2009 Tax Strategy VI – Deductable Taxes

This is my sixth posting of a daily tax tip. This is about Tax Deductions

Generally, the following taxes are deductable:
(1) State and local income tax [Includes the California SDI]
(2) Real Property Tax
(3) Personal Property Tax
(4) Foreign Tax Paid
(5) The larger of
(a) State and Local Income Tax paid
(b) Sales tax paid
(6) If 4(b) is not used, sales or excise tax paid on the purchase of a new vehicle

To deduct the above taxes, two general tests must be meet
(1) The tax must be imposed on the Taxpayer (except where local law does not specify on whom the tax is imposed).
(2) The tax must be paid during the year.

In the case of sales tax, either the Taxpayer can deduct the actual amount paid during the year or use an IRS income based schedule. If the Taxpayer decides to deduct actual tax paid, they must have all receipts to support the deduction. Generally, Taxpayers have not kept all of their receipts, so using the IRS table is recommended

For the sales tax on new vehicles, there are additional requirements.
(1) This includes tax on cars and motorcycles
(2) The maximum cost of the vehicle cannot exceed $49,500.

For property taxes, if the Taxpayer does not itemize deductions, an additional amount can be added to the standard deduction, but no more than $500 for single Taxpayers and $1,000 for Married filling Joint Taxpayers.

It is important to understand that under the Tax Benefit Rule, the amount deducted or credited for income tax in an earlier tax year needs to be included in income in the current year. However, if the Taxpayer chooses to deduct sales tax instead of stat income tax and receive a state refund for that year that refund is not 100% taxable. The amount of refund includable in income is limited to the excess of the income tax the taxpayer chose to deduct over the sales tax they did not choose to deduct.

Example 1 – Assume in 2008 the Taxpayer chooses an $11,000 state income tax deduction over a $10,000 sales tax deduction. Since the state income tax deduction is the largest, he chooses to deduct the state income tax. In 2009, he receives a $2,500 state income tax refund. According to the Tax Benefit Rule by deducting the $11,000 state income tax was only $1,000 more than, if the $10,000 sales tax deduction was used. Thus, only $1,000 of the $2,500 refund is taxable.

Example 2 - If in the above example the facts are reversed, the Taxpayer chooses an $11,000 sales tax deduction over a $10,000 state income tax deduction. In this case, none of the income tax refund is deductable

2009 Tax Strategy V – Roth Plans

This is my fifth posting of a daily tax tip. This is about Roth Plans. There are many rules and exceptions so this blog is only intended as an introduction; you need to consult with your CPA for more detailed and individual advice.

As discussed in my last posting much Tax Planning (as it relates to retirement plans) has been focused on delaying tax to a future date believing tax rates will decrease. However, with the significant increase in the national debt, many tax professionals are beginning to question if that is still a valid assumption; taxes could increase in the future. In this case, the goal is to have as much income taxed in the current year. A Roth is a good vehicle to achieve this for contributions by the Taxpayer are not tax deductable, but income earned in the Roth is tax free at the later of the Taxpayer reaches 59 1\2 or the account has been in existence for five years.

Types of Plans: There are several types of Roth plans, an employer sponsored plan [401(k) or Roth 403(b) - known as tax-sheltered annuity] or an individual Roth IRA. There are similarities but a major difference being the employer-sponsored plans have employer matching of all or a portion of an employee contribution. The employer matching is pre tax and taxed when distributed.

Contribution Limits: For 2009, the contribution limits for a Roth IRA is $5,000 for Taxpayers under 50 and $6,000 for Taxpayers 50 or over. For an employer-sponsored plan, the limits are $16,500 for Taxpayers under 50 and $22,000 for Taxpayers 50 or over. Unused employee PTO can be used as a contribution to an employer sponsored plan.

Rollovers: Rollovers are allowed from non-Roth plans to Roth plans, but special rules apply including Adjusted Gross Income [AGI] limitation of $100,000 in 2009 [There is no AGI limitations in 2010]. This is a good feature if a Taxpayer’s goal is to tax as much income as possible in the current year. However, a word of caution is need here. If a retirement account funded by pre-tax dollars is rolled over into a Roth, taxable income will increase and could place the Taxpayer into the Alternative Minimum Tax [AMT] and effect the qualification of some popular tax credits,

AGI limits: Contribution to a Roth IRA are phased out starting at $167,000 for married filling a joint return and $105,000 for all others, except for married filling separate returns. For them the phase out starts at zero income and is eliminated at AGI of $9,999. However, there are no AGI limitations for an employer-sponsored plan.

