Tax Tip Archive - 2006

January

401K Plan 

It is important to be aware of the tax consequences of an outstanding 401k plan loan balance if you are planning on leaving your employer.  If your loans are not paid off by the termination of employment, prior to you rolling over your plan proceeds into some other plan, your employer will reduce or offset your vested 401k plan benefit by the unpaid balance of the loan.  The offset is considered a distribution of funds, which is required to be included in your gross income, along with a early withdrawal penalty unless other exceptions are met.

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Underpayment Penalties for Retirees 

There is an exception form the estimated tax rules for some newly retired retirees.  If you retire after the age of 62, you can apply for relief from underpayment penalties if the underpayment results from reasonable cause and not due to willful neglect.  This relief is available only in the year of retirement or in the proceeding tax year.

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Umbrella Insurance

Umbrella liability insurance is designed to supplement the liability coverage provided by homeowners and automobile insurance policies.  When purchasing an umbrella liability policy, it is recommended that the policy limits should be at least equal to your net worth to provide adequate protection.

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Maximizing Estate Tax Savings

Instead of leaving everything to your spouse, the use of a marital deduction trust and a non-marital trust will often maximize estate tax savings.  The non-marital trust provides the surviving spouse with needed income during their life.  However, because the survivor lacks control over that trust, the assets are not included in their estate upon death.  On the other hand, the marital deduction trust provides the survivor with the bulk of the funds needed during life.  If planned correctly, the two trusts will help ensure that the liability for estate taxes is minimized.

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Including the Kids' Unearned Income

Parents may elect to include unearned income subject to the kiddie tax directly on their return by attaching the Form 8814, Parents’ Election to Report Child’s Interest and Dividends.  The income in excess of $1,600 is taxed at the parents’ highest bracket rate.  No tax is imposed on the first $800 and income between $800 and $1,600 is taxed at a 10% rate.  If you do not make the election, Form 8615, Tax for Children Under Age 14 with Investment Income of More that $1,600 generally must be attached to the parents tax return filed by or on behalf of the child.

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February

Child Care Employer

If you hire someone to care for your children and the care is provided within your home, the IRS generally considers you an employer.  If you pay the care provider more that $1,400 during the 2005 year, you will be liable for the employer’s share of the FICA tax.  No federal income tax need to be withheld unless your employee requests it and you both come to an agreement.  Any of the taxes owed due to your employer status, are reported on Schedule H, Household Employment Taxes with your 1040.

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Deduction, Exclusion, or Credit?

Which is better - a deduction, exclusion or a credit?  The answer depends upon an individual’s tax bracket.  A deduction or exclusion reduces the amount of taxable income that falls within the tax bracket.  A credit reduces the dollar amount of tax that is computed from your taxable income.  For example say one is in the 25% tax bracket, and you have the option of a $1,000 deduction or a $200 credit.  Which one better benefits you…$1,000 x 25% = $250 or the $200.  The deduction is a better benefit.  However assume one is in the 15% tax bracket instead.  The credit would be more beneficial because the $1,000 x 15% = $150.

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Educational Loan Interest

If you took out a loan to pay for your child’s college expenses, you are entitled to the deduction for up to $2,500 of the interest paid on that loan, as long as the loan is used strictly for education expenses.  However, if your child takes out the loan, only he or she is entitled to deduct the interest on the loan, even if you pay it.  Also, remember that your child will not be eligible to deduct this amount if they are claimed as a dependent on your return.

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Higher Education Deductions

The deduction for higher education expenses may be available to taxpayers who do not qualify for the Hope and lifetime learning credits since their adjusted gross income (AGI) exceeds the phase-out threshold.  For 2005, the credits are phased out completely if modified AGI exceeds $53,000 or $107,000 for joint filers.  However, the maximum $4,000 deduction is available for taxpayers with an AGI up to $65,000 or $130,000 for joint filers.

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March

Income Variance

If your income varied considerably during the year, possibly due to a large capital gain, you may reduce or eliminate an estimated tax penalty by annualizing your income.  This procedure informs the IRS that your did not receive your income in equal amounts during the year and that your estimated tax payments were based on the amounts actually received during the various periods of the year.  To use the annualized method, you must file Form 2210 and Schedule AI with the IRS.

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Latest Possible Time For Acquisitions

Businesses should avoid any indications that a decision to make an acquisition has been reached, until the latest possible time.  The preparation of a letter of intent, even though nonbinding, is indicative that a decision to purchase a particular business has been made and could result in disqualification of later-incurred expenses that would otherwise qualify as deductible and/or amortizable.

