Cynthia Dawkins: And now Gail Patterson from the National Office will introduce our third speaker.

Transcription

1 Wi$e Up Teleconference Call February 28, 2007 Tax Saving Strategies Speaker 3 Jeff Schnepper Cynthia Dawkins: And now Gail Patterson from the National Office will introduce our third speaker. Gail? Gail Patterson: Thank you, Cynthia. Jeff A. Schnepper runs a full-time accounting and legal practice in Cherry Hill, New Jersey, and is Associate Economics Editor for USA Today. He s also the author of several books on finance and taxation and is Microsoft s MSN Money tax expert. Mr. Schnepper is a former professor of taxation, accounting, and finance at The American College in Bryn Mawr, Pennsylvania. He received his J.D. from State University of New York at Buffalo Law School with a concentration in taxation and corporate law and his LL.M. from New York University with a concentration in taxation. He was an economic editorial consultant for WORK-TV (ABC), has testified on economic issues before the Senate Finance Committee and the House Ways and Means Committee, and is an Accredited Public Accountant. He has been a member of the International Association of Financial Planners (IAFP) Tax Policy Analysis Committee, and was invited to the White House to consult on the 1986 tax bill.

2 Welcome, Jeff. Jeff Schnepper: Thank you, Gail. Before I get into my topic, I just want to comment very quickly on what Carmen said about not filing. She did an excellent job talking about all of the civil penalties that are there, but something that everybody has to remember is that there are also criminal penalties if you don t file. So my very strong suggestion is that if anybody out there has not filed, that they immediately send a letter to the IRS indicating that they recognize that they have not filed and that they intend to file. That letter will undercut any possible criminal penalties. Now, let s get into my topic. My topic is the changes in the tax law from last year, and we have had major tax law changes in 40 of the last 44 years. It s been said that the only difference between death and taxes is that death doesn t become more complicated and convoluted every time Congress meets. And last year, we had three major tax laws put into effect. Ron ably talked about the last one in December--that last minute tax act with the extensions. I want to talk about the other two. The first one being what our genius Congress titled The Tax Increase Prevention and Reconciliation Act of Maybe they didn t have a calendar. It was signed into law on May 17, I guess these guys

3 are somewhat conservative. They don t change their calendars until perhaps June. Let s talk about what is in there. An excellent tax bill if you are an investor. This bill reduced the tax rate on capital gains and dividends extended through 2010 [i.e. The bill extended through 2010 the reduced tax rate on capital gains and dividends]. Currently the maximum tax rate on long-term capital gains -- these are assets held for more than one year before being sold -- and qualified corporate dividends--is 15%. For people in the lowest two [tax] brackets, the [tax] rate is 5% through 2007 and then is scheduled to be 0% in These rates were scheduled to rise in 2009 and now will remain in place at least through Second thing, the income limitation on Roth conversions disappears in Under current rules, you can only convert your [traditional] IRAs into a Roth IRA if your income is less than $100,000. That same threshold -- $100, applies to a single individual and to married couples alike. The younger you are and the lower your current tax bracket, the more advantageous the Roth IRA. With Roth IRAs, everything comes out tax-free. It is tax-free and not just tax-deferred, but you don t get a current [tax] deduction. [As defined by Investopedia.com, taxdeferred refers to investment earnings such as interest, dividends or capital gains that accumulate free from taxation until the investor withdraws and takes possession of them. The most common types of tax-deferred investments include those in individual retirement

4 accounts (IRAs) and deferred annuities. By deferring taxes on the returns of an investment, the investor benefits in two ways. The first benefit is tax-free growth: instead of paying tax on the returns of an investment, tax is paid only at a later date, leaving the investment to grow unhindered. The second benefit of tax deferral is that investments are usually made when a person is earning higher income and is taxed at a higher tax rate. Whereas after a person retires, their income may decrease, thus resulting in their tax rate being lower.] Starting in 2010, the income limitation is going to disappear, and anybody can convert their traditional IRAs into a Roth IRA. When you do the conversion, you re going to have the option to pay the taxes during a single year or to spread the tax liability over two years. What should you do if your income is too high for a current Roth IRA? Contribute to what s known as a non-deductible [traditional] IRA. Then, in 2010 convert [your traditional IRA] into a Roth. You will only pay tax on the gain between now and 2010, and that tax can be spread over two years. Next change. Biggie, if you ve got kids. The kiddie tax increased to age 17. Under prior law, any unearned income above a certain threshold earned [received] by a child under the age of 14 was taxed at the parent s higher rate. [According to Investopedia.com, unearned income is any income that comes from investments and other sources unrelated to employment services. Examples of unearned income include interest from a savings account, bond interest, tips, alimony, and dividends from stock. As long as this income is "realized" then it is taxable.]