2009 Tax Strategy IV – Types of Retirement Plans for Self Employed and Small Business

This is my fourth posting of a daily tax tip. This is about Retirement Plans for Self Employed and Small Business. Like a traditional IRA, these retirement plans are a good vehicle to save for retirement. Income is taxed either in the current tax year or in the future. As discussed in my last posting it has been traditionally assumed that the tax rates will be lower in the future thus much Tax Planning (as it relates to retirement plans) has been focused on delaying tax to a future date. However, as discussed, with the significant increase in the national debt, many tax professionals are beginning to question if that is still a valid assumption; taxes could increase in the future. Some of the plans listed below delays tax to a future date, but with the ROTH plans, income is taxed in the current year and the revenue generated is tax-free in the future. There are important changes to the ROTH plans for 2010, which will be discussed in a future Blog. Please feel free to call me if you have any questions.

Self Employed and Small Business Retirement Plans

(1) Keogh
(a) Contribution limit for 2009
 The lesser of 25% of compensation [max $245,000] or $49,000
(b) 2 types of plans
 Money Purchase plan [based on compensation and are mandatory]
 Profit-Sharing plans [based on companies profits and are NOT mandatory]
(c) Must be set up prior to 1-1-2010
(d) Contributions are to be made by the extended due date of return
(e) Needs to have an administrator and file From 5500

(2) SEP
(a) Contribution limit for 2009 is the lesser of:
 25% of compensation [max 20% of Net income less SEP ] or $49,000
(b) Can be set up after 12-31-2009, but by the extended due date of return
(c) Contributions are to be made by the extended due date of return
(d) Needs to have an administrator and file From 5500

(3) Traditional 401(k) Plan
(a) Contribution limit for 2009
 Under Age 50: $16,500
 Over Age 50: $22,000
(b) Plan must meet specific qualifications & have employees
(c) Must have 3rd party administrators
(d) Must be set up prior to 1-1-2010
(e) Contributions are to be made by 4-15-2010

(4) Solo (mini) 401(k)
(a) Similar to Traditional 401(k), but relaxed rules to allow for No Full Time Employees
(b) Contribution limit for 2009
 Salary Deferral same as a Traditional 401(k)
PLUS
 Profit Sharing same as SEP or KEOGH
(c) No need for 3rd party administrators
(d) Must be set up prior to 1-1-2010
(e) Contributions are to be made by 4-15-2010

(5) Deferred Compensation Plans – Sec 457
(a) Only for Employees and Independent Contractors of State and Local Governments and tax-exempt organizations [except churches]
(b)Contribution limit for 2009 same as for Traditional 401(k)

(6) Tax-Sheltered Annuities
(a) For all Tax Exempt organizations including [including churches] and public school employees
(b) Must be set up prior to 1-1-2010
(c) Contribution limit is the same s 401(k)
(d) Additional $3,000 annual contribution is allowed for those with 15 years or more of service

(7) ROTH IRAs
(a) Contributions are not deductable, but distributions are tax free
(b) Good if one believes tax rates will increase in future
(c) Can convert Traditional IRA, SEP-IRA, SIMPLE-IRA or rollover IRA into ROTH
 The pre-tax contributions will be taxed.
(d) The AGI ceiling of $100,000 is eliminated in 2010

2009 Tax Strategy III – Types of Retirement Plans

This is my third posting of a daily tax tip about Traditional IRAs. An IRA can be a good vehicle not only to save taxes, but also to save for retirement. With Traditional IRAs, taxability of income is delayed to future years, normally when one retires.

Traditionally it has been assumed that the tax rates will be lower in the future, especially upon retirement. However, with the significant increase in the national debt, many tax professionals are beginning to question if that is still a valid assumption; taxes could increase in the future. The Taxpayer, with consultation with his/her CPA, should develop a philosophy on this and if it is determined that tax rates will increase in the future, a strategy of speeding up the taxability of income. Please feel free to call me if you have any questions.

