Moore Colson :: News & Resource Center

Why Dec. 31 should be your personal tax deadline
Some tax-saving strategies must be implemented before year end

Most people spend a significant portion of their earnings on income taxes — often more than any other single expense. Yet it’s not unusual for them to put more effort into getting the best price on a new car than into reducing their tax bills.

One possible reason for this is that employer withholding and estimated payments take some of the sting out of the April 16 tax payment deadline. But just because you don’t have to send a payment to the IRS next April doesn’t mean you shouldn’t take advantage of opportunities to save.

Getting out your crystal ball

To plan effectively, you need to gaze into your crystal ball and estimate your income, deductions and tax liabilities for both this year and next. There may be opportunities to shift income and expenses between 2006 and 2007, reducing your overall tax burden.

The rule of thumb is that you’ll save money by deferring taxes as much as possible, for example, by accelerating deductions into this year or delaying income until next year. But that’s not always the case. If you expect your marginal tax rate to be higher in 2007, it might make sense to do the opposite and pay more tax at this year’s lower rate.

Your marginal rate could go up next year for any number of reasons, such as increased income bumping you into a higher tax bracket or causing you to lose deductions or exemptions that are phased out above certain income levels.

There are many ways to shift income and expenses between tax years. You can accelerate deductions by paying property taxes early or defer income by asking your employer to pay your year end bonus in 2007.

You may also benefit by “bunching” certain expenses into one year. For instance, medical expenses are deductible only to the extent they exceed 7.5% of your adjusted gross income. When you’re close to the threshold and need additional medical treatment, schedule it in the year you expect your medical expenses to be higher. Before implementing these timing strategies, consider the alternative minimum tax (AMT).

Reviewing your investments

Take stock of your investment portfolio because you may want to sell some of the losers to offset capital gains you’ve already recognized this year from asset sales or mutual fund distributions. Remember, you can use net capital losses to offset up to $3,000 of ordinary income each year and carry over unused losses indefinitely to offset gains in future years.

One popular strategy is to sell securities at a loss and then replace them with the same securities. This allows you to generate tax deductions while keeping your portfolio intact. But under the wash sale rule, this technique works only if you buy the replacement securities more than 30 days before or after the sale.

If you plan to contribute to charity this year, consider donating appreciated stock or other securities held for more than one year. Although there are limitations, you can typically take a charitable tax deduction for the stock’s full fair market value while avoiding capital gains tax on the appreciation. If you’re thinking about donating stock that’s declined in value, however, you’re better off selling the stock and donating the proceeds to charity. That way you can take a deduction for the capital loss and the charitable donation.

Taking a tip from TIPRA

The Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA), signed into law a few months ago, may affect your tax planning in several areas, including:
AMT. TIPRA increases the AMT exemption amount, for this year only, to $62,550 for married couples filing jointly and $42,500 for single taxpayers. As of this writing, next year the AMT exemption is scheduled to roll back to its pre-2001 levels of $45,000 and $33,750, respectively.

Although Congress may extend the higher exemption amount into 2007 or beyond, uncertainty about the AMT’s future makes planning a challenge. Ordinarily, you’d look at strategies for avoiding or minimizing the AMT this year. But if the AMT exemption drops substantially next year, you might want to increase your AMT income this year to avoid even higher taxes next year.

Kiddie tax. A popular tax strategy for families is to shift investment income to children in a lower tax bracket, but TIPRA changes to the “kiddie tax” have limited this strategy’s advantages. How? Dependent children under age 14 with unearned income exceeding $1,700 pay tax at their parents’ marginal rate. TIPRA raises the age limit to 18, effective Jan. 1, 2006, with certain exceptions.

This change eliminates the advantages of shifting stocks and other income-producing assets to children over age 14. It also wipes out a tax windfall many families had planned to take advantage of in 2008. By postponing the sale of a child’s portfolio until that year, when the capital gains rate for the lowest tax brackets drops to zero, they would have been able to cash out their investments tax free.

Keeping an eye on tax legislation

No matter how carefully you plan, lawmakers can change everything with the stroke of a pen. Congress may pass additional tax laws before the year winds down, so be sure to monitor legislative activity and be prepared to adjust your plan accordingly.

Back to top

Tax tips
Watch out for business use of “listed” property

Many business assets qualify for expensing or accelerated depreciation deductions. But special rules apply to “listed property,” such as computers (if they’re used away from the office), cars, cell phones, and certain audio and video equipment.