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Organizational Expenses

Along with the deduction for start-up costs, a corporation may elect to deduct up to $5,000 of organizational expenses it incurs in tax year in which it begins business.  Like the start-up costs, the deduction is reduced by the amount of organizational expenses that exceeds $50,000.  Any remaining balance not immediately deductible must be amortized over a 180 month period (15 years).  An organizational expense is those which are directly related to the creation of the corporation. 

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Employment of Children

Parents may find that substantial tax savings will result if they can employ their children.  This will usually result in income being shifted from a higher tax bracket (parent’s) to a lower tax bracket (child’s).  Earned income is not subject to the kiddie tax.  However, wages paid by a parent to a child who is over 18 and who is employed in the parent’s trade or business are subject to Social Security taxes.

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April

Depreciation Limitations

Trucks and vans, including SUVs and minivans built on a truck chassis that have a gross vehicle weight (GVW) greater than 6,000 pounds are not subject to any of the depreciation limitations.  Therefore, if your purchase a SUV for your trade or business and use the vehicle 100% for business, you may deduct the full amount of allowable depreciation for the year if it has a GVW in excess of 6,000 pounds which is $25,000.

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How to Use Code Sec. 179

Carefully picking assets for use in Code Section 179 expensing is a worthwhile strategy to maximize tax savings.  The election to expense may be applied against the entire cost or a portion of the cost of one or more assets.  To accelerate deductions, it is generally preferable to allocate the expense allowance to assets with the longest recovery period.

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Moving Expenses

You may claim your moving expense before actually meeting the employment post-move test.  If you reasonably anticipate satisfying the requirements, you may deduct the qualified moving expenses in the year of the move.  However, in the event that you later do not meet those requirements, you should then file an amended return paying taxes on the now non-deductible moving expenses.

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Travel Expense

The deductibility of travel expense is another reason why employing one’s spouse can be beneficial.  If the spouse’s presence fills a legitimate business need, the cost of the spouse accompanying you on your business trip as an employee of your business will be fully deductible.  However, if any part of the trip is recreational, expenses need to be prorated between business and pleasure.  Remember the cost of your return to your tax home will still be deductible even if you take a vacation following a business trip.

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May

Entertainment Expenses

The price of tickets to popular sporting or theatrical events obtained through a legal ticket broker will not be entirely deductible.  The face value of those tickets is only considered a deductible expense for income tax purposes.  Therefore, to pay $1,000 for box seats to a musical with a face value of $250 will only gain you a $250 tax deduction.

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Tips Are Subject to Taxes

Do you work at a hair salon, barber shop, casino, golf course, hotel or restaurant or drive a taxicab? The tip income you receive as an employee from those services is taxable income.

 Here as some tips about tips:

 ·        Tips are taxable. Tips are subject to federal income, social security and Medicare taxes, and may be subject to state income tax as well.  The value of non–cash tips, such as tickets, passes or other items of value, is also income and subject to federal income tax.

 ·        Include tips on your tax return. You must include in gross income all cash tips you receive directly from customers, tips added to credit cards, and your share of any tips you receive under a tip–splitting arrangement with fellow employees.

 ·        Report tips to your employer. If you receive $20 or more in tips in any one month, you should report all your tips to your employer. Your employer is required to withhold federal income, Social Security and Medicare taxes.

 ·        Keep a running daily log of your tip income. You can use IRS Publication 1244, Employee's Daily Record of Tips and Report to Employer, to record your tip income. For a free copy of Publication 1244, call the IRS toll free at 1-800-TAX-FORM (1-800-829-3676).

 For more information, check out IRS Publication 531, Reporting Tip Income, or Publication 3148, Tips on Tips.  They are available by calling 1-800-TAX-FORM (1-800-829-3676) or by going to the IRS Web site at IRS.gov. 

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Tax Facts about Capital Gains and Losses

  Almost everything you own and use for personal purposes, pleasure or investment is a capital asset. When you sell a capital asset, the difference between the amounts you sell it for and your basis, which is usually what you paid for it, is a capital gain or a capital loss. While you must report all capital gains, you may deduct only capital losses on investment property, not personal property.

  Here are a few tax facts about capital gains and losses:

·        Capital gains and losses are reported on Schedule D, Capital Gains and Losses, and then transferred to line 13 of Form 1040.

  ·        Capital gains and losses are classified as long-term or short-term, depending on how long you hold the property before you sell it. If you hold it more than one year, your capital gain or loss is long-term. If you hold it one year or less, your capital gain or loss is short-term.

