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February 2007

by Andrew D. Schwartz, CPA

A dollar today is worth more than a dollar tomorrow.  Known as the time value of money, that's one of the first concepts taught at any business school program.

If that statement doesn't makes sense to you, don't overlook the impact of inflation.  Even at a low rate of 3%, a dollar today only buys 97 cents worth of goods and services after one year.  Wait ten years and the buying power of a dollar falls to just 77 cents.

So what does this have to do with taxes? Unless the amount of a tax break is indexed for inflation, that tax break becomes less valuable over time.  And less valuable tax breaks equate to your paying higher taxes.

During 1986, President Reagan signed the massive Tax Reform Act of 1986 into law.  Even though 20 years have since passed, some of the tax breaks haven't increased at all over the years.  But how has the dollar fared since then?  According to the calculator available at the website of The Department of Labor, Bureau of Labor Statistics, a basket of goods and services that cost $1,000 in 1986 now costs  $1,850 today. 

Let's look at some of the tax breaks which haven't changed over the years:

Mortgage Interest Deduction:  The Tax Reform Act of 1986 capped the mortgage interest you can deduct to $1.1 million of mortgage debt on your primary residence and a second home.  Since this threshold hasn't increased in 20 years, the maximum allowable inflation-adjusted mortgage interest deduction continues to fall.  To keep pace with inflation, the mortgage debt ceiling would have to be increased to $2,035,000 in 2006.

Rental Losses:  The Tax Reform Act of 1986 also introduced limits to the annual rental losses that could be claimed each year.  Under the existing rules that haven't changed since being introduced twenty years ago, deductible rental losses are capped at $25,000.  Factor in 20 years of inflation, and the maximum rental loss of $25,000 falls to an inflation-adjusted $13,500.   Another part of the 1986 Tax Act limits the rental losses you can claim once your income exceeds $100,000, and then disallows any current year losses once your income exceeds $150,000.  Since these thresholds haven't been increased for inflation since 1986, the phase-out range of $100,000 to $150,000 is now equivalent to just $54,000 to $81,000. 

Student Loan Interest:  While the Tax Reform Act of 1986 eliminated the student loan interest deduction, Congress re-instated this deduction back in 1997.  Since 2001, the maximum student loan interest deduction has been stuck at $2,500.  Based on 6 years with no increases, the $2,500 student loan interest deduction has eroded to be worth only $2,200.

Capital Losses:  Each year, you're allowed to claim your capital losses against your capital gains, and then can claim up to $3,000 in additional capital losses to offset you wages and other income.  Any excess losses will be carried forward to your next year's return.  Sounds like a pretty good deal, right?  Unfortunately, the $3,000 capital loss limit hasn't changed for at least 20 years.  Due to inflation, the maximum capital losses you can claim is now worth just $1,621 in inflation-adjusted dollars.  For this tax break to have remained equivalent to the $3,000 allowed in 1986, the allowable capital losses would need to jump to $5,550.

Roth Contributions:  Yes, the amount you can contribute to a Roth IRA each year has increased since these tax-free investment opportunities were first introduced in 1998.  The problem is that the income limitations haven't budged in those 9 years.  To qualify to contribute to a Roth IRA, your income can't exceed $110,000 if single or $160,000 if married.  Over these 9 year, the thresholds have actually decreased to an inflation-adjusted $89,000 for single taxpayers and $129,000 for married couples, resulting in it becoming more difficult each year for you to contribute to a Roth IRA.

No Increases = Big Decreases

Since many of your tax breaks are indexed for inflation, it doesn't make sense the the items listed above haven't increased at all over the years.  But until such time that Congress decides to bump up these tax breaks, inflation will continue to make a fibber of anyone serving in the executive or legislative branches who brags about no new taxes.


by Neil L. Cohen, Esq.

Looking for a good way to pass some of your wealth to your children or grandchildren without giving Junior the opportunity to use your hard-earned savings to purchase a new Lamborghini?  If you are not interested in tying up your money in a trust, take a look at the 529 Plan.  Named for the section of the Internal Revenue Code that authorized its creation, a 529 Plan is actually a “qualified tuition plan” designed to encourage savings for college expenses.

There are two types of 529 Plans: pre-paid tuition plans and college savings plans. Most prepaid tuition plans are sponsored by state governments, have residency requirements, and allow a college saver (the “Account Holder”) to purchase units or credits at participating colleges and universities for future tuition, thus locking in today’s prices.  Pre-paid tuition plans make sense for people who fear that the stock market will not keep pace with the rising cost of a college education.

College savings plans, on the other hand, generally permit the Account Holder to establish an account for a student (the “Beneficiary”) for the purpose of paying the Beneficiary’s eligible college expenses.  An Account Holder typically chooses among several investment options including mutual funds and money market funds, as well as age-based portfolios that are automatically reallocated toward more conservative investments as the Beneficiary gets closer to college age.  These plans are much more flexible than pre-paid tuition plans, since you can invest in any state’s plan and use the funds at any college or university accredited by the U.S. Department of Education.  For the balance of this article, references to the 529 Plan will mean the college savings plan variation.

