J.K. Lasser's New Tax Law Simplified 2010: Tax Relief from the American Recovery and Reinvestment Act, and More

J.K. LASSER’S TM NEW TAX LAW SIMPLIFIED 2010 J.K. LASSER’S TM NEW TAX LAW SIMPLIFIED 2010 Tax Relief from the Ameri...

Author: Barbara Weltman

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J.K. LASSER’S TM

NEW TAX LAW SIMPLIFIED 2010

J.K. LASSER’S TM

NEW TAX LAW SIMPLIFIED 2010 Tax Relief from the American Recovery and Reinvestment Act, and More Barbara Weltman

John Wiley & Sons, Inc.

C 2010 Barbara Weltman. All rights reserved. Copyright

Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, 978-750-8400, fax 978-646-8600, or on the web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, 201-748-6011, fax 201-748-6008, or online at www.wiley.com/go/permissions. Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages. For general information on our other products and services, or technical support, please contact our Customer Care Department within the United States at 800-762-2974, outside the United States at 317-572-3993 or fax 317-572-4002. Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our Web site at www.wiley.com. Library of Congress Cataloging-in-Publication Data: ISBN 978-0-470-56009-9 Printed in the United States of America. 10 9 8 7 6 5 4 3 2 1

Contents

Introduction

vii

1. New Rules for Income and Exclusions

1

2. Changes in Figuring Your Adjusted Gross Income

31

3. New Breaks for the Standard Deduction and Itemized Deductions

45

4. New Ways to Trim Your Tax Computation

63

5. New Credits to Cut Taxes

75

6. Money-Saving Breaks for Other Taxes

99

7. Tax-Saving Changes for Small Businesses

115

8. Planning Opportunities for Estate, Gift, and Generation-Skipping Transfer Taxes

131

Appendix A

Expiring Laws

141

Appendix B

2010 Inflation Adjustments

147

Appendix C

Other Forms and Worksheets

157

Glossary Index

171 183

v

Introduction

e are living in interesting times. The tough economy is a once-in-ageneration event, causing massive unemployment, a large number of home foreclosures, and substantial losses in the stock market and in retirement savings plans. In addition, there have been unprecedented financial frauds and natural disasters, causing personal and financial losses to many individuals. To combat some of the pain in these tough times, Congress has enacted a number of measures that can impact your taxes for 2009, 2010, and beyond:

W

r The Emergency Economic Stabilization Act of 2008, signed into law on October 3, 2008, includes over 100 separate tax provisions and over $150 billion in tax breaks. r The Worker, Retiree, and Employer Recovery Act of 2008, signed into law on December 23, 2008, makes important changes primarily affecting retirement plans. r The American Recovery and Reinvestment Act of 2009, signed into law on February 17, 2009, is a massive economic stimulus package including nearly $300 billion in tax relief. These new acts contain hundreds of pages of new or expanded tax breaks. But you don’t have to read through these highly technical and complex

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INTRODUCTION

pages; this book does it for you. It presents the new rules in an easy-to-understand way so that you can know immediately whether something applies to you and how to take advantage of it. In addition to the numerous new laws, there are many tax breaks created under prior laws as well as those resulting from cost-of-living adjustments that can impact your tax bill for this year, for next year, and in later years. And that’s not all. The Internal Revenue Service (IRS) and the courts have been busy providing clarifications that effectively present new opportunities for tax savings. Again, the changes may seem overwhelming, but don’t worry. You can easily tell from a quick read of this book whether there’s an opportunity you can use to slash your tax bill. In order to take advantage of these breaks, often you must take action and plan ahead. You can’t wait until you file your return after the year has ended to see what was new for the year; you have to understand your options well in advance so you can act. A number of breaks run for only a limited time so if you don’t act soon, the opportunity may be lost forever. What this book will do for you is explain in understandable terms what the new rules are all about, what you need to do to benefit from them, and when you must take action so as not to lose out on a valuable tax-saving opportunity. Judge Learned Hand, a famous jurist, said, “Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the treasury. There is not even a patriotic duty to increase one’s taxes. . . . Nobody owes any public duty to pay more than the law demands.” So, armed with the information in this book, you can use the tax rules to minimize (legally) the taxes you pay. The book is organized along the lines of your tax return. In each chapter, not only will you find new tax law explanations and specific planning strategies to maximize new law breaks, but you’ll also learn about tried-and-true planning strategies for income, adjusted gross income, deductions, tax computations, credits, and other taxes that you can use to supplement new tax law planning and save money. In the first chapter you’ll see what new breaks there are for reporting your wages and other income, as well as special rules for not reporting income. The next chapter explains how to reduce your income by certain deductions to arrive at adjusted gross income. The next chapter deals with new rules for the standard deduction and itemized deductions, followed by a chapter on the changes affecting your tax computation. New sizable

INTRODUCTION

tax-saving opportunities involving tax credits are covered next, then changes to other taxes, including the alternative minimum tax. A separate chapter deals with important and helpful changes for small business owners, particularly selfemployed people who file Schedule C with their Form 1040. While not impacting your income taxes, the estate, gift, and generation-skipping taxes have changed dramatically for 2009 and could affect you and your family’s wealth; a chapter has therefore been included on these transfer tax changes. A final thought before you begin to grow your tax savings: The law is constantly changing, so these tax breaks may not be the final word for 2009, 2010, or beyond. Many of the tax cuts created in 2001 and other tax acts during the Bush administration are set to sunset (expire) at the end of 2010. Still other rules have later expiration dates. What will happen to these expiring rules is unclear at this time. In Appendix A, you’ll find a discussion of key provisions affecting individuals and businesses that are set to expire in 2009 and 2010, and in Appendix B you’ll find cost-of-living adjustments for 2010. Use this information, which includes predictions for extensions, to plan ahead. In Appendix C you’ll find helpful worksheets and new Tax forms for taking advantage of tax breaks on your 2009 returns. If you need more of an explanation about basic tax rules and strategies, you can find information in J.K. Lasser’s Your Income Tax and J.K. Lasser’s 1001 Deductions and Tax Breaks. To stay alert to new opportunities, including additional tax legislation in 2009 and the fate of expiring provisions, connect at www.jklasser.com.

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NEW TAX LAW SIMPLIFIED 2010

CHAPTER 1

New Rules for Income and Exclusions

ncome can come from many sources: your job, a business, investments, bank interest, and alimony, to name a few. In most cases, all of your income is included in the “Income” section on your tax return. Sometimes, however, a special tax rule allows you not to report some or all of an item of income. There may be breaks if your income is low. For example, Social Security retirement or disability benefits are not taxed if your income is below set amounts; if not fully tax free, then the benefits are included in income at 50 percent or 80 percent, again depending on your other income. The tax law may have an exclusion or exemption for certain types of income. Without a specific exclusion or exemption, the income is taxable; with it, the income becomes tax free. The exclusion may be for some or all of the income item. Eligibility for an exclusion may depend on your adjusted gross income (AGI), which is your income minus adjustments to gross income, or your modified adjusted gross income (MAGI), which is usually AGI without regard to certain foreign income exclusions. This chapter covers the new rules affecting income and exclusions in 2009 and 2010. It also covers some important rules that are set to expire soon, so you can act now to take advantage of them. And the chapter provides planning

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NEW RULES FOR INCOME AND EXCLUSIONS

strategies for income that you can use to save money on your return for 2009 and for years to come.

COMPENSATION AND OTHER JOB-RELATED BENEFITS There are an estimated 140 million U.S. workers on company payrolls. They are paid wages and may also receive various fringe benefits. The benefits may be cash, in the form of bonuses, vacation pay, sick days, and personal leave. The benefits may also be tax-free fringe benefits where the employer pays for certain items on which the employee is not taxed, such as health insurance and employer contributions to retirement plans. If you are among those who are employed today, here are some changes of note related to your compensation package. In this tough economy, not everyone has been able to keep their job. In July 2009, the national unemployment rate was 9.4 percent. Also included in this section is information that may relate to you or a family member who has lost a job.

Elective Deferrals If you are employed and participate in a 401(k) plan, a 403(b) annuity, a 457 government plan, a salary reduction simplified employee pension (SARSEP) established before 1997, or a savings incentive match plan for employees (SIMPLE), you can opt to have part of your wages added to the plan. The wages you add to the plan are called elective deferrals or salary reduction contributions. You do not get a tax deduction for your contribution (although you may be eligible for a tax credit related to your contribution, as explained in Chapter 5). Instead, the contribution is not included in your income for the year, so you don’t pay tax now on your contribution to the plan. Note: You still pay Social Security and Medicare (FICA) taxes on elective deferrals even though you don’t pay income tax on them.

Contribution Limits for Plans Other Than SIMPLEs For 2009, the tax law increased the elective deferral limit to $16,500 (up from $15,500 in 2008). This is called the “basic” elective deferral limit.

ELECTIVE DEFERRALS

If you are at least age 50 by December 31, 2009, you can add an additional elective deferral amount, called a “catch-up contribution” for 2009. The catch-up amount for 2009 is $5,500 (up from $5,000 in 2008). Example A salaried person age 52 can add $22,000 ($16,500 + $5,500) to a 401(k) plan in 2009 as long as wages are at least $22,000 and the pan allows the full limit.

Typically, the elective deferral is spread out over the year, with an allocated portion subtracted from each paycheck (or from one paycheck each month for those with a twice-a-month paycheck schedule). For 2010 and later years, the basic and catch-up contribution amounts can be adjusted upward for inflation. These amounts usually are announced late in the year so plan participants can agree to their contributions for the coming year. PLANNING

If you will celebrate your 50th birthday during the year, you can make the catch-up contribution throughout the year. You don’t have to wait until your birthday passes to start making catch-up contributions. Elective deferrals can be as great as 100 percent of compensation, up to the dollar limit for basic and catch-up contributions for the year. However, most plan participants contribute only a small percentage of their wages. It is highly advisable to contribute at least the minimum amount needed to obtain employer matching contributions. Usually, employer matching contributions are based on up to 6 percent of compensation. However, in these tough economic times, some employers have reduced or eliminated matching contributions, so check with your employer before committing to next year’s elective deferral amount. If you are enrolled in an automatic enrollment plan (one in which your employer enrolls you but you have the ability to opt out or reduce the automatic elective deferral amounts), review your contribution amounts for the coming year. The elective deferral percentage under an automatic enrollment plan can and usually does increase each year. You can choose to increase or decrease this percentage amount. If you have any questions about elective deferrals, ask your plan administrator.

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Starting in 2010, small employers (those with 500 or fewer employees) can offer a hybrid retirement plan that combines a defined benefit (pension) plan with a 401(k) plan. This type of plan is called a DB(k). If your employer adopts this type of plan, ask the plan administrator to explain elective deferral limits and other rules.

Contribution Limits for SIMPLEs Savings incentive match plans for employees (SIMPLEs) are plans offered by some small employers. From an employee’s perspective, they look and act much like a 401(k) plan, although the dollar limits on elective deferrals are lower. For 2009, the elective deferral to a SIMPLE plan is $11,500 (up from $10,500 in 2008). If you are at least age 50 by December 31, 2009, you can also make a catch-up contribution for 2009. The catch-up amount for 2009 is unchanged at $2,500. Example A salaried person age 52 can add $14,000 ($11,500 + $2,500) to a SIMPLE plan in 2009 as long as compensation for the year is at least $14,000 and the plan allows the full limit.

PLANNING

Decide on your elective deferral contribution for next year. You can add up to 100 percent of your wages, up to the dollar limit for the basic and catch-up contributions for the year. If your employer makes a nonelective contribution (usually 3 percent of your compensation), you receive the benefit of this contribution only if you, too, contribute to the plan for the year. For 2010 and later years, the basic and catch-up contribution amounts can be adjusted upward for inflation. These amounts usually are announced late in the year so plan participants can decide on their contributions for the coming year.

Transportation Fringe Benefits Usually, your out-of-pocket costs for commuting to and from work each day are not deductible; they are considered nondeductible personal expenses. There are, however, ways around this rule. Your employer can pay for certain transportation

TRANSPORTATION FRINGE BENEFITS

fringe benefits up to set limits and you are not taxed on the payments made on your behalf. The monthly benefits include: • Free parking—parking spaces for employees on or near the employer’s business premises or at or near a location from which the employees commute to work by mass transit, car pooling, or van pooling, such as a train or bus station. • Monthly transit passes—payments for mass transit travel to and from work. • Van pooling—a program that the employer sets up for transporting employees to and from work in a company-owned “commuter highway vehicle” that seats at least six adults (not counting the driver) and for which at least 80 percent of the mileage is used to transport the employees to and from work.