·        Net capital gain is the amount by which your net long-term capital gain is more than your net short-term capital loss.

·        The tax rates that apply to net capital gain are generally lower than the tax rates that apply to other income and are called the maximum capital gains rates. For 2005, the maximum capital gains rates are 5%, 15%, 25% or 28%.

·        If your capital losses exceed your capital gains, the excess is subtracted from other income on your tax return, up to an annual limit of $3,000 ($1,500 if you are married filing separately)

For more information about reporting capital gains and losses, get Publication 17, Your Federal Income Tax, and Publication 550, Investment Income and Expenses, available on the IRS Web site at IRS.gov or by calling 1-800-TAX-FORM (1-800-829-3676).

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Taxes on Early Distributions from Retirement Plans

Payments that you receive from your IRA or qualified retirement plan before you reach age 59½ are normally called ‘early’ or ‘premature’ distributions. These funds are subject to an additional 10 percent tax and must be reported to the IRS . 

There are a number of exceptions to the age 59½ rule if you make an early withdrawal. Some exceptions apply only to IRAs, some only to qualified retirement plans, and some to both.

In addition to the 10 percent tax on early distributions, you generally must include the distribution in your income. If you received a distribution from an IRA, other than a Roth IRA, to which you made any nondeductible contributions, the portion of the distribution attributable to those contributions is not taxed. If you received a qualified distribution from a Roth IRA, none of the distribution is taxed.  If you received a distribution from any other qualified retirement plan, the portion of the distribution attributable to your cost, not including pre-tax contributions, is not taxed.

A ‘rollover” is a way to avoid paying tax on early distributions. Generally, a rollover is a tax-free transfer of cash or other assets from an IRA or qualified retirement plan to another eligible retirement plan. An eligible retirement plan is a traditional IRA, a qualified retirement plan, or a qualified annuity plan. You must complete the rollover within 60 days after the day you received the distribution. The amount you roll over is generally taxed when the new plan pays you or your beneficiary.

For more information see IRS Publication 560, Retirement Plans for Small Business (SEP, SIMPLE, and Qualified Plans), Publication 575, Pension and Annuity Income, or Publication 590, Individual Retirement Arrangements (IRAs), available on IRS .gov or by calling 1-800-TAX- FORM (1-800-829-3676).

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June

Income from Foreign Sources

Many United States citizens earn money from foreign sources. These taxpayers must remember that they must report all such income on their tax return, unless it is exempt under federal law.

U.S. citizens are taxed on their worldwide income. This applies whether a person lives inside or outside the United States . The foreign income rule also applies regardless of whether or not the person receives a Form W-2, Wage and Tax Statement, or a Form 1099 (information return).

Foreign source income includes earned and unearned income, such as:

• Wages and tips

• Interest

• Dividends

• Capital Gains

• Pensions

• Rents

• Royalties

An important point to remember is that citizens living outside the U.S. may be able to exclude up to $80,000 of their 2005 foreign source income if they meet certain requirements. However, the exclusion does not apply to payments made by the U.S. government to its civilian or military employees living outside the U.S.   

For more information, check out IRS Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad. It’s available on the IRS Web site at IRS .gov or by calling 1-800-TAX- FORM (1-800-829-3676).

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Deferral of Back Taxes for Military

Reservists called to active duty and enlistees in the armed forces may qualify for a deferral of taxes owed if they can show that their ability to pay taxes was affected by their military service.

The Servicemembers Civil Relief Act, which provides this benefit, covers:

• Active duty members of the military services — Army, Navy, Air Force, Marine Corps and Coast Guard

• Commissioned officers of the uniformed services, Public Health Service and the National Oceanic and Atmospheric Administration.

• Reservists placed on active duty.

• National Guard personnel called to active duty by the president of the United States

The deferral applies to taxes due before or during military service, and extends the payment deadline to 180 days after the military service ends. No interest or penalty accrues during the deferral period.

The taxpayer must apply for the deferral, as it is not automatic. When applying, the taxpayer must show how the military service affected their ability to pay. A taxpayer must also have received a notice of tax due, or have an installment agreement with the IRS, before applying for the deferral.

The deferral does not extend the deadline for filing any tax returns. However, taxpayers in the armed forces may get extra time to file under other provisions, such as being stationed overseas, in a combat zone, in a qualified hazardous duty area, or if they are serving in direct support of a combat zone.

