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Second Annual MDTAXES Conference

We'll be hosting our second annual MDTAXES conference, exclusively for our member CPA firms, in Washington, DC, on Friday, October 17th.  During the conference, we'll focus on various tax and financial planning issues applicable to young health care professionals.

All CPAs who are members of The MDTAXES Network are invited to attend.  For information, please e-mail us at info@mdtaxes.com.

 

 
July, 2003

WHY GOOD TAX PLANNING BACKFIRES

by Andrew D. Schwartz, CPA

Don't pay any taxes before you absolutely have to.  That was the generic tax advice offered by CPAs when I first started working fifteen years ago.  And for good reason.  Prior to 1987, tax rates were high, tax shelters were abundant, and deductions such as sales tax paid and credit card interest were still allowable. 

Everything changed in 1997, however, with the advent of Roth IRAs.  While Roths grow tax-free, amounts contributed into a Roth aren't deductible.  All of a sudden, financial advisors and CPAs found themselves in uncharted waters, and began instructing their clients to forego a tax deduction today in anticipation of tax-free growth in the future.

The 1997 Tax Act pushed the tax planning community into even more treacherous and uncharted waters.  That's because you could also elect to pre-pay your taxes on your retirement money by converting your traditional IRAs and certain 401(k) plans to a Roth IRA.  The amount converted would be taxed at your tax rate - so if you rolled over $10,000 from your traditional IRA into your Roth IRA, and were in the 28% tax bracket, you'd pay $2,800 in federal income taxes.  Depending on your age, you'd pay those taxes decades earlier than would otherwise be necessary.

I'm not disputing that Roth IRAs are a great investment opportunity that make sense for lots of people.  But is it worth foregoing a tax deduction today, or pre-paying taxes years earlier than necessary, just to maximize the amount of money in your Roth IRA?  Only time will tell.  If Congress ever replaces the current tax code with an alternative tax, or needs money so badly that they decide to make Roth IRA distributions taxable, then the strategy of paying higher taxes in exchange for maximizing the money invested within your Roth would surely backfire.

"The government wouldn't do such a thing", you say to yourself.  Or would they?  Just look back a few years, and you'll see that the government increased the percentage of social security benefits that is taxable from 50% to 85%.  Considering that the social security taxes you pay aren't deductible, this change in the law means you'll essentially be taxed twice on any social security benefits you ultimately receive.  If the government tinkered with the taxability of social security benefits, why wouldn't they look at Roth IRA distributions as a way to raise tax revenues down the road?

For more proof, take a look at what the 2003 Tax Act did to a provision of a previous tax law change.  Under the pre-2003 rules, a new 18% capital gains tax rate was slated to take effect.  The reduced rate would have only applied to investments purchased subsequent to January 1, 2001 that were held for more than five years before being sold. 

To be fair (and to raise tax revenues), the government allowed you to pre-pay taxes on your investments purchased prior to 2001 that had appreciated in value, even though those investments weren't actually sold.  By pretending to sell some or all of your investment portfolio on January 1, 2001, and then paying taxes on the appreciation, those investments would qualify for the 18% tax rate as long as they were held for at least five more years.

Sounds like a great deal, right?  It might have been, until President Bush signed the 2003 Tax Act into law.  As part of this tax bill, Congress reduced the capital gains tax rate on investments held for more than one year to 15% through 2008.  Anyone who elected to pre-pay taxes in 2001 on their investments did so at a rate of 20%, which is a whopping 33% premium over the new rate of 15%.  Plus, they paid their taxes at least 2 years earlier than necessary.  

Here's the moral of this story.  No matter how great a tax planning opportunity might look on paper, pre-paying taxes and foregoing tax deductions is risky business, since you're relying on the government not to change the rules of the game.  And based on the frequency of the tax law changes that I've seen during my 15 years in practice, I don't like the odds of that happening in the long run.  For that reason, the safest strategy is one we've all heard before - Don't pay any taxes before you absolutely have to.

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GOOD NEWS FOR RECIPIENTS OF NIH LOAN REPAYMENT PROGRAMS

If you're fortunate enough to have been selected to participate in the NIH Loan Repayment Program, you're aware that the NIH remits taxes to the IRS on your behalf to cover the approximate taxes due on the loan repayment proceeds.  Did you know that they will reimburse you if your tax liability ends up being higher than the amount of taxes remitted?

To find out more, check out  this link.  As part of the process, you'll need to obtain a letter from a CPA licensed in your jurisdiction of residency.  To find a CPA familiar with the steps to take, go to our Directory of Affiliated Offices or click on our Map of the United States.

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ARE YOU AN EMPLOYEE OR AN INDEPENDENT CONTRACTOR?

by Andrew D. Schwartz, CPA

It's a debate that's been going on for years.  Are you an employee or an independent contractor?

The IRS prefers that people be compensated as employees, since they're more likely to get their tax dollars.  Remember, employees have social security, Medicare, and usually federal income taxes withheld from their pay.