How does investing in a 529 Plan affect federal and state income taxes?

Investing in a 529 Plan offers the Account Holder special income tax benefits.  Under the current rules, earnings within a 529 Plan grow free of federal and, in most cases, state income taxes.  Withdrawals are also income tax free, so long as you use the funds for eligible college expenses such as tuition, fees, books, and reasonable costs for room and board.

Many states offer additional benefits such as matching grants for investments in a 529 Plan.  Keep in mind, however, that to be eligible for these benefits, you must generally participate in a 529 Plan sponsored by your state of residence.  Some states also allow their residents to deduct contributions to their state sponsored 529 Plan on their state income tax returns. 

What happens if money withdrawn from a 529 Plan is not used for qualified education expenses?  Expect to pay taxes plus a 10% federal penalty tax on the earnings portion of these withdrawals.

Estate and Gift Tax Benefits of 529 Plans

A 529 Plan is a good compliment to your overall estate plan.  Setting up a 529 Plan for children or grandchildren is a fantastic way to reduce estate taxes and transfer wealth to your heirs without getting deeply involved in the various estate and gift tax issues.

As with any gifting program, you can gift as much as $12,000 annually to a 529 Plan free from gift tax (often referred to as the “annual exclusion”), thus removing those assets from your estate.  If you are married, you can gift up to $24,000 per beneficiary per year, as long as your spouse joins you in “gift-splitting”. 

A unique feature of the 529 Plan allows you to make a lump-sum gift of $60,000 ($120,000 if your spouse joins you in gift-splitting) to a 529 Plan without incurring gift taxes.  The only requirement is that you file a gift tax return (Form 709) with the IRS, reflecting that you are making a special election to treat the gift as if it were made equally over a five-year period. 

Another benefit of 529 Plans is that you can make as many of these gifts as there are Beneficiaries.  Grandparents with several grandchildren can put a large dent in their taxable estates by front-end loading a 529 Plan for each grandchild.

Understand, however, that as part of your overall estate plan, contributing $60,000 to a 529 Plan precludes you from making any other gifts to the Beneficiary for a five-year period without incurring a gift tax liability.  In addition, if the donor dies within the five-year period, a portion of the gift will be brought back into that person's estate and subjected to estate taxes.

The other striking difference between the 529 Plan and any other mechanism for passing wealth down to the younger generation is that the Account Holder of a 529 Plan retains control of the assets, even after the gift is made.  If the Beneficiary gets a full scholarship, changes his or her plans to attend college, or if the funds need to be distributed earlier than expected, the Account Holder can either take back the money or change the beneficiary to another family member.

This statutory ability of the Account Holder to retain control leads to an anomaly in the gift giving area.  Generally, the law requires that you must give up control of an asset to remove it from your taxable estate.  Under section 529 of the Internal Revenue Code, a gift to a 529 Plan removes the funds from your taxable estate while still allowing you to take the assets back at any time. 

As always, when deciding whether a 529 Plan makes sense for your individual needs, make sure to consult your CPA and estate planning attorney.

Neil Cohen is an attorney with the Boston area law firm of Woodman & Eaton, PC.  Neil specializes in the area of estate and gift tax planning, and can be reached at (978) 369-0960.  For more information, please visit the firm website at




Income Taxes

Saving and Investing



  • Get a jump on your tax prep and call one of the MDTAXES CPAs by 2/28/07 to set up an appointment
  • Organize your tax information
  • Try to have holiday credit card balances paid off by 2/28/07


2006 & 2007 TAX FACTS

  • For 2006, the standard deduction for a single individual is $5,150 and for a married couple is $10,300. A person will benefit by itemizing once allowable deductions exceed the applicable standard deduction. Itemized deductions include state and local income taxes (or sales taxes), real estate taxes, mortgage interest, charitable contributions, and unreimbursed employee business expenses.
  • For 2006, the personal exemption is $3,300. Individuals will claim a personal deduction for themselves, their spouse, and their dependents. 
  • The maximum earnings subject to social security taxes is $97,500 for 2007, up from  $94,200 in 2006.
  • The standard mileage rate is $.445 per business mile for 2006, increasing to $.485 per mile in 2007.
  • The maximum annual contribution into a 401(k) plan or a 403(b) plan is $15,500 in 2007.  And if you'll be 50 or older by December 31, 2007, you can contribute an extra $5,000 into your 401(k) or 403(b) account this year.
  • The maximum annual contribution to your IRA is $4,000 for 2006 and 2007.  And if you turn 50 by December 31st, you can contribute an extra $1,000 that year.  You have until April 15, 2007 to make your 2006 IRA contributions. 


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Most recent information issued by the IRS

Check out the memorandum issued by the U.S. District Court in Minneapolis and you'll see that the court found that medical residents and fellows might not be subject to FICA taxes in many instances.

For more information, go to our February 2001 Newsletter or read through the IRS' Chief Counsel Advice Memorandum on this issue.

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