Details of applying for the tax payment deferral and information on a wide range of tax issues affecting members of the military are in IRS Publication 3, Armed Forces’ Tax Guide, which is available on the IRS Web site, IRS.gov, or by calling 1-800-TAX-FORM (1-800-829-3676). Additional information on tax issues affecting the military, including information on what areas are considered combat zones, can be found on IRS.gov on the Individuals page under the Military tab.

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Are You Eligible for a Tax Credit?

Taxpayers should consider claiming tax credits for which they might be eligible when completing their federal income tax returns.  A tax credit is a dollar-for-dollar reduction of taxes owed. Some credits are refundable – taxes could be reduced to the point that a taxpayer would receive a refund rather than owing any taxes. Below are some of the credits taxpayers could be eligible to claim:
  
• The Earned Income Tax Credit is a refundable credit for low-income working individuals and families.  Income and family size determine the amount of the credit.  For more information, see IRS Publication 596, Earned Income Credit.

• The Child and Dependent Care Credit is for expenses paid for the care of children under age 13, or for a disabled spouse or dependent, to enable the taxpayer to work or look for work. For more information, see IRS Publication. 503, Child and Dependent Care Expenses.

• The Child Tax Credit is for people who have a qualifying child. The maximum amount of the credit is $1,000 for each qualifying child. This credit can be claimed in addition to the credit for child and dependent care expenses. For more information on the Child Tax Credit, see IRS Publication 972, Child Tax Credit.

• Adoption Credit: Adoptive parents may qualify for a tax credit of up to $10,630 for qualifying expenses paid to adopt an eligible child. The credit may be allowed for the adoption of a child with special needs even if you do not have any qualifying expenses. For more information, see the instructions for Form 8839, Qualified Adoption Expenses.

• Credit for the Elderly or the Disabled: This credit is available to individuals who are either age 65 or older or are under age 65 and retired on permanent and total disability, and who are U.S. citizens or residents. There are income limitations. For more information, see IRS Publication 524, Credit for the Elderly and the Disabled.

There are other credits available to eligible taxpayers. Since many qualifications and limitations apply to the various tax credits, taxpayers should carefully check the instructions for Form 1040, the publications and additional information on the IRS web site at www.irs.gov. IRS publications are available on the IRS web site at IRS .gov or by calling 1-800-TAX- FORM (1-800-829-3676). 

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The Earned Income Tax Credit

Millions of Americans forfeit critical tax relief each year by failing to claim the Earned Income Tax Credit, a federal tax credit for low-to-moderate income individuals who work. Taxpayers who qualify and claim the credit could owe less federal tax, owe no tax or even receive a refund.

In 2004, more than 21 million taxpayers received approximately $39 billion in EITC. However, the IRS estimates 25 percent of people who qualify for the credit do not claim it. At the same time, there are millions of Americans who have claimed the credit in error, many of whom simply don’t understand the criteria.

This year it’s even easier to determine whether you qualify for the EITC. The EITC Assistant, an interactive tool available on IRS .gov, removes the guesswork from eligibility rules. Just answer a few simple questions about yourself, your children, your living situation and your income to find out if you qualify and estimate the amount of your EITC. You will see the results of your responses right away. Taxpayers, tax professionals, employers, community groups and public service organizations are encouraged to use the EITC assistant which is available in both English and Spanish.

The EITC is based on the amount of your earned income and whether or not there are qualifying children in your household. If you have children, they must meet the relationship, age and residency requirements. Additionally, you must file a tax return to claim the credit.

If you were employed for at least part of 2005 and at least age 25, but under age 65, you may be eligible for the EITC based on these general requirements:

• You earned less than $11,750 ($13,750 if married filing jointly) and did not have an any qualifying children

• You earned less than $31,030 ($33,030 if married filing jointly) and have one qualifying child

• You earned less than $35,263 ($37,263 if married filing jointly) and have more than one qualifying child

For more information about the EITC, go to IRS .gov or see Publication 596, Earned Income Credit, which contains eligibility criteria and instructions for claiming the tax credit. Copies of the publication are available in English and Spanish and can be found on IRS .gov or by calling 1-800-TAX- FORM (1-800-829-3676).

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July

Claiming the Child Tax Credit

With the Child Tax Credit, you may be able to reduce the federal income tax you owe by up to $1,000 for each qualifying child under the age of 17.

