Year-End Tax Planning Quicklist

  •  If you have any capital gains or losses from sales of stock or other capital assets or you have stock or other capital assets that are ripe for sale, coordinate timing your gains and losses to minimize tax on your gains and maximize the tax benefit from your losses. (See item 25.)
  • If you or a family member are thinking of selling appreciated stock or other capital assets, and your (or their) income is not taxed at a rate higher than 15%, it may pay to defer the sale until 2008. By deferring you may pay a zero tax on the gain, while selling this year could result in a 5% tax on the gain. (See first planning tip under “Tax-Efficient Investment Strategies,” page 11.) 
  • If you own an interest in a pass-through entity (e.g., partnership, S corporation), you may need to increase your tax basis in the entity so that you can deduct current year losses. (See item 53.) 
  • Consider using a credit card to prepay expenses that can generate deductions for this year. (See item 49.) 
  • If you are contemplating making energy-saving improvements to your home, such as installing energy-saving windows or putting in extra insulation, consider doing so before year-end in order to qualify for a tax credit that may not be available after 2007. (See item 62.)
  • If you are thinking of buying a hybrid vehicle eligible for a tax credit, purchase it before year-end after confirming that the particular model still qualifies for the credit. The credit phases out after the manufacturer has sold a certain number of qualified vehicles. (See item 62.)
  • In order to maximize a potential casualty loss deduction this year you may want to settle an insurance or damage claim.
  • Reduce or eliminate a penalty for underpayment of estimated tax by increasing your withholding. (See item 58.)
  • If you are self-employed, consider setting up a self-employed retirement plan. (See item 19.)
  • You may be able to save taxes this year and next year by applying a bunching strategy to “miscellaneous” itemized deductions, medical expenses and other itemized deductions. (See item 50.) 
  • Gift and estate taxes can be saved by making gifts before the end of the year. (See item 57.) 
  • If you are considering donating a used auto to charity, you may want to inquire whether the charity plans to sell the car or use it in its charitable activities; the latter may yield a bigger deduction for you. (See item 46.)
  • If you are contemplating marriage or divorce, consider how marriage “penalties” may affect you.
  • This year, the kiddie tax rules apply to children under age 18; in 2008 they will also apply to most children age 18 and most fulltime students age 19 through 23. If your child holds appreciated stock, and is not in kiddie tax territory this year but will be next year, consider having him or her sell the stock this year. In many cases this will result in a 5% tax on the gain, instead of 15% if the sale is postponed until next year. (See item 57.)
  • Depending on your particular situation, you may also want to consider disposing of a passive activity to allow you to deduct suspended losses. (See item 52.)
  • If you are age 70½ or older, and own IRAs (or Roth IRAs), and are thinking of making a charitable gift before year-end, arrange for the gift to be made directly by the IRA trustee. Such a transfer can achieve important tax savings but, under current law, it will not be available after 2007. (See item 47.)
  • Consider asking your employer to increase withholding of state and local taxes to pull the deduction of those taxes into this year (but, as always, make sure that doing so will not increase your exposure to the AMT). (See state and local taxes under item 50.)
  • Consider extending your subscriptions to professional journals, paying union or professional dues, enrolling in (and paying tuition for) job-related courses, etc., to bunch into 2007 miscellaneous itemized deductions subject to the 2%-of-AGI floor (again, making sure that doing so will not increase your exposure to the AMT). (See item 50.)
  • For businesses, consider making expenditures that qualify for the $125,000 business property expensing option. (See item 6.) It is our hope that you will find this guide informative and useful, and we encourage you to consult with us.

Tax Changes First Effective in 2007

In recent years, President Bush signed into law various tax legislation, namely the Tax Increase Prevention and Reconciliation Act of 2005 (“TIPRA”), the Pension Protection Act of 2006 (“PPA”), and the 2007 Small Business Act (the “SBA”). Below we have summarized the most significant provisions affecting individuals for the first time in 2007, together with tax planning strategies.

1. SELL OR EXCHANGE SELF-CREATED MUSICAL COMPOSITIONS OR COPYRIGHTS IN MUSICAL WORKS IN 2007. TIPRA included a favorable provision for these types of assets. Under pre-TIPRA law, literary, musical, or artistic compositions, letters or memoranda, or similar property held by a taxpayer whose personal efforts created the property, were not treated as capital assets. For example, when a taxpayer sold copyrights he owned in songs he created, gain from the sale was treated as high-taxed ordinary income rather than low-taxed capital gain.

Under TIPRA, at the election of the taxpayer, the sale or exchange of musical compositions or copyrights in musical works created by the taxpayer’s personal efforts is treated as the sale or exchange of a capital asset. This change is effective for sales in tax years beginning after May 17, 2006 (in general, for tax years beginning January 1, 2007 for individuals) for sales that occur prior to 2011.

2. TAKE QUALIFIED PLAN DISTRIBUTIONS IN 2007. PPA provides that, for distributions after 2006, nonspouse beneficiaries may directly rollover amounts inherited to an IRA structured for such purposes, Under pre-PPA law, only participants and surviving spouses were able to rollover amounts from qualified plans, 403(b) annuities, and IRAs to another plan or IRA; nonspouse beneficiaries were not eligible to rollover inherited amounts.

3. MAKE A TAX SIMPLIFICATION ELECTION FOR HUSBAND-WIFE PARTNERSHIPS. Prior to the SBA, a husband-wife joint venture that was treated as a partnership for federal tax purposes was required to file Form 1065, U.S. Return of Partnership Income, annually, and issue each spouse a separate Schedule K-1. Filing the Form 1065 and issuing the Schedules K-1 increased tax compliance costs. Prior to the SBA, only qualifying husband-wife ventures in community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin) were afforded similar relief.

The SBA now allows some husband-wife ventures to “elect out” of the partnership rules for federal tax purposes. To be eligible, the spouses must file jointly, and the husband-wife operation must be a qualified joint venture, which means a trade or business operation where: (1) the husband and wife are the only members of the venture, (2) both spouses materially participate in the trade or business, and (3) both spouses agree to elect out of the partnership tax rules.

After electing out, each spouse must report his or her share of the federal income tax items from the venture on the appropriate IRS form (e.g., on a separate Schedule C for each spouse). Similarly, each spouse must report his or her share of net selfemployment income from the venture on a separate Schedule SE (each spouse will receive credit for that SE income for Social Security benefit eligibility purposes). The new elect out option is available for tax years beginning after 2006. To the extent that a state follows federal law, or elects to follow this provision, state tax compliance savings may also result.


IRS Audit Letters Issued in October 2007

In the Summer 2005 edition of the Tax Accounting Review, we reported that the IRS intended to step up its audit efforts by increasing the number of audits, moving to a risk-based audit system using statistical data compiled from returns and other public information, and by instituting the National Research Program (NRP), in which thousands of randomly selected taxpayers would be subject to intense line-by-line audits. Furthermore, in the Summer 2007 edition of the Tax Accounting Review, we discussed the increased audit risk for various taxpayers as well as the items that increase that risk. Creating the NRP was in response to the growing “gross tax gap”, which is the difference between what taxpayers should pay and what they actually do pay on a timely basis, which the IRS estimated to be $290 billion for tax year 2001. Research derived from the prior NRP study was used by the IRS in updating its audit selection system.

As a result of the completion of the most recent NRP, the IRS announced plans to examine approximately 13,000 randomly selected 2006 individual returns, and to continue with similar sample sizes for subsequent tax years.

Under the new NRP study the initial group of targeted taxpayers began receiving official letters in October informing them that they had been selected for the new research program. For most taxpayers this will involve an in-person audit with an IRS examiner who will confirm the accuracy of specific lines on their returns. Some individuals selected may avoid contact with the IRS if they can obtain matching and third-party data confirming the accuracy of their returns.

In addition to the NRP for individuals, the IRS is also completing a compliance research project examining reporting compliance of S corporations. This segment of the research project includes approximately 5,000 S corporation returns for tax years 2003 and 2004.

Should you receive an audit notice, please let us know. Please also feel free to contact us if you have any questions regarding this IRS audit initiative.

Issues that Congress May Tackle by December 31, 2007

According to the most recent Congressional Research Service (CRS) Report for Congress, the legislative agenda for the remainder of 2007 could include discussing a permanent solution to the AMT, the possible extension of tax cuts initially enacted in 2001, and revenue offsets to partially pay for these items.