Traditional IRAs

(1) Contribution Limit for 2009:
(a) Under Age 50: $5,000
(b) Age 50 to 70 1/2: $6,000
(c) If Taxpayer is an Active Participant, the contributions are phased out at Modified AGI:
 Single: $55,000 to $65,000
 Married Filling Joint [Each spouse if both participating – See (d) bellow)]: $89,000 - $109,000
 Married Filling Joint [With one participating – See (d) bellow)]: $166,0000 to $176,000
 Head of Household: $89,000 to 109,000
 Married Filling Separate: $0.00 to $10,000
 Delta Amount: Single $10,000 / Married $20,000
 Formula: [(“Delta Amt” – “AGI over threshold”)/”Delta Amt”] X Maximum

(d) Definition of Active Participant: When the Taxpayer or his/her spouse is participating in one of the following:
 Qualified Annuity Plan
 Tax-Sheltered Annuity
 Simplified Employee Pension (SEP)
 Government or Tax Exempt Origination Plan [special rule exempt members of the Armed Forces Reserves and Volunteer Firefighters]

(e) Definition of Modified AGI: AGI [Line 37 on 1040] added back
 Saving Bond Proceeds
 Adoption Expense
 Student Loan Interest Deduction
 Higher Education Expense
 Foreign Tax Deduction

(f) Victimized Employees Can contribute additional $3,000
 Victimized employee is -- the Employer matching of the 401(k) was in Employers stock and the Employer either filed bankruptcy or was indicted
(g) Contributions to be made by 4-15-2009
(h) Taxpayers who where in combat has 3 years to make the contribution

(2) Spousal IRA
(a) A spouse who has lower income or none can deduct the full amount of an IRA deduction using the other spouse income

2009 Tax Strategy II – When is an Expense Deductable

This is my second posting of a daily tax tip about when is an expense deductable for taxes. Please feel free to call me if you have any questions.

When is an Expense Deductable

I was recently asked if parents could take a partial deduction for Property Taxes paid by their daughter and son-in-law. The parents sold their home and moved in with their children and paid for an addition to the home in which they lived.

The parents are not allowed to deduct the property taxes because of two general rules that dictate when a Taxpayer is allowed to take a tax deduction:

(1) The expenditure must be in payment of a legal obligation of the taxpayer or the Taxpayer must have benefited from or consumed the expenditure
(2) The Taxpayer must make the payment of the expenditure himself/herself.

So in this case a tax deduction for property taxes is not allowed because the parents:

(1) Were not legally required to pay the property taxes; and
(2) They did not pay the tax directly

Another example: In order to take a medical deduction the person receiving the services is the only person that can take the deduction, PROVIDING the person paid for the medical expense. The only exception is in case of dependents of the Taxpayer.


To help with your 2009 US taxes, I will post a daily tax tip on my Blog from now until April 15.

2009 Tax Strategy I - Sales Tax and State Tax Refund

With the beginning of 2010, it is time to start thinking about our 2009 taxes, as painful as that might be. To help out, I am going to be posting a daily tax tip from now until April 15. Please feel free to call me if you have any questions.

Sales Tax and State Tax Refund

Under the tax benefit rule, the recovery of an amount deducted or credited in an earlier tax year is included in a taxpayer's income in the current (recovery) year, except to the extent the deduction or credit didn't reduce federal income tax (or alternative minimum tax). (IRC §111(a))

For tax years 2004 through 2007, a taxpayer has the option to deduct as an itemized deduction either the state (and local) income tax paid during the year or state and local sales tax. On first examination would assume that (1) if the client chooses to deduct state income tax and subsequently receives a refund from the state, then that refund is taxable. However, (2) if they choose to deduct sales tax instead of state income tax and receive a state refund for that year that refund is not taxable! Actually, the IRS has taken a much more liberal approach to this issue. Their position is that for purposes of the tax benefit rule the amount of refund includable in income is limited to the excess of the tax the taxpayer chose to deduct over the tax they did not choose to deduct.

Example – Assume the taxpayer can choose an $11,000 state income tax deduction or a $10,000 state general sales tax deduction. Since the state income tax deduction is the largest, he chooses to deduct the state income tax. In the subsequent, he receives a $2,500 state income tax refund. Using the IRS’s more liberal approach the tax benefit derived from by deducting the $11,000 state income tax was only $1,000 more than, if the $10,000 sales tax deduction was used. Thus, the benefit from only $1,000 of the state tax deduction and as a result only $1,000 of the $2,500 refund is taxable the next year.

Strategy – In order to benefit from the IRS’ liberal tax benefit rule position you must be able to compute the difference between sales tax deduction and state tax deduction. Thus it is important (when there is a state tax refund and the state tax deduction exceeds the sales tax deduction) to determine the allowable sales tax deduction for the client and record it in your file. Otherwise, there is no way of computing the tax benefit rule. Be Sure To Look Back – And take advantage of this tax benefit rule.