A qualifying child for this credit is someone who meets the following criteria:
• Dependent Is claimed as your dependent
• Age Was under age 17 at the end of 2005
• Relationship Is your son, daughter, adopted child, grandchild, stepchild or eligible foster child, your sibling, stepsibling or their descendant 
• Citizenship Is a U.S. citizen or resident alien

The credit is limited if your modified adjusted gross income is above a certain amount. The amount at which this phase-out begins varies depending on your filing status:
• Married Filing Jointly   $110,000
• Married Filing Separately  $  55,000
• All others     $  75,000

In addition, the Child Tax Credit is generally limited by the amount of the income tax you owe as well as any alternative minimum tax you owe.

If the amount of your Child Tax Credit is greater than the amount of income tax you owe, you may be able to claim some or all of the difference as an “additional” Child Tax Credit. The additional Child Tax Credit may give you a refund even if you do not owe any tax.  For 2005, the total amount of the Child Tax Credit and any additional Child Tax Credit cannot exceed the maximum of $1,000 for each qualifying child.

You may claim the Child Tax Credit on Form 1040 or 1040A. Details on how to compute the credit can be found in the forms’ instructions and in Publication 972, Child Tax Credit. The forms and publications are available from the IRS Web site at IRS.gov or by calling 1-800-TAX-FORM (1-800-829-3676).

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Claiming the Credit for the Elderly or Disabled

You may be able to take the Credit for the Elderly or the Disabled if you were age 65 or older at the end of 2005, or if you are retired on permanent and total disability. Like any other tax credit, it’s a dollar-for-dollar reduction of your tax bill, with a maximum amount of $1,125.

You can take the credit for the elderly or the disabled if:
• You are a Qualified Individual
• Your Adjusted Gross Income is less than specific limits depending on your filing status
• Your Nontaxable Income from Social Security or other nontaxable pension is less than specific limits depending on your filing status

Generally, you are a qualified individual for this credit if you are a U.S. citizen or resident at the end of the tax year and you are age 65 or older. Taxpayers younger than 65 qualify if they are retired on permanent and total disability, received taxable disability income, and did not reach mandatory retirement age before the beginning of the tax year.

Even if you do not retire formally, you are considered retired on disability when you have stopped working because of your disability.

If you are under 65, you must have your physician complete a statement certifying that you were permanently and totally disabled on the date you retired. You do not have to file this statement with your tax return, but you must keep it for your records.

Use Schedule R, Form 1040, or Schedule 3, Form 1040A, to compute the credit. You cannot take the credit if you file Form 1040EZ.

For more information, including limits on AGI and Nontaxable Income, see IRS Publication 524, Credit for the Elderly or the Disabled, which you may obtain from IRS .gov or by calling the IRS at 1-800-TAX- FORM (1-800-829-3676).

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Offset Education Costs

Education tax credits can help offset the costs of higher education for yourself or a dependent. The Hope Credit and the Lifetime Learning Credit are two education credits available which may benefit you. You may be able to subtract them in full from your federal income tax, rather than just deducting from your taxable income.

The Hope Credit
• Applies only for the first two years of post-secondary education, such as college or vocational school. It does not apply to graduate and professional-level programs.
• It can be worth up to $1,500 per eligible student, per year.
• You're allowed 100% of the first $1,000 of qualified tuition and related fees paid during the tax year, plus 50% of the next $1,000.
• Each student must be enrolled at least half-time for at least one academic period which began during the year.

The Lifetime Learning Credit
• Applies to undergraduate, graduate and professional degree courses, including instruction to acquire or improve job skills.
• If you qualify, your credit equals 20% of the first $10,000 of post-secondary tuition and fees you pay during the year, for a maximum credit of $2,000 per tax return.

You cannot claim both the Hope and Lifetime Learning Credits for the same student in the same year.

To qualify for either credit, you must pay post-secondary tuition and fees for yourself, your spouse or your dependent. The credit may be claimed by the parent or the student, but not by both. Students who are claimed as a dependent cannot claim the credit.

These credits are phased out for Modified Adjusted Gross Income over $43,000 ($87,000 for married filing jointly) and eliminated completely for Modified AGI of $53,000 or more ($107,000 for married filing jointly). If the taxpayer is married, the credit may be claimed only on a joint return.

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How to Avoid Tax Time Problems

Are you looking for ways to avoid the last-minute rush for doing your taxes? Here are some stress relieving ideas to help you.

• Don’t Procrastinate Resist the temptation to put off your taxes until the very last minute. Your haste to meet the filing deadline may cause you to overlook potential sources of tax savings and will likely increase your risk of making an error.