Without a change in the AMT law, an estimated 20 million additional taxpayers will owe additional tax in 2007. Although taxpayers are permitted an exemption amount in calculating their AMT, the exemption is fixed at a flat dollar amount that does not include the inflation-indexed features that are common to other provisions in the tax law, such as the income tax brackets and qualified plan contributions. According to the CRS, recent rate reductions and tax decreases for married couples, as well as other tax cuts, have magnified the problem. In addition, the exemption amounts have reverted, in 2007, to the pre-Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) amounts of $45,000 and $33,750 for couples and singles, respectively, which results in more taxpayers being subject to it.

Sen. Chuck Grassley (R-Iowa) supports the Individual Alternative Minimum Tax Repeal Act of 2007, which would permanently repeal the AMT without any offsetting revenues. Repealing the AMT, without offsets, is expected to cost more than $1 trillion. A similar bill, H.R. 1366, was introduced in the House of Representatives and referred to the Committee on Ways and Means. Under Sen. Grassley’s proposal, in computing tax for purposes of the penalties in the tax code dealing with underpayment of estimated tax, a taxpayer would be permitted to disregard the AMT if the individual was not liable for the AMT in the preceding tax year.

In October, House Ways and Means Committee Chair Charlie Rangel (D-N.Y.) said that he will introduce the details of two separate pieces of tax legislation: (1) a “stop-gap” bill that would contain a one-year AMT patch and a group of popular tax extenders; and (2) the “mother of all reform bills” that would contain provisions to permanently eliminate the AMT, cut the corporate tax rate, and raise taxes on upper income wage earners.

As a result of Congress’ attention to the pressing AMT tax policy and revenue concerns, year-end planning may turn out to be more of a “last-minute” challenge this year.


 Consider exercising incentive stock options (ISOs), also known as statutory options. The special tax treatment afforded to taxpayers for regular tax purposes when an ISO is exercised includes no taxation at the time the ISO is exercised, deferral of tax on the benefit associated with the ISO until disposition of the stock, and taxation of the entire profit on the sale of stock acquired through ISO exercise at the lower longterm capital gain rates (maximum 15% federal tax rate) as long as you hold the option for more than two years from date of grant and one year from date of exercise. Employment taxes do not apply on the exercise of an ISO.

Manage your AMT risk. While exercising ISOs could trigger AMT, the AMT may be avoided with careful planning. For example, for tax year 2007, the potential AMT harshness may be ameliorated by the availability of a partial refund for unused AMT credits that are more than three years old. In addition, disqualifying dispositions of incentive stock options can be used for AMT purposes. Assuming the exercise of the ISO creates an AMT liability, the sale of some or all of the securities obtained through the exercise of the ISO prior to the end of the year in which the options were exercised (otherwise known as a disqualifying disposition) may provide meaningful benefits. First, even though any gain on the sale would be subject to ordinary income tax, the amount of the ISO creating the AMT liability will be reduced and possibly eliminated. Secondly, the proceeds realized from selling the securities can be used to make an estimated tax payment to cover some or all of the AMT liability created by the exercise of the ISO. See the discussion on Page 11 concerning the AMT and methods to manage this secret tax. Incidentally, federal income tax withholding is not required on disqualifying dispositions.

As you can see, these technically complex ISO rules require careful tax planning strategies. Please call if you would like to discuss any of these matters in more detail.

Take advantage of deferred compensation contributions to maximize the benefits of deferring income. Annual limits for compensation must be taken into account for each employee in determining contributions or benefits under a qualified retirement plan. For 2007, the limit, as adjusted for inflation, is $225,000. This means that, for an executive earning $300,000 a year, deductible contributions to, for instance, a 15% profit-sharing plan are limited to 15% of $225,000 or $33,750. But there is a way to avoid this limitation which you might want to consider.

Benefits that are not subject to the qualified plan limitations can be provided through Nonqualified Deferred Compensation (NQDC) agreements. These deferred compensation agreements are contracts between an employer and an employee for the payment of compensation in the future—at retirement, on the occurrence of a specific event (such as a corporate take-over), or after a specified number of years, in consideration of continued employment by the employee.

Unlike a qualified plan, these NQDC plans are funded at the discretion of the employer and are subject to the claims of creditors. Essentially, the trust is under the employer’s control, and, structured properly, will result in a deferral of income taxes for the employee on the amount of compensation deferred above the traditional limitations. Although the recent IRC Sec. 409A regulations have imposed additional requirements on NQDC plans, these plans still may provide valuable benefits to corporate executives.

Consider filing an IRC Section 83(b) election with regard to year-end restricted stock grants to preserve potential capital gain treatment. If you make the election within 30 days of the grant you will pay income taxes currently on the spread between the market price (the value of the stock) and the grant price (the amount you paid for the stock). The benefit, however, is that you defer taxation on the future appreciation in the value of the restricted stock until the stock is sold and the post-election increase in the stock’s value is taxed at the lower capital gain rates rather than the higher ordinary income rates. The risk with making the election, however, is that the stock price might decline by the vesting date and you will have then prepaid income tax on an unrealized gain. The rules governing restricted stock awards are technically complex and call for some careful tax planning strategies to be used. Please call if you would like to discuss any of these matters in more detail.

Opt for a lump-sum distribution of employer stock from a retirement plan. Employer stock distributed as part of a lumpsum distribution from a qualified plan is taxed based on the plan’s basis in the stock rather than on its value, unless a taxpayer elects otherwise. Consequently, assuming the value of the stock exceeds its cost, the tax on the unrealized appreciation is deferred until a later date, when the stock is sold. This could be many years after receipt of the employer stock. As an added benefit, when the stock is sold at a later date the gain is subject to tax at the more favorable long-term capital gains rate. Cash or other non-employer stock distributed as part of the lump-sum distribution will be taxed at ordinary income tax rates.

Implement strategies associated with international tax planning. For executives on assignment in foreign countries, consider implementing strategies that will reduce your individual tax costs, such as maximizing the new foreign earned income and housing exclusion provisions. Also, the preparation of tax equalization calculations may be necessary to attract and retain key talent.

Consider engaging a new tax service provider. Corporate executives in a financial oversight role within their companies may need to select a new tax service provider in order to comply with rules that require executives to utilize tax service providers other than the company audit firm, thereby avoiding any potential conflicts of interest. These rules were adopted by the Public Company Accounting Oversight Board (PCAOB) and require that the auditor’s firm not prepare the tax returns or provide tax planning advice to the corporate executives of their public company audit clients. We anticipate that there will be increased scrutiny regarding the nature of services provided by CPA firms to private companies and we recommend that these companies also separate tax and audit service providers.

We administer a flexible Executive Tax Assistance Program (ETAP) designed for corporate executives, providing comprehensive, confidential and highly personalized individual and business tax preparation, planning and consulting services. The principal objectives of ETAP are to streamline interaction between the busy executive and needed advisors and to assist the executive in achieving tax, financial and related objectives. This is accomplished through a coordinated approach delivered by a primary core of specialists intimately familiar with, and taking a personal interest in, the executive’s tax and related financial objectives. The result of our ETAP is more effective solutions and greater peace of mind for the busy executive without the conflict-of-interest risks presented by the dual activities of the employer company’s auditors performing tax services for company personnel. Should you have any questions in connection with our ETAP, please feel free to contact us. We would be pleased to assist you

 Words of Caution

Whether you should accelerate taxable income or defer deductions between 2007 and 2008 largely depends on your projected highest (formally known as “marginal”) tax rate for each year. While the highest official marginal tax rate for 2007 and 2008 is currently 35%, your actual highest rate may be greater as a result of the phaseout of itemized deductions and personal exemptions. Chart 1 summarizes the tax rates together with corresponding taxable income levels. A change in taxable income of $1 can catapult you into the next higher or lower bracket. Effective management of your tax bracket can provide meaningful tax savings.

Tax Planning Strategies for Businesses

Below are some of the most attractive business-oriented yearend tax planning strategies.

4. SELECT THE APPROPRIATE BUSINESS AUTOMOBILE. For business cars first placed in service in 2007, the ceiling for depreciation deductions is $3,060. Higher deductible amounts apply for certain trucks and vans (passenger autos built on a truck chassis, including SUVs and vans). Vehicles such as SUVs and vans with gross vehicle weight ratings of between 6,000 pounds and 14,000 pounds are eligible for unrestricted first-year depreciation, in addition to the $25,000 that is allowed to be expensed under IRC Section 179.