Many people prefer to be compensated as independent contractors, however.  That's because they can deduct expenses directly against their income, and can usually set aside a lot more money into pre-tax retirement accounts.  Plus, self-employed individuals can be more aggressive with their deductions, and can even deduct some personal type expenses such as automobile expenses or home-office expenses.

When trying to determine whether you're an employee or an independent contractor, there are very specific guidelines to follow.  Head on over to www.irs.gov, and download IRS Publication 15-A.  Starting on page 5, there is an explanation of who qualifies as an employee and who qualifies as an independent contractor.

Basically, the IRS looks at the three factors to determine the degree of control maintained by your employer and the degree of independence maintained by you.  The more control your employer has over you, the more likely you should be classified an employee for tax purposes.

The first factor is behavioral control.  You're most likely an employee if your employer tells you:

  • When and where to do the work
  • What tools or equipment to use
  • Where to purchase supplies and services
  • What work must be performed by specific individuals
  • What order or sequence to follow

The second factor is financial control.  If you have a significant investment in equipment, get paid by the job instead of being on a set salary or hourly wage, and can realize a profit or loss, then you're most likely an independent contractor.

The third and final factor is type of relationship.  If you receive benefits from your employer, or have been hired for an ongoing and indefinite period, you're most likely an employee.

In addition to analyzing these three factors, you need to take a look at how similar workers in your industry are generally classified.  In many instances, the standard practice in your industry carries a lot of weight in determining whether you should be classified as an employee or an independent contractor.

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WHAT'S NEW WITH THE FICA REFUND?

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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TAX AND FINANCIAL PLANNING CALENDAR FOR JULY, 2003

Month

Income Taxes

Saving and Investing

 

July

  • If you changed jobs, give one of our CPAs a call to discuss filling out new W-4 Forms

  • Now's the time to work through your 2003 income tax projection

  • Update your monthly cash flow budget

  • If your Keogh accounts are worth more than $100,000, Form 5500-EZ due by 7/31/03

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2002 & 2003 TAX FACTS

  • For 2002, the standard deduction for a single individual is $4,700 and for a married couple is $7,850. A person will benefit by itemizing once allowable deductions exceed the applicable standard deduction. Itemized deductions include state and local income taxes, real estate taxes, mortgage interest, charitable contributions, and unreimbursed employee business expenses. Our February, 1998 newsletter addressed the issue of itemizing your deductions.
  • For 2002, the personal exemption is $3,000. Individuals will claim a personal deduction for themselves, their spouse, and their dependents. 
  • The maximum earnings subject to social security taxes has increased to $87,000 in 2003 from $84,900 in 2002.
  • The standard mileage rate is $.36 per mile for 2003, down from $.365 per mile for 2002. Deducting automobile expenses was addressed in our February, 1996 newsletter .
  • The maximum annual contribution to a 401(k) plan or a 403(b) plan has increased to $12,000 for 2003 from $11,000 in 2002.  And if you'll be 50 or older by December 31, 2003, you can contribute an extra $2,000 into your 401(k) or 403(b) account this year.
  • The maximum annual contribution to your IRA is $3,000 for 2003 and 2002.  And once you turn 50, you can contribute an extra $500 into your IRA this year.

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copyright - 2003 - The MDTAXES Network



Tax and financial planning calendar for July, 2003


The Millionaire Next Door.  Find out the habits of America's wealthy. You'll be surprised at who comprises the bulk of America's millionaires.

Organize Your Finances with Quicken 2001 in a Weekend

Both these books are available at Barnes&Noble.com.



If you have a friend, colleague, or family member who is always bragging about things they have done to cut their taxes, then check out our new gift items with the saying - "Everything is deductible...until you get audited!"


Interact with our CPAs everyday on The MDTAXES Message Board


Join our Live Tax Chat on the first Wednesday of each month at 9 pm (eastern time)


SAVE MONEY BY TAKING ADVANTAGE OF LOW INTEREST RATES

Are you taking advantage of these reduced rates?  Lower rates will help you cut down on the time it takes you to get out of debt by minimizing the interest you pay each month.  Remember, the lower the interest rate, the larger the portion of your monthly payment that will get applied against your outstanding balances.

  • If you're carrying a balance on your credit cards, there are plenty of opportunities available to cut your interest rate.  Check out CardOffers.com to find the best deals available.

  • If you still owe student loans, see how much you'll save by consolidating your loans into one loan with a lower interest rate at FinancialAid.com.

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HAVE YOU CHECKED YOUR CREDIT REPORT LATELY?

You work hard to keep your credit report as clean as possible. Even so, the current credit reporting system allows for incorrect items to appear on your report that could adversely affect your credit score. Make sure that the information on your credit report is accurate by ordering a free copy of your credit report on-line at  OnlineCreditInfo.com or by purchasing a merged credit report reflecting information from all three credit reports at 130secondreport.com.

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