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Tax Newsletter
December 2007

Year-end tax planning tips typically fall into two general groups: (1) the traditional strategies that have proven themselves useful year after year, and (2) new opportunities that have arisen from recent changes to the tax laws. While no major federal income tax reforms have been enacted this year, a law change signed in May 2007 could impact those with dependent children or investments in business assets.

A number of tax credits are currently set to expire at the end of 2007, unless Congress extends them. Tax breaks set to expire at the end of 2007 include the state and local sales tax deduction, above-the-line deduction for educator out of pocket expenses and deduction for qualifying tuition and fees. There is potential last minute legislation that could be passed before year-end, with the biggest question mark having to do with Alternative Minimum Tax. Congress is working on approving a “patch” that would limit the number of people who will owe AMT.

Kiddie Tax. For 2007, a child under the age of 18 is subject to the “kiddie tax”; that is, the child’s unearned income in excess of $1,700 is taxed at his or her parents’ marginal rate. As a result of 2007 legislation, however, beginning in 2008 the kiddie tax will apply to a child under the age of 19 and full time students under age 24. The kiddie tax does not apply if the child provides more than half of the cost of his or her support with earned income. In light of this new development, parents should review their children’s portfolios and make decisions about selling/holding appreciated assets, especially if the child will be in the 19 to 24 year-old category next year.

Many taxpayers set up “Uniform Gift to Minor Act” (UGMA) accounts for education purposes. The income earned on these accounts is taxed to the children; however, unearned income over $1,700 is taxed at the parent’s higher tax rate as a result of the kiddie tax. Consideration should be given to converting these UGMA accounts to Section 529 plans to avoid future tax on the earnings, so long as the amounts are used for education. Unfortunately, section 529 plans are funded initially with cash; therefore, the conversion of UGMA assets may result in capital gains subject to tax.

Low capital gains rates. The federal capital gain rate continues at a historically low 15%. The combined federal and California tax rate for long term capital gains is approximately 25%. Although low by historical rates, the capital gains tax is still significant when disposing of low basis securities. Accordingly, the use of charitable remainder trusts remains a viable planning alternative to avoid or defer the capital gains tax, where the gains will be significant, and there is also a desire to leave money to charity.

For taxpayers in the 10- or 15- percent tax rate brackets, the tax rate on long term capital gains is 5% in 2007; however, it is reduced to zero for 2008-2010. If the kiddie tax applies, however, the parents’ higher tax rates may apply.

Taxpayers who are considering recognizing losses on securities to offset gains should be reminded of the wash sale rules that preclude tax losses if substantially identical securities are purchased within 30 days before or after the date of sale.

Investment expenses. Investment expenses are deductible as miscellaneous itemized deductions, subject to the 2%-of-adjusted-gross-income limit. These may include:

  • Fees for financial and investment advice;
  • Servicing fees from banks, custodians, or brokers;
  • Subscriptions to professional and investment periodicals and books;
  • Travel to and from a broker’s office to transact business ($0.485/mile);
  • Rental of office space or payment for secretarial and other clerical expenses; and
  • Depreciation on property used to manage investments

The impact of AMT The Alternative Minimum Tax (“AMT”) system was put in place to ensure that all taxpayers pay a minimum level of tax. Unfortunately, for California residents, the current AMT system often results in higher taxes due. This is because deductions are not allowed for California income tax paid and real property taxes in the AMT calculation.

While the alternative tax is a burden, it also may present a planning opportunity, particularly for taxpayers who are subject to the AMT in one year but not in the next (or vice versa). In order to determine whether AMT is a factor in the current year, and to assess year-end planning opportunities, a projection of taxable income for the year is generally required.

Prepayment of expenses. As the year-end approaches, evaluate if you are subject to AMT, and consider prepaying tax deductible expenses, such as state taxes and real estate taxes, to the extent you get a current year tax benefit.

Medical expenses. Within certain limits, medical expenses are deductible and may provide tax benefits. Medical care includes:

  • Doctors, nurses, hospitals and/or prescriptions;
  • Health insurance premiums;
  • Medically related expenses while living in a nursing home; and
  • Long term care insurance premiums (there are some limitations)

Health Savings Account (HSA) A tax-advantaged medical savings account available to taxpayers who are enrolled in a High Deductible Health Plan (HDHP). The funds contributed to the account are not subject to federal income tax at the time of deposit. Funds may be used to pay for qualified medical expenses at any time without federal tax liability. Withdrawals for non-medical expenses are treated very similarly to those in an IRA account in that they may provide tax advantages if taken after retirement age, and they incur penalties if taken earlier.