For 2009, the dollar limit on the exclusion for free parking for all of the year is $230 per month. For March through December 2009, the exclusion for monthly transit passes and van pooling is $230 per month; for January and February 2009 it is $120 for these transportation fringe benefits. In 2008, free parking was limited to $220 per month and transit passes and van pooling were limited to $115 per month. For 2010, the dollar limit on these three transportation fringe benefits could have been increased for inflation but there will be no adjustment. Free parking, monthly transit passes, and van pooling will remain in parity so that there is the same monthly limit for each type of commuting fringe benefit. For 2009, there is a new transportation fringe benefit for bicycle commuting. An employee can receive from an employer $20 per month tax free to cover the cost of buying, storing, and maintaining a bicycle used to get to and from work. The $20 per month benefit will not be indexed for inflation and will remain at $20 per month in 2010. To receive this fringe benefit, an employee cannot receive free parking, commuter passes, or van pooling. PLANNING

Your employer may allow you to pay for monthly transit passes on a pretax basis. Like contributions to 401(k) plans, the amount of your wages that you opt to apply toward the purchase of monthly transit passes is not treated as taxable

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wages (the amount is subtracted from your wages). The elective deferral that reduces your wages cannot exceed the dollar limit for transit passes for the year. You can enjoy both free parking and monthly transit passes or van pooling, for a maximum monthly exclusion in 2009 of $460 each month for most of the year. For example, if your employer pays for parking at the train station and transit passes for the train, you can exclude the cost of each up to $230 a month for parking and $230 a month for the train travel for March through December ($120 for January and February).

Foreign Earned Income Exclusion If you work abroad, you may still owe U.S. income taxes. The tax law generally requires U.S. citizens and residents to file U.S. income tax returns and pay U.S. income taxes on their worldwide income. However, the law allows you to exclude income earned outside of the United States from income on a U.S. tax return up to a set limit. For 2009, the limit is $91,400; in 2008 it was $87,600. To qualify for this exclusion, you must meet one of two tests: • A foreign residence test—you are a U.S. citizen and you reside abroad. • A foreign physical presence test of 330 days—you are a U.S. citizen or resident living in a foreign country for an uninterrupted period that includes one full year.

Only compensation paid by a private employer or self-employment income earned in a foreign country qualifies for the exclusion. U.S. government pay does not qualify for the exclusion, regardless of the fact that you live abroad. The exclusion does not apply to those who work in locations that are not foreign countries: • Antarctica • International airspace • International waters PLANNING

The exclusion amount can be adjusted annually for inflation. See Appendix B for details. Foreign income taxes paid on foreign wages or self-employment income can be claimed as a tax deduction or credit on a U.S. income tax return.

UNEMPLOYMENT BENEFITS

Housing Expenses If you are living abroad and qualify for the foreign earned income exclusion, you can also exclude housing expenses over a set amount. For 2009, the base housing amount has increased to $40.07 a day, or $14,624 for the entire year; expenses over this amount are excludable. However, the excludable amount cannot exceed 30 percent of the foreign earned income exclusion of $91,400, or $27,420 in 2009. Higher dollar limits apply in certain so-called high-cost areas. PLANNING

The exclusion amount can be adjusted annually for inflation. See Appendix B for details.

Combat Pay Payments to noncommissioned U.S. military personnel and part of the pay to commissioned officers serving in a combat zone or while hospitalized as a result of combat-related wounds or disease are excludable from gross income. The exclusion does not extend any further. The Internal Revenue Service (IRS) has made it clear, however, that this exclusion does not apply to civilian employees of the armed forces or for supplemental compensation paid by private businesses to members of the U.S. armed forces. PLANNING

Civilian employees cannot use the combat pay exclusion but may qualify for the regular foreign earned income exclusion discussed earlier. Military personnel eligible to exclude combat pay from gross income may opt to include it in order to claim certain tax benefits, such as the earned income credit and a deduction for individual retirement account (IRA) contributions.

Unemployment Benefits Generally, unemployment benefits paid by states to individuals who are terminated from their jobs are all included in income. However, for 2009 only (unless Congress extends this break), a recipient can exclude up to $2,400 of such benefits from income. This exclusion applies without regard to your overall income for the year.

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PLANNING

Recipients of unemployment benefits can opt to have income taxes withheld from their benefits by filing Form W-4V, Voluntary Withholding. If this is done, withholding is taken at the rate of 10 percent. For certain individuals, voluntary withholding can avoid the need to pay estimated taxes.

COBRA Subsidy COBRA (an acronym for the Consolidated Omnibus Budget Reconciliation Act) is a federal law requiring employers that regularly employ at least 20 workers and that offer health coverage to allow workers who leave the job to continue in the group plan for 18 months. Usually, the employee pays the full cost of COBRA coverage, plus an administrative fee of up to 2 percent of premiums. Under a special rule, certain terminated workers can receive federal assistance for COBRA premiums. An assistance-eligible individual pays only 35 percent of COBRA premiums for nine months; the federal government pays the other 65 percent of premiums for this period (the employer pays this portion and receives reimbursement from the government via a reduction of employment taxes). To qualify for the COBRA subsidy, you must have been involuntarily terminated from employment on or after September 1, 2008, and before January 1, 2010. You don’t get the subsidy if you left the job for your own reasons. Once involuntarily terminated, you must make a timely election for COBRA coverage. (Under a special rule, those who were terminated before February 17, 2009, were given an additional 60 days to elect COBRA coverage and receive the federal subsidy.) You receive the subsidy regardless of the amount of your income for the year. However, the subsidy is tax free to you only if your modified adjusted gross income (MAGI) does not exceed a set amount ($125,000 for singles or $250,000 for joint filers). If your MAGI exceeds the limit, then the federal subsidy is included in gross income. A worksheet for figuring recapture of COBRA premium assistance is in Appendix C. PLANNING

If you are eligible for this COBRA subsidy, decide whether it is less costly than obtaining health coverage elsewhere. For example, it may be less costly to seek

INTEREST ON SAVINGS BONDS

individual coverage to obtain the type of benefits you need and not pay for those you don’t (which may be part of the price of the employer’s coverage). Note that the federal subsidy runs for only nine months but you can continue federal COBRA for another nine months (18 months in total). If your employer pays for some months of COBRA, this reduces the period of the federal subsidy. For instance, if your employer lays you off and agrees to pay all of your COBRA costs for three months, you can then obtain the federal subsidy for only six months (not the usual nine months). Even if you work for an employer who is not subject to federal COBRA (there are fewer than 20 workers on the payroll), a state law, called mini-COBRA, may apply. The nine-month federal subsidy can be used to the extent of your state’s COBRA coverage period.

INTEREST AND DIVIDENDS

Build America Bonds Build America Bonds (BABs), created by the American Recovery and Reinvestment Act, are taxable municipal bonds issued by states and municipalities for schools and infrastructure. What sets them apart from other bonds is the fact that the federal government effectively pays 35 percent of the bond interest. Typically, the issuer retains this federal subsidy and offers a higher rate of interest on the bond. The issuer is allowed to pass the 35 percent interest credit on to the investor; if the credit cannot be fully utilized by the investor in one year, it can be carried over to the next. These bonds can be issued only in 2009 and 2010. From your perspective as an investor, these bonds offer a relatively high yield and safety (the bonds are AAA-rated). However, the bonds are not guaranteed by the federal government even though there is the interest subsidy, so an investor still needs to exercise caution in buying a BAB. PLANNING

Because BAB interest is taxable, the bonds are probably best held in an IRA so that the interest becomes tax deferred.

Interest on Savings Bonds If you own U.S. savings bonds—series EE and I—you can opt to report interest annually, but this is rarely done. Typically, bondholders wait to report the

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interest until they redeem the bonds or the bonds mature. At that time, a part of what you receive represents principal (what you paid for the bonds) and the balance is interest. Savings bond interest usually is fully taxable for federal income tax purposes; it is always tax free for state income tax purposes. However, you may be able to exclude some or all of the interest from your federal tax return if you use the bonds to pay for college (see discussion under “Your Education” later in this chapter). PLANNING

If you already own bonds and want to transfer them to a revocable trust (often referred to as a living trust), you can do so without triggering immediate taxation. Title to the bonds is transferred to the trust, and the interest continues to be taxable to you when and to the extent described as long as you are treated as the owner of the trust.

Interest on California Registered Warrants Because of California’s budget crisis in 2009, the state in June 2009 began to issue IOUs (technically called registered warrants) to individuals and businesses providing goods and services to the state, as well as to taxpayers owed income tax refunds and to owners of unclaimed property. The IOUs bore an interest rate of 3.75 percent and were redeemable on October 2, 2009 (or sooner if the state determined there were funds available for redemption). According to the California controller’s office, the interest on a warrant redeemed within one year of its maturity date is tax free for both federal and California income tax purposes. California also allowed holders of these warrants to use them to pay state income taxes; they cannot be used to pay federal income taxes.

Tax on Qualified Dividends The same tax rules for qualified dividends that applied in 2008 continue to apply for 2009 and 2010, unless Congress changes the rules (as it has talked about doing). This means that qualified dividends are taxed at 15 percent for taxpayers in tax brackets above 15 percent (tax brackets are explained in Chapter 4). There is no tax on qualified dividends for taxpayers in the 10 percent or 15 percent tax bracket. For 2009, the 15 percent tax bracket covers taxable income up to

GENERAL CAPITAL GAINS RATES

$67,900 for joint filers, $45,500 for heads of households, and $33,950 for singles. (Taxable income is income after subtracting deductions and exemptions.) How do you know whether the dividends you received qualify for this special tax treatment? On Form 1099-DIV, Dividends and Distributions, which you receive early in the year following the year of dividend payments, qualified dividends are identified in Box 1b.

YOUR INVESTMENTS You may own stocks, bonds, mutual fund shares, antiques and collectibles, realty, or other investments that can produce income (or losses) for you in the form of capital gains and losses. The tax law looks favorably on gains but often restricts your ability to deduct your losses.

General Capital Gains Rates During the stock market downturn, people have been focused more on their losses than on their gains. However, some people have continued to enjoy capital gains on the sale of stocks, bonds, mutual fund shares, and other capital gain property. The tax law continues to provide favorable treatment for capital gains. Technically a capital gain for this purpose means a net long-term capital gain in excess of any net short-term capital losses. Long-term capital gains and losses result from sales or exchanges after holding the assets for more than one year. Capital gain distributions from mutual funds are taxed like long-term capital gains. The maximum tax rate on most capital gains continues for 2009 and 2010 to be 15 percent. For taxpayers in the 10 percent or 15 percent tax brackets, there is no tax on capital gains. The taxable income limit for the 15 percent tax bracket is listed in the preceding section, “Tax on Qualified Dividends.” The extent of capital gains representing depreciation recapture is taxed at 25 percent for taxpayers in tax brackets of 25 percent or higher. Capital gains on the sale or exchange of collectibles and certain small business stock (after an exclusion explained later in this Chapter) are taxed at 28 percent for taxpayers in tax brackets of 28 percent or higher. PLANNING

Since taxpayers in the 10 percent or 15 percent tax bracket pay no tax on capital gains, it may be helpful to give appreciated securities to an elderly parent whom

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you are already helping to support. The parent can sell the securities and pay no capital gains, allowing more money to be retained within the family. Example You are helping to support your elderly mother and usually give her $750 a month in cash. You own 100 shares of XYZ stock now worth $9,000, which cost you $3,000 to acquire. If you sell the stock, you’ll have only $8,100 after tax (your $6,000 gain [$9,000 – $3,000] incurs tax of $900 [$6,000 × 15%]). If you give your mother the shares and she sells them, she can use the entire proceeds, $9,000, in place of your monthly $750 for an entire year!

Small Business Stock Usually, gain on the sale of stock held for more than one year is taxed at a capital gains rate of no more than 15 percent. However, there is a special rule for stock that is qualifying small business stock. Gain on the sale of qualifying small business stock (defined shortly) held for more than five years is not fully taxed. Instead, a portion of the gain can be excluded from income; the balance is subject to tax at a rate up to 28 percent. For some time now the exclusion for gain on qualifying small business stock has been 50 percent. There has also been a 60 percent exclusion for small business stock in a business within an empowerment zone (an economically-disadvantaged area designated by the federal government) if the stock is acquired after December 31, 2000, and before January 1, 2014. Now a higher exclusion is possible. For stock issued by any small business after February 17, 2009, and before January 1, 2011, the exclusion is increased to 75 percent. Qualified small business stock is stock in a C corporation (not an S corporation) acquired in the original issue for money or property other than stock, or as compensation for services other than underwriting the stock offering. PLANNING

Obviously, because of the five-year holding period, the higher exclusion won’t come into play for a number of years. However, action now can ensure that you acquire stock within the applicable time frame.

LOSSES IN PASSIVE ACTIVITIES

If, after 2009, you sell small business stock that had been in an empowerment zone, you can disregard the end of the empowerment zone designation on December 31, 2009, so that you still qualify for the 60 percent exclusion. Using the exclusion for small business stock sales for regular tax purposes requires an adjustment for alternative minimum tax purposes. This is explained in Chapter 6.

Mark-to-Market Reporting Those who regularly trade in securities may make a tax election, called markto-market accounting, to treat all securities positions as having been sold at the end of the year for their fair market value, with all gains and losses deemed to be ordinary gains or losses. Thus, those who incur losses would be able to report them all as ordinary losses rather than as capital losses subject to limitations. However, the time limit for making a mark-to-market election is limited. The election for a tax year must be made no later than the due date of the return for the prior tax year. For example, a mark-to-market election for 2010 has to be made by April 15, 2010 (the due date for the 2009 return). A timely election applies to the year for which it is made and all later years unless the IRS grants permission to revoke the election. As recent court decisions have demonstrated, the election cannot be made retroactively and no extension can be granted to make a late election. Thus, the election cannot be made on an amended return (which, by definition, is filed after the due date of the return for the year in question).

