed for self-employed individuals and corporations who do not have any employees other than a spouse. Many of the discrimination rules to protect employees that apply to standard 401(k) plans do not apply to a Solo 401(k) which simplifies administration. The plan also works well for people who do a great deal of freelance work in addition to their normal employment but are not covered by any other retirement plan. Plans must be established in the tax year of the deduction but contributions are not due until the tax return is due, including extensions.

As with a standard 401(k), contributions to the plan are comprised of employee and employer contributions, with an overall contribution limit for 2006 of $44,000 for individuals under age 50 or $49,000 for individuals age 50 or over. The employee portion can be up to 100% of self-employment income to a maximum of $15,000 (same limit as the standard 401(k)). The Solo 401(k) also allows people age 50 or over to make “catch-up” employee contributions of up to $5,000 for a total of $20,000. The employer contribution is calculated in the same manner as a SEP contribution. If you compare the maximum contribution allowed for a self-employed individual over the age of 50 with $100,000 of income, you can see how much more income can be deferred in a Solo 401(k) as opposed to a SEP or SIMPLE IRA.

Other advantages to the Solo 401 (k) are:

• Access to loans from the plan. SEP and SIMPLE IRA plans do not allow for loans.
• Relatively easy setup and inexpensive administration.
• Catch-up contributions available if age 50 or over.
• Funding is completely discretionary. There are no mandatory contributions.
• Can consolidate multiple retirement accounts into one account to take advantage of larger investment opportunities.
  
• Potential ability to exclude part-time employees otherwise required to be covered under a SEP or SIMPLE IRA.

Some drawbacks to the plan are:

• An annual tax return is required if assets in the plan exceed $100,000.
• The plan may need to cover employees if they satisfy certain hours of service requirements.
• The plan document needs to be in compliance with current law, so it may require amendments from time to time.

The Solo 401(k) plan offers self-employed people and single employee corporations a chance to save a greater amount of money for retirement than other types of retirement plans with a minimal amount of additional hassle. If you would like addition information or an analysis of your retirement plan please give us a call.

NEW WISCONSIN MINIMUM WAGE
In June 1, 2006, Wisconsin minimum wage for adults (age 18 or older) increased from $5.70 per hour to $6.50 per hour. The minimum wage for minors (under the age of 18) increased from $5.30 per hour to $5.90 per hour. Wisconsin’s minimum wage rule changes also contain a number of specialized pay rate adjustments for persons employed in certain types of work, including camp counselors, golf caddies, and agricultural employees. Please contact us if you need more information on these employees. Despite the law changes, there was one rule that did not change. The minimum wage rate for Wisconsin tipped employees will remain the same. The minimum rate for a tipped employee is $2.33 per hour; however, an employer can only pay this minimum rate if the employer is able to establish by payroll records that the tips plus wages paid equal or exceed the new minimum wage rates ($6.50 per hour for adults and $5.90 per hour for minors). If the employer pays the tipped employee $2.33 per hour and the employer is later unable to substantiate via payroll records that the new minimum wage rate has been paid to the employee, the employer will be responsible for back pay necessary to get the employee to the new minimum rate.

If you have any questions regarding minimum wage rules or you would like us to review your payroll records for substantiation purposes please feel free to contact us.

BEWARE OF IRS E-MAILS
The IRS does not currently communicate by email with taxpayers. If you receive an email from the IRS, it is a fraudulent email phishing for information. Phishing is an email trick where an email claiming to be from a legitimate enterprise is sent to a user. The fraudulent email attempts to scam the user into providing private information to identity thieves. These emails can look rather official, often times using official-looking graphics and logos. The fraudulent IRS emails going around contain the official IRS logo, and are in regard to the status of your tax refund or additional refunds you might be eligible for. The fraudulent email instructs that to obtain the status of your refund you must follow the link to enter in your social security number and other personal information including bank account numbers and ATM card PIN’s.

To avoid phishing scams, be suspicious of any email with urgent requests or requesting personal information, especially from emails that are not personalized to you. If you suspect that the email is not authentic, do not use the link in the email to get to the web page. Either call the company or type the web address directly into your browser. If the email is fraudulent or you suspect it is, forward it to the company or institution, so they can work on shutting down these schemes and prevent others from being victimized.

FURTHER INFORMATION ON ENERGY INCENTIVE TAX BREAKS
by Bill Wright

Last fall Congress and the President passed the Energy Tax Act which expands the tax breaks available for the purchase of qualified hybrid vehicles and also provides for significant tax incentives beginning in 2006 and lasting through 2007 to homeowners and businesses that install energy saving products in their residences or buildings. Included in this article is further clarification of what qualifies for the credits.

HYBRID VEHICLES
Over the past few years the federal government has encouraged the increased use of hybrids by providing deductions to those who purchased these vehicles. Now with the passage of this new legislation, the deduction has given way in 2006 to a more generous credit. Credits are generally more valuable than deductions as they reduce your tax dollar for dollar rather than a percentage based upon your tax rate. The hybrid credit ranges from $650 to $3,150 depending upon the vehicle and when you make your purchase. Here is a current list of vehicles and the maximum tax credit available for each:

• y 2006 Ford Escape Hybrid 4WD: $1,950
• y 2006 Ford Escape Hybrid Front WD: $2,600
• y 2006 Lexus RX400h 2WD: $2,200
• y 2007 Lexus GS 450h: $1,550
• y 2006 Mercury Mariner Hybrid 4WD: $1,950
• y 2005 Toyota Prius: $3,150
• y 2006 Toyota Highlander 2WD Hybrid: $2,600
• y 2006 Toyota Highlander 4WD Hybrid: $2,600
• y 2005-6 Toyota Prius: $3,150
• y 2007 Toyota Camry Hybrid: $2,600
• y 2005-6 Honda Accord Hybrid AT: $650
• y 2006 Honda Accord Hybrid AT: $1,300 (without updated control callibration qualifies for a credit amount of $650)
• y 2005 Honda Civic Hybrid (SULEV) CVT & MT: $1,700
• y 2005 Honda Civic Hybrid (SULEV) CVT & MT: $1,700
• y 2006 Honda Civic Hybrid CVT: $2,100
• y 2005-06 Honda Insight CVT: $1,450

Also, Chevrolet/GMC, Nissan, and Saturn will be bringing hybrid vehicles to market soon that should qualify for the credit.

The full credit is available if you purchase a hybrid vehicle before the end of the first calendar quarter after the quarter in which the manufacturer sells its 60,000th hybrid vehicle. After that date the credit phases out and a reduced credit is available over the next fifteen months.

The IRS has yet to provide guidance on three important issues that could affect how much of a credit you could potentially receive: the rules for which a lessor of a hybrid can claim the credit, the rules preventing the credit from offsetting the alternative minimum tax, and what if any of the credit will have to be recaptured upon sale of the vehicle.

Installation of Energy Efficient Products
While many may be aware of the energy tax breaks for hybrid cars, the tax breaks for installing energy efficient products in your home are less well known. These breaks vary depending on whether you are a businesses or individual.

For homeowners a maximum $500 annual credit may be taken for “residential energy property expenditures, or ten-percent of the cost of “qualified energy efficient improvements, or a combination of both. “Residential energy property expenditures” include:

• Up to $150 credit for any energy-efficient qualified natural gas, propane, or oil furnace or hot water boiler that has a 95% or greater AFUE rating (Annual Fuel Utilization Efficiency)
• Up to $50 credit for purchasing a replacement gas or oil furnace incorporating an “advanced main air circulating fan” regardless of the furnace’s AFUE rating. If the furnace has both an AFUE rating of 95% or higher and incorporates the “advanced main air circulating fan”, both the $50 and $150 tax credits may be claimed.
• Up to $300 credit for energy-efficient building property. This includes electric and geothermal heat pumps (both open loop and direct expansion), central air, and natural gas, propane, or oil water heaters. Central air conditioners must have a SEER rating (Seasonal energy efficiency rating) of 12 or higher. Water heaters must have a Energy factor of 0.80 or higher. Currently only gas tankless water heaters meet that requirement.

These products will be labeled as to their particular rating and you will find that those that qualify will often be advertised as such at your local home improvement stores. For a more detailed list of qualifying products you can visit the Energy Star website and follow the links for products and tax credits or type in www.energystar.gov/index.cfm?c=products.pr_tax_credits

“Qualified energy efficiency improvements” allow for a credit of 10% of the purchase and installation costs for components in the home that satisfy the 2000 IEC (International Energy Conservation) Code. Components include insulation materials, exterior door and windows, and metal roofs with special pigmented coatings. The exterior windows may include skylights and storm windows but are limited to a credit of $200.

Only energy-efficient improvements to your principal residence qualify for these credits. You may install the products yourself, but you will need to prove the date of installation and you cannot include the cost of your own time in determining the cost to calculate the credit. Remember that not only do these products qualify for a tax credit; they also cut your energy costs significantly, providing for increased savings down the road.

If you own commercial property, the new tax act offers a maximum deduction of $1.80 per square foot of the building for improving energy consumption. In order to qualify the property must be:

• Depreciable
• Installed as part of the interior lighting system, the heating, cooling, ventilation and hot water systems, or the building envelope, and
• Installed based on a plan to reduce total annual energy and power costs by 50% or more. (Although it appears a reduced deduction will be available to those that reach specific energy-efficient goals while not reaching the 50% mark).

Whether the qualified improvement is done to your residence or to commercial property, the IRS has not yet provided exact details on how and what information must be reported in order to receive the credit. We strongly encourage anyone who purchases or installs any of these products to retain all documentation until such a time as we have more detail. In the meantime if you need more information please call us anytime and we will be happy to answer your questions.

PHONE EXCISE TAX ENDED - REFUNDS TO BE ISSUED
After repeated losses in court, the IRS has finally conceded its battle to keep collecting the federal
excise tax on long-distance telephone services. Beginning July 31, consumers will stop paying a 3% excise tax on long-distance and bundled services. Not only will the tax cease going forward, but by using their 2006 federal income tax return, consumers can request a refund for back excise tax paid since March 2003 and interest will be paid on the refund. To request a refund, individuals and businesses must substantiate the amount being requested, but the IRS will refund individuals a “safe harbor” amount (to be announced) which will not require any documentation. No “safe harbor” amount is proposed for businesses; therefore, they will be required to substantiate the amount of their refund request. The federal excise tax on local telephone service is still in place, but signs point to it also being repealed, this time through congressional action.

Due to the suddenness of this news, many of the details are still being worked out by the IRS as well as by the phone companies. Our recommendation is to review your phone bills and make sure that after July 31 you are no longer being charged this excise tax. Be sure to save your old bills to use in the calculation and substantiation of the refund amount you will request even though we believe that the majority of individuals will opt for the “safe harbor” refund amount once all the details are worked out.

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.