By way of comparison, the $35,000 in deductions for the SUV reflected above compares favorably with a passenger automobile costing $75,000 and placed in service before the manufactures, grows, produces or extracts; construction; producing software, film, or videotape; farming; and processing agricultural products and food. Furthermore, businesses engaged in certain civil engineering or architectural services also may qualify for the deduction.

Accordingly, business owners who qualify for the U.S. production activities deduction should look at their compensation policies and consider increasing owner salaries, assuming these salaries qualify as production salaries, to make sure that their deduction is not limited. Furthermore, since the deduction is based on net income from qualifying activities, they should look at their accounting systems to be sure the systems will allow them to determine the income from qualifying activities, including expenses directly related to or allocable to the activity. If the system does not do that, some modifications to the system may be in order.

10. ESTABLISH AN ACCOUNTABLE EXPENSE REIMBURSEMENT PLAN. Employers are allowed to deduct, and employees are allowed to exclude from gross income, employer expense reimbursements if paid under an accountable plan. Accordingly, both the employer and employee benefit with an accountable plan. Since the maximum corporate tax rate of 38% exceeds the maximum individual tax rate of 35%, additional tax savings may also result.

11. IMPLEMENT A COST SEGREGATION STUDY. To maximize your depreciation deductions, implement a cost segregation study. By properly identifying and pricing nonstructural components and land improvements separately from your building, you can materially increase your depreciation expense deduction.

12. CONSIDER THE ADVANTAGES OF EMPLOYING YOUR CHILD (OR GRANDCHILD). Employing your children (or grandchildren) shifts income from you to them, which typically subjects the income to the child’s lower tax bracket and may actually avoid tax entirely (due to the child’s standard deduction). There are also payroll tax savings since wages paid by sole proprietors to their children age 17 and younger are exempt from both Social Security and unemployment taxes. Employing your children has the added benefit of providing them with earned income, which enables them to contribute to a traditional IRA. Better yet, making contributions to Roth IRAs on income shielded by the child’s standard deduction is tax-free now and, in general, will be tax-free upon distribution.

13. DON’T OVERLOOK YOUR BUSINESS TAX CREDITS. Credits are dollar for dollar reductions in tax and are much more valuable than deductions (which are valued at the corporate tax bracket of up to 38%). Employers can claim the Work Opportunity Tax Credit (“WOTC”), a 40% credit for the first $6,000 of wages paid to each employee, if they hire individuals from designated target groups.

14. PERFORM A COMPENSATION STUDY. Businesses can maintain deductibility, yet avoid payroll taxes, on compensation moved from salary to fringe benefits. Employees will enjoy the tax savings resulting from lower taxable compensation. Benefits typically shifted include medical insurance, parking and employee discounts. This may be a positive way to attract and retain employees. Keep in mind, however, and as noted above, that the deduction for U.S. production activities is limited by the amount of wages paid to employees, so shifting amounts from compensation into fringe benefits may reduce that deduction.

15. ESTABLISH CAFETERIA PLANS (A.K.A. SECTION 125 PLANS OR FLEXIBLE SPENDING ACCOUNTS). These plans provide an IRS-approved way to lower taxes for both employers and employees, since they enable employees to set aside, on a pre-tax basis, funds from their paychecks for adoption expenses, certain employer-sponsored insurance premium contributions, dependent care costs and unreimbursed medical expenses. Furthermore, Section 125 plans are allowed to offer salary-reduction Health Savings Account (“HSA”) contributions for eligible employees as part of the menu of plan choices. Thus, employers can sponsor the HSAs and employer contributions are not subject to income or employment taxes.

Funds contributed by employees are free of federal income tax (at a maximum rate of 35%), Social Security and Medicare taxes (at 7.65%), and most state income taxes (at maximum rates as high as 9%), resulting in a tax savings of as much as 51%. The employer pays less in Social Security matching tax. Like an accountable expense reimbursement plan, it can assist an organization in achieving its strategic goals by enhancing its ability to attract and retain talented, experienced people. Since many restrictions apply, you should carefully review this arrangement before instituting a plan. Please contact us for details.

16. CONSIDER THE NECESSITY OF A SUCCESSION PLAN. It is important for business owners to create a strategy to transfer the business in the event of death, disability or retirement. A failure to properly transition the business cannot only create a greater tax burden, but also turn a successful business into a failed business. Together with your lawyer and financial advisers, you can transfer control as desired, develop a buy-sell agreement, create an employee stock ownership plan and carry out the succession of your business in an orderly fashion.

17. DETERMINE THE MERITS OF SWITCHINGFROM THE ACCRUAL METHOD TO THE CASH METHOD OF ACCOUNTING. Businesses that sell merchandise generally use the accrual (rather than the cash) method of accounting to account for revenue and inventory related to the merchandise. While this may provide a more complete picture of the financial status of a business, from a tax perspective it provides much less flexibility in terms of planning options and is more difficult to use than the cash method of accounting. The good news is that businesses with average gross receipts over the last three years of $1 million or less, that would otherwise be required to use the accrual method of accounting, can elect to use the cash method. While there are some caveats to obtaining this relief, it is a taxsavings strategy worth considering if your business can meet the average gross receipts test and is currently using the accrual method of accounting.

18. DEDUCT YOUR BUSINESS BAD DEBTS. Since business bad debts are treated as ordinary losses and can be deducted when either partially or wholly worthless, it is prudent to examine your receivables before year-end. Not getting paid for services or merchandise that you have sold is bad enough; do not pour salt into the wound by paying income tax on income you will never realize.

19. ESTABLISH SELF-EMPLOYED RETIREMENT PLANS TO CLAIM ADEDUCTION FOR 2007. The plan, in general, must be established by December 31, 2007, but it does not have to be funded until the due date of your tax return, including extensions. Simplified employee pensions (known as SEPs), however, can be established as late as the due date of your return, including extensions, or as late as October 15, 2008, and permit a contribution of up to $45,000.

20. SELECT THE MOST TAX-EFFICIENT INVENTORY METHOD. If you must track inventories, you may be able to realize meaningful income tax savings based on your selected inventory method. For example, in a period of falling prices, the first-in, first-out (FIFO) method will provide larger tax savings since it assumes that higher priced inventory units purchased first are the first ones sold. Conversely, in a period of rising prices, the use of the last-in, first-out (LIFO) method can produce income tax savings since it assumes that the higher priced inventory units purchased last were the first ones sold. IRS approval may be needed. Call us for details.

21. DO NOT BECOME TRAPPED BY THE HOBBY LOSS RULES. If your business will realize a loss this year, you should address the so-called “hobby loss” rules to ensure that the loss will be deductible and thereby maximize the tax benefits of the loss.

22. SELL YOUR COMPANY’S STOCK, RATHER THAN ITS ASSETS. If you are considering selling your business, try to structure the transaction as a sale of the company’s stock, rather than as a sale of the company’s assets. A sale of your company’s stock will be treated as the sale of a capital asset, and the preferential long-term capital gain rates discussed below will apply. A sale of the company’s assets, on the other hand, will typically result in at least some of the gain being taxed at the much higher ordinary income tax rates. However, since the buyer will generally want to structure the transaction as a purchase of the company’s assets, in order to increase his or her depreciation deductions, some negotiating by both parties should be expected.

Tax Planning Strategies for Individuals

Beware of the Secret Tax

As counterintuitive as it may seem, the first step in individual income tax planning for the regular income tax is assessing your exposure to the AMT. As noted previously, a strategy that is effective for regular tax purposes can create an AMT liability because of the differences in the way that certain deductions and income exclusions are handled. Consequently, it is crucial that you understand your AMT position in order to properly assess your tax planning options.

As we have indicated in the past, individuals actually compute their income tax liability under two systems—the regular tax system and the AMT system—and pay the higher of the two amounts. (Since the higher of the two is paid, the alternative minimum tax might more properly be called the alternative maximum tax.) Although the AMT was originally intended only to apply to taxpayers who claimed certain (or excessive) tax breaks, it has evolved into a system that affects many unsuspecting taxpayers. Although Congress has taken certain measures to deal with the problem (such as temporarily increasing the AMT exemption amount for years 2003-2006), they are neither significant enough nor last long enough to keep the AMT from creating an additional tax burden for many taxpayers. As noted in our discussion on potential 2007 Congressional action, temporary AMT relief for 2007 is also possible and probably likely.

Many taxpayers can unwittingly fall into the AMT. Taxpayers especially vulnerable are those who exercise incentive stock options during the year, recognize substantial long-term capital gains, deduct significant amounts of miscellaneous itemized deductions (for example, unreimbursed employee business expenses or investment advisory fees), or pay large real estate taxes (such as residents of Illinois, New Jersey and New York) and state and local income taxes (such as residents of California, Montana, New York, Oregon and Vermont).