Investment Losses in Ponzi Schemes If you lost money in a Ponzi scheme, such as the Bernard Madoff debacle, you may be able to deduct your losses as casualty losses (not as capital losses). See Chapter 3.

Losses in Passive Activities As a way to clamp down on so-called tax shelters, the tax law limits losses from activities treated as passive activities (all rental realty as well as other businesses in which you do not materially participate) to the amount of income

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from such activities for the year. If losses cannot be claimed currently under this rule, the excess can be carried forward and used to offset passive activity income in future years. If you dispose of an investment in a passive activity, you can then report all of the carried-over losses from such activity without regard to passive activity income that year. These are called the passive activity loss (PAL) rules. If you are a limited partner in a business, you are automatically treated as owning an interest in a passive activity. However, courts recently have concluded (despite IRS objections) that investments in limited liability companies (LLCs) or limited liability partnerships (LLPs) are not automatically treated as passive activities. Even though owners in LLCs and LLPs have personal liability protection, they can participate in the operations of the business and may materially participate so as to avoid the passive activity loss limits.

YOUR RETIREMENT INCOME You may receive various forms of income to support you in retirement. Common types of retirement income include Social Security benefits, distributions from qualified retirement plans, and withdrawals from IRAs. Some of this income may be fully taxable, while other income may be partially or fully tax free.

Required Minimum Distributions If you have an IRA or a qualified retirement plan (such as a 401(k) plan), usually you are required to take annual distributions from the plan starting at age 701/2 . However, because of the dramatic drop in the stock market in the fall of 2008, Congress suspended the required minimum distribution (RMD) rules for 2009. It is hoped that the stock market will recover so that account values will also recover. The suspension of RMDs applies both to IRA owners and plan participants as well as to beneficiaries of IRAs and retirement plan benefits. Usually, distributions by beneficiaries are figured using an IRS table for life expectancy (called the single life expectancy table) and commence by the end of the year following the year of the account owner’s death (though no distributions are required for 2009). However, distributions can be based on a five-year rule. Under this rule, no distributions are required to be taken by the end of the year

ROTH IRA CONVERSIONS

following the year of the account owner’s death but rather are postponed until five years after death. Then the entire account (not just a partial distribution) is taken. Because of the suspension of the RMD rules, a beneficiary using the five-year rule does not include 2009 as one of those five years. PLANNING

The suspension does not bar you from taking any or all of the money from your retirement accounts in 2009. However, by leaving the funds untouched, you may allow the value of your account to recover somewhat from the devastating losses so many people experienced in 2008. If you take withdrawals from traditional IRAs and qualified retirement plans, you are taxed on the distributions. If you’re under age 591/2 (or under 55 when you separate from service and take distributions from a plan), you are subject to a 10 percent early distribution penalty. There are a number of exceptions to this penalty. For example, if you withdraw funds from an IRA to pay for health insurance after being unemployed for 12 weeks, there is no penalty. However, the Tax Court has made it clear taking hardship withdrawals from IRAs or retirement plans is not one of the allowable exceptions to this penalty. Anyone under age 591/2 (or under age 55 as just described) who has taken distributions from an IRA or a qualified retirement plan because of a need for the money will owe both regular income tax on the distribution as well as the 10 percent early distribution penalty.

Roth IRA Conversions A Roth IRA is a type of IRA that allows earnings to grow into tax-free income. You can create an IRA in two ways: by making annual contributions (explained in Chapter 2) and/or by converting a traditional IRA or qualified retirement plan account, such as a 401(k) plan, into a Roth IRA. When you make the conversion, the income that would have been taxed had you taken a distribution from the traditional IRA or qualified retirement plan account becomes fully taxable. The rules for converting a traditional IRA or retirement plan account to a Roth IRA have not changed for 2009. To be eligible to make a conversion, your adjusted gross income (AGI) cannot be more than $100,000 (without regard to the income from the conversion), whether you are single or a joint filer. Married persons filing separately are ineligible in 2009 to make the conversion.

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Starting in 2010, however, the AGI limit as well as the bar to married persons filing separately disappears. Anyone will be eligible to convert some or all of their IRA accounts to a Roth IRA. As mentioned earlier, the cost of conversion is reporting the income that would have been taxable if the funds had been distributed from the account rather than converted to a Roth IRA. For those with traditional (deductible) IRAs or a 401(k) plan, this means all of the funds that are converted are taxable. There is a special rule for conversions made in 2010 only. Fifty percent of the resulting income is reported as income in 2011 and the other 50 percent in 2012. However, you can opt to report all of the conversion income in 2010 and not use the deferral option. Which way is better? It’s difficult to answer this now, because the tax rates that will be in effect after 2010 have yet to be set by Congress. The rates could be higher after 2010, making it better to report all of the income in 2010. However, deferral means you only have to take half of the income into account in each of two years. This spread could lower the tax bracket you are in, depending of course on the amount of conversion income and your other income. PLANNING

Conversion isn’t an all-or-nothing decision; you can convert some or all of your IRA or IRAs. You can make conversions year after year if you want to. In deciding whether to convert an IRA to a Roth IRA or how much to convert, take into account the impact that the conversion may have on the taxation of Social Security benefits. The income from the conversion can trigger or increase the amount of benefits subject to tax if you make the conversion when you are already receiving Social Security benefits. In deciding how much to convert, make sure you have the funds set aside to pay the taxes (don’t use IRA funds for this purpose). If you convert funds to a Roth IRA in 2009, later on you may wish to undo the action. Perhaps your income in 2010 will be lower than it was in 2009. Or maybe the value of the account has declined below its value at the time of conversion. Generally, you have until October 15 of the year following the year of conversion to recharacterize the transaction. This means retitling the Roth IRA as a traditional IRA in order to avoid having the account treated as a taxable distribution.

IRA ROLLOVERS

Example In March 2009 when the stock market was still low, you thought it was wise to convert your traditional IRA to a Roth IRA. Now, in March 2010, you see that the value of the holdings in your account is even lower than in the previous year. You have until October 15, 2010, to recharacterize the transaction. If you filed your 2009 return before this date, you’ll need to file an amended return to delete the conversion income.

IRA Rollovers You can transfer funds from one IRA to another without any current tax cost. As long as you complete a rollover within 60 days of taking a distribution (you can do this only once a year) or you instruct the trustee or custodian of your current IRA account to transfer the funds directly to the trustee or custodian of a new IRA account (called a direct transfer), there is no current tax on the amount rolled over (you can do this as often as you like). Rollovers are also allowed from qualified retirement plans to other qualified retirement plans or to IRAs. For example, if you leave your job, you may be able to roll over your 401(k) account to your IRA. If you die and your spouse inherits the benefits, he or she can roll them over to his or her own IRA. This is helpful for younger individuals because it allows spouses to delay starting required minimum distributions until they reach age 701/2 . But what about benefits inherited by those who are not surviving spouses? The tax law changed a couple of years ago to allow nonspouses who inherit benefits in qualified retirement plans to make a rollover rather than simply being taxed immediately on the benefits they inherited. There was, however, confusion about whether plans had to permit the rollover or whether it was discretionary. Under a new law, starting in 2010, plans must permit nonspouse beneficiaries to make a rollover of inherited benefits. PLANNING

If you inherit qualified retirement plan benefits from a person who is not your spouse and you make an IRA rollover, be sure to note how the account must be titled. You must retain the deceased person’s name in the title.

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Example An IRA with inherited funds must be titled “Ann Smith, as beneficiary of Betty Smith, deceased” or “Betty Smith, deceased, IRA, for the benefit of daughter Ann Smith, beneficiary.”

YOUR HOME The housing market has been in a bad way for the past two years, with home prices declining and foreclosures rising. Still, the national home ownership rate for the second quarter of 2009 was 67.4 percent, only slightly lower than a year earlier (68.1 percent). When you move out of your home because of a sale or a foreclosure, you may be eligible for special tax breaks. This section explains new developments as well as breaks that are set to expire soon.

Home Sale Exclusion Even in this tough housing market, homes are selling and some homeowners are reaping a profit (especially those who have owned their residences for a number of years). A homeowner who sells his or her main residence can exclude from the gain income up to $250,000 ($500,000 on a joint return). To qualify for this exclusion, the homeowner must have owned and used the home as his or her principal residence for at least two of the five years before the date of sale (special rules apply for those in the military and foreign service). In the past, it was possible for homeowners to convert vacation homes and rental property to or from a principal residence, satisfy the two-year ownership and use test, and then use the home sale exclusion for gain on the sale of the converted property. This is no longer possible, because Congress has closed this loophole. Effective for homes sold in 2009 and later years, the exclusion can no longer be used for any gain related to nonqualified use of the home after 2008. Nonqualified use means use of the home as a vacation home or rental property. Nonqualified use does not include absences due to the following: • Military service (up to 10 years).

CANCELLATION OF DEBT

• Temporary absences (up to two years) due to a change in employment, health conditions, or other unforeseen circumstances. • Leaving the home vacant while waiting to sell it after you relocate to a new principal residence. PLANNING

In this tough real estate market where there is a glut of inventory and depressed housing prices, sellers may wish to take a wait-and-see approach. It may become financially necessary or desirable to rent a home out until the housing market improves. In making the decision to rent the home, be sure to factor in the impact it can have on the home sale exclusion.

Cancellation of Debt If you have a mortgage on your home and some or all of the remaining balance on the loan is forgiven because of a foreclosure, a mortgage workout, or a short sale (which avoids the need for foreclosure), the amount forgiven usually is treated as taxable income. However, under a special rule for a principal residence, such debt forgiveness is not taxable. To be tax free, the debt must have been used to buy, build, or substantially improve your main home and the debt must have been secured by the home (this is called “qualifying debt”). If the debt was refinanced, the amount qualifying for this break is limited to the mortgage principal immediately before the refinancing. The limit on qualifying debt cannot be more than $2 million ($1 million for a married person filing separately). The lender will issue a Form 1099-C, Cancellation of Debt, reporting the mortgage forgiveness and the portion that is not taxable. Then you must file Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, to report the transaction on your income tax return for the year of the debt forgiveness (see Appendix C). PLANNING

This break applies only to qualified debt forgiven on a main home in 2007 through 2012. The break does not apply to a mortgage on a second home, rental property, or business property.

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Even though your home has been foreclosed upon, you may still have to recognize gain from the foreclosure sale if the amount realized (the fair market value of the home, as reported to you in Box 7 of Form 1099-C) is more than the basis in your home. This gain is not forgiven as is debt cancellation. If you have a loss on the foreclosure (the fair market value is less than your basis), you cannot deduct the loss, because it is a nondeductible personal loss.

Losses on the Sale of a Residence In this tough real estate market, many sellers who have been able to find buyers for their homes may wind up losing money. It is a fact of tax law that you cannot deduct losses on the sale of a principal residence. This is considered a personal asset and no losses are allowed on the sale or exchange of personal assets. There had been rumbling in Congress to reverse this result and allow homeowners to claim their losses on their tax returns. So far, there have been no positive developments on this front.

YOUR EDUCATION Unless someone else is paying the bill—an employer, a school scholarship—the cost of higher education can be steep. Still, in the tough economy, children continue to attend college and many laid-off workers have gone back to school to retool their careers. The tax law provides various higher education incentives. Some breaks encourage savings, while others help to defray the cost of paying for tuition and other education expenses. An above-the-line deduction for tuition and fees discussed in Chapter 2. Tax credits for higher education are discussed in Chapter 5.

Savings Bond Interest You can exclude from income the interest earned on series EE or I U.S. savings bonds that you redeem to pay for qualified higher education costs for yourself, your spouse, or a dependent. The exclusion applies only to interest on bonds purchased in your name after 1989; you must have been at least 24 years old at the time of purchase. You can claim the exclusion only if your modified adjusted gross income (MAGI) is no more than a set limit. This limit is adjusted annually for inflation.

SECTION 529 PLANS

TABLE 1.1

Savings Bond Interest Phaseout Ranges

Filing Status

2009 MAGI

2008 MAGI

Single Married filing jointly

$69,950 to $84,950 $104,900 to $134,900

$67,100 to $82,100 $100,650 to $130,650

Table 1.1 shows the MAGI limit for fully or partially excluding savings bond interest based on your filing status for 2009 compared with 2008. Find the MAGI limits for 2010 in Appendix B. Example You’re a single parent and redeem bonds in 2009 to pay your child’s college tuition. Interest on the redeemed bonds is $4,000 (all of which is used to pay qualified costs). If your MAGI is below $69,950, you may exclude all of the interest. If your MAGI is $77,450, you may exclude $2,000 of interest from your income. If your MAGI is over $84,950, you cannot exclude any interest.

PLANNING

Many people make gifts to babies and children in the form of savings bonds. Recognize that these gifts won’t qualify for the interest exclusion even though they may be redeemed to pay for higher education costs. The reason: The bond owner (the child) isn’t over age 24 and didn’t purchase them him/herself. Instead, consider giving money to a child’s 529 account if one has been set up for the child.

Section 529 Plans Saving for college is challenging, especially in tough economic times when there are many demands on a family’s budget. However, taking a long view for college savings can reduce the funds needed to be added each year. One of the best savings plans for college is the 529 plan (the name comes from the section in the Internal Revenue Code governing it). There are two types of plans: 1. A prepaid tuition plan, which guarantees to cover some or all of tuition costs, depending on your contributions. 2. A savings plan, which provides funds based on investment performance of your contributions.