• Visit the IRS Online In fiscal year 2005, there were more than 176 million visits to IRS.gov and 1.2 billion page views. Anyone with Internet access can also find tax law information and answers to frequently asked tax questions.

• File Your Return Electronically More than 68 million taxpayers filed their returns electronically in 2005. Aside from ease of filing, IRS e-file is the fastest and most accurate way to file a tax return. If you’re due a refund, the waiting time for e-filers is half that of paper filers.

• Don’t Panic if You Can’t Pay. If you can’t immediately pay the taxes you owe, consider some stress-reducing alternatives. You can apply for an IRS installment agreement, suggesting your own monthly payment amount and due date, and getting a reduced late payment penalty rate. You also have various options for charging your balance on a credit card. There is no IRS fee for credit card payments, but the processing companies charge a convenience fee. Electronic filers with a balance due can file early and authorize the government’s financial agent to take the money directly from their checking or savings account on the April due date, with no fee. 

• Request an Extension of Time to File – But Pay on Time If the clock runs out, you can get an automatic six month extension of time to file to October 16. The extension itself does not give you more time to pay any taxes due. You will owe interest on any amount not paid by the April deadline, plus a late payment penalty if you have not paid at least 90 percent of your total tax by that date. See IRS Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return for a variety of easy ways to apply for an extension. Form 4868 is available at IRS.gov or by calling 1-800-TAX-FORM (800-829-3676).  Taxpayers needing Form 4868 should act soon to be sure they have the item in time to meet the April deadline.

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August

Itemizers Can Deduct Certain Taxes

Did you know that you may be able to deduct certain taxes on your federal income tax return? You can receive these deductions if you file Form 1040 and itemize deductions on Schedule A. Deductions decrease the amount of income subject to taxation.

There are four types of deductible non-business taxes:

• State and local income or sales taxes: You can choose to claim a state and local tax deduction for either income or sales taxes on your return. You can deduct any estimated taxes paid to state or local governments and any prior year's state or local income tax as long as they were paid during the tax year. If deducting sales taxes instead, you may deduct actual expenses or use the optional tables provided by the IRS to determine your deduction amount, relieving you of the need to save receipts. Sales taxes paid on motor vehicles and boats may be added to the table amount, but only up to the amount paid at the general sales tax rate. 

• Real estate taxes: Deductible real estate taxes are usually any state, local or foreign taxes on real property. If a portion of your monthly mortgage payment goes into an escrow account and your lender periodically pays your real estate taxes to local governments out of this account, you can deduct only the amount actually paid during the year to the taxing authorities. Your lender will normally send you a Form 1098, Mortgage Interest Statement, at the end of the tax year with this information.

• Personal property taxes: Personal property taxes are deductible when they are based on the value of personal property, such as a boat or car. To be deductible, the tax must be charged to you on a yearly basis, even if it is collected more than once a year or less than once a year.

• Foreign income taxes:  Generally, you can take either a deduction or a tax credit for foreign income taxes, but not for taxes paid on income that is excluded from U.S. tax.

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More Help to Give and Save

If you're still behind the ball with your retirement savings, there's some good news for the over-50 crowd in 2006. Your catch-up contribution increases substantially. In 2005, the 401(k) limits maxed out at $14,000 a year, plus an additional $4,000 catch-up for the folks 50 and over. For 2006, the annual contribution increases to $15,000, with a $5,000 catch-up contribution, says Bob Scharin, editor of Warren , Gorham & Lamont/RIA's Practical Tax Strategies, a monthly journal written for tax professionals. So if you're in the 50+ crowd, you can contribute up to $20,000 to your 401(k) in 2006. That's a huge help, so do it if you can.

The IRA contribution limits stay the same at $4,000, although, again, the catch-up amount increases to $1,000 in 2006 from $500 in 2005.

Estate and gift tax limits will increase in 2006 as well.

In 2005, you could give $11,000 to anyone without incurring gift tax. In 2006, that number jumps to $12,000.

And on the estate tax front, a single person previously could exclude $1.5 million from estate tax. In 2006, $2 million will be estate-tax free. And remember, the estate tax is scheduled to go away in 2010, so if you can time your death, go for it. Better yet, if you can time the death of the person you stand to inherit money

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What To Do If You Receive an IRS Notice

It’s a moment many taxpayers dread. A letter arrives from the IRS — and it’s not a refund check. Don’t panic; many of these letters can be dealt with simply and painlessly.