If you have determined that you will be subject to the AMT, you should try to control the timing of items that give rise to the AMT. Since the AMT rate (up to 28%) is generally lower than the effective maximum regular tax rate (35%), it may be to your advantage to take steps to accelerate income into 2007 if you will otherwise be subject to the AMT this year and expect to be in the 33% or higher tax bracket next year. At the same time, since many itemized deductions are generally added back to taxable income to arrive at alternative minimum taxable income (AMTI), they produce little or no tax savings in the year you are subject to the AMT. Therefore, you should defer such deductions until 2008 (if 2008 is a non-AMT year). However, since most mortgage interest, investment interest and charitable contributions are deductible for both regular tax and AMT purposes, you should still consider accelerating these deductions.

Now that we have addressed the AMT, at least to the extent possible in the current climate of uncertainty surrounding it, the balance of this guide will focus on specific planning strategies that normally apply to the vast majority of taxpayers, that is, those in a regular tax situation where the time-honored strategies of accelerating deductible expenses and deferring taxable income will result in maximum tax savings.

Tax-Efficient Investment Strategies

For 2007, long-term capital gains and qualifying dividend income are subject to a tax rate of only 15% for taxpayers in a regular tax bracket of 25% or higher and 5% for taxpayers in the lower regular tax brackets. Since tax rates can be as high as 35% for other types of income, these rates can result in substantial tax savings. Here are some ways to capitalize on the lower rates as well as other tax planning strategies for investors.

23. MAXIMIZE THE BENEFIT OF LOWER TAX RATES ON CAPITAL GAINS. To be eligible for the lower 15% (or 5%) capital gain rate, a capital asset must be held for more than one year. That is why it is important, when disposing of your appreciated stocks, bonds, investment real estate, and other capital assets, to pay close attention to the holding period. If it is less than one year, consider deferring the sale so that you can meet the longer-than-oneyear period (unless you have long-term or short-term losses to offset). While it is generally not wise to let tax implications be your only consideration in making investment decisions, you should not ignore them either. Keep in mind that realized capital gains may increase AGI, which in turn may reduce your AMT exemption and therefore increase your AMT exposure.

24. REDUCE THE RECOGNIZED GAIN OR INCREASE THE RECOGNIZED LOSS. When selling stock or mutual fund shares, the general rule is that the shares you acquired first are the ones deemed sold first. However, if you choose, you can specifically identify the shares you are selling when you sell less than your entire holding of a stock or mutual fund. By notifying your broker of the shares you want sold at the time of the sale, your gain or loss from the sale is based on the identified shares. This sales strategy gives you better control over the amount of your gain or loss and whether it is long-term or short-term. Once the specific identification method is chosen, however, you may not use a different method (e.g., average cost method or firstin, first-out method) for the particular security you have specifically identified or throughout the life of the fund (unless with permission from the IRS).

25. TAKE ADVANTAGE OF YOUR CAPITAL LOSSES. It always makes sense to periodically review your investment portfolio to see if there are any “losers” you should sell. This is especially true as year-end approaches, since that is your last chance to offset capital gains recognized during the year or to take advantage of the $3,000 ($1,500 for married separate filers) limit on deductible net capital losses. But do not run afoul of the wash sale rule, discussed next.

26. DO NOT RUN AFOUL OF THE WASH SALE RULE. An often overlooked rule, the wash sale rule provides that no deduction is allowed for a loss if you acquire substantially identical securities within a 61-day period beginning 30 days before the sale and ending 30 days after the sale. However, there are ways to avoid this rule. For example, you could sell securities at a loss and use the proceeds to acquire similar, but not substantially identical, investments. If you wish to preserve an investment position and realize a tax loss, consider the following options:

  • Sell the loss securities and then purchase the same securities no sooner than 31 days later. The risk inherent in this strategy is that any appreciation in the stock that occurs during the waiting period will not benefit you.
  • Sell the loss securities and reinvest the proceeds in shares in a mutual fund that invests in securities similar to the security you sold or reinvest the proceeds in the stock of another company in the same industry. This approach considers an industry as a whole, rather than a particular stock. After 30 days, you may wish to repurchase the original holding. This method may reduce the risk during the waiting period.
  • Buy more of the same security (double up), wait 31 days and then sell the original lot, thereby recognizing the loss. This strategy allows you to maintain your position but also increases your downside risk. Keep in mind that the wash sale rule typically will not apply to sales of debt securities (such as bonds) since such securities usually are not considered substantially identical due to different issue dates, rates of interest paid, and other terms.

27. CONSIDER DIVIDEND PAYING STOCKS. The favorable capital gain tax rates (15% or 5%) may make dividend-paying stocks more attractive than they were in the past when dividends were taxed at ordinary income rates. This may cause you to reconsider the makeup of your investment portfolio. Keep in mind that to qualify for the lower tax rate on dividends, the shareholder must own the dividendpaying stock for more than 60 days during the 121-day period beginning 60 days before the stock’s exdividend date. For certain preferred stock, this period is expanded to 90 days during a 181-day period.

 28. INVEST IN MUNICIPAL BONDS. Today’s intermediate tax free yields are about 4.2%. The equivalent taxable yield for high-income taxpayers in the 35% federal tax bracket and 5% state tax bracket, therefore, is about 7%. In addition, tax-exempt interest is not included in adjusted gross income, so deduction items based on AGI are not adversely affected. As long as your investment portfolio is appropriately diversified, greater weight in municipal bonds may be advantageous. However, be mindful of the AMT impact on income from private activity bonds, which is a preference item for AMT purposes. In general, a private activity bond is a municipal bond issued after August 7, 1986 whose proceeds are used for a private (i.e., non-public) purpose. Accordingly, review the prospectus of the municipal bond fund to determine if it invests in private activity bonds. Anyone subject to the AMT should avoid these funds.

29. AVOID MUTUAL FUND INVESTMENT PITFALL. Before you invest in a mutual fund prior to February 2008, you should contact the fund manager to determine if year 2007 dividend payouts are expected. If such payouts take place, you may be taxed in 2007 on part of your investment. You need to avoid such payouts, especially if they include large capital gain distributions. In addition, certain dividends from mutual funds are not “qualified” dividend income and therefore are subject to tax at the taxpayer’s marginal income tax rate, rather than at the preferential 15% (or 5%) rate.

30. DETERMINE WHETHER YOU ARE A TRADER OR INVESTOR. Discount brokers and online trading have changed the way many people invest in the stock and securities markets. As a result, many individuals spend a considerable amount of time regularly trading stocks. If this describes you, please let us know as soon as possible because the tax treatment of your income and expenses from your trading activity can differ dramatically depending on whether the tax law classifies you as a trader or an investor. Your status as a trader or investor may not be clear, so a careful analysis of your situation should be done before year-end in order to determine your status and the tax planning opportunities that may exist. In general, an investor’s activities are limited to occasional transactions for his own account, while a trader’s activities must be substantial, frequent, regular and continuous.

31. DETERMINE WORTHLESS STOCK IN YOUR PORTFOLIO. Your basis in stock that becomes totally worthless is deductible (generally as a capital loss) in the year it becomes worthless, but you may need a professional appraiser’s report or other evidence to prove the stock has no value. Instead, consider selling the stock to an unrelated person for at least $1.

You have now eliminated the need for an appraiser’s report and are almost guaranteed a loss deduction.

32. MAXIMIZE HOME-RELATED EXCLUSION. Federal law (and many, but not all, states) provides that an individual may exclude, every two years, up to $250,000 ($500,000 for married couples filing jointly) of gain realized from the sale of a principal residence. The exclusion ordinarily does not apply to a vacation home. However, with careful planning, you may be able to apply the exclusion to both of your homes.

33. ENJOY THE TAX-FREE ROLLOVER OF SALES PROCEEDS USED TO PURCHASE STOCK (OR A PARTNERSHIP INTEREST) IN A SPECIALIZED SMALL BUSINESS INVESTMENT COMPANY LICENSED BY THE SMALL BUSINESS ADMINISTRATION. An individual may elect to avoid tax on gains from the sales of publicly traded securities to the extent that the sales proceeds are so used. The rollover of sales proceeds must occur within 60 days of the sale, and the maximum gain that can be excluded for a single individual or a married couple filing jointly is the lesser of $50,000 or $500,000, reduced by any gain excluded in prior years. The exclusion for married individuals filing separately is half of these amounts. For example, if the gain on the sale of publicly traded securities is $75,000, no previous proceeds were used to purchase stock in a qualified specialized small business investment company, and the proceeds are rolled over within 60 days of the sale, the excluded gain would be $50,000. Alternatively, if $460,000 of the gain from previous sales had been used to purchase stock in a qualified specialized small business investment company, only $40,000 of the $75,000 gain could be excluded.