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With both types of plans, there is no federal income tax deduction for contributions (there may be state-level deductions or credits for making contributions). However, earnings grow tax deferred and withdrawals are completely tax free if used to pay qualified higher education expenses. Qualified higher education expenses include tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution (any college, university, vocational school, or postsecondary school eligible to participate in federal student loan programs). Room and board are also a qualified higher education expense if the student is at least a half-time student.

Computer Technology For 2009 and 2010, qualified higher education expenses also include technology equipment. This means computers, Internet access fees, and software. However, it does not include software for games, sports, or hobbies unless the software is “predominantly educational in nature.” PLANNING

A computer that is paid for by funds from a 529 plan does not have to be used exclusively for educational purposes to qualify for the exclusion.

Changing Investments The tax law usually lets you change your 529 plan investment selections once a year and whenever there is a change in the beneficiary. However, due to the state of the economy in 2008 and 2009, the IRS has said that two investment changes are permissible in 2009. Whether the IRS will extend this rule to 2010 depends on how the economy progresses.

OTHER INCOME AND EXCLUSIONS There are many other types of income you can receive besides income related to a job, investments, retirement, your home, or education. Some of this other income may be fully taxed, while other items may be partially or fully tax free.

DAMAGES

Cash for Clunkers Buying Incentive The federal government’s $1 billion cash for clunkers program, which was extended through an infusion of an additional $2 billion, began on July 24, 2009, as a way to spur the ailing auto market by allowing the more than 16,000 participating dealers to offer $4,500 to buyers trading in vehicles that meet certain requirements (so-called clunkers) so consumers would purchase or lease more fuel-efficient vehicles. A smaller incentive of $3,500 was available for less fuel-efficient models. Individuals who were able to receive the incentives also get favorable income tax treatment; the incentives are tax free to buyers. The incentives could not be converted to cash; they could only be applied toward the purchase or lease of a new vehicle.

Cancellation of Debt (Other Than Home Mortgages) Generally, when a lender forgives some or all of the amount owed on a loan, the forgiven amount is cancellation of debt income or discharge of indebtedness income. This income is taxable unless you are insolvent or bankrupt at the time of the debt forgiveness. For example, in a recent Tax Court case, a car was repossessed and the finance company forgave the remaining installments of the loan. Because the borrower was not insolvent at the time, the cancellation of this debt was taxable income. The lender will report this income to the borrower on Form 1099-C, Cancellation of Debt.

Damages Generally, all damages received are fully taxable except for compensatory damages for physical injury or sickness. It is often problematic to decide when emotional distress, and the compensation for it, is excludable as payment for a physical injury or taxable as a nonphysical injury. The Tax Court has reiterated that in discrimination actions that do not involve physical injury or sickness, the exclusion covers damages for emotional distress only to the extent the amounts are expended for medical care attributable to emotional distress. The fact that

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there is an allegation of physical injury is not sufficient; the settlement or award allocated to emotional distress must clearly connect the emotional distress to a physical injury.

Selling or Surrendering Life Insurance Policies When you no longer need a life insurance policy, you may be able to pocket some money by selling it or simply surrendering it to collect the cash surrender value. The following three examples show the extent to which the cash received is taxable and whether the resulting income is ordinary income or capital gain.

Example 1 A person who bought a whole life insurance policy on his life eight years ago, with the proceeds payable to a family member, retained the right to change the beneficiary, take out a policy loan, or surrender the contract for its cash surrender value. He chose to surrender the policy for its $78,000 cash surrender value (after a $10,000 reduction for charges collected by the insurer). His premiums totaled $64,000, so he has to recognize $14,000 of income. The Tax Code does not specify whether income recognized upon the surrender of a life insurance contract is treated as ordinary income or as capital gain. Since this was a surrender and not a sale, the income is ordinary income and not capital gain. In effect, the IRS has restated a 1964 ruling that says that the proceeds received by an insured upon the surrender of a life insurance policy constitute ordinary income to the extent such proceeds exceed the cost of the policy.

Example 2 Same as Example 1 except that the insured sold the contract for $80,000 to an unrelated person. The cost of insurance was $10,000. In this situation, there is $26,000 of income ($80,000 sale proceeds minus $64,000 premiums and $10,000 cost of insurance). Part of the income is ordinary income and part is capital gain. Under the “substitute for ordinary income” doctrine, income that has been earned but not yet recognized by a taxpayer cannot be converted into capital gain by a sale or an exchange (e.g., a lottery winner who sells the right to receive future installments of lottery winnings still has ordinary income, not capital gain). For the sale of a life insurance policy, the portion of the

EXCLUSION FOR BENEFITS PAID FROM LONG-TERM CARE POLICIES

gain that would have been ordinary income if the policy had been surrendered (i.e., the inside buildup under the contract) is ordinary income. However, any income over that amount can qualify for capital gains treatment. In this example, $14,000 of the $26,000 gain is ordinary income representing the inside buildup under the contract. The remaining $12,000 of income is long-term capital gain.

Example 3 Same as Example 1 except the policy is not a whole life policy but rather a 15-year level-premium term policy with no cash surrender value. Total premiums paid were $45,000 when the policy was sold to an unrelated party for $20,000. In this case, the adjusted basis of the term life contract for purposes of determining gain or loss is the total premiums paid minus charges for the provision of insurance before the sale. The cost of insurance in this case amounted to $44,750, so the insured’s adjusted basis is $250 ($45,000 total premiums minus the $44,750 cost of life insurance protection). Because the policy has no cash surrender value, the $19,750 of income ($20,000 sale proceeds minus $250 basis) is all long-term capital gain. PLANNING

If the insured is terminally ill, funds can be withdrawn tax free from the policy under an accelerated death benefit clause, as explained shortly.

Exclusion for Benefits Paid from Long-Term Care Policies The costs of long-term care for a chronic illness or simply for the frailties of old age are not covered by Medicare or other standard health insurance policies. Some people carry a long-term care policy to pay for in-home assistance or nursing home care. If you have a long-term care insurance policy and require long-term care, some or all of the benefits paid under the policy are tax free. Payments made from a long-term care policy to cover long-term care costs are fully tax free. If, under the terms of the policy, you receive a daily dollar benefit without regard to your long-term care costs, you can exclude up to $280 a day in 2009 (up from $270 a day in 2008). The 2010 daily limit is in Appendix B.

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Exclusion for Accelerated Death Benefits Life insurance is designed to pay benefits to a named beneficiary when the insured dies; all of the proceeds of a life insurance policy paid at death are tax free. However, some life insurance policies may allow payments to be made to the insured during his or her lifetime because of health conditions. If you have a life insurance policy that permits benefits to be paid for long-term care, the benefits used for this purpose may be partially or fully tax free. Accelerated death benefits made from a life insurance policy to an insured who is terminally ill are tax free under an accelerated death benefit clause. A person is terminally ill if he or she has a noncorrectable illness or condition that is expected to result in death within 24 months of a physician’s statement of this fact. Accelerated death benefits made from a life insurance policy to an insured who is chronically ill are excludable up to $280 a day (up from $270 a day in 2008). (The 2010 per day limit is in Appendix B). A chronically ill person is someone who has been certified by a licensed health-care practitioner within the preceding 12 months as being unable to perform for a period of at least 90 days at least two of the following activities without assistance: eating, toileting, dressing, bathing, continence, or transferring (getting in and out of bed).

Reimbursements to Parents of Disabled Children Under the Individuals with Disabilities Education Improvement Act of 2004, a board of education may be required to pay for nonpublic education services obtained by parents for their disabled children if: (1) the services offered by the board are inadequate or inappropriate, (2) the services obtained by the parents are appropriate, and (3) there are equitable considerations to support the parents’ claim. The IRS has said that these payments are not taxable to the parents or the children and can be excluded from gross income. There is no dollar limit on the amount that can be excluded from gross income.

Gambling Winnings and Losses For casual gamblers (nonprofessionals), wagering gains are taxable while wagering losses are deductible only as a miscellaneous itemized deduction and

TAX STRATEGIES FOR INCOME

only to the extent of reported gains. The itemized deduction is not subject to the 2-percent-of-AGI floor applicable to most other miscellaneous itemized deductions. According to the IRS, for those who play slot machines, gains result only when a gambler can establish winning above the amounts played. If the gambler uses tokens, then the winnings are the tokens redeemed minus the initial tokens played. In effect, gain is determined at the end of slot machine play. Day-by-day results are netted to determine gain (or loss) for the year.

Example A casual gambler starts out with $100 in tokens and at the end of the day redeems tokens for $300. The gambler has a $200 gain ($300 winnings minus $100 original tokens played). This is so even though the gambler may have had winnings on a spin of $1,000, $800, or other amount that he subsequently lost during the day. If the gambler loses the $100 he started out with and walks away, he has a $100 loss for the day, even if he also had winnings on a spin or $1,000, $800, or other amount during the day.

PLANNING

Keep good records of gambling activities throughout the year to support your claims of losses and prove the limit of reportable gains.

TAX STRATEGIES FOR INCOME Many of the tax rules for reporting income and relying on exclusions have not changed. For example, the tax rate for net capital gains and qualified dividends remains highly favorable and unchanged from 2008. Taxpayers who are in a tax bracket of 25 percent or higher pay just 15 percent on net capital gains and qualified dividends (information about determining your tax bracket can be found in Chapter 4). Taxpayers in the 10 percent or 15 percent tax bracket pay no tax on this income in 2009. The same rule is set to apply in 2010, but Congress could change it; there has been talk about raising the tax rate on this type of income. Here are some strategies to consider now in light of current rules and uncertainty about the future.

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Year-End Strategies for Capital Gains and Losses Markets go up; markets go down. To some extent, however, you have the ability to control your gains and losses and, consequently, the taxes you pay each year. As the year comes to a close, review your holdings in your taxable—non-IRA/non401(k)—accounts. Look at the gains and losses you’ve already taken for the year as well as your paper gains and losses (the potential results if you sell now). The following are some basic strategies to minimize your tax results. Of course, be sure to adapt them to your personal financial situation and consult with your financial adviser. Above all, do not let tax results override investment objectives.

Take Capital Gains This year may be the final opportunity to enjoy historically low capital gains rates of 15 percent (or zero for those in the 10 percent or 15 percent tax bracket). These capital gains rates are scheduled to expire at the end of 2010, allowing the single rate of 20 percent to apply; Congress could raise the rate even sooner. For 2009, the 15 percent tax bracket covers taxable income (income after deductions and exemptions) up to $33,950 for singles and $67,900 for joint filers. After the sale of securities, shares can be repurchased to maintain the same investment position, although you’ll have to pay commissions for selling and buying.

Take Capital Losses Capital losses can be used to offset all of your capital gains. If losses exceed your gains, the excess can be used to offset up to $3,000 of ordinary income ($1,500 for married persons filing separately). (There have been proposals to increase the $3,000 limit, the dollar limit in effect since 1978, but nothing has been enacted thus far.) If you still have excess losses after offsetting ordinary income, the excess can be carried forward and used in future years; there is no time limit on the carryforward. Beware, however, of the wash sale rule that bars you from recognizing losses on the sale of securities if you acquire substantially identical securities within

INSTALLMENT SALES

30 days before or after the date of sale. The loss disallowance rule applies even though the 61-day period starts this year but ends next year. Remember that losses in your IRA or 401(k) plan cannot be used to offset gains from your other investments. Losses in these accounts can only be recognized for tax purposes in very limited circumstances. Also, the wash sale rule applies if you take the loss in a taxable account and then cause your IRA or 401(k) plan to acquire substantially identical securities within the wash sale period.

Determine Worthless Securities If you’re holding securities that have become completely worthless, you can write them off this year as if they had been sold on the last day of the year. There must be no hope of recovery; the fact that the company has filed for bankruptcy is not enough to show worthlessness. There are two ways around the rule that requires you to show there is no hope of recovery. You can abandon the securities, which means giving up any rights without receiving any compensation. Alternatively, you can sell them for a nominal amount. Some brokerage firms make accommodation sales for pennies to help their customers write off nearly worthless securities.

Installment Sales If you sell property and receive at least one payment after the year of the sale, you are treated has having transacted an installment sale. Gain on the sale generally is reported over the term of the sale. However, you can opt to report all of the gain in the year of the sale, even though you have not yet received all of the proceeds from the sale. There is no special election form to file; just report all of the gain on the return for the year of the sale. This may be a good year to opt out of installment reporting if you have an installment sale. This will ensure that the gain is taxed at current low capital gains rates. If, instead, you report your gain over a number of years, some of that gain may be taxed at rates higher than the rates in effect today. While no one has a crystal ball to predict tax rates in the future, it’s likely that capital gains rates will rise (see the earlier discussion, “Take Capital Gains”). If you don’t opt out in the year of the sale and later wish you had, usually the IRS won’t let you change your mind.

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Section 1244 Stock If you’ve invested in a privately held corporation that has gone under this year, you may be able to write off your loss as an ordinary loss under Section 1244 in the Internal Revenue Code rather than as a capital loss subject to limitations discussed earlier in this chapter. Under a special rule for losses in stock in a corporation (whether it is a C or an S corporation), you can deduct up to $50,000 of the losses as an ordinary loss ($100,000 on a joint return). Section 1244 losses in excess of these dollar limits are treated as capital losses. Losses on Section 1244 stock do not require any special forms or other schedules; just make sure that the stock meets the definition of Section 1244 stock. Generally, this means the corporation’s equity cannot exceed $1 million, you acquired your stock by purchase (not as a gift or inheritance), and the corporation is an operating corporation (not a holding company).

