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MONTHLY TAX NEWSLETTER

February 2008

A TAX DOLLAR SAVED IS A DOLLAR EARNED

by Andrew D. Schwartz, CPA

Ben Franklin was a man ahead of his time.  Even though he died more than 100 years before the current income tax code was put into place, one could argue that he gave some pretty good tax advice when he coined the phrase, "A penny saved is a penny earned." 

Any time you take advantage of a tax savings opportunity, less of your hard-earned money goes to taxes and, therefore, more ends up in your pocket.  So let's follow another piece of advice from Ben, "An investment in knowledge pays the best interest," and review some of the tax breaks available to you these days.

Pre-Tax Opportunities

When is $100 worth $155?  If you're in the 28 percent tax bracket, that's the value of paying for personal expenses with pre-tax dollars.  Whenever post-tax dollars are involved, you need to earn $155 to have $100 left over after paying your federal income taxes, social security taxes, and Medicare taxes.  Here are some pre-tax opportunities that might be available to you:

  • Medical expenses paid through a Flexible Spending Account: Most employers, as part of their benefits package, allow their employees to elect to have certain expenses paid with pre-tax dollars through a "flexible spending account (FSA)", including as much as $5,000 per year to be used for medical and dental expenses. Please beware that  this benefit comes with a big caveat, you either use it or lose it. In other words, if you don't spend the money that is set aside, it won't be refunded to you.  If you haven't spent all of last year's money, don't despair.  Under the current rules, your employer can give you to as late as March 15, 2008 to spend any money that you set aside for this pre-tax benefit in 2007.

  • Childcare expenses paid through a Flexible Spending Account:  If you're paying child care expenses, and both you and your spouse work, you can set aside $5,000 per household through your employer's FSA to pay for your dependent's care expenses. The catch is that you need to report the name, address, and taxpayer identification number of the care provider on your tax return, or the $5,000 becomes taxable to you again. If you only have one child, paying for the child's care through the FSA saves you a lot in taxes.

  • Health Savings Accounts:   With health insurance premiums on the rise, more people are looking into high-deductible products.  Did you know that you can couple a high-deductible plan with a special type of savings account known as a Health Savings Account (HSA)?  While either you or your employer contributes pre-tax dollars into an HSA in your name, money withdrawn from the HSA for health care expenses is completely tax-free.  Plus, any money remaining in your HSA once you turn 65 is available to help fund your retirement.

  • Business expenses paid through employer's "slush fund":  If you have the option of having your employer pay for some of your out-of-pocket expenses in exchange for a reduced bonus or salary, those expenses are paid with pre-tax dollars.

Tax-Free Opportunities:

Tax-free opportunities are a relatively recent phenomenon.  Prior to some of the tax law changes during the late 1990's, there were very few tax-free options available to taxpayers.  Even though you don't get a current tax deduction in most cases, the potential for decades of compounded growth coupled by tax-free withdrawals down the road makes them worth a close look.

  • Roth IRAs: For 2007, you can contribute up to $4,000 to a Roth IRA, as long as you have earned income, and your adjusted gross income doesn't exceed $114,000 if single or $166,000 if married.  Starting in 2008, the maximum annual contribution jumps by 25% to $5,000 per year.  Anyone 50 or older can contribute an extra $1,000 annually.  Amounts contributed to a Roth grow tax-free as long as you don't withdraw any of the earnings until you turn 59 1/2, use $10,000 for first-time homebuyer costs, or meet certain other exceptions.

  • 529 Plans: College savings plans allow you to put away a sizeable amount of money for a child's education. Currently, you can contribute up to $12,000 per child per year into a 529 Account.  You can even frontload five years worth of contributions, up to $60,000, all at one time, but then you can't add to that child's account for the next four years. Amounts withdrawn from your 529 plan are not taxed as long as the money is used to pay for tuition and other qualified college expenses.

  • Principal residence:  When you sell your principal residence, you aren't taxed on the first $500,000 of gain if you are married, or the first $250,000 of gain if you are single, as long as the home was your principal residence for two out of the previous five tax years. If you sell the house in connection with a job related move or meet certain other conditions of hardship, and lived in the house for less than two years, you can exclude a prorated amount.

  • Other Tax-Free Opportunities:  Gifts received from parents and relatives are generally not taxable to you.  Instead, the donor might be subject to a "gift tax" if the value of the gift to another person exceeds $12,000.  Life insurance proceeds aren't subject to income taxes either.  Depending on who owned the policy, however, the proceeds might be subject to estate (inheritance) taxes.  Make sure to talk with an estate planning attorney about these two items.

Tax-Deferred Opportunities:

With a tax-deferred savings opportunity, you save taxes today, and then generally owe taxes when you withdraw the money later on.  Even so, these opportunities make sense for a variety of reasons.  For starters, a dollar today is more valuable than a dollar tomorrow, due to the time value of money.  Plus, the government lets you invest the taxes you save and keep the compounded earnings on that money.  For both these reasons, tax-deferred savings opportunities make a lot of sense.

  • 401(k) & 403(b) plans: These salary deferral retirement savings plans are only available through your employer's benefit package. Amounts contributed during the year reduce your taxable earnings and grow tax-deferred. For 2008, the maximum contribution into either of these plans through salary deferrals is $15,500.  Anyone 50 or older by December 31st can contribute an additional $5,000 this year. If you go with the Roth version of these plans, you forego a tax savings today in exchange for a promise from the government of tax-free withdrawals down the road.

  • SEPs, SIMPLEs, and Solo 401(k)  Plans: If you have some self-employment earnings, or own a small business, you're entitled to set up your own retirement plan. You can contribute up to 20% of your net earnings into a SEP and up to $10,500 plus 3% of your income into a SIMPLE.  If you don't have access to a 401(k) or 403(b) plan through another employer, you can contribute $15,500 ($20.5k if 50 or older) plus 20% of your net earnings into a Solo 401(k).  Amounts contributed to these plans reduce your taxable income and grow tax-deferred.

Be A "Learned Blockhead"

Ben Franklin put it best when he said, "A learned blockhead is a better blockhead than an ignorant one."  And with the complexity of today's tax code, Ben warns us that, "By failing to prepare, you are preparing to fail" and will end up paying higher taxes.

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"TAX BREAK" WEEKLY RADIO SHOW FEBRUARY SCHEDULE

Andrew D Schwartz CPA has agreed to host a weekly, one-hour radio show on taxes through WorldTalkRadio.com. The show can be heard live each Wednesday at 7 pm ET (4 pm PT) at www.worldtalkradio.com. Each week, Andrew will interview various guests who can add information and insight to that week's topics, as well as take questions directly from the listeners.

Please join Andrew and his guests to discuss the following topics during January:

  • February 6th - Are You At Risk Of Being Audited?
  • February 13th - College Savings Confusion
  • February 20th - Work From Home and Save Taxes
  • February 27th -  Basic Estate Planning

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DECISIONS ABOUT DEDUCTIONS

by Andrew D. Schwartz, CPA

For the most part, calculating your deductions each year is relatively straightforward. Simply tally up the amount you spent, and that's what you deduct.  When making your calculations, don't forget to include checks you wrote, purchases made by credit card, and expenses paid through loan disbursements.

A few deductions require you to make a decision, however.  For your automobile expenses, you need to decide between basing your deduction on the standard mileage rate or on actual expenses incurred.  And if you went on any business trips last year, you'll choose to base your deduction for meals and entertainment on the per-diem rates or on what you actually spent.

Automobile Expenses:

When you use your car for business, driving between job sites is deductible.  So is driving between your home and a temporary job site, job interviews, and conferences.  Commuting between your home and a regular place of business generally isn't tax deductible.

There are two ways for you to calculate your automobile expenses.  You can either claim $.485 per business mile driven in 2007 (increasing by a lousy two cents to $.505 for 2008), or you can base your deduction on the percentage of miles your car was driven for business multiplied by the actual costs incurred during the year.  Allowable costs include gas, insurance, repairs, parking at home, and either your lease payments, or if you own your car, a factor for depreciation.

Generally, unless you drive your car relatively few miles each year, with most of those miles being allowable business miles, you're better off basing your deduction on the standard mileage rate.

For Example

Let's say you lease a car for $400 a month that you drive only 3,000 total miles during the year.  And of those miles, 2,000 qualify as deductible business miles.  By calculating your deduction based on the standard mileage rate, you'll end up with a deduction of just $970 (2,000 business miles * $.485 per mile).

What would your deduction be based on the actual expenses incurred, assuming you spend $1,200 on insurance, $.10 per mile driven for gas, and $1,200 on parking at home?  Based on $7,500 of total automobile expenses (including the lease payments), multiplied by two-thirds (2,000 business miles divided by 3,000 total miles), your allowable deduction for your automobile expenses jumps to $5,000 - more than five times the $970 allowed using the standard mileage rate.

Now let's see what happens if you drive 20,000 total miles during the year.   Assuming your allowable business miles remains at 2,000, you can either claim an automobile deduction of $970 based on the standard mileage rate, or $920 based on one-tenth (2,000 business miles divided by 20,000 total miles) of your actual automobile expenses incurred.

Expense 3,000
total miles
driven
20,000
total miles
driven
Lease payments $4,800 $4,800
Insurance $1,200 $1,200
Gas ($.10 per mile driven) $300 $2,000
Parking at home $1,200 $1,200
     
Total costs $7,500 $9,200
     
Business use % on 2,000
     business miles driven
66.67% 10%
     
Allowable deduction for
     auto expenses based
     on actual expenses
$5,000 $920

There are a few rules that you should be aware of when deciding which method to use to calculate your automobile deduction.  According to the IRS, "A taxpayer may not use the business standard mileage rate for a vehicle after using any depreciation method under the Modified Accelerated Cost Recovery System (MACRS), after claiming a Section 179 deduction for that vehicle, for any vehicle used for hire, or for more than four vehicles used simultaneously.  Revenue Procedure 2006-49 [available at www.irs.gov] contains additional information on these standard mileage rates."

Meal & Entertainment While Traveling

Whenever you’re on a business trip, 50% of your meals and business related entertainment is deductible.  You have two ways you can calculate your deduction. 

One option is to keep track of the actual money spent during your trip.  The easiest way to do this is by keeping all the receipts together, or by charging everything on one credit card.  At the end of the trip, simply tally up what you spent.

The other option is to base your deduction on the per-diem rates.  Here, the IRS has actually made your life easier by assigning one of six rates to every metropolitan area in the country.  Currently, the rates range from $39 to $64.  A complete listing of the per diem rates by city can be found at www.gsa.gov.  To calculate your deduction using the per diem rates, simply multiply the number of days you were in a city by that city’s rate.  It couldn’t be easier, and it relieves you of the burden on keeping track of your individual meals and entertainment receipts.

Which method should you choose?  For each trip, you get to decide whether you’ll base your meals and entertainment deduction on the per diem rates or actual expenses.

Claiming Your Business Deductions

Calculating your deductions is one thing.  You still need to figure out how to claim them on your tax return.

If you're compensated as an employee, you'll generally report your deductible business expenses on a Form 2106, and claim this deduction as a miscellaneous itemized deduction on the Schedule A.  Keep in mind that miscellaneous itemized deductions are only allowable to the extent they exceed 2% of your income, and are not allowable when calculating the Alternative Minimum Tax (AMT).

If you're compensated as an independent contractor, you'll get a much bigger bang for your buck. That's because you'll generally claim your allowable business expenses directly against your self-employment income on your Schedule C.  

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TAX AND FINANCIAL PLANNING CALENDAR FOR FEBRUARY, 2008

Month

Income Taxes

Saving and Investing

 

February

  • Get a jump on your tax prep and call one of the MDTAXES CPAs by 2/29/08 to set up an appointment
  • Organize your tax information
  • Try to have holiday credit card balances paid off by 2/29/08

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2007 & 2008 TAX FACTS

  • For 2007, the standard deduction for a single individual is $5,350 and for a married couple is $10,700. 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 2007, the personal exemption is $3,400. Individuals will claim a personal deduction for themselves, their spouse, and their dependents. 
  • The maximum earnings subject to social security taxes is $102,000 for 2008, up from $97,500 in 2007.
  • The standard mileage rate is $.485 per business mile for 2007, increasing to $.505 per mile in 2008.
  • The maximum annual contribution into a 401(k) plan or a 403(b) plan is $15,500 in 2007 and 2008.  And if you'll be 50 or older by December 31st, you can contribute an extra $5,000 into your 401(k) or 403(b) account that year.
  • The maximum annual contribution to your IRA is $4,000 for 2007, increasing to $5,000 in 2008.  And if you turn 50 by December 31st, you can contribute an extra $1,000 that year.  You have until April 15, 2008 to make your 2007 IRA contributions. 

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This Month's Topics

A Tax Dollar Saved Is A Dollar Earned

"Tax Break"  Weekly Radio Show February Schedule

Decisions About Deductions

The FICA Refund for Medical Residents 

2007 & 2008 Tax Facts

Tax and Financial Planning Calendar for February 2008

 

NEWSLETTER ARCHIVES
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WHAT'S NEW WITH THE FICA REFUND?

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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