Each year, the IRS sends millions of letters and notices to taxpayers to request payment of taxes, notify them of a change to their account or request additional information. The notice you receive normally covers a very specific issue about your account or tax return. Each letter and notice offers specific instructions on what you are asked to do to satisfy the inquiry. You should review the correspondence and compare it with the information on your return.

• Agree? If you agree with the correction to your account, no reply is necessary unless a payment is due.

• Disagree?  If you do not agree with the correction the IRS made, it is important that you respond as requested. Write to explain why you disagree. Include any documents and information you wish the IRS to consider, along with the bottom tear-off portion of the notice. Mail the information to the IRS address shown in the upper left-hand corner of the notice. Allow at least 30 days for a response.

• Questions?  Most correspondence can be handled without calling or visiting an IRS office, if you follow the instructions in the letter or notice. However, if you have questions, call the telephone number in the upper right-hand corner of the notice or call the IRS at 1-800-829-1040. Have a copy of your tax return and the correspondence available when you call so your account can be readily accessed.

Sometimes, the IRS sends a second letter or notice requesting additional information or providing additional information to you. Be sure to keep copies of any correspondence with your records.

For more information about IRS notices and bills, see Publication 594, Understanding the Collection Process. Information about penalties and interest charges is available in Publication 17, Your Federal Income Tax. Both publications are available at IRS.gov or by calling 1-800-TAX-FORM (1-800-829-3676).

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Some More Money-Saving Miscellany

Remember, the sales tax deduction is supposed to go away at the end of 2005, but there's talk amongst our tax nerds that the big boys are thinking of extending it. So it wouldn't hurt to save your 2006 receipts just in case, especially if you plan on making a big purchase, such as a car, ring, watch or boat.

Teachers, you should save your receipts from classroom purchases too. While the $250 teacher's deduction is also scheduled to end in 2005, that too might resurface in 2006. So keep track of your out-of-pocket expenses.

And finally, there's a new saving tool in town. The Roth 401(k) will become available in January. Starting in 2006, if your employer's 401(k) plan allows it, you'll be able to designate part or all of your 401(k) contribution to a Roth IRA. As with a regular Roth IRA, your contributions to a Roth 401(k) are nondeductible, but the upside is that all of the income will be tax-free when you take it out in retirement.

Even better, the contributions in a Roth 401(k) follow 401(k) rules, not the regular Roth IRA rules. That means you can put up to $15,000 (or $20,000 if you're 50 and over) in a Roth 401(k), as opposed to only $4,000 (or $5,000) in a regular Roth. And there are no income limits to the Roth 401(k). So whereas a married couple filing jointly cannot contribute to a regular Roth if their adjusted gross income exceeds $160,000, the sky's the limit with a Roth 401(k). Be sure to ask your HR folks about this new offering.

And take advantage of all the good that's coming in 2006. We've got plenty of Hollywood gossip, tons of new techno gadgets and a fair amount of tax savings to keep us busy throughout the year.

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September

Amending Your Tax Return

Oops! You’ve discovered an error after your tax return has been filed. What should you do? You may need to amend your return.

The IRS usually corrects math errors or requests missing forms -- such as W-2s or schedules. In these instances, do not amend your return. However, do file an amended return if any of the following were reported incorrectly:
• Your filing status
• Your total income
• Your deductions or credits

Use Form 1040X, Amended U.S. Individual Income Tax Return, to correct a previously filed Form 1040, 1040A, 1040EZ or electronically-filed return. Be sure to enter the year of the return you are amending at the top of Form 1040X. If you are amending more than one tax return, use a separate 1040X for each one and mail each return in a separate envelope to the IRS processing center for the area in which you live. The 1040X instructions list the addresses for the centers. Your professional tax advisor or accountant can help you in the preparation of these forms.

If you are filing to claim an additional refund, wait until you have received your original refund before filing Form 1040X. You may cash that check while waiting for any additional refund. If you owe additional tax for 2005, you should file Form 1040X and pay the tax by the April due date to avoid any penalty and interest.

Generally, to claim a refund, you must file Form 1040X within three years from the date you filed your original return or within two years from the date you paid the tax, whichever is later.

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Capital Gain and Dividend Income

Tax rates for 2006 and 2007

Generally, for 2006 and 2007, the maximum long-term capital gain rates for individuals is 15% (or 5% for individuals in the 10% or 15% income tax brackets).  Higher rates apply to certain types of capital assets, such as collectibles and unrecaptured Code Sec. 1250 gain.  In addition, dividend income is generally taxed at the same rate as capital gains for 2006 and 2007.  The Tax Increase Prevention and Reconciliation Act of 2005 extended dividend and capital gain tax rate cuts scheduled to expire at the end of 2008 for two more years through December 31, 2010.  Without further legislative action, dividends received by an individual after 2010 will be taxed at ordinary income rates.  In addition, capital gains realized after 2010 will be taxed at 20% (or 10% for individuals in the 10% or 15% income tax brackets).