CHAPTER 2

Changes in Figuring Your Adjusted Gross Income here are a number of deductions and other subtractions that are taken from gross income to arrive at adjusted gross income (commonly referred to as AGI). Some of these are direct offsets to gross income, such as the $3,000 deduction for capital losses in excess of capital gains and net operating losses. Others are referred to as “above-the-line” deductions and are reported in the “Adjusted Gross Income” section on page 1 of Form 1040. These deductions are claimed whether or not other personal deductions are itemized. In reviewing the changes to adjusted gross income that you will find throughout this chapter, be sure to take note of two key points: effective dates and income limits. Many of the new rules run for only a limited time; you need to take or to have taken action within this window of opportunity in order to claim the tax break. You also can benefit from the break only if your modified adjusted gross income (MAGI) is below a set amount; there may be a partial benefit if your MAGI is within a phaseout range. MAGI generally means your adjusted gross income without regard to the foreign earned income exclusion; so if you don’t work abroad, just think about your AGI. In some cases, however, MAGI is adjusted gross income without regard to several otherwise allowable tax breaks. These particular rules are discussed in relation to each tax break.

T

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CHANGES IN FIGURING YOUR ADJUSTED GROSS INCOME

This chapter explains the changes to adjusted gross income for 2009 and what you can expect for 2010 so you can plan ahead. It also contains planning strategies for AGI and MAGI that can help you qualify for a great number of tax breaks that are dependent on these income figures.

Individual Retirement Accounts Individual retirement accounts (IRAs) were created in 1974 to enable workers who were not covered by company retirement plans to save for their retirement on a tax-advantaged basis. In the past 35 years, IRAs have grown to be vehicles for substantial retirement savings. You can reduce the income that is taxed while saving for your retirement by adding money to an IRA. There are three basic types of IRAs: traditional (deductible) IRAs, nondeductible IRAs, and Roth IRAs. While the contribution limits for all deductible IRAs in 2009 remain unchanged from 2008, several other rules are different.

Contribution Limit The maximum contribution to an IRA in 2009 is $5,000. Those who will be at least 50 years old by the end of the year can add another $1,000, for a total contribution limit of $6,000. If a married person has a nonworking spouse and both spouses are at least 50 years old, the working spouse can add $6,000 to each spouse’s IRA, for a total of $12,000 in savings in 2009. The amount of the IRA contribution cannot exceed the amount of the person’s earned income, so a part-timer earning $3,000 in 2009 cannot contribute more than $3,000.

IRA Contributions for Workers of Bankrupt Employers If you participated in your company’s 401(k) plan for at least six months before the company filed for bankruptcy and was indicted or convicted based on transactions related to the bankruptcy filing, you may be eligible to add an additional $3,000 to your IRA in 2009. The employer must have matched 50 percent of your contributions with employer stock. If you rely on this special catch-up break, you can’t also add an extra $1,000 for being at least 50 years old. This break applies only through 2009 unless Congress extends it.

INDIVIDUAL RETIREMENT ACCOUNTS

Damages for Mismanaged IRAs If you recover damages from an investment adviser for mismanaging your IRA account, you can redeposit the funds into your IRA. The redeposited funds are not treated as additional contributions and are not subject to contribution limits discussed later. The redeposits are simply viewed as “restorative payments” that make you whole.

Other Basic IRA Rules The basic rules for IRA contributions remain unchanged for 2009. To fund any type of IRA, you need earned income from a job or self-employment, taxable alimony, combat pay for which an election has been made to treat the pay as taxable, or wage differential payments (certain payments made by employers to employees activated for military service for more than 30 days). For married couples, if one spouse has earnings, he or she can make a contribution to an IRA or Roth IRA for the nonworking spouse. To add money to a traditional or nondeductible IRA, you must be under age 701/2 . There is no age limit for adding money to a Roth IRA. There is no minimum age, so, for example, teenagers who work can add money to an IRA or a Roth IRA. You can set up an IRA with most financial institutions, including banks, brokerage firms, insurance companies, and mutual funds. Contributions must be made in cash (e.g., you can’t use shares of stock to make contributions). IRA contributions can be invested in a wide array of financial products, including certificates of deposit (CDs), stocks, bonds, mutual fund shares, annuities designed specifically for IRAs, and even real estate (with restrictions); you cannot invest in collectibles other than gold, silver, platinum and palladium bullion, state-issued coins, and certain U.S. minted gold, silver and platinum coins. Contributions for IRAs can be made up to the due date of the return for the year. For example, a 2009 IRA contribution can be made anytime starting January 1, 2009, and ending April 15, 2010. Even if you obtain a filing extension for your 2009 return, you don’t have additional time to make an IRA contribution.

Eligibility to Make Deductible IRA Contributions If you participate in a qualified retirement plan, such as a company profitsharing plan or pension plan, you can make deductible IRA contributions only

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TABLE 2.1

MAGI Phaseout Ranges for IRAs

Filing Status

2009

2008

Single Married filing jointly Married filing separately

$55,000 to $65,000 $89,000 to $109,000 $0 to $10,000

$53,000 to $63,000 $85,000 to $105,000 $0 to $10,000

if your modified adjusted gross income (MAGI) is below set limits. MAGI over a set limit causes the contribution limit to be phased out; it is fully phased out when MAGI exceeds another limit. The phaseout limits have increased for 2009 and can be adjusted for inflation in 2010 and later years. The phaseout range is listed in Table 2.1. If one spouse is an active participant and the other spouse is not, the spouse who is not covered by a qualified retirement plan can make IRA contributions. There is a higher phaseout range in this case. The phaseout range based on the couple’s combined MAGI in 2009 is $166,000 to $176,000; in 2008 it was $159,000 to $169,000. No contributions can be made to nor deductions claimed for inherited IRAs. However, a surviving spouse who inherits a deceased spouse’s IRA and rolls it over to his or her own IRA can treat the IRA as his or her own and add to it in the future if otherwise eligible to do so. A worksheet for figuring for 2009 reduced IRA deduction is in Appendix C.

Eligibility to Make Roth IRA Contributions You can make a nondeductible Roth IRA contribution regardless of whether you are also covered by a qualified retirement plan. However, the ability to contribute to an IRA depends on your modified adjusted gross income (MAGI). If your MAGI is too high, you cannot fund a Roth IRA. The phaseout range for 2009, as compared with 2008, can be found in Table 2.2. The phaseout range for 2010 can be found in Appendix B. TABLE 2.2

MAGI Phaseout Ranges for Roth IRAs

Filing Status

2009

2008

Single Married filing jointly Married filing separately

$105,000 to $120,000 $166,000 to $176,000 $0 to $10,000

$101,000 to $116,000 $159,000 to $169,000 $0 to $10,000

INDIVIDUAL RETIREMENT ACCOUNTS

You cannot make contributions to an inherited Roth IRA if you are a nonspouse beneficiary; a spouse who treats the inherited Roth IRA as his or her own account can make regular or conversion contributions to it.

PLANNING FOR IRAs Traditional IRA versus Roth IRA Suppose you are eligible to contribute to either type of account. Which one makes more sense for you? Remember, the dollar limit on contributions for the year applies to the aggregate of contributions to a traditional and Roth IRA, so if you are under age 50 and add $5,000 to a traditional IRA in 2009, you’re barred from adding anything to a Roth IRA in 2009. Generally, younger people with many years before retirement who are eligible to make either a deductible IRA contribution or a Roth IRA contribution should probably opt for the Roth IRA. The loss of the current income tax deduction probably is not as significant as the opportunity to build up tax-free income for retirement.

Nondeductible IRAs If you are an active participant who is barred from making traditional IRA contributions because of your MAGI for 2009, you can still make a nondeductible contribution (assuming you have earned income and are under age 701/2 ). Such a contribution may make sense if you plan to convert an IRA to a Roth IRA after 2009 when the AGI limit no longer applies. Understand, however, that nondeductible IRA contributions complicate record keeping. This is because distributions from an IRA that includes nondeductible contributions are only partially taxable; a portion of the distribution related to the nondeductible contributions is tax free. You may need to work with a tax adviser to figure out how much of the Roth IRA conversion is taxable when you make the conversion.

Working Couples If, as a couple, you have only limited funds to contribute to retirement savings, it’s important to coordinate where the family funds should be directed so that

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they’ll do the most good. Take into account several factors if you have to make this important decision: • Eligibility for plan participation. If both couples are eligible to participate in their companies’ plans, then decide which plan offers the greater benefit (factoring in employer matching contributions and investment options discussed later). If only one spouse is eligible to participate in a plan, then decide whether funds should be directed to that plan or to IRAs. • Employer matching contributions. Obviously contributions should be made where they’ll earn the greater employer matching contributions. For example, if one spouse’s plan has 3 percent matching and the other plan has 6 percent matching up to a set limit, the latter plan is probably a better option. • Investment options. A 401(k) plan is required to provide a menu of investment options so you can structure the type of retirement savings portfolio that is best suited to your investment temperament, number of years remaining until retirement, and other factors. Compare the options under each plan. If you opt for an IRA, you can have virtually an unlimited number of investment options by setting up a self-directed IRA.

Tax Savings Consider using so-called found money, such as a tax refund or the payroll savings from the Making Work Pay credit, to fund your retirement accounts. You can even fund your IRA using a tax refund before you actually receive the refund from the government. Here’s how: File your return early enough to allow time for the IRS to process it and transfer the funds to the IRA according to your instructions before the April 15 deadline. Include your IRA account information (account number and routing number) on your tax return. This way, the IRS will automatically transfer your refund directly into your IRA. However, it’s up to you to alert your IRA account manager that the funds coming into the account from the IRS are to be applied toward a prior-year contribution.

HEALTH SAVINGS ACCOUNTS

Example You are owed a $3,000 tax refund for 2009 after factoring in a contribution of $3,000 to a traditional IRA (assume you are eligible to make a deductible contribution). You file your 2009 income tax return electronically with the IRS at the beginning of March 2010, reporting the IRA contribution as if it had already been made. You include your IRA account information and have the entire $3,000 refund sent to your IRA. You inform the IRA custodian that the funds transferred into your account represent a prior-year contribution (for the 2009 tax year).

Health Savings Accounts Health savings accounts (HSAs) started in 2004, and today there are over 8 million people covered by them. HSAs are a way for many Americans to obtain affordable health care. They combine a high-deductible (low-cost) health plan (called an HDHP) with an IRA-like savings account. HSAs provide a triple tax benefit: 1. Contributions (up to set limits) are tax deductible. 2. Earnings on contributions grow on a tax-deferred basis (there are no annual taxes on the account). 3. Withdrawals to pay medical costs not covered by insurance are tax free. To be eligible to make contributions, you must be covered by an HDHP. This means an insurance plan that has a minimum insurance deductible and a cap on out-of-pocket costs. The HDHP limits for 2009 can be found in Table 2.3, and the HDHP limits for 2010 can be found in Table 2.4. TABLE 2.3

HDHP Limits for 2009

2009

Self-Only

Family

High-deductible health plan deductible at least Policy out-of-pocket expense limit Deductible contribution limit Additional contribution for being age 55 or older

$1,150 5,800 3,000 1,000

$ 2,300 11,600 5,950 1,000 per spouse

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TABLE 2.4

HDHP Limits for 2010

2010

Self-Only

Family

High-deductible health plan deductible at least Policy out-of-pocket expense limit Deductible contribution limit Additional contribution for being age 55 or older

$1,200 5,950 3,050 1,000

$ 2,400 11,900 6,150 1,000 per spouse

Once you are covered by an HDHP, through either a policy at work or one that you purchase on your own, then you can make tax-deductible contributions to the HSA. You do not have to contribute the full amount up to the deduction limit; you can add whatever you can afford. If your employer contributes to your HSA, you cannot deduct this contribution; you are not taxed on your employer’s contribution to your HSA. Contributions can be made up to the due date of the return. For example, 2009 contributions can be made through April 15, 2010; you do not gain any extra time if you have an extension to file your return. PLANNING

Looking ahead, decide whether an HSA is right for you. In planning, consider the higher contribution limits that apply for 2010 (they may be adjusted annually for inflation after 2010). Contributions can be made by depositing a tax refund into an HSA (as in the case of an IRA explained earlier). Just give the IRS the account number and routing number for the HSA. If you want to use a 2009 tax refund to make a 2009 contribution, you’ll need to file your 2009 income tax return early enough so that the return is processed and the funds transferred to the HSA according to your instructions before the April 15, 2010, deadline. You must keep track of your medical costs for the year. You don’t have to file the bills or receipts with your tax return; retain them in case you are audited and the IRS asks you to prove that distributions from your HSA were taken for medical purposes. HSAs do not have a use-it-or-lose-it feature associated with flexible spending accounts. Any money you don’t withdraw from the HSA by the end of the year continues to grow within the account. You can use HSA funds for any purpose, but you’ll pay income tax on the withdrawal plus a 10 percent early distribution penalty if you’re under age

MOVING EXPENSES

65 (the penalty is waived for distributions on account of disability or death). Because there is no 10 percent penalty once you reach age 65, many have suggested that healthy individuals can use HSAs for retirement income. If the IRS levies on your HSA to cover taxes you owe and you’re under age 65, you’ll owe the 10 percent penalty even though the withdrawal was involuntary. For more information about HSAs, visit www.hsainsider.com, www. healthdecisions.org, www.hsafinder.com, and www.ehealthinsurance.com.

