JS+A 2006 Tax Alerts

Hello everyone! Throughout the year we like to send our clients alerts to keep them updated on changes to the tax code and offer seasonal tax planning advice. Here are the alerts we sent out in 2006. Remember, tax rules are complex and often counter-intuitive. This is GENERAL advice. If you are a client of John Schachter + Associates, call or email us for advice on your particular situation.

Warm Heart Equals Cold Cash, If You Follow These Tax Rules

This is the time of year when many people make contributions to their favorite charitable organizations, and when tax season rolls around, they enjoy getting a tax break in return. However, there are some extra caveats this time around. This year you must get a receipt for cash contributions, and most folks can only take a deduction for donations of clothing and household items if they're in "good" condition.

Effective as of the date of enactment of the new law, no deduction will be allowed for any contribution of cash, check, or other monetary gift unless you can show a bank record or a written communication from the charity. This means you'll have to either get a receipt for every cash donation you make, or make your donation by check, credit card, or debit card, so your bank statement will show it. Congress made this change to crack down on taxpayers who inflate their cash contributions.

The new pension reform law also cracks down on donations of broken or malfunctioning household items and poor or soiled clothing. Household items and clothing must be in "good condition" to be deductible. If the gift isn't in good condition, you can still deduct it if the amount claimed is more than $500 and if you include a "qualified appraisal" with the tax return. The IRS is expected to issue guidance about what is "good condition" in time for the 2007 tax filing season, as this change is also effective as of the date of enactment of the new law. In the meantime, websites such as Intuit Inc.'s ItsDeductible (www.itsdeductible.com), the Salvation Army's online Valuation Guide (www.satruck.org/ValueGuide.aspx) and Goodwill Industries' (www.goodwillpromo.org) can help donors figure out the charitable value of many household goods.

While the new law imposes restrictions on contributions of cash, household goods, and clothing, it expands some other deductions. Last year, in response to Hurricane Katrina, Congress enhanced the deduction for donations of food and books. The new law extends this special treatment through December 31, 2007.

If you are age 70½ or older, you will be able to make a tax-free distribution of IRA proceeds up to $100,000 to a charitable organization through December 31, 2007. This allows retirees to avoid paying income tax on the money that they are required to take out of their IRA each year (provided that the withdrawal goes directly to charity). This change is important for individuals who don't itemize their deductions, since nonitemizers can't get a tax deduction for charitable gifts. The new rule also makes sense for seniors with well-funded IRAs who already have plenty to live on, or for individuals whose required minimum distributions would bump them into a higher tax bracket. However, this tax break is only available in 2006 and 2007, and the gifts must be made directly from an IRA to a charity to benefit from the new tax treatment. Also, donors can't also take a tax deduction for these IRA rollovers to charity, since the income isn't reported.

Paying for Employee Health Care -- One Way or the Other

Massachusetts employers: if you have more than ten employees and if you don't offer a "fair and reasonable" health plan, you may have to pay Massachusetts as much as $295 per employee next year. If you have fewer than eleven employees, your company probably will not be liable for this new assessment.

Here's the scoop:

Under the new Massachusetts Health Care Reform Law, the state can impose an annual surcharge of up to $295 per full-time employee on any employer that has 11 or more employees and is not a "contributing employer." A "contributing employer" is one that offers a group health plan to its employees and "makes a fair and reasonable premium contribution." This latter provision means that if the Commonwealth determines that the employer's premium contribution is too low, the employer may be assessed the tax.

Companies with 11 or more full-time employees, which can include combinations of full- and part-time employees, can avoid this assessment in two ways:

If at least 25 percent of a business's workers are enrolled in that company's group health plan and the employer contributes to it
If the business offers to pay at least 33 percent of an individual's health insurance premium for full time workers employed at least 90 days since the law came into effect.

The amount of the assessment (up to $295) will be based on how often employees use the free care pool versus how many employees were offered insurance between October 1, 2006 and September 30, 2007.

Employers with 11 or more employees are also now required to offer cafeteria plans to their employees. A cafeteria plan allows employees to make contributions toward health care costs with pre-tax dollars. For more details, see:

"Determination of the Employer Fair Share Contribution," Massachusetts Division of Health Care Finance and Policy http://www.mass.gov/Eeohhs2/docs/dhcfp/g/regs/114_5_16.pdf

"An Overview for Employers of the New Massachusetts Health Care Reform Law," http://www.foleyhoag.com/files/tbl_s10News/FileUpload44/11309/eBulletinApril1806.pdf

Hybrid Cars -- When to Act

If you're considering buying a new Toyota or Lexus hybrid vehicle, you may want to act quickly, since the new federal tax credit for hybrids begins to phase out for Toyota and Lexus models after September 30.

Toyota, which also makes Lexus, has sold its 60,000th hybrid this quarter. This means the allowable credit for hybrids purchased from October 1, 2006 through March 31, 2007 will drop 50 percent. The credit will be cut by 75 percent for hybrids bought from April 1, 2007 through September 30, 2007, after which it will drop off completely.

Currently the credit is $3,150 for a Prius, $2,600 for a Highlander, and $2,200 for the Lexus RX400h. It may take more than a month to get the model you prefer, so start planning now. Also, there's no rush to buy hybrids from Ford or Honda, since they're nowhere near the 60,000 cap for this year.

Buy your parents' home -- tax breaks for you and for them

If your parents are retired and they own their home, it may be beneficial to both you and them if you buy their house from them and then rent it to them at the going rate.