Planning for Higher Education Costs

Many tax-savings opportunities exist for education-related expenses. If you or members of your family are incurring these types of expenses now or will be in the near future, it is worth examining them in some detail. Prior editions of the Tax Accounting Review focused on this issue in detail, so please feel free to contact us if you would like a copy of our education planning newsletters. Here, in abbreviated form, are some strategies to consider as year-end approaches.

34. CONSIDER SECTION 529 QUALIFIED TUITION PLANS. We will briefly indicate the most important features of these plans, since a full description of these plans is beyond the scope of this guide. The ownership and control of the plan is with the donor (typically the parent or grandparent of the beneficiary student), not with the beneficiary, so the plan is not considered an asset of the student for financial aid purposes. Consequently, higher financial aid is possible. For federal income tax purposes, plan contributions are on an after-tax basis, although many states allow a deduction. Contributions and earnings on contributions that are subsequently distributed for qualified higher education expenses (including tuition, room and board, and other expenses) at accredited post-secondary schools anywhere in the U.S. are free of federal income tax, and may be free of state income tax. To the extent that distributions are not for qualified higher education expenses, regular income tax plus a 10% penalty may apply. As contrasted with the other education strategies discussed below, contributions may be made regardless of the donor’s AGI.

An election can be made to treat a contribution to a Section 529 plan as having been made over a five-year period; consequently, for 2007, a married couple can make a $120,000 contribution to a Section 529 plan without incurring any gift tax liability, since the annual gift exclusion for 2007 is $12,000 per donor (unchanged from 2006) and the contribution can be split.

Any increase in the annual gift exclusion will also increase the amount that is eligible for this election. Finally, in general, to the extent that contributions to a Section 529 plan are not distributed for the benefit of the beneficiary, the account may be transferred to a member of the beneficiary’s family, penalty-free. As long as the amounts transferred are used for qualified education expenses, they will still be free of federal income tax, as noted above. Please do not hesitate to contact us with any questions you may have on Section 529 plans.

35. BE FAMILIAR WITH THE EDUCATION CREDIT OPTIONS. If you pay college or vocational school tuition and fees for yourself, your spouse, or your children, you may be eligible for either the Hope Scholarship Credit or the Lifetime Learning Credit. These credits reduce taxes dollar for dollar, but begin to phase out when 2007 AGI exceeds certain levels. Chart 2 provides a summary of the phaseouts.

TAX TIDBIT: The credits are allowed for tuition paid during the year for education received that year or during the first three months of the next year. Consequently, consider paying part of 2008 tuition at the end of 2007 if you have not yet reached the above thresholds.

36. PAY QUALIFIED EDUCATION EXPENSES. In 2007, you can deduct up to $4,000 of college tuition and related expenses for you, your spouse or your dependents, provided your AGI does not exceed certain levels. Chart 2 provides a summary of the phaseouts.

Although the deduction is available regardless of whether you itemize expenses, you cannot claim it if you claim an education credit for the same student. Unlike many other tax breaks subject to income limits, this one does not phase out over a range of income. Instead, it is all or nothing, depending on whether your income is above or below the amounts indicated below. If you can benefit from this deduction, but your AGI is at or near the applicable limits, monitor your AGI level between now and year-end and, to the extent possible, take steps to keep it below the limit.

37. REMIT ADDITIONAL STUDENT LOAN PAYMENTS. An “above the line” deduction of up to $2,500 is allowed for interest due and paid in 2007, with no change in the maximum deduction for 2008. The deduction is phased out when AGI exceeds certain levels. Chart 2 provides a summary of the phaseouts.

38. CONTRIBUTE TO A COVERDELL EDUCATION SAVINGS ACCOUNT. These accounts must be established in a tax-exempt trust or custodial account organized exclusively in the United States, at the time the trust or account is established the designated beneficiary must be under 18 (or a special needs beneficiary), and all contributions must be made in cash and are not deductible. The maximum annual contribution is limited to $2,000 per year, and the contribution is phased out when AGI exceeds certain levels. Distributions from Coverdell Education Savings Accounts are excludable from gross income to the extent that the distributions do not exceed the qualified education expenses incurred by the designated beneficiary, which include kindergarten through grade 12, as well as higher education, expenses. If distributions exceed qualified expenses, a portion of the distributions is taxable income to the designated beneficiary. Furthermore, to the extent that distributions are not used for educational expenses, a 10% penalty applies.

Strategies To Implement Throughout the Year

Virtually any cash-basis taxpayer can benefit from, and can exercise a fair amount of control over, strategies that accelerate deductions or defer income based on the premise that it is generally better to pay taxes later rather than sooner (especially when income tax rates are not scheduled to increase). For example, a check you deliver or mail during 2007 generally qualifies as a payment in 2007, even if the check is not cashed or charged against your account until 2008. Similarly, payments of deductible expenses by credit cards are not deductible when you pay the credit card bill (for instance, in 2008), but when the charge is made (for instance, in 2007). With respect to income deferral, cash-basis businesses, for example, can delay year-end billings so that they fall in the following year or accelerate business expenditures to the current year. On the investment side, income from short-term (i.e., maturity of one year or less) obligations like Treasury Bills and short-term certificates of deposit is not recognized until maturity, so purchases of such investments at this time will push taxability of such income into 2008. For a wage earner (excluding an employee-shareholder of an S corporation with a 50% or greater ownership interest) who is fortunate enough to be expecting a bonus, he or she may be able to arrange with his or her employer to defer the bonus (and his or her tax liability for it) until 2008. However, if any of this income becomes available to the wage earner, whether or not cash is actually received, the bonus will be taxable in 2007. This is known as the constructive receipt doctrine.

39. CONSIDER LIKE-KIND EXCHANGES. Like-kind exchanges have long been a valuable tool in deferring income taxes. Typically, a buyer and seller swap appreciated properties (i.e., properties worth more than their tax bases) that are similar in nature and either held for investment or for use in a trade or business. If you would like additional information on this important tax-deferral strategy, be sure to check with us if you are thinking of disposing of an investment (or property used in your business) because a like-kind exchange might work in your situation. As long as certain expanded holding period requirements are met, a like-kind exchange can also be effective for a principal residence with a home office.

40. PARTICIPATE IN AND MAXIMIZE PAYMENTS TO 401(K) PLANS, 403(B) PLANS, KEOGH (SELF EMPLOYED) PLANS, IRAS, ETC. These plans enable you to convert a portion of taxable salary or self-employed earnings into taxdeductible contributions to the plan. In addition to being deductible themselves, these items increase the value of other deductions, since they reduce AGI. Deductible contributions to IRAs are generally limited to $4,000 in 2007 and $5,000 in 2008, while substantially higher amounts can be contributed to 401(k) plans, 403(b) plans and Keogh plans. For example, $15,500 may be contributed to a 401(k) plan in 2007, as part of the regular limit of $45,000 that may be contributed to a defined contribution (e.g., money purchase, profit-sharing) plan in that year. These limits, as well as the limits for “catch-up” contributions (contributions for individuals who have attained age 50 by the end of the year), are reflected in Chart 3.

41. CONTRIBUTE THE MAXIMUM TO ANON-WORKING SPOUSE’S IRA. As long as one spouse has $8,000 of earned income in 2007, each spouse can contribute $4,000 to their IRAs. The deductibility of the contributions depends on the AGI reflected on the tax return and on whether the working spouse is a participant in an employer-sponsored retirement plan. Keep in mind that an individual is not considered an active participant in an employer-sponsored plan merely because his or her spouse is an active participant for any part of the plan year. Thus, it is possible to have contributions to the working spouse’s IRA that are nondeductible while having contributions to the nonworking spouse’s IRA that are deductible, or to have contributions to both IRAs that are deductible. Any individual making an IRA contribution, whether it is deductible or not, may wish to make it sooner rather than later in order to maximize the tax-deferred income on the contributed amount. In addition, “catch-up” IRA contributions, described above, are also permitted.

42. CONSIDER PURCHASING ANNUITIES. Once you have maximized the use of qualified retirement plans (e.g., SEPs, Keoghs, 401(k)s) and IRAs, the purchase of annuities offers another opportunity for deferral of tax.