Moving Expenses The U.S. Census Bureau says about 34 million Americans move each year—some locally and others to distant locations. If you relocate because of a change in employment or self-employment, you may qualify to deduct your moving expenses. Most of the tax rules for the moving expense deduction, which can be claimed whether or not you itemize your other personal deductions, have not changed. Still, it is a valuable write-off. There is no dollar limit and the deduction does not depend on your income. To be eligible for this deduction, the distance between your new job or business and your former home must be at least 50 miles more than the distance between your old job or business and your former home. Also, you must work in the locality of the new job as a full-time employee for at least 39 weeks (78 weeks if you are self-employed in your new location). You can’t deduct moving expenses if you are relocating because of retirement or if you are accepting your first job out of school. If you’re eligible to deduct moving expenses and you use your car, van, or pickup truck to move household goods and/or your family, you can deduct your actual costs or a standard mileage rate set by the IRS. For 2009, the standard mileage rate is 24 cents per mile (in 2008 it had been 19 cents per mile for the first half of the year and 27 cents per mile for the second half of the year). Whether you deduct actual expenses or the standard mileage rate, you can add parking and tolls to your deduction. PLANNING

If your new employer pays or reimburses you for the move, you are not taxed on the reimbursement as long as you could have deducted your moving expenses if

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TABLE 2.5

MAGI Phaseout Ranges for Student Interest Deduction

Filing Status

2009

2008


$60,000 to $75,000 $120,000 to $150,000

$55,000 to $70,000 $115,000 to $145,000

you hadn’t received reimbursement. Of course, you cannot also claim a deduction for the expenses that were reimbursed.

Student Loan Interest Deduction Most students pursuing higher education cannot pay the tab without relying to a greater or lesser extent on student loans. At some point, the loans must be repaid. If you are repaying student loans, you may be able to deduct some of the interest. The tax law lets you deduct interest on student loans up to $2,500; this limit has not changed. This deduction is an adjustment to gross income, so you can take it regardless of whether you itemize your other deductions. The deduction can be claimed only if your modified adjusted gross income (MAGI) is below set amounts. Table 2.5 shows the phaseout ranges, based on your filing status, for 2009 compared with 2008. The same phaseout ranges apply in 2010.

Business-Related Adjustments A number of business-related adjustments to gross income, including the deduction for contributions to self-employed retirement plans, are discussed in Chapter 7.

Other Adjustments to Gross Income There are a number of other adjustments that you can claim on a 2009 income tax return; whether they will all be available in 2010 is not yet certain. They include: • Educator expenses up to $250 (set to expire at the end of 2009). • Tuition and fees deduction for higher education (set to expire at the end of 2009). • Certain business expenses of reservists, performing artists, and fee-based government officials.

OTHER ADJUSTMENTS TO GROSS INCOME

• One-half of self-employment tax (this tax is explained in Chapter 6). • Self-employed retirement plan contributions (the deduction for these contributions is explained in Chapter 7). • Self-employed health insurance deduction. • Penalty on early withdrawals from savings accounts. • Alimony payments.

AGI/MAGI PLANNING More than two dozen tax breaks are tied to adjusted gross income or modified adjusted gross income. Thus, the more you can control AGI/MAGI, the greater these tax breaks will be. Some of the breaks (many of which are discussed throughout this book) that are tied to AGI (or modified AGI) include: • A $25,000 rental loss allowance for expenses that exceed income from rental properties. • The portion of Social Security benefits included in income. • An exclusion for interest on U.S. savings bonds used to pay higher education costs and employer-paid adoption costs. • Eligibility to contribute to a deductible IRA by active participants in qualified retirement plans, to contribute to a Roth IRA, and to contribute to a Coverdell education savings account. • Eligibility to convert a traditional IRA or retirement plan account to a Roth IRA in 2009. • Full or partial tax-free treatment for the federal COBRA subsidy for certain terminated workers. • Above-the-line deductions for college tuition and student loan interest. • A reduction in personal exemptions and in itemized deductions for 2009. • Additional standard deduction for state and local sales and excise taxes on vehicle purchases. • Ability to claim certain itemized deductions (medical expenses, mortgage insurance premiums, charitable contributions, casualty and theft losses, and miscellaneous itemized deductions).

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TABLE 2.6

Medicare Part B Premiums for 2009

MAGI of Singles

MAGI of Marrieds

Monthly Premium

Over $85,000 but not over $107,000 Over $107,000 but not over $160,000 Over $160,000 but not over $213,000 Over $213,000

Over $170,000 but not over $214,000 Over $214,000 but not over $320,000 Over $320,000 but not over $426,000 Over $426,000

$134.90 $192.70 $250.50 $308.30

• Ability to claim certain tax credits (child tax credit, earned income credit, dependent care credit, American Opportunity and Lifetime Learning credits, credit for the elderly and disabled, adoption credit, and credit for certain retirement plan contributions).

For those on Medicare, MAGI is the basis for determining whether higher premiums for Part B apply. Generally, your MAGI two years prior to the year of paying the premiums determines what those premiums will be. In effect, your MAGI for 2009 will impact your 2011 Part B premiums, even if you aren’t on Medicare in 2009 or 2010. About 5 percent of current Medicare recipients are subject to the additional premium costs. These additional premiums can be quite steep. As an example, Table 2.6 shows the Medicare Part B premium schedule for 2009 (the tables for 2010 and later are not yet available). For 2010, the basic monthly premium rate will remain at $96.40 for about 75 percent of Medicare beneficiaries because of very low inflation in 2009; the other 25 percent of beneficiaries (new Social Security recipients, high-income individuals subject to the surtax, and low-income individuals whose premiums are paid by their state) face a higher basic premium of $104.20 per month (the estimated amount at the time this book went to press).

Strategies for Controlling AGI/MAGI Generally you aim to keep your AGI/MAGI down so you are eligible to claim various tax write-offs or other benefits. Only in limited situations may you want to increase your AGI/MAGI for certain purposes (such as to claim greater charitable contribution deductions). Here are some ways to achieve your objectives of decreasing (or increasing) AGI/MAGI.

OTHER ADJUSTMENTS TO GROSS INCOME

• Use salary reduction options to decrease AGI/MAGI. To the extent you reduce your income, your AGI/MAGI is lower. You can so do without forgoing earnings by taking advantage of various salary reduction arrangements you may be offered. These include making contributions to 401(k) plans, 403(b) annuities, and SIMPLE plans, contributing to flexible spending arrangements (FSAs) to pay for medical and dependent care expenses on a pretax basis, and paying for monthly commuter transit passes on a pretax basis. The amounts you contribute for these purposes are not treated as current income—they are not included in your W-2 pay—so your AGI is lower even though you obtain a tax benefit from your earnings (retirement savings, selection of benefit options, etc.). • Invest for tax-free or tax-deferred income to decrease AGI/MAGI. To the extent you can avoid reporting income this year you can keep your AGI/MAGI down. Consider investing in tax-free bonds or tax-free bond funds if you are in a tax bracket above 25 percent. Also consider deferraltype investments—U.S. savings bonds and annuities—where income is not reported until a future year. You may even wish to switch from dividendpaying stocks to growth stocks to eliminate current income while attaining appreciation that will be reported as capital gains later on (even though dividends are taxed at the same low rates as capital gains, they are still counted in full in determining AGI/MAGI). • Sell on an installment basis or make a tax-free exchange to decrease AGI/MAGI. An installment sale spreads your gain over the term you set so that your income won’t spike in the year of the sale. Or defer the gain by making a tax-free exchange of investment or business property—gain realized on the initial exchange is postponed until the property acquired on the exchange is later disposed of. • Use year-end strategies to decrease AGI/MAGI. Defer income as explained in Chapter 1 to minimize your AGI/MAGI for the current year. Important: Increasing your itemized deductions, such as deductions for medical expenses or charitable contributions by accelerating discretionary payments won’t cut your AGI/MAGI (itemized deductions are taken into account after you figure your AGI). • Take advantage of above-the-line deductions to decrease AGI/MAGI. Make full use of the $3,000 capital loss write-off against ordinary income—make

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sure that you realize sufficient losses before the end of the year to do so while enabling you to reposition your holdings if this makes investment sense. • Report a child’s income on your return to increase AGI/MAGI. If you have a child subject to the kiddie tax (see Chapter 6) whose income for 2009 is less than $9,500, all of which is from interest, dividends, or capital gains distributions, you can elect to report the child’s income on your return. Generally, this election is not advisable because it increases your AGI/MAGI, thereby limiting your eligibility for many tax items. But in some cases, the election not only saves you the time and money of preparing a child’s separate return, but also enables you to achieve some benefits. Two key situations in which increasing AGI/MAGI is helpful: (1) when you want to boost your investment interest deduction by adding your child’s investment income to your own so you can claim a larger deduction for investment interest, and (2) when you want to increase AGI/MAGI so you can claim a larger charitable contribution deduction.

CHAPTER 3

New Breaks for the Standard Deduction and Itemized Deductions eductions are subtractions from your income. You can only claim deductions created by the tax law for which you meet eligibility requirements. If there’s no rule allowing a deduction, you can’t take it. For example, there are no deductions for most of your personal living expenses, such as rent, food, utilities, insurance, and clothing. Some personal living expenses can become tax deductible if there’s a business reason for them (e.g., the clothing is for work and is not suitable for everyday street use). You have a choice when it comes to writing off many of the personal deductions that are not otherwise subtracted directly from gross income (as explained in Chapter 2): Take a standard deduction (along with additional standard deduction amounts if eligible) or claim your itemized deductions. It’s one or the other. The standard deduction is an amount fixed by law and is adjusted annually for inflation. As the standard deduction increases each year because of inflation, more and more people rely on it rather than troubling themselves to keep track of and add up various itemized deduction amounts. In fact, in 2007 (the most recent year for statistics), 63.8 percent of all returns used the standard deduction. However, those who have sizable personal write-offs may be better served by keeping records of medical costs, charitable contributions, and other itemized

D

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46

NEW BREAKS FOR THE STANDARD DEDUCTION

deductions so they can claim their actual outlays to the extent allowed by the tax law. In fact, the only way to know whether you are better off claiming the standard deduction or itemizing is to track your itemized deductions throughout the year so you can compare them to your standard deduction amount. This chapter explains the basic rules for the standard deduction and itemized deductions, with special emphasis on new rules for 2009 and later years. The chapter also details various strategies that can be used to maximize your deductions within the limits of the law.

Standard Deduction The standard deduction can be claimed by any taxpayer, with two exceptions. The standard deduction cannot be claimed by: • A dependent of another taxpayer. • A spouse who files separately if the other spouse itemizes his or her deductions. This spouse must itemize, too.

The basic standard deduction amounts are increased annually for inflation. In Table 3.1 you’ll find the basic standard deduction amounts for 2009 as well as amounts for the prior year. Basic standard deduction amounts for 2010 are in Appendix B.

Additional Standard Deduction Amounts Nowadays, there’s nothing standard about the standard deduction. There are a number of situations in which you can increase the basic standard deduction you claim on the return. These additional amounts include write-offs for: • Age and/or blindness. • Real property taxes. TABLE 3.1

Basic Standard Deduction Amounts

Filing Status

2009

2008

Married filing jointly Head of household Single Married filing separately

$11,400 8,350 5,700 5,700

$10,900 8,000 5,450 5,450

ADDITIONAL STANDARD DEDUCTION AMOUNTS

• State and local sales and excise taxes on vehicle purchases. • Losses in federal disaster areas.

Because there are now so many additions to the basic standard deduction, the IRS has created a new schedule, Schedule L, that must be used to total up these amounts on 2009 income tax returns. (See Exhibit 3.1.)

Age and/or Blindness If you are age 65 or older and/or legally blind, you can add to the standard deduction the following: • Unmarried: Add $1,400 in 2009 (up from $1,350 in 2008). • Married: Each spouse can add $1,100 (up from $1,050 in 2008).

You are not limited to a single additional amount. If you meet both the age and blindness tests, then you can double the additional amounts. If both spouses are at least 65 years old, again, two additional amounts can be claimed. Example In 2009, you are 72 and your spouse is 68 and file jointly. You can increase your standard deduction of $11,400 by $2,200 ($1,100 + $1,100). Your total standard deduction is $13,600 ($11,400 + $2,200). PLANNING

If you were born on January 1, you are deemed to be age 65 on the previous December 31. For example, if you were born on January 1, 1945, you are treated as being age 65 in 2009 and can use the additional standard deduction amount. The additional standard deduction amounts for 2010 are listed in Appendix B.

Real Estate Taxes Usually, local property taxes on your home, vacation home, or other personally held realty are claimed as itemized deductions. However, in 2009, you can opt to deduct up to $500 if single, or $1,000 if a joint filer, as an additional standard deduction amount. This break does not apply after 2009 unless Congress extends it.

