On the eve of filing your 2007 federal
income tax Form 1040, high-income
earners should already be planning for tax year 2008. “Aligning with a qualified tax
preparer is key, because so many of the rules
pertaining to deductions and tax rates are
changed or taken away from year to year,”
says Andrea H. Sheets, CPA, a principal at
Skoda Minotti. “For instance, the recently
enacted Alternative Minimum Tax (AMT)
patch will impact taxpayers with high unreimbursed business expenses and those who
pay high state and local taxes.”
Smart Business spoke with Sheets about
how changes in federal tax laws can impact
you this year and down the road.
What legislation will affect tax payers this
year?
The AMT was originally devised to make
sure that a group of high-income taxpayers
who benefitted too much from certain tax
deductions pay their fair share of federal
income tax. A growing number of middle
income taxpayers have discovered over the
past few years that they are also subject to
AMT. Through a recently enacted ‘patch,’
Congress has exempted millions of additional taxpayers from being classified as ‘high-income taxpayers.’ However, this patch is
only a one-year fix that will need to be
addressed again for tax year 2008. A new
mortgage relief/debt forgiveness act creates a
retroactive new exception for certain discharges of home mortgage debt that was/is
incurred between 2007 and 2009. It allows
homeowners to exclude from gross income
‘up to $2 million of qualified principal-residence indebtedness used to acquire, construct or improve their personal residence.’
Additionally, the IRS liberalized the home
sale gain exclusion for surviving spouses.
Under the existing provision, a couple filing a
joint return is allowed a tax-free gain upon
selling their principal residence of up to
$500,000. Individuals are allowed up to
$250,000. An unmarried surviving spouse is
not permitted to file a joint return after the
year in which his or her spouse dies.
Therefore, the larger gain exclusion was not
available when an unmarried surviving
spouse sold a principal residence in the years
after the spouse’s year of death.
The new Mortgage Relief Act allows an unmarried surviving spouse to take advantage of the
$500,000 exclusion if the home sale occurs within two years after the spouse’s death and all
other requirements for the gain exclusion were
met (immediately before that spouse’s death).
The mortgage insurance premium deduction
was also extended for three years. If you take out
a mortgage loan and have to pay mortgage insurance on your qualified residence, this is a deduction subject to an AGI phase-out.
Lastly, don’t forget the changes to the ‘Kiddie
Tax’ rules. Kiddie tax affects a child’s income
earned, typically from investments. This income
gets taxed at the parents’ higher marginal tax
rate. For tax year 2007, Kiddie Tax affects those
who are under age 18, but for tax year 2008, it
affects children who are age 18 and fulltime students ages 19 to 23 as of December 31, 2008.
Of what traps should taxpayers be aware?
First and foremost, not giving yourself time
to understand the rules and instructions can
be costly. AMT is creating a stir. All tax software packages and IRS computers are currently being updated and reprogrammed.
Keep in mind that all taxpayers are technically required to calculate their regular tax, as
well as AMT. This means that people who prepare their returns by hand and/or people
utilizing a canned software package need to
be sure they understand what is required and
prepare all calculations accordingly. Another
trap is not understanding the potential tax
credits and deductions and how they’re treated for AMT, and what income phase-out
ranges are applicable.
What can high earners do?
Plan. If you wait too long to calculate your
income taxes, mistakes can be made and
potential deductions and credits can be overlooked. The planning process requires projecting and calculating, and every situation is
very unique for each individual taxpayer.
Effective tax planning is always done for two
years concurrently. A deduction on this year’s
return could be a pitfall, depending on what
is claimed and deducted on next year’s
return. Make decisions because they make
good financial sense, and understand the tax
ramifications and benefits of the decisions.
Never make a financial decision only to save
tax dollars. If you spend a dollar to save 25
cents of federal tax, the 75 cents should be a
good investment in the eyes of the investor.
Don’t forget about the state tax impact of a
potential financial decision, if applicable.
What happens if you don’t file on time?
If you haven’t planned adequately and an unexpected balance due is not affordable due to cash
flow issues, always be sure to file the tax return
regardless of your ability to pay the tax. Failure
to file penalties can be quite steep. Both the IRS
and the state of Ohio will work out payment
plans that can reduce penalties and interest
charges. Still, an extension of time to file is not
an extension of time to pay the tax balance due.
If the reason for not filing is solely due to financial limitations, file the returns and request an
installment arrangement. Both the IRS and state
of Ohio are looking for good-faith efforts on
behalf of the taxpayer upon considering installment payment arrangements, as well as potential abatements of any penalties and/or interest.
However, if you don’t file the proper forms on
time, penalties and interest accrue and compound, and they can get pretty ugly. <<
ANDREA H. SHEETS, CPA, is a principal at Skoda Minotti. Reach her at [email protected].