43. PARTICIPATE IN FLEXIBLE SPENDING ACCOUNTS (IRC SECTION 125 ACCOUNTS). These plans enable employees to set aside funds on a pre-tax basis for (1) medical expenses that are not covered by insurance, (2) dependent-care costs up to $5,000 per year and (3) pre-tax transportation programs of $110 per month for mass transit costs and $215 per month for qualified parking costs. Funds contributed by employees are free of federal income tax (at a maximum rate of 35%), Social Security and Medicare taxes (at 7.65%), and most state income taxes (at maximum rates as high as 9%), resulting in a tax savings of as much as 51%. Paying for these expenses with after-tax dollars, even if they meet various AGI requirements, is more costly under the current tax rate structure. Since many restrictions apply, such as the “useit- or-lose-it” rule, you should carefully review this arrangement before making the election to participate.

For tax years beginning in 2007, the maximum deductible contribution to an HSA is no longer limited to the highdeductible health plan’s annual deductible. So, for 2007, the maximum amount that can be contributed to an HSA (and deducted) is $2,850 for self-only coverage and $5,650 for family coverage. Prior to 2007, the maximum amount that could be contributed and deducted was the high-deductible health plan’s deductible, which typically was lower than the maximum contribution allowed. Furthermore, individuals who reached age 55 before the end of 2007 can still make an additional $800 “catch-up” contribution.

For example, if John’s salary is $150,000 and Mary’s salary is $50,000, FSA contributions of $10,000 by John will not reduce his Social Security tax (since, even reflecting the FSA contributions, his Social Security wages exceed $97,500), while FSA contributions of $10,000 by Mary will save her approximately $600.

44. CONSIDER OPTIMAL TIMING FOR RETIREMENT PLAN DISTRIBUTIONS. If you are age 70½ or older, you are normally subject to the minimum distribution rules with regard to your retirement plans. Under these rules, you must receive at least a certain amount each year from your retirement accounts. You can always take out more than the required amount, but anything less is subject to a 50% penalty on the shortfall amount. Therefore, if you have not taken your required distribution for 2007, do so before year-end to avoid a hefty penalty.

If you have reached age 70½ in 2007, you can delay your 2007 required distribution until April 1, 2008 if you choose. However, waiting until 2008 will result in two required distributions in 2008—the amount required for 2007 plus the amount required for 2008. While deferring income is normally a sound tax strategy, here it may result in bunching income into 2008, which may or may not push you into a higher tax bracket or have a detrimental impact on other tax deductions you normally claim. A careful timing assessment is needed. “Crunching the numbers” for 2007 and 2008 will help you to determine the optimal timing of the distributions. Please contact us if you have any questions.

45. CAREFULLY PLAN ROTH CONVERSIONS. Taxpayers who decide to rollover or convert from a regular IRA to a Roth IRA, and who also expect their AGI and tax bracket to remain more or less constant, should consider staggering the total amount they plan to shift over a period of years. For example, a taxpayer who plans to convert a total of $85,000 from a regular IRA to a Roth IRA should consider converting $17,000 per year for five years. This strategy may prevent the conversion from pushing a taxpayer into a higher tax bracket, since the conversion is taxable. Conversions are only permitted if the taxpayer’s AGI, not including the IRA conversion, is $100,000 or less; taxpayers filing married filing separately are not permitted to make conversions. Converting may also make sense if the taxpayer’s IRA investments have declined significantly in value. If, after conversion, they increase in value, then the tax paid on conversion will be less than the tax that would have been paid had the investments remained in a traditional IRA.

Tax legislation passed in 2006, however, eliminates the $100,000 AGI limit noted above, as well as the prohibition against married taxpayers filing separately, for rollovers or conversions in tax years beginning after December 31, 2009. Consequently, if your AGI typically exceeds $100,000, consider fully funding your IRA for 2006 through 2009 and then converting in 2010. In addition, an individual receiving a full distribution of his 401(k) balance, due to his leaving employment, should consider rolling it into an IRA, if he wants to take advantage of this provision.

46. AVOID DEDUCTION LIMITS FOR CHARITABLE CONTRIBUTIONS. The charitable deduction for airplanes, boats and vehicles may not exceed the gross proceeds from their re-sale. Form 1098-C must be attached to tax returns claiming these types of noncash charitable contribution. Furthermore, donations of used clothing and household items, including furniture, furnishings, electronics, linens, appliances and similar items must be in “good” or better condition to be deductible. You should maintain a list of such contributions together with photos to establish the item’s condition. See Chart 4 for documentation requirements for items that are in “good” or better condition. To the extent they are not in “good condition,” you will need to secure a written appraisal to deduct individual items valued at more than $500.

47. MAKE CHARITABLE CONTRIBUTIONS OF UP TO $100,000 OF 2007 DISTRIBUTIONS FROM IRAS. Current law provides an exclusion from gross income for certain distributions of up to $100,000 per year from a traditional IRA or a Roth IRA, where the distribution is contributed to a tax-exempt organization to which deductible contributions can be made. This special treatment, which is scheduled to end in 2007, applies only to distributions made on or after the date the IRA owner attains age 70½ and must be made directly from the IRA trustee to the charitable organization. Distributions that are excluded from income under the new provision are not allowed as a deduction.

48. CONSIDER DEDUCTING STATE AND LOCAL SALES TAXES IN LIEU OF DEDUCTING STATE INCOME TAXES. For 2007, instead of deducting state and local income taxes, taxpayers are able to choose to deduct state and local sales taxes by either (1) accumulating receipts; or (2) using IRS sales tax tables and adding actual sales taxes paid for major items, such as vehicles. Accordingly, to the extent possible, accumulate the receipts reflecting sales taxes you have paid this year and compare the total to the state income taxes paid this year. Keep in mind that the deduction for state and local sales taxes includes the amount provided in IRS tables plus the amounts of general state and local sales taxes paid on the purchase of motor vehicles, boats and airplanes. Under current law, the deduction ends after 2007.

49. CHARGE CHARITABLE CONTRIBUTIONS. Charitable contributions charged to a credit card are deductible in the year charged, not when payment is made on the card. Therefore, charging charitable contributions to your credit card before year-end enables you to increase your 2007 charitable contributions deduction even if you are temporarily short on cash or simply want to defer payment until next year. Note, however, that any interest paid with respect to the charge is not deductible.

50. “BUNCH” ITEMIZED DEDUCTIONS SUCH AS STATE AND LOCAL TAXES, MEDICAL EXPENSES, CHARITABLE GIFTS, ETC., INTO ONE YEAR AS OPPOSED TO SPREADING THE PAYMENTS OVER TWO YEARS. By bunching deductions and deferring taxable income along with using AGI-reducing techniques, you increase the value of all deductions and reduce your overall tax liability. If your 2007 AGI exceeds the $156,400 threshold, however, the effectiveness of the bunching technique will be reduced. As always, consideration must also be given to the AMT. In considering the strategies noted below, however, keep in mind that if you pay a deductible expense in December 2007 instead of in January 2008, you reduce your 2007 tax instead of your 2008 tax, but you also lose the use of your money for one month. Generally, this will be to your advantage, unless you have an alternative use for the funds that will produce a rate of return in that one month that will exceed the tax savings. In other words, you must decide whether the cash used to pay the expense early should be for something more urgent or more valuable than the increased tax benefit.

State and local taxes. Consider paying in December 2007 those state and local taxes that have accrued (property, estimated income, etc.) that you would normally pay in the first part of 2008. This will allow you to accelerate your federal tax deduction a full year, if applicable. Since state and local taxes are not deductible for AMT purposes, however, review your regular and AMT positions to determine the most effective tax strategy.

Deductible mortgage interest. You may wish to pay your January 2008 payment in December 2007, but ensure that the lender receives and includes the interest component on Form 1098. Otherwise, the administrative cost of proving the deduction to the IRS may exceed the tax benefit.

Chart 5 illustrates the tax treatment of selected types of interest.

Charitable contributions. Consider paying 2008 pledges in 2007. Also consider donating appreciated property. Under current law, and subject to the deduction limits for charitable contributions of airplanes, boats and vehicles noted at item 46 above, you may claim a deduction equal to the full fair market value for both regular tax and AMT purposes. In addition, outof- pocket expenses such as costs for meals, lodging (while away from home overnight attending a meeting as a representative of the charitable organization or performing services) and transportation also qualify as a charitable deduction. A full deduction for contributions of qualified appreciated stock to private foundations is also allowed, subject to percentage-of- AGI limitations.