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SCHEDULE L (Form 1040A or 1040) Department of the Treasury Internal Revenue Service (99)

OMB No. 1545-0074

Standard Deduction for Certain Filers 䊳 Attach to Form 1040A or 1040.

2009

䊳 See instructions on back.

Attachment Sequence No.

Name(s) shown on return

57

Your social security number

File this form only if you are increasing your standard deduction by certain state or local real estate taxes, new motor vehicle taxes, or a net disaster loss. 1

2

3

4 5 6 7

8 9 10

11 12

13 14

15 16 17

18 19 20 21

Enter the amount shown below for your filing status. ● Single or married filing separately—$5,700 ● Married filing jointly or Qualifying widow(er)—$11,400 . . . ● Head of household—$8,350 Can you (or your spouse if filing jointly) be claimed as a dependent? No. Skip line 3; enter the amount from line 1 on line 4, and go to line 5. Yes. Go to line 3. Is your earned income (defined on the back) more than $650? Yes. Add $300 to your earned income. Enter the total . . . No. Enter $950 Enter the smaller of line 1 or line 3 . . . . . . . . . . .

1

3 .

4

Multiply the number on Form 1040, line 39a, or Form 1040A, line 23a, by $1,100 ($1,400 if single or head of household). If blank, enter -0- . . . . . . . . . . . . . . . . Form 1040 filers only, enter any net disaster loss from Form 4684, line 18 . . . . . . .

5 6

Enter the state and local real estate taxes that would be deductible on Schedule A, line 6, if you were itemizing your deductions. Do not include foreign real estate taxes (see instructions) . . . . . . . . . . . . . . . . . . Enter $500 ($1,000 if married filing jointly) . . . . . . . . . Enter the smaller of line 7 or line 8 . . . . . . . . . . .

.

.

.

.

.

.

.

.

7 8 .

.

.

.

.

.

.

.

.

9

.

.

20

Did you (or your spouse if filing jointly) pay any state or local sales or excise taxes in 2009 for the purchase of a new motor vehicle after February 16, 2009 (see instructions)? No. Skip lines 10 through 20 and go to line 21.

Yes. If Form 1040, line 38, or Form 1040A, line 22, is less than $135,000 ($260,000 if married filing jointly), enter the amount of these taxes paid. Otherwise, skip lines 10 through 19, enter -0- on line 20, and go to line 21 10 Enter the purchase price (before taxes) of the new motor vehicles 11 (see instructions) . . . . . . . . . . . . . . . . Is the amount on line 11 more than $49,500? No. Enter the amount from line 10.

Yes. Enter the portion of the tax from line 10 that is attributable to the first $49,500 of the purchase price of each new motor vehicle (see instructions) Enter the amount from Form 1040, line 38, or Form 1040A, line 22 Form 1040 filers only, enter the total of any— ● Amounts from Form 2555, lines 45 and 50; Form 2555-EZ, line 18; and Form 4563, line 15, and ● Exclusion of income from Puerto Rico . . . . . . . . . Add lines 13 and 14 . . . . . . . . . . . . . . . Enter $125,000 ($250,000 if married filing jointly) Is the amount on line 15 more than the amount on line 16?

12 13

14 15 16

No. Skip lines 17 through 19, enter the amount from line 12 on line 20, and go to line 21. 17 Yes. Subtract line 16 from line 15 . . . . . . . . . Divide line 17 by $10,000. Enter the result as a decimal (rounded 18 to at least three places). If the result is 1.000 or more, enter 1.000 19 Multiply line 12 by line 18 . . . . . . . . . . . . . . Subtract line 19 from line 12 . . . . . . . . . . . . . . . . . . . . Add lines 4, 5, 6, 9, and 20. Enter the total here and on Form 1040, line 40a, or Form line 24a. Also check the box on Form 1040, line 40b, or Form 1040A, line 24b . .

For Paperwork Reduction Act Notice, see Form 1040A or 1040 instructions.

EXHIBIT 3.1

Schedule L

Cat. No. 49875F

. .

1040A, .

.

.

21

Schedule L (Form 1040A or 1040) 2009

ADDITIONAL STANDARD DEDUCTION AMOUNTS

PLANNING

If your taxes are substantial, it probably makes more sense to itemize your tax deductions. In this case, you could deduct all of the property taxes (not just the $500/$1,000 amount allowed as an additional standard deduction amount).

State and Local Sales and Excise Taxes on Motor Vehicle Purchases If you buy a new motor vehicle after February 16, 2009, and before January 1, 2010, you can deduct state and local sales and excise taxes as an additional standard deduction amount (or as an itemized deduction explained later in this chapter). The deduction amount is limited to taxes and fees paid on up to $49,500 of the purchase price of a new car, light truck, motor home, or motorcycle. The deduction phases out for individuals with modified adjusted gross income (MAGI) between $125,000 and $135,000 for singles and between $250,000 and $260,000 for married persons filing jointly. If you live in Alaska, Delaware, Hawaii, Montana, New Hampshire, or Oregon, states with no sales tax, you can deduct the fees and other taxes imposed by the state or local government. The fees or taxes must be assessed on the purchase of the vehicle and must be based on the sale price or calculated as a per unit fee. If you itemize your deductions, you cannot also claim the additional standard deduction amount. This additional standard deduction amount does not apply to new car purchases after December 31, 2009, unless Congress extends it. PLANNING

The deduction does not apply to taxes related to the purchase of a pre-owned vehicle. If you opt to itemize state and local sales taxes, a deduction that is based on an IRS table according to your state, household size, and income, you can add any sales tax for the purchase of any vehicle—new or used. When itemizing state and local sales taxes, the cost of the vehicle and your MAGI are not limitations on your write-off. If you itemize state and local income taxes, then your deduction for sales tax on the purchase of a vehicle is limited in the same way as if you’d claimed the additional standard deduction (explained earlier); how you figure your itemized deductions is explained later.

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If you’ve taken advantage of the cash for clunkers voucher program established by the Consumer Assistance to Recycle and Save (CARS) Act and received a voucher of $3,500 to $4,500 to trade in a gas guzzler for a more fuel-efficient model, you get a triple benefit: The $3,500 or $4,500 voucher is not taxable, you can deduct the sales and excise taxes on the purchase, and you save money on gasoline. The old vehicle needed a fuel economy rating of no more than 18 miles per gallon and the new car must get at least 4 miles per gallon more for the smaller voucher or 10 miles per gallon more for the larger voucher (or 2 mpg or 5 mpg, respectively, for a light truck). Whether you paid sales taxes on the amount of the cash for clunkers voucher depends on your state’s law. See Chapter 1 for more details on the cash for clunkers program, or go to www.cars.gov.

Losses in Federal Disaster Areas If you suffered a loss in an area declared eligible for federal disaster relief, you can add your casualty loss deduction to your standard deduction rather than claiming it as an itemized deduction. The rules for figuring losses in federal disaster areas are explained later in this chapter.

Itemized Deductions Itemized deductions are simply a listing of personal deductions that the tax law lets you write off. The deductions are reported on Schedule A of Form 1040 (you can’t use Form 1040A or 1040EZ if you want to itemize your deductions). Schedule A is in Appendix C. Table 3.2 shows average itemized deductions for 2007 (the most recent year for statistics) based on adjusted gross income. TABLE 3.2

Average Itemized Deductions for 2007

AGI (Thousands)

Medical

Taxes

Interest

Charitable Donations

$15≤$30 $30≤$50 $50≤100 $100≤200 $200≤250 $250 and over

$ 6,849 6,040 6,690 9,922 22,810 32,813

$ 2,959 3,623 5,822 10,370 17,013 49,370

$ 9,102 9,262 10,558 13,766 18,030 28,110

$ 1,931 2,127 2,612 3,790 5,733 23,817

MEDICAL EXPENSES

TABLE 3.3

AGI Limits for Phaseout of Itemized Deductions

Filing Status

2009

2008

All taxpayers except married filing separately Married filing separately

$166,800 83,400

$159,950 79,975

In 2009, you may not be able to deduct all of the otherwise allowable itemized deductions. If your income is over a set amount, you can lose up to one-third of your itemized deductions. The AGI limits for 2009 as compared with 2008 are found in Table 3.3. Once AGI exceeds this amount, you are subject to some or all of the phaseout. In 2010, the AGI limit on itemized deductions no longer applies.

Medical Expenses Medical costs can be a sizable expense, even if you have health insurance coverage. Medical costs that are not covered by insurance (other than cosmetic surgery done for nonmedical purposes) can be deducted as an itemized deduction to the extent they exceed 7.5 percent of adjusted gross income. Example In 2009, your adjusted gross income is $42,000. Your out-of-pocket medical costs are $5,000. You can treat as an itemized deduction $1,850 [$5,000 – ($42,000 × 7.5%)].

Medical expenses include qualified costs for yourself, your spouse, your dependents, and individuals who would qualify as dependents but for the fact that they have gross income over a set limit ($3,650 for 2009). Example You pay more than half the cost of support for your elderly parent, including $8,000 in medical costs. Your parent has gross income of $10,000 in 2009. You can’t claim your parent as a dependent because of the gross income, but you can add $8,000 to your deductible medical costs in determining your itemized medical deduction.

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Examples of deductible medical expenses include doctors and hospital bills, medical insurance premiums, and prescription drugs and insulin. As noted earlier, you cannot deduct the cost of cosmetic surgery unless it is done for medical purposes (to improve a disfigurement).

Medical Driving If you use your car, van, or pickup truck to visit a doctor, go to a pharmacy, travel to a therapy session, or for any other medical driving, you can deduct your actual costs or a standard mileage rate set by the IRS. For 2009, the standard mileage rate is 24 cents per mile (in 2008 it had been 19 cents per mile for the first half of the year and 27 cents per mile for the second half of the year). Whether you deduct actual expenses or the standard mileage rate, you can add parking and tolls to your deduction. PLANNING

To deduct medical driving using the actual cost method or the standard mileage rate, you must keep a written record of the trips. Make a note of the mileage for each medical trip, along with the date and destination.

Long-Term Care Insurance A portion of the premiums you pay for long-term care insurance is treated as a deductible medical expense. The portion is based on your age at the end of the year. The portions for 2009 have increased over 2008 limits. The deductible portion of long-term care insurance premiums for 2009, as compared with 2008, can be found in Table 3.4. The deductible portion for 2010 is in Appendix B.

TABLE 3.4

Deductible Portion of Long-Term Care Premiums

Age at the End of the Year

2009

2008

40 or less More than 40 but not more than 50 More than 50 but not more than 60 More than 60 but not more than 70 More than 70

$ 320 600 1,190 3,180 3,980

$ 310 580 1,150 3,080 3,850

TAXES

PLANNING

If you are self-employed, you can add the portion of your long-term care insurance premiums to your other medical insurance and deduct the total from gross income; you are not limited to an itemized deduction.

Taxes Personal taxes may be deductible. You can deduct state, local, and foreign income taxes; sales, local, and foreign real property taxes; and state and local personal property taxes. Instead of deducting state and local income taxes, you can opt to deduct state and local sales taxes. The deduction for state and local sales taxes can be your actual tax payments based on sales slips, credit card receipts, and other records, or the amount taken from an IRS table accompanying instructions to Form 1040. The figure in the table depends on your state in which you live, your family income and size of your household. To the figure in the table you can add certain “big ticket” items, such as sales tax on a car, a boat, or building materials to renovate your home.

Sales Tax on Vehicle Purchases If you don’t itemize your deductions, then state and local sales and excise taxes paid on the purchase of a new vehicle within a certain period in 2009 can be deducted as an additional standard deduction amount (explained earlier in this chapter). If you’re itemizing your deductions, you have a choice on how to treat these taxes: • If you deduct state and local income taxes, you can also deduct the sales tax on the vehicle purchase (up to a cost of $49,500) as an additional itemized deduction (assuming your income does not exceed set limits explained earlier in this chapter). Use the worksheet for line 7 (new motor vehicle tax deduction) accompanying Schedule A of Form 1040 to figure the limits on this additional itemized deduction. (See Appendix C). • If you deduct state and local sales taxes, you can add the taxes on the vehicle purchase to the amount in the IRS table. In this case, there is no limit on the purchase price of the vehicle, the vehicle does not have to be

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new, the purchase does not have to be made within the time limit described earlier, and there are no income restrictions. PLANNING

The special deduction for sales taxes on vehicle purchases applies only to those made through December 31, 2009, unless Congress extends this break. Whether there will be an extension depends on how the car industry is doing.

Interest Expenses Most types of personal interest are not deductible. Key exceptions include interest on student loans (deductible as an adjustment to gross income, explained in Chapter 2) and home mortgage interest within certain limits.

Home Mortgage Interest Interest on a loan to acquire, construct, or substantially improve a “qualified residence” (a principal residence and one other designated residence) is deductible on debt up to $1 million. For a home equity loan, interest is deductible on debt up to $100,000. Thus, the maximum amount of debt on a residence that can give rise to deductible interest is $1.1 million. According to the IRS, the dollar limits apply in the aggregate for the residence and not for each homeowner. For example, say two unrelated people jointly own a residence that they purchased with a mortgage exceeding $1 million. The maximum interest deducted by both owners combined cannot exceed the interest on debt up to $1 million.