To qualify for accelerated depreciation or expensing, listed property must be used more than 50% for business and it must pass that test for each year during the cost-recovery period.

If business use drops below 50%, you may have to recapture excess deductions taken in previous years and pay tax on those amounts. To avoid unpleasant surprises, monitor the use of listed property and keep detailed records showing that business use is more than 50%.

Beware of tax scams

The IRS recently published the 2006 “Dirty Dozen” — this year’s installment of its annual list of the most notorious tax scams. The list includes several well-established scams, including misuse of trusts, abuse of charitable organizations and offshore transactions. A couple of new scams have also made the list: “Zero wages” and “Form 843 tax abatement,” both of which involve filing IRS forms to claim that tax bills have been wrongly inflated.

New school of thought on avoiding estate taxes

In a recent private ruling, the IRS gave passing marks to a novel estate planning technique: prepaying tuition. It allowed a taxpayer to prepay tuition for his six grandchildren through 12th grade, without triggering estate, gift or generation-skipping transfer taxes — and without using up any of his exemptions.

Taxpayers have always been able to bypass transfer taxes by paying tuition on behalf of children and grandchildren, provided the payments are made directly to the school. But if you’re concerned about living long enough to pay tuition expenses as they’re incurred, this new technique allows you to pay for several years of schooling in advance, removing large sums of wealth from your taxable estate.

For this strategy to work, the payments must be nonrefundable, so be sure to check the terms of the school’s prepaid tuition program. Remember that your family will forfeit the money if your student drops out or changes schools.

Investor or trader?

For most people, investment expenses are considered miscellaneous itemized deductions, which are tax-deductible only to the extent they exceed 2% of adjusted gross income. In addition, the deduction for investment interest — that is, interest on debt you incur to buy or carry an investment — is generally limited to your net investment income.

These limitations don’t apply to traders. Keep in mind that you might qualify as a trader if you devote enough time to buying and selling securities, and execute a large enough volume of trades. To find out if you’re eligible for the tax benefits available to traders, consult your tax advisor.

Back to Top

Is Internet sales tax in your future?

If you think state taxing authorities are sitting idly by while Internet businesses avoid collecting sales tax on purchases, think again. In 2005, state and local governments lost $18 billion in uncollected sales taxes on Internet purchases, according to economist William Fox of the University of Tennessee’s Institute for State Studies. The Institute also forecasts this figure will grow to almost $55 billion by 2011.

Some states are projected to lose up to 10% of their total sales tax revenues due to e-commerce. That’s a dire prediction considering that sales taxes account for one-third of all state revenues.

Collecting taxes hasn’t been easy

Current law mandates that only businesses with a physical presence in a buyer’s state need to collect sales on goods sold over the Internet. Buyers who purchase goods on which sales tax is not collected are technically supposed to pay an equivalent “use” tax. But in reality few do, and in the past it wasn’t generally cost effective for states and municipalities to pursue these buyers. Some states are stepping up their audit activity in this area, however.

Attempts to get federal legislation passed that would mandate sales tax collection on Internet sales have so far been unsuccessful. But 19 states have enacted the Streamlined Sales and Use Tax Agreement (SSUTA). SSUTA doesn’t mandate the collection of taxes by out-of-state merchants, but it provides incentives for those that voluntarily do so.

States that have signed on to SSUTA are offering a one-year amnesty for companies that owe taxes on any previous online sales that were made in any of the participating states. They’ve also agreed to adopt more uniform sales tax definitions and policies, fewer rates, state-level administration of local taxes, and reduced audit burdens for sellers using state-certified software.

Moreover, the governing board of SSUTA is working with vendors to offer automated calculation, remittance, and return filing service, paid for, primarily, by the state taxing authorities.

Differing views fuel the debate

Many Internet businesses, especially the small ones, argue that collecting the tax would be too hard and expensive. It’s a point well taken when you consider that there are 7,600 sales taxing jurisdictions in the United States with differing rates, exemptions and remittance requirements. Companies such as eBay are particularly concerned on behalf of the thousands of small entrepreneurs who earn their livelihoods selling through their auction sites.

But not all businesses oppose the taxation of Internet sales. Many brick-and-mortar businesses believe the current setup gives online retailers an unfair advantage. Business groups representing all types of merchants have joined together as the E-Fairness Coalition to support federal legislation to level the playing field.

Along with encouraging legislation such as SSUTA, they are lobbying for federal laws that would streamline the process by providing uniform definitions of products and product-based exemptions, while prohibiting overlapping taxing jurisdictions that complicate rate calculation.