This can benefit your parents in several ways. It puts cash into their pockets without them having to refinance their home or take out a home-equity loan. They can then turn around and put that money into safer investments. Additionally, if their home has appreciated a lot in value over the years, they may end up paying less tax on its sale if they choose to sell it now (rather than waiting additional years, when its value and the tax will probably be even higher).

This can result in tax breaks for you as the homeowner as well. As the owner of a rental property, you will be able to write off operating expenses such as utilities, maintenance, insurance, repairs, and supplies, as well as the travel expenses involved in visiting the house (and your parents). You can also claim depreciation deductions for the home. This works the same way whether you buy the house outright or your parents give you a mortgage and you make payments to them.

A word of caution: in order to legitimately claim these deductions, you will have to pay a fair price for the house, and your parents should pay no less than 80 percent of the fair market rent.

Changes to the Tax Law for 2006 and beyond

The new Pension Protection Act of 2006 goes way beyond retirement issues, with important changes that will affect almost everyone. Here are some highlights.

Inherited retirement plans -- a break for heirs who get IRAs

Up until now, taxpayers who inherited retirement plans from anyone other than their spouse were required to take out money -- and pay tax on it -- within a year of the account holder's death. But starting in 2007, taxpayers will be able to roll the inherited money into their own IRAs, avoiding an immediate tax hit.

Auto-enrollment 401(k) plans -- help employees; help the owners, too

A problem with 401(k) plans is that many eligible employees decline to take part. This can limit the tax benefits of the plan to company owners because of so-called non-discrimination rules. Under the new law, it will be easier to sign employees up automatically. Employers can also automatically increase the percentage of employees' contributions.

Roth 401(k)s -- here to stay

Roth 401(k)s were created in 2001, but employers could only start offering them this year. Roth 401(k)s are similar to Roth IRAs. That means you don't get a tax break now, when you put money in, in exchange for a potentially much greater tax break later. Unlike Roth IRAs, Roth 401(k)s are available to people with high incomes. The new law makes them permanent, and this should encourage more employers to offer them.

Options for Depositing 2006 Tax Refunds

Taxpayers will have more options for depositing tax refunds next year. You can choose Health Savings Accounts, Coverdell education savings accounts, or Archer medical savings accounts, in addition to an IRA or a checking or savings account. New IRS rules allow folks to direct that their refunds go to as many as three accounts. To take advantage of this, you will need to fill out a new Form 8888 and attach it to your 1040.

Energy-efficient upgrades -- beneficial for the environment and for you

Thanks to new tax credits that kicked in this year and increasingly competitive prices on energy-efficient appliances, it's easier than ever to boost your home's energy efficiency without going broke. Under the Energy Policy Act, in 2006 and 2007 consumers can receive federal tax credits for making energy-efficient upgrades to their homes. Here's what the credit covers:

Home energy-efficiency improvements: You can get a one-time tax credit of up to $500 for projects that involve the home's shell (insulation, windows, sealing) or its home heating and cooling equipment. Each project must meet specific criteria, and must be put in place during 2006 or 2007. Eligible projects include new windows (10% of the cost, up to $200), central air conditioners (up to $300 of the full purchase price), hot water boilers (up to $150 of the full purchase price), and pigmented metal roofs (10% of the cost, up to $500).

Solar energy systems: you can get a one-time tax credit for the cost of installing an alternative energy system in your home. For installing a photovoltaic system (which produces electricity) or a solar water heating system, you'll receive a credit for 30% of the cost of the system -- a maximum of $2000. Each project must meet specific criteria, and must be put in place during 2006 or 2007.

Separately, Massachusetts homeowners may also claim a credit for energy-efficient heating items purchased between November 1, 2005 and March 31, 2006. These can include home insulation, new window installation, programmable thermostats, fuel efficient furnaces, boilers, solar hot water systems, and other improvements. Each taxpayer can claim a one-time credit of 30% of the cost of these upgrades, up to $600 (or $1000 for a multi-unit dwelling). This credit is limited to improvements related to heat conservation.

Convert a traditional IRA into a Roth IRA

Many middle- and upper-income taxpayers have been unable to open Roth IRAs. But an opportunity to do so is coming. Making preparations now can help you avoid a big tax hit later. Beginning in 2010, you will be able to convert a traditional IRA into a Roth IRA, regardless of your income (this privilege is currently restricted to taxpayers with an adjusted gross income of less than $100,000)

The conversion is taxable, but you can choose to spread the tax bill over three years, which could make doing so much more palatable.

Roths are almost always a better deal than traditional IRAs. Distributions from a Roth IRA are generally tax-free, and unlike other retirement accounts, you are not required to begin withdrawing from a Roth at age 70½. It's also generally easier to get access to your money if it's in a Roth.

There are steps you can take now in preparation. If you have a traditional IRA, now is a good time to begin bulking it up. You can also roll assets from a qualified retirement plan into a traditional IRA now and convert them to a Roth IRA in 2010 (you cannot, however, roll over directly from a retirement plan into a Roth IRA).

Section 529 Plans -- Smarter than ever

You may already know about Section 529 plans, the state-sponsored college savings vehicles that provide tax-free accumulation of investments used to fund higher education costs. Recent changes in the tax laws provide even more reason to have one. Beginning this year, any unearned income -- like interest or dividends -- over $1700 received by a child under 18 is taxable at the parents' top tax rate (the threshold used to be age 14). A Section 529 plan will avoid such taxes, while allowing you either to prepay your child's future higher education costs or to establish a savings plan to pay them. The money will accumulate tax-free, and the distributions are tax-free as long as they're used for qualified education expenses.

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