Investment interest. This is interest on loans used to purchase or carry property held for investment purposes (e.g., interest on margin accounts, interest on debt used to purchase taxable bonds, stock, etc.). Investment interest is fully deductible to the extent of net investment income, unless incurred to purchase securities that produce tax-exempt income. Net investment income is equal to investment income less deductible investment expenses. Sources of investment income include income from interest, nonqualified dividends, rents and royalties. Investment expenses include depreciation, depletion, attorney fees, accounting fees and management fees. If you bunch your investment expenses in one year so that little or no investment interest is deductible, the nondeductible investment interest can be carried forward to a succeeding tax year.

You may be able to convert nondeductible interest to deductible investment interest by rearranging your borrowing. In addition, you may be able to increase your otherwise nondeductible investment interest by disposing of property that will generate a short-term capital gain. The extra investment interest deduction may even offset the entire tax on the gain. Disposing of property that will generate long-term capital gain will not increase your investment income unless you elect to pay regular income tax rates on the gain. Accordingly, you should review your debt and investment positions before disposing of such property.

Medical and dental expenses. A medical deduction is allowed only to the extent that your unreimbursed medical outlays exceed 7.5% of your AGI. To exceed this threshold, you may have to bunch expenses into a single year by accelerating or deferring payment, as appropriate.

Miscellaneous itemized deductions. Bunching miscellaneous itemized deductions, such as tax preparation fees, investment advisory fees and other expenses incurred in generating investment income, in one year, in order to exceed the 2% of AGI floor that applies to such deductions, may also reduce your tax liability. Again, however, keep in mind that miscellaneous itemized deductions are not deductible for AMT purposes.

51. DETERMINE YOUR LEVEL OF PARTICIPATION IN ACTIVITIES TO EITHER AVOID OR QUALIFY FOR PASSIVE ACTIVITY LOSS TREATMENT. In general, if an individual spends more than 500 hours participating in an activity during the year, the activity will not be considered passive. There are other exceptions, as well. As for real estate professionals, eligible taxpayers may deduct losses and credits from rental real estate activities in which they materially participate, since they will not be treated as passive and may be used to reduce non-passive income. An eligible taxpayer for these purposes spends more than 750 hours of services during the tax year in real property trades or businesses. In addition, a taxpayer’s personal use, or rental to others, of a vacation home during the last few days of the year may have a substantial tax impact.

52. DO NOT OVERLOOK THE ADVANTAGES OF SELLING PASSIVE ACTIVITIES TO FREE UP SUSPENDED LOSSES. Passive losses can be used to offset non-passive income in the year you dispose of or abandon your entire interest in the activity in a taxable transaction, whether the transaction results in a gain or a loss.

53. INCREASE YOUR BASIS IN PARTNERSHIPS OR S CORPORATIONS TO TAKE ADVANTAGE OF ANY LOSSES GENERATED BY THE PASS-THROUGH ENTITIES. Keep in mind that loans made by a third party lender to an S corporation, and guaranteed by an S corporation shareholder, do not increase the shareholder’s basis. The loan must be directly from the S corporation shareholder to the S corporation in order to increase his or her basis.

54. CONSIDER CAPITALIZING YOUR INVESTMENT FEES. For taxpayers subject to the phaseout of miscellaneous itemized deductions or those that are subject to the AMT, characterizing investment fees as a capital cost (i.e., as an increase to basis) may result in significant tax savings. This technique, in general, may allow an investor to benefit from expenses that would otherwise yield little or no tax benefit. The result of employing this technique is that the investment fees would be added to the tax basis of the investment, thereby reducing the gain or increasing the loss on a subsequent disposition of the investment, instead of being disallowed as an itemized deduction. Please do not hesitate to contact us if you have any questions, or would like to employ this investment fee capitalization strategy.


56. MAKE INTELLIGENT GIFTS TO CHARITIES. Do not give away loser stocks (those that are worth less today than what you paid for them). Instead, sell the shares and take advantage of the resulting capital loss to shelter your capital gains or income from other sources, as explained above. Then give cash to the charity. Since you just sold the stock, you will have the cash on hand. As for winner stocks, give them away to charity instead of donating cash. Under either situation, you recognize multiple tax benefits. When gifting appreciated stock to charity, you not only avoid paying capital gains taxes and gift taxes, but you may also be able to deduct the value of the stock for income tax and AMT purposes.

For example, you can donate an easement on scenic farmland next to a national park and continue to farm the property. You may have to grant some access to the public, depending on the circumstances, but this can be limited in a manner that permits your continued enjoyment of the property. The amount of the deduction is generally the present value of the remainder interest on the date of the gift. Like other charitable contributions, gifts of remainder interests are subject to the AGI limitations and other restrictions on charitable deductions, so contact us for details.

Another strategy to consider is a charitable remainder trust, where income-producing assets are transferred to an irrevocable trust. The donor or other noncharitable beneficiaries receive trust income for life, or for a period of years. The donor receives an up-front charitable contribution equal to the present value of the remainder interest. The charity receives the remaining trust assets when the income interests end.

57. TAKE ADVANTAGE OF THE $12,000 ANNUAL GIFT EXCLUSION AND UNLIMITED MEDICAL AND EDUCATION EXPENSE EXCLUSION. Adonor may make a gift of $12,000 to any one donee or $24,000 to any one donee provided the donor is married and the gift is split with his or her spouse. Thus, a gift of $48,000 may be made by a husband and wife to another married couple. Medical and education expenses paid directly to the providing institution are not subject to gift tax. In addition, as indicated in the education planning section, contributions to Section 529 plans may also qualify for special gift tax exclusion treatment. A substantial tax reduction can be achieved by making gifts to your child or grandchild.

For example, a parent can reduce the capital gains tax from the 15% rate to 5% by gifting stock or certain mutual funds, in lieu of cash, to a child or grandchild who is in the 15% tax bracket. Keep in mind that gifting to a child under 18 (for 2007; for 2008 and later years, the kiddie tax rules may apply to children as old as 23) may not have the desired effect, since the kiddie tax may result in some of his or her income being taxed at your higher income tax rate. That is, for 2007, gains recognized by children under age 18 may be taxed at their parents’ marginal rates under the socalled kiddie tax rules. Usually that means the child will pay more than the mere 5% rate you expected when you made the gift. Our professionals can assist you in this complicated area, so feel free to contact us for a customized plan.

58. INCREASE FEDERALTAX WITHHOLDINGTO AVOID THE UNDERPAYMENT OF ESTIMATED TAX PENALTY. For taxpayers with AGI of more than $150,000, 110% of your prior year liability (or 90% of your current year liability) must be paid to avoid the penalty. Attempting to compute how much tax you will owe and when you must pay it to avoid underpayment penalties is the key to determining which of the two methods to use. Accordingly, minimizing 2007 taxable income will result in the lowest possible estimated tax payments in 2008, if using the prior-year safe harbor method. In addition, since withholding is treated as paid equally throughout the year, a penalty for an estimate that was paid late can be eliminated through increased withholding. Similarly, you may wish to increase withholding of state and local taxes to avoid underpayment penalties and accelerate a federal tax deduction.

59. MAXIMIZE YOUR ADOPTION CREDIT/EXCLUSION.The adoption credit for children applies for both regular income tax and AMT purposes. The employer-provided adoption assistance exclusion was also permanently extended. Effective for tax years beginning in 2007, the maximum credit (or employerprovided adoption assistance exclusion) is $11,390 per eligible child and the beginning of the income phaseout range is increased to $170,820 of modified AGI.

60. REVIEW YOUR ESTATE PLAN DOCUMENTS. In light of the tax law changes in recent years, the landscape of estate and gift tax planning has changed dramatically. Without effective planning, gift and estate taxes can cost more than 50% of the value of your estate. If you have not examined your estate plan within the last two years, you should consider doing so immediately. While addressing your will, also consider the benefits of a living will, medical power of attorney and durable power of attorney, and the appropriateness of your beneficiary designations on your retirement accounts and life insurance policies.

61. CONSIDER TAX PAYMENTS BY CREDIT CARD. IRS accepts tax payments by credit and debit cards. Consequently, taxpayers may wish to pay tax payments with a credit card to earn frequent flyer miles, cash-back bonuses, reward points and other perks. The fees charged to you (on average 2.5% of the tax paid) by the card issuer, however, may exceed the benefits received.