Be prepared, just in case

If states get their way, the SSUTA is just an intermediate step before collection becomes mandatory. It’s hard to say when mandatory collection will become law, but legislation has been introduced in Congress and momentum continues to build for its passage. If your company sells on the Internet, you’d better start exploring your options.

More information about SSUTA is available at www.streamlinedsalestax.org.

Back to Top

Employers are catching on to Health Savings Accounts

Are you looking for a way to control your company’s health care costs while still providing the coverage your employees need? Then you may want to consider Health Savings Accounts (HSAs). HSAs offer a tax-advantaged way for employers to pass along health care costs to employees, while helping employees save for these costs.

A survey released in November 2005 by the Deloitte Center for Health Solutions found that 22% of responding companies already have an HSA in place and another 21% plan to offer one soon. Since they were introduced in January 2004, enrollment has grown to over 3.2 million individuals as of January 2006, according to a report released in March by America’s Health Insurance Plans, an insurance industry trade group.

Many experts project exponential growth to continue and for HSAs to become one of the dominant types of health plans over the next five years.

HSAs 101

HSAs are tax-advantaged accounts — similar to IRAs. Because employee contributions are made on a pretax basis, they can enjoy a lower taxable income. And they can withdraw funds tax free to pay qualified health care expenses — including long-term care expenses and insurance premiums. Unlike with a Section 125 Cafeteria Plan (also commonly referred to as a Flexible Spending Account or FSA), unused funds roll over from year to year. The balance in an HSA can grow over time and, once the employee reaches age 59½, can be used for any purpose, though withdrawals not used for health care expenses will be taxed.

Their main drawback is that HSAs must be coupled with a high-deductible health plan. The 2006 minimum deductible for this health coverage is $1,050 for an individual and $2,100 for a family. Currently, employees can contribute up to the lesser of the health plan’s deductible or $2,700 for individuals and $5,450 for a family. You also may provide part of this contribution if you wish.

Factor in everything

Successfully implementing an HSA isn’t a slam dunk. First, you’ll need to research various providers and evaluate alternatives, including FSAs, Health Reimbursement Arrangements and Medical Savings Accounts.

Whether an HSA will be the only option or one of many you provide your employees, it’s important to educate them on how the program will work, how to manage their individual accounts and what costs they may be liable for.

Also consider what type of provider network, if any, will be included in the high-deductible health plan. If the plan is provided by a company that also offers HMO or PPO plans, it’ll probably include a network of providers that can be accessed at the plan’s discounted rates, thus providing additional savings to your employees.

Administrative simplicity is also important. Some HSA providers offer debit cards that participants can use to pay for their qualified health care expenses. This eliminates paperwork for the employee, who would otherwise have to pay each provider bill and then submit claims to the HSA administrator for reimbursement.

Early results from HSAs are promising

While HSAs are gaining popularity, it’s too early to have definitive answers on how well they work. The findings of a number of studies are encouraging, however.

Employers who switch from traditional low-deductible policies to high-deductible health plans are definitely seeing lower premiums — so much so that, according to the Kaiser Family Foundation, the switch can amount to an annual savings of about $400 per employee for single employee coverage and even more for family coverage. Moreover, some employers who offer both HSA/high-deductible plans and traditional, first-dollar coverage health plans noted smaller percentage annual increases this year for the high-deductible plans.

In other areas, results are mixed. A September 2005 Blue Cross survey found that enrollees in HSAs were just as satisfied as those in traditional plans, while other studies have found opposite results. Likewise, some researchers have found that HSAs disproportionately attract young, healthy workers, a concern often cited by HSA critics, while others have found this not to be the case. The problem of how lower-income workers will adequately fund their HSAs also still needs to be addressed.

Just as with a traditional health plan, any business that has an increase in catastrophic health events among its covered workers will likely see a significant increase in its annual premium expense. How well HSAs help people in these circumstances limit their health care expenses remains to be seen.

Slow down runaway costs

With more of the employees’ funds at risk, the hope is that HSAs will reduce costs for both you and your workers because they’ll have an incentive to take better care of themselves and be better health care consumers.

Not even the strongest proponents of HSAs believe, however, that they alone can stop runaway health care costs. But HSAs may become an important part of the solution. If you haven’t already, take a look at whether an HSA, coupled with a high-deductible health plan, makes sense for your company and its employees.

Back to Top