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Taking Advantage of Flexible Spending Accounts (FSA’s)

Setting up an FSA with your employer can result in substantial tax savings

An employee can set up an account with pre-tax wages to pay in advance for eligible health and/or dependent care expenses.  There is no statutory limit on the amount of contributions that may be made to a health FSA, however, contributions to a dependent care FSA are limited to $5,000 per year.  This limit applies whether you are single or married.

Carefully estimating the health care and/or dependent care expenses is crucial for using FSAs successfully.  Once money is put into a spending account, it can only be used to reimburse you for qualifying current-year expenses.  If your expenses during the plan year (which may include up to an additional 2 ½ month grace period if elected by the employer) are less than the amount in your account, any remainder will be lost.

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Business Expenses

Some important points to remember.

As year-end approaches, you should make sure that you have substantiated all of your business expenses to your employer or have returned any amounts paid under an accountable plan in excess of substantiated expenses.  As a general rule, expenses should be substantiated within 60 days after they are incurred.  Excess reimbursements should be repaid to the employer within 120 days after the employer makes the reimbursement, or within 120 days of the statement date (if periodic or quarterly statements are used to show the employee where he/she stands).

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October

Try to Collect on Debts

Have you loaned someone money and are now unable to collect?

If you have loaned someone money and are now unable to collect the amount owed to you, you may be able to claim a deduction for a bad debt.  There is a distinction between non-business bad debts and business bad debts, and the rules are different for each.

You may deduct a non-business bad debt only in the year in which the debt becomes totally worthless.  You may deduct a partially worthless business debt when the uncollectible amount can be identified with reasonable certainty.

If you have a worthless debt owed to you, it is important that you begin efforts to collect the debt well before the end of the year.  These efforts should provide you with the evidence you need to prove the debt’s worthlessness or you’ll collect the debt.  Either way, you’re money ahead!

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Incentive Stock Options

How to obtain favorable long-term capital gain treatment.

Year-end is a good time to review the holding periods of any incentive stock options that you have exercised.  In order to obtain favorable long-term capital gain treatment, stock acquired under an ISO may not be sold before the later of two years from the date of the grant of the option, or one year from the date of exercise of the option.  Thus, in addition to the usual one-year holding period for favorable long-term capital gain treatment, the special ISO holding requirements must also be met.  Market forces also factor into the decision of when to exercise an ISO.  The more rapidly the underlying stock appreciates, the greater the risk you will owe alternative minimum tax on the exercise of the option.

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IRA Distributions

Planning on receiving an early distribution from your IRA?

The 10% penalty on early distributions from IRA plans does not apply if the distribution is used to pay non- reimbursed medical expenses that exceed 7.5% of AGI.  In addition, if certain requirements are met, the 10% penalty will not apply to IRA distributions that are used to pay for health insurance premiums for unemployed individuals.  The rules for avoiding the 10% penalty are complex and you should consult your tax advisor before taking any action.

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Thinking About Selling a Mutual Fund?

Some points to consider to maximize tax advantages. 

If you are thinking about selling a mutual fund in 2006, when determining your potential capital gain or loss, don’t forget to add all your reinvested interest, dividends, capital gains distributions, and sales charges to your original cost basis.  By including these already-taxed items of income into your basis, your taxable gain will be reduced, or your deductible loss will be increased.

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How to Avoid “ Wash ” Sales

Techniques that you may use to avoid the loss limits imposed by the wash sale rules.

1.  Wait at least 31 days before purchasing substantially identical stock or securities.  The risk inherent in using this technique is that you lose out on any gain on the stock that may occur during the waiting period.

2.  “Double up,” that is, buy a second lot that is equal to the original holding, wait 31 days, and then sell the original lot, thereby recognizing the loss.  This allows you to maintain a continuing interest in the stock.  However, you have to tie up additional funds for at least 31 days to accomplish your goal and you double the downside risk.

3.  Sell the loss stock and reinvest in the stock of another company in the same industry that has historically performed the same way as the loss stock.  After 31 days, you can reverse the process to restore your original holding.  This method minimizes your risk during the waiting period and you do not violate the wash sale rule because the stocks of two different companies are not considered to be substantially identical.

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November

December