62. QUALIFY FOR ENERGYTAX CREDITS. For 2007, the following primary tax credits are available:

  • Credits for energy-efficient improvements made to personal residences. Improvements eligible for credits are qualified home improvements on your principal residence (including metal roofs coated with heat-reduction pigments, energy efficient electric heat pumps, central air conditioners, qualified hot water boilers, and similar items) and qualified solar water heating equipment, electricity-generating solar photovoltaic property, and fuel cell property. The credit for the qualified home improvements is limited to a lifetime limit of $500. The credit for the qualified solar water heating equipment and related items is $2,000 per item. Both credits are scheduled to end on December 31, 2007.
  • Hybrid vehicle credit. The tax credit ranges, depending on the fuel economy of the vehicle, from $650 up to $3,400. The credit, for passenger automobiles and light trucks of not more than 8,500 pounds, expires after December 31, 2010.

63. CONSIDER ACCELERATING LIFE INSURANCE BENEFITS. Subject to certain requirements, an individual who is chronically or terminally ill may exclude payments received under a life insurance policy from income. Similarly, payments received from selling a life insurance policy to a viatical settlement provider, who regularly engages in the business of purchasing or taking assignments of such policies, may also be excluded.

64. EXCLUDE AMOUNTS RECEIVED FOR PHYSICAL INJURIES AND DEDUCT QUALIFIED LEGAL FEES AGAINST GROSS INCOME. Although amounts received as damages attributable to non-physical injuries and punitive damages are gross income in the year received, amounts received for physical injuries are excluded from gross income. Legal fees attributable to employment-related unlawful discrimination lawsuits (as well as certain other actions) are chargeable against gross income, which is preferable to being treated as miscellaneous itemized deductions subject to the 2% of AGI floor and not being deductible for AMTpurposes. Finally, damages received by a spouse, which are due to loss of consortium due to physical injuries of the other spouse, are also excluded from income.

65. DEDUCT MOVING EXPENSES. Qualified moving expenses are deductible whether or not the individual incurring them itemizes his or her deductions, so there are no AGI phaseouts to contend with. Qualified expenses include the cost of moving household goods and personal effects, plus traveling (including lodging but not meals) to your new residence from your old residence. Distance, length of employment, and commencement of work tests must be satisfied in order for the expenses to be deductible.

66. MANAGE YOUR NANNYTAX. If you employ household workers, try to keep payments to each household worker under $1,500. If you pay $1,500 or more to a worker, you are required to withhold Social Security and Medicare taxes from them, and remit those withholdings, along with matching employer payroll taxes, on your individual income tax return, on Schedule H. You can also give your household worker up to $110 per month for expenses to commute by public transportation without this amount counting toward the $1,500 threshold or being included in the worker’s gross income.

Tax Planning Strategies for Non-Profits

67. CUT A FOUNDATION'S EXCISE TAX LIABILITY IN HALF. Private foundations that are exempt from federal income tax generally are subject to a 2% excise tax on their net investment income. However, the tax is reduced to 1% in any year in which the foundation's percentage of distributions for charitable purposes exceeds the average percentage of its distributions over the five preceding taxable years. If you would like our assistance in calculating the amount you need to distribute before year-end to qualify for the reduced 1% excise tax, please give us a call.

68. BEWARE OF RECAPTURE OF TAX BENEFIT ON PROPERTY NOT USED FOR AN EXEMPT PURPOSE. In general, this new provision recovers the tax benefit for charitable contributions of tangible personal property with respect to which a fair market value deduction is claimed and which is not used for exempt purposes. The provision applies to appreciated tangible personal property that is identified by the donee organization, for example on IRS Form 8283, as for a use related to the purpose or function constituting the donee’s basis for exemption, and for which a deduction of more than $5,000 is claimed.

Under the provision, if a donee organization disposes of applicable property within three years of the contribution of the property, the donor is subject to an adjustment of the tax benefit. If the disposition occurs in the tax year of the donor in which the contribution is made, the donor’s deduction generally is its basis and not fair market value. If the disposition occurs in a subsequent year, the donor must include as ordinary income for its taxable year in which the disposition occurs an amount equal to the excess, if any, of (1) the amount of the deduction previously claimed by the donor as a charitable contribution with respect to such property, over (2) the donor’s basis in such property at the time of the contribution.

Apenalty of $10,000 applies to a person that identifies applicable property as having a use that is related to a purpose or function constituting the basis for the donee’s exemption knowing that it is not intended for such use.

69. NEW FILING REQUIREMENTS FOR SMALL TAXEXEMPT ENTITIES. Tax-exempt organizations, whose gross receipts are normally $25,000 or less, are not required to file Form 990, Return of Organization Exempt From Income Tax, or Form 990-EZ, Short Form Return of Organization Exempt From Income Tax. However, these organizations will now generally need to electronically file Form 990-N, Electronic Notice (e-Postcard) for Tax-Exempt Organization Not Required to File Form 990 or 990-EZ, each year beginning with the 2007 reporting year.

The IRS is now required to revoke the tax-exempt status of any organization (large or small) that fails to meet its annual filing requirement for three consecutive years. Thus, organizations that do not file the new e-Postcard (Form 990-N) or a Form 990 or 990-EZ for three consecutive years will have their tax-exempt status revoked as of the filing due date of the third year. Such an organization will need to reapply for recognition of their exempt status and pay the appropriate use fee if they want to regain their exempt status.

Since these requirements affect an individual taxpayer, it is critical that the tax-exempt entity involved in these types of transactions ensure that it is aware of these provisions. This will not only allow the tax-exempt entity to respond to a potential donor’s questions, but will also help ensure that it retains its tax-exempt status, which is obviously important for its ability to continue to receive public support.

70. DO NOT RUN AFOULOFTHE ELECTRONIC FILING REQUIREMENTS. Mandatory electronic filing applies to organizations that file a total of over 250 returns in a year (including, for example, Forms W-2 and 1099); this applies only if the organization has been in existence for at least one year and has previously filed at least one Form 990, Return of Organization Exempt from Income Tax, or Form 990-PF, Return of Private Foundation or Section 4947(a)(1) Trust Treated as a Private Foundation. Furthermore, exempt organizations that file Form 990 are subject to the requirement if their total assets are $10 million or more.

71. ENSURE THAT YOUR PRIVATE FOUNDATION MEETS THE MINIMUM DISTRIBUTION REQUIREMENTS. Afoundation is required to distribute approximately 5% of the average fair market value of its assets each year. Qualifying distributions meeting this requirement include grants and certain operating expenses. Penalties are imposed in the form of an excise tax on the foundation if it fails to make qualifying distributions within 12 months after the close of the tax year. For our clients, we calculate and report the foundation’s progress against the required minimum annual 5% distribution of foundation assets throughout the year. However, if you currently serve as an officer for a private foundation and need assistance in determining your required minimum distribution, please give us a call.

Tax Planning Strategies for Trusts

72. MINIMIZE THE INCOME TAXES APPLICABLE TO ESTATES AND TRUSTS. The tax rates that apply to estates and trusts continue to be significantly compressed. Estate and trust taxable income (exclusive of long-term capital gain and qualified dividend income) of more than $10,450 for 2007 is taxed at a marginal tax rate of 35%. Consequently, it may be beneficial to distribute income from the estate or trust to the beneficiary for the purpose of shifting the income to a lower tax rate. Additionally, trusts and estates can minimize income taxes by employing many of the tax planning strategies that are applicable to individuals, including the investment, “bunching” of deductions, and deferral of income strategies noted above.

73. CONSIDER TAKING ADVANTAGE OF THE 65-DAY ELECTION. Complex trust and estate distributions made within the first 65 days of 2008 may electively be treated as paid and deductible by the trust or estate in 2007. Other factors, such as loss of control of the funds, should also be considered.

74. CONSIDER CHANGES TO TRUSTS. Minor trust accounts or Crummey trusts may need to be changed, based on changes to the kiddie tax rules, primarily because they tended to rely on strategies that resulted in taxable income to the beneficiary of the account or trust when he or she reached age 14. Now that the kiddie tax applies to most children as old as 23, these accounts should be re-examined.

Final Thought

As many of the 2007 tax-savings opportunities disappear after December 31, 2007, now may be the last time to execute strategies that can both improve your 2007 tax situation and establish future tax savings. Without investing a little time before year-end, you may only discover tax-savings opportunities when your tax return is being prepared, at which time it will likely be too late. If you would like to discuss the strategies indicated herein or have other concerns, please do not hesitate to contact us. We will be pleased to help you achieve your tax and financial objectives.