5 Now this kiddie tax applies to children who are 17 or younger and earn [receive] more in 2006, more than $1,700 in interest, dividends, capital gains, and other non-wage income. What you do now is, if you ve got a kid that is under age 18, invest for long-term appreciation. Consider Section 529 plans ( Consider EE bonds ( You want the income to be taxed to the children up to the exclusion, but anything in excess of that, you want that deferred until they are over age 17. What else? If you create musical works, if you re in the business of creating musical works, new rules apply now. The sale or exchange of musical copyrights or compositions in musical works created by your own effort will be treated as a sale or exchange of capital assets. What this means is that if you were selling musical works, you used to pay taxes [at a rate] as high as 35%. Now the maximum tax [rate] is going to be 15%. What else? Offers in compromise. Bad news. Bad news. An offers in compromise is where you go to the government and you say, I m going to pay you pennies on the dollar based either on doubt as to liability, doubt as to collectability, or effective administration of the tax system. You need some sort of reason that the IRS will buy into in order to get these pennies on the dollar deals that may be

6 available. [For more information on the offer in compromise program, visit the IRS Web page, Well now, under the new law, you have to make a good faith down payment of 20% of any lump sum offer or, if you re planning to pay them off on an installment basis, you ve got start making the installment payments [right away]. Second tax act passed in 2006 was the Pension Protection Act of This one they got right. Let s talk about some of the stuff in this one. Tax-free IRA distributions to charities. If you re age 71-1/2 or older for the years well it s gone now, but you can do it for 2007 as well--you can distribute [take out and contribute] as much as $100,000 directly from your IRA without recognizing any income [without it being considered and taxed as income] if you're making the distribution to a charity. What s the advantage of this over taking the money, paying the tax, and taking a deduction for the charitable contribution? It sort of balances out. Well, it really doesn t balance it out because if you took the income, that would increase your adjusted gross income (AGI). [Gross income is money, goods, services, and property a person receives that must be reported on a tax return. It includes unemployment compensation and certain scholarships. It does not include welfare benefits and nontaxable Social Security benefits. Adjusted Gross Income is gross income reduced by certain amounts, such as a deductible IRA contribution or student loan interest.

7 A higher adjusted gross income would potentially decrease your medical deductions, decrease your miscellaneous itemized deductions, potentially decrease your exemptions for dependents, and your total itemized deduction allowance. It will also increase your exposure for Social Security income tax [the amount of Social Security tax you pay]. If you are over age 70-1/2 and you do want to make contributions to charities, this is the way to do it. Talking about charities -- and here s where I get so disturbed by our tax code -- our [tax] code is so complicated; it is so convoluted. Everybody knows that [when] you make a contribution to your charity, [e.g.] you write a check to the Red Cross, that s deductible. You write a check to your church or your synagogue, that s deductible. Starting this year, you must get a receipt. No more. When I say this year, 2007, starting in 2007, you must have a receipt. So if you're throwing cash into your church collection plate, you're making a contribution. You're just not going to be able to deduct it unless you get some sort of written record. I'm getting close to the time out over here. Let me give you just one or two more. Clothing and household items donated to charity. Talking about charity, if you don t have any cash, what can you do? You can actually put a charitable contribution on a credit card and take the deduction in the year of the charge, even though you pay it in the subsequent year. If you don t have any cash, if you don t have any credit, empty out your closet. Give out your old clothes, your old furniture.

8 But as of August 18, 2006, those donations must be donations of items in good or better condition. I'm running out of time, I apologize. I will turn back to our Cynthia Dawkins: Well, you have a few more minutes if you want. Jeff Schnepper: I can have a few more minutes? Okay, I didn t want to cut in on what was left. All right, let s talk about additional changes and additional things that you may be able to do. Section 529 plans [college saving plans] were scheduled to lose their tax-free status. New rule: as of 2010, [529 plans] are permanently tax-free -- good news. More good news the saver s credit was made permanent. [Individuals who make eligible contributions to an employersponsored retirement plan or to an individual retirement arrangement (IRA) may be able to take the retirement savings contribution credit (saver s credit). There are various criteria for claiming the credit. See Retirement Savings Contribution Credit in Publication 590 (2006), Individual Retirement Arrangements, at on the Internal Revenue Service Web site.] More good news you can now have a stretching [out] of your payout on an inherited IRA. It used to be that if you had a retirement plan and you left it to your spouse, your spouse could take the payments over that spouse s lifetime. But if you left it to kids or to a trust, they

9 had to take it [out] in a shorter period of time, normally within the first five years. Now, non-spouse beneficiaries have that same stretch-out flexibility as spouses did in the past. You also wanted me to talk about the Earned Income [Tax] Credit. Quite frankly, I consider the Earned Income [Tax] Credit a disgrace. The Earned Income [Tax] Credit is a negative income tax. It is structured to provide benefits to those taxpayers who are in our lowest earning classification, and it is probably the most complicated and insane provision in the Internal Revenue Code. It is so complicated, it is so obtuse that the IRS says all we need from you is to fill out a form the EITC form on which we ask you to put down the names, the ages, and the Social Security numbers of your kids. Write down EITC on the line where you're supposed to take the credit and they will figure it out for you. That s how complicated it is. Finally, you asked me to touch base with respect to whether people should paper file or e-file. Well, from the IRS perspective, you ve got to e-file. They want you to e-file. It s faster. You can get your refund faster. If you have the opportunity to e-file, I highly recommend it. There are lots of programs out there that help you with e-filing. As a matter of fact, if your income qualifies--and I think it s about $52,000 as a cap this year--the IRS Web site allows you to e-file for free. Get onto click on free file, and you will be able to file for free.

10 [The Free File program is a free federal tax preparation and electronic filing program for eligible taxpayers developed through a partnership between the Internal Revenue Service and the Free File Alliance LLC, a group of private sector tax software companies. Free File allows taxpayers with an Adjusted Gross Income (AGI) of $52,000 or less in 2006 to e-file their federal tax returns for free.] Cynthia Dawkins: Thank you so much, Jeff. That was also very informative.