Charitable Contributions Americans are very generous people. Even in tough economic times, Americans support their schools and charities with donations of cash and property. Donations you make to an IRS-approved charity or government unit are deductible as itemized deductions. Certain limits based on adjusted gross income apply.

CASUALTY AND THEFT LOSSES

Religious School Tuition Payments made to religious day schools cannot be treated as charitable contributions. Parents who sent their children to such schools argued that a portion of the tuition should be allowed as a charitable contribution deduction under the “dual payment test.” This test would allow a deduction if the value of the religious school benefits exceeded the value of the secular benefits. The courts considering the question of a deduction for religious school have concluded that no deduction is allowed. It cannot be shown that there is any value above that for secular school. PLANNING

Donations require substantiations. For cash donations of any amount, you need a bank record or an acknowledgment from the charity showing the amount of the donation. For cash donations of $250 or more, you must have an acknowledgment from the charity; a canceled check won’t do. For property donations, appraisals may be required. You can’t deduct the value of your time doing volunteer work. You can, however, write off your out-of-pocket expenses on behalf of the charity. For example, you can deduct the cost of driving to do charity work at the rate of 14 cents per mile. This rate has not changed from 2008, although there have been proposals in Congress to up the mileage rate; nothing yet has been enacted.

Casualty and Theft Losses If your property is damaged, destroyed, or stolen, it is hoped that you have insurance to cover your loss. A loss of personal property, such as your home and belongings, that is not compensated by insurance or other recoveries can be deductible.

Limits To be deductible for 2009, a casualty or theft loss must exceed $500. In the past, the threshold was $100 per occurrence in the year. As in the past, losses in excess of 10 percent of adjusted gross income are deductible.

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Example Jewelry worth $12,000 is stolen and the loss was not covered by your insurance. Your AGI for 2009 is $80,000. First reduce the $12,000 loss by $500. Then subtract 10 percent of AGI, or $8,000. Your theft loss deduction is $3,500.

Special Rules Apply to Losses in Federal Disaster Areas For 2009 disaster losses, the 10-percent-of-AGI threshold does not apply. However, the loss must still be reduced by $500. Disaster losses in 2008 had only a $100 reduction. The disaster loss can be claimed as an additional standard deduction amount by those who do not itemize their personal deductions, as explained earlier in this chapter.

Victims of Ponzi Schemes The Bernard Madoff Ponzi scheme and other similar financial frauds in 2008 left thousands of investors without their money and with uncertainty about how to handle their losses for tax purposes. More financial schemes are being uncovered. The IRS has created a safe harbor for affected investors under which they can treat losses as a theft loss and claim a deduction. The safe harbor avoids problems of proof of how much income reported in prior years was fictitious or a return of capital. Who qualifies? The safe harbor can be used only by an investor in a taxable account if the lead figure, such as Bernard Madoff, has been charged federally or under state law with fraud, embezzlement, or a similar crime and the investor invested solely with such lead figure (and not through a fund or other entity). The safe harbor does not apply to investments made through tax-deferred accounts, such as IRAs. What to deduct. Under the safe harbor an investor can deduct 95 percent of the “qualified investment” if he or she isn’t pursuing any third-party recovery, or 75 percent if pursuing or intending to pursue a third-party recovery. The qualified investment is the sum of cash and the basis of property invested in the arrangement over the years, plus income (even so-called phantom income) derived from the arrangement that was included for federal tax purposes in the

MISCELLANEOUS ITEMIZED DEDUCTIONS

investor’s income, minus any cash or property withdrawn by the investor from the arrangement. After applying the 95 percent or 75 percent, the deductible amount is then reduced by any actual or potential insurance or Securities Investor Protection Corporation (SIPC) recovery. When to claim the deduction. Eligible investors can claim this safe harbor deduction in the year of discovery, which is usually the year in which the lead figure has been indicted. Attach to the return for the year of discovery a form created by the IRS (see Exhibit 3.2). Also, since the loss is treated as a theft loss, Form 4684 must be used to report the theft loss. Enter the “deductible theft loss” on line 34 of Form 4684 (mark “Revenue Procedure 2009-20” across the top of the form). PLANNING

Since the loss can give rise to a net operating loss, amounts that can’t be used in the current year can be carried back to offset income in prior years. For losses discovered in 2009 and later years, the carryback period is two years (unless Congress makes it longer). For losses discovered in 2008, there had been a five-year carryback for individuals with income under $15 million.

Miscellaneous Itemized Deductions Deductions that fall into this category are deductible only to the extent that the total exceeds 2 percent of adjusted gross income. For example, if your miscellaneous itemized deductions total $2,500 and your adjusted gross income is $65,000, your write-off is limited to $1,200 (2 percent of $65,000 is $1,300; subtract $1,300 from $2,500 to get $1,200). Miscellaneous itemized deductions include unreimbursed employee business expenses (look at Chapter 7 for rules on various deductions that could fall within this category such as business use of a personal car and a home office deduction for an employee), union dues, costs of job hunting, work-related education costs (that are not used in figuring a tax credit or above-the-line deduction for tuition and fees), investment expenses (e.g., rental for a safe-deposit box used to store stock certificates and other investment papers), costs related to tax advice and return preparation, and appraisal fees for charitable contributions and casualty losses. Certain miscellaneous deductions that are not subject to the 2 percent

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Statement by Taxpayer Using the Procedures in Rev. Proc. 2009-20 to Determine a Theft Loss Deduction Related to a Fraudulent Investment Arrangement Part 1. Identification 1. Name of Taxpayer _____________________________________________ 2. Taxpayer Identification Number ___________________________________ Part II. Computation of deduction (See Rev. Proc. 2009-20 for the definitions of the terms used in this worksheet.) Line 1 2 3 4 5 6

Computation of Deductible Theft Loss Pursuant to Rev. Proc. 2009-20 Initial investment Plus: Subsequent investments Plus: Income reported in prior years Less: Withdrawals ( ) Total qualified investment (combine lines 1 through 4) Percentage of qualified investment (95% of line 5 for investors with no potential third-party recovery; 75% of line 5 for investors with potential third-party recovery)

7 8 9 10

Actual recovery Potential insurance/SIPC recovery Total recoveries (add lines 7 and 8) Deductible theft loss (line 6 minus line 9)

(

)

Part III. Required statements and declarations 1. I am claiming a theft loss deduction pursuant to Rev. Proc. 2009-20 from a specified fraudulent arrangement conducted by the following individual or entity (provide the name, address, and taxpayer identification number (if known)). _______________________________________________________________

2. I have written documentation to support the amounts reported in Part II of this document. 3. I am a qualified investor as defined in § 4.03 of Rev. Proc. 2009-20. 4. If I have determined the amount of my theft loss deduction under § 5.02(1)(a) of Rev. Proc. 2009-20, I declare that I have not pursued and do not intend to pursue any potential third-party recovery, as that term is defined in § 4.10 of Rev. Proc. 2009-20.

5. If I have already filed a return or amended return that does not satisfy the conditions in § 6.02 of Rev. Proc 2009-20, I agree to all adjustments or actions that are necessary to comply with those conditions. The tax year or years for which I filed the return(s) or amended return(s) and the date(s) on which they were filed are as follows: ________________________________________________________________ ________________________________________________________________ ________________________________________________________________ ________________________________________________________________ EXHIBIT 3.2

Taxpayer Statement for Revenue Procedure 2009–20


Part IV. Signature I make the following agreements and declarations: 1. I agree to comply with the conditions and agreements set forth in Rev. Proc. 2009-20 and this document. 2. Under penalties of perjury, I declare that the information provided in Parts I-III of this document is, to the best of my knowledge and belief, true, correct and complete.

Your signature here _________________________ Date signed: _______ Your spouse’s signature here _____________________ Date signed: ______ Corporate Name ________________________________ Corporate Officer’s signature ___________________________ Title ___________________________ Date signed ________ Entity Name _____________________________________________________ S-corporation, Partnership, Limited Liability Company, Trust Entity Officer’s signature _____________________________________ Date signed ___________

Signature of executor __________________________________________ Date signed __________________________________________________ EXHIBIT 3.2

(Continued )

floor include gambling losses to the extent of winnings, casualty and theft losses from investment property, losses allowed in Roth IRAs or other retirement accounts funded with after-tax dollars, impairment-related work expenses if you are disabled, federal estate tax attributable to income in respect of a decedent, amortization of bond premium, and a deduction for repayment of amounts held under a claim of right. Unreimbursed employee business expenses may include travel, a home office deduction, and other work-related costs. These business expenses are explained in Chapter 7.

Convenience Fees for Charging Tax Payments If you pay your taxes by credit or debit card, you are charged a convenience fee by the processor (the IRS does not charge any fee for making a payment

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in this manner). The IRS has ruled that this fee, which generally runs about 2.5 percent of the amount of tax charged, is a miscellaneous itemized deduction. PLANNING

There are two IRS-approved credit or debit card processors for tax payments. You can find them in Table 3.5. You can pay your estimated taxes and income taxes through these processors. You can pay your taxes electronically with no processing fee by using the Electronic Federal Tax Payment System (EFTPS) (www.eftps.gov). You authorize transfers from your bank account by telephone or the Internet. You can use EFTPS to pay regular income taxes, estimated taxes, and employment taxes.

Gambling Losses Rules for gambling losses are explained in Chapter 1.

TAX PLANNING FOR DEDUCTIONS Deductions are referred to in the tax law as a matter of “legislative grace.” It’s up to Congress to create them, although sometimes the IRS or courts interpret rules favorably for taxpayers, effectively creating write-offs to which you may be entitled. Here are some strategies that you can use to maximize your deductions this year and in years to come.

Bunching Deductions With the ever-increasing standard deduction amount, a growing number of taxpayers may have deductible expenses hovering around their standard deduction amount, especially when additional standard deduction amounts are factored in. One strategy that you can use to maximize your write-offs is to bunch TABLE 3.5

IRS-Approved Credit Card Processors

Company

Web Site

Toll-Free Number

Link2Gov Corporation Official Payments Corporation

www.pay1040.com www.officialpayments.com

888-PAY-1040 800-2PAY-TAX


deductions, which means making discretionary expenditures (e.g., charitable contributions) in one year so you can itemize for that year, and then claim the standard deduction in the next year. Example You are single and your itemized deductions for 2009 thus far total $5,500. You are not eligible for any additional standard deduction amounts, so your basic standard deduction amount for 2009 is $5,700. If you make a charitable donation before the end of the year of $500, upping your 2009 deductions to $6,000, you’ll be able to itemize deductions because your total will exceed $5,700. If you normally make this same $500 donation each year, consider giving your 2010 amount before the end of 2009 to increase your itemized deductions to $6,500. Next year, when you don’t make that the charitable donation, you can claim the standard deduction. You can repeat the bunching strategy every other year.

Record Keeping Boring as it may sound, the key to claiming all the deductions you’re entitled to is keeping required books and records. You need the records to show the IRS in case your return is questioned. While there is some leeway in certain situations to allow deductions without records, you may lose out by not having the complete documentation as required by law. Here are some suggestions to help you in this task throughout the year. • Use a system. Whether your system is automated (e.g., you use Quicken or similar software to track your expenses) or you keep paper records, set up and follow your system throughout the year. • Retain receipts and other required records. For example, be sure to retain acknowledgments and appraisals for charitable contributions. Keep these receipts organized using an accordion folder or other method.

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CHAPTER 4

New Ways to Trim Your Tax Computation

fter you list your income and deductions for the year, you then have to figure your taxes. If you use computer software or online preparation solutions or a paid preparer, the actual computation is done automatically for you, but it’s helpful to understand how the computation works so you can take advantage of opportunities and strategies to reduce your tax bill. Before there is any tax computation, there’s still one important subtraction from your income for personal and dependency exemptions. To figure your tax liability for the year, reduce your adjusted gross income (AGI) (your gross income minus adjustments to gross income explained in Chapter 2). Then subtract your standard deduction or itemized deductions (explained in Chapter 3). Finally, subtract your personal and dependency exemptions (explained in this chapter). This is your taxable income; it is this figure on which your tax is computed. Most individuals find their tax liability by looking at a tax table if they do their return manually. Some filers, however, such as those with taxable income over $100,000 or capital gains, use a tax rate schedule and worksheets to figure the tax. What you need to know from this chapter is the amount of your exemptions and your tax bracket. This will enable you to do tax planning to minimize your tax bill for this year and in the future.

A

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NEW WAYS TO TRIM YOUR TAX COMPUTATION

Personal and Dependency Exemptions You can take an exemption for yourself (your spouse can claim an exemption, too), plus an exemption for each dependent. For 2009, the exemption amount is $3,650 (up from $3,500 in 2008), the amount remains unchanged in 2010. No exemption can be taken by a taxpayer who is eligible to be claimed as a dependent on another taxpayer’s return. Thus, for example, if your dependent child files a tax return to report his income, this child (who is your dependent) cannot claim any personal exemption; you can claim a dependency exemption for your child even though he files a tax return (as long as you meet the dependency requirements that follow).

New Definition of Qualifying Child If your child lives with you and is under age 19, or is a full-time student under age 24, there is no gross income requirement. In other words, your child can earn any amount without your losing a dependency exemption as long as the child does not provide more than half of his or her support. The Fostering Connections to Success and Increasing Adoptions Act of 2008 restricts the definition of a qualifying child for purposes of the dependency exemption (as well as