Charitable contributions. Charitable contributions continue to be one of the most flexible of the deductible expenses. Gifts of appreciated property (e.g., stocks) may have a significant tax advantage over cash contributions. You receive a charitable contribution deduction for the fully appreciated value of the property, while avoiding tax on the capital gain that would have been realized if you had sold the property and contributed the proceeds. Charitable remainder trusts and private foundations are additional planning tools that may help you reduce income taxes while helping you achieve your charitable goals.

Charitable provisions from recent legislation.

  • Beginning in 2007, there are two sets of rules for cash contributions. For contributions greater than $250, you must obtain a written acknowledgement from the charitable organization to support a charitable deduction. For contributions under $250, you must obtain a bank record (e.g., cancelled check) or a written acknowledgment from the charity. Without appropriate documentation, a contribution deduction is not available.
  • 2007 is the final year for taxpayers, age 70 ½ or older, to make tax-free distributions from IRAs to charities. The distributions must be made directly from the IRA to charity. The maximum amount per year is $100,000. While a charitable contribution deduction is not available, the withdrawal from the IRA will not generate taxable income, and will satisfy the Minimum Distribution Requirement for the year.
  • A deduction is not allowed for used clothing and household items unless the items are in “good” condition. There is no guidance as of yet on what constitutes “good condition”.

Maximize retirement plan contributions. Contributions to tax deferred retirement plans remain a valuable financial planning tool. One of the easiest and least expensive ways to save for your retirement is to take advantage of your employer qualified plans and/or IRAs, by making annual pre-tax contributions to such plans. Increased contribution limitations and catch-up provisions allow older workers to increase their retirement savings. Parents with children that have earned income may want to consider making a gift to a child, which the child can contribute to an IRA up to the amount of his or her earned income.

IRA planning decisions are affected by annual contribution limits, taxable income limitations and whether there is coverage under an employer plan.

  • In 2007, the IRA (regular and Roth) contribution limit is $4,000. ($5,000 for those age 50 and over). In 2008, these amounts increase to $5,000 ($6,000 if over age 50).
  • To qualify for the maximum Roth contribution, married taxpayers filing a joint return must have a 2007 combined Adjusted Gross Income (AGI) of less than $156,000 and earned income must be at least as much as the amount of the contribution to the Roth IRA. For singles, AGI must be less than $99,000 and earned income must be an amount at least equal to the contribution amount.
  • Taxpayers covered by an employer plan are precluded from making contributions to a regular IRA. If one spouse is covered by an employer plan, the non-participant spouse may make a contribution to a regular IRA, subject to certain limitations based on AGI.

Recent legislation has added flexibility to Roth IRA planning but has also increased the complexity of retirement plan decisions. Issues that may arise in the planning process include:

  • Whether to make a deductible contribution to a regular IRA or a nondeductible contribution to a Roth. The decision may hinge upon assumptions regarding current and future tax rates and projected income in retirement.
  • Whether to convert from a regular IRA to a Roth. There are income limitations and tax costs to a conversion that must be considered. Income limitations are currently scheduled to expire in 2010, so this is another factor to take into account.
  • Whether to contribute to a nondeductible IRA. If other options are not available, a nondeductible IRA contribution may still be of benefit.

Gifting. The current top marginal rate is 45% for estate and gift tax purposes. A gift-giving program continues to be an effective way to reduce transfer taxes and provide for beneficiaries:

  • The first $12,000 (per donee) of gifts made by a donor is not subject to gift tax.
  • The first $1,000,000 (excluding annual $12,000 gifts) of lifetime gifts is not subject to gift tax.
  • Direct payments of medical and/or educational expenses to the institutions on another person’s behalf, do not count against the $12,000 annual exclusion.
  • Consider gifts of appreciated stock to children (but watch out for the kiddie tax)

Estate tax

Although the lifetime gift tax exclusion (described above) continues to be limited to $1,000,000, the estate tax exclusion increased to $2,000,000 in 2006.

Running the numbers. We recommend running tax projections for 2006 and 2007 before implementing year-end tax strategies. Please let us know if you would like our assistance in preparing a projection.

We often remind our clients that tax considerations should generally not drive financial decisions. However, once financial objectives are defined and understood, it becomes easier to determine the tax planning strategies that are consistent with overall objectives. Unfortunately, frequent changes in the income tax rules, coupled with the changes and uncertainty in the estate tax area, make both short and long-term planning more complex. With the year-end approaching, it may be a good time to review your financial objectives with a view toward assessing whether any of the recent tax incentives can be incorporated into the financial plan.


The information contained in this newsletter is general in nature and does not constitute tax advice or opinion. Applicability to specific situations should be determined through consultation with your tax advisor.

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