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MONTHLY TAX NEWSLETTER
THE RELATIVE VALUE OF A TAX BREAK
Andrew D. Schwartz, CPA
tax breaks are created equally. Due to the complexities
and nuances of
the continually evolving tax code, certain credits and
deductions save you significantly more in taxes than others.
Let's look at an
example comparing the mortgage interest deduction with the student loan interest
deduction. With the high cost of college these days, you can easily owe
more than $100,000 in student loan debt upon completion of your degree. On
$100,000 of debt, which type of interest saves you more in taxes?
When you have a
mortgage on your primary residence, you deduct the full amount of interest
paid on up to $1 million of mortgage debt. For your student loans, you
are limited to the first $2,500 of interest paid each year.
Without even factoring in that you're also required to phase-out this deduction
once your Adjusted Gross Income (AGI) exceeds $115k if married or $55k if
single, there is no question that the mortgage interest deduction is a much more
valuable tax break than the student loan interest deduction.
Determine Relative Value
Figuring out how to
objectively compare tax breaks took quite a bit of thought. To determine the
relative value of a variety of tax saving opportunities, we designed our
analysis to factor in the following six criteria:
Type of Tax
Break: Credits are more valuable than deductions, and
tax-free growth trumps tax-deferred growth.
Minimum Tax: Any deduction or credit limited by the AMT is less
valuable - until Congress either fixes or eliminates this tax.
Most tax breaks limit how much you can spend each year before maxing out the
deduction or credit. The lower the annual limit, the lower the
Phase-out: Some tax
breaks are phased-out based on your AGI, and the value of those tax breaks is
tax breaks, such as medical expenses and miscellaneous itemized
deductions, are only deductible to the extent they exceed a percentage of
your AGI. The higher this threshold, the lower the relative value.
Reporting: Any tax break that requires you to either complete and
attach an additional tax form or to work through a separate worksheet
indicates that the rules for this tax break are complicated, impacting its
Using these six
criteria, we calculated a score for each tax break, with a maximum score of 100.
Let's take a look at the winners and losers.
What were some of the
attributes that the six winning tax breaks all had in common? None are
limited by the AMT. Plus, the amount of the maximum annual expenditures
are pretty substantial.
Here are the six tax
breaks with a score of 75 or higher:
Deduction - (Score: 75) Full deduction for interest paid
on the first $1 million of outstanding debt on your primary residence and
second home. Plus, your allowable mortgage interest is deductible when
calculating the AMT as well.
Retirement Plans - (Score: 77) Maximum contribution of $46k for
2008, which reduces your AGI and is exempt from the AMT.
401(k) and 403(b)
Salary Deferrals - (Score - 76) Contributions into these employer
sponsored retirement savings accounts reduce your taxable wages by up to
$15,500 ($20,500 if 50 or older), grow tax deferred, and are unaffected by
Contributions - (Score - 80) Did you know you can deduct
charitable donations of up to 50% of your AGI each year? Plus, like
mortgage interest, this itemized deduction is also deductible when
calculating the AMT.
529 Plans -
(Score - 85) Even though 529 plans don't provide for a current year deduction,
you and your spouse can sock away up to $120k all at once into these
tax-free college savings accounts.
Accounts - (Score - 75) Through your employer's FSA, you can pay
for up to $5,000 of dependent care expenses, and an equal amount of your
family's healthcare expenses, with pre-tax dollars.
You may be surprised to
see the tax breaks that provide the least bang for the buck under the current
- (Score - 36) A meager $3,500 ( in 2008) for you, your spouse, and
each of your children and other dependents. And even though the
phase-out threshold is reasonably high, anyone in the AMT loses out on this
Savers Tax Credit
- (Score - 46) While the government paying you to save for
retirement is a great deal, the combination of an annual expenditure limit
of just $2,000 and a low phase-out of $52k for married couples and $26k for
single individuals gives this tax break a low value.
Hybrid Tax Credit
- (Score - 41) Not even factoring in that the credit for hybrids
manufactured by Toyota and Lexus are fully phased out, and those
manufactured by Honda will soon be fully phased out, the fact that this
credit isn't allowed if you're in the AMT greatly reduces its value.
interest - (Score - 52) Low annual limit of $2,500 coupled with
an AGI phase-out starting at $115k if married or $55k if single gives the
student loan interest deduction a low value.
Interest on An
Equity Loan Not Used to Improve Your Home - (Score - 54) While
you get to deduct the interest paid on up to $100,000 of your equity loan or
line of credit no matter how you spend the money you borrow, not being able to deduct this interest when calculating the
ATM if you don't use the proceeds to improve your residence hurts its value.
Interpreting the Results
Own where you live.
Max out your retirement savings opportunities. Save for your child's
education. Even though the US Tax Code is overly complex, the current set
of rules do reward you for make prudent financial planning decisions.
TALK TO THE IRS ON YOUR TERMS
Did you know that the
IRS has personnel available to meet with you face-to-face?
According to the IRS,
"if you need to resolve a tax problem, have questions about how
the tax law applies to your individual tax return, or you're
more comfortable talking with someone face-to-face, visit your
local Taxpayer Assistance Center where you can spread out your
records and talk with an IRS representative across the counter.
No appointment is necessary - just walk in."
http://www.irs.gov/localcontacts/index.html to find the IRS
Taxpayer Assistance Center closest to your home or workplace.
Andrew D. Schwartz, CPA
With each passing Tax Act, there seem to be fewer and fewer
for Exaggeration" remaining on your federal income tax return. One
such tax break targeted by Congress in recent years
is the value people claim for their non-cash contributions.
2004, Congress first went after the increasingly popular (and often
exaggerated) tax savings opportunity available to people who
donate a vehicle to charity. As of January 1, 2005, the deduction you can claim
for a donated vehicle is limited to what the
charity sell your car for. Unless you meet one of three very specific
exceptions, you can no longer claim this tax break based on the vehicle's Blue Book
After passing that rule, Congress wasn't done yet,
and a few years later passed the Pension Protection Act of 2006 which
containied a provision greatly affecting non-cash contributions
of clothing and household items.
Effective August 17, 2006, the date the bill was signed into law, you can
only claim a deduction for donated goods that are in good condition or
Let's take a look at the
guidelines provided by the IRS to help taxpayers comply with this new
standard. First stop, the instructions to the
- Non-cash Charitable Contributions, where we are told:
FMV of used household items and clothing is usually
much lower than when new. A good measure of value
might be the price that buyers of these used items
actually pay in consignment or thrift shops. You can
also review classified ads in the newspaper or on
the Internet to see what similar products sell for.
You cannot claim a deduction for clothing or
household items you donate after August 17, 2006,
unless the clothing or household items are in good
used condition or better. However, you can claim a
deduction for a contribution of an item of clothing
or household item that is not in good used condition
or better if you deduct more than $500 for it and
include a qualified appraisal of it with your
Our second stop is
Publication 526 - Charitable Contributions,
where the IRS sheds more light
onto this issue:
fair market value of used household items, such as
furniture, appliances, and linens, is usually much
lower than the price paid when new. These items may
have little or no market value because they are in a
worn condition, out of style, or no longer useful.
For these reasons, formulas (such as using a
percentage of the cost to buy a new replacement
item) are not acceptable in determining value.
should support your valuation with photographs,
canceled checks, receipts from your purchase of the
items, or other evidence. Magazine or newspaper
articles and photographs that describe the items and
statements by the recipients of the items are also
useful. Do not include any of this evidence with
your tax return.
We Can Help
Properly valuing your donated
clothing and household rules has become more important in the post August
17, 2006 "Good or Better" world. If you ever get audited, there is a good chance that
the IRS will use these new rules as a way to greatly reduce the deduction
they will allow you to claim unless you can:
Substantiate that the donated
goods were in good condition or better, and
Demonstrate how you came up with
the Fair Market Value you claimed
To help you put a value on the
donated goods, we have created a few different tools based on the published values of used
merchandise sold at the thrift shops of the Salvation Army and Goodwill
Industries. Download our Non-cash Charitable Donation worksheet in
format or as an
Interactive Microsoft Excel Spreadsheet. (To download the Excel
Spreadsheet, right click your mouse and hit "Save Target As", and then choose
the directory on your computer where you want this file to sit.)
Simply complete either version of
this worksheet, take a few photos of what you are donating, and file along
with your tax records. Hopefully this information will do the trick if
you ever get audited. While we don't recommend that you exaggerate the
value you claim for the items you're donating, we do believe you should take
the full deduction based on the fair market value of the stuff you gave
Understanding the new rules and
documenting what you give away will help ensure that the deduction you claim
on your tax return will withstand reasonable scrutiny from our friends at the IRS.
TAX AND FINANCIAL PLANNING CALENDAR FOR
Saving and Investing
2nd quarter estimates due 6/15/08
Income tax returns for Ex-Patriots due 6/15/08
Determine if you are on track to meet the savings and
debt reduction goals you set back in January
See if you have adequate
Disability Insurance in place.
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
- For 2007, the personal exemption is $3,400.
Individuals will claim a personal deduction for themselves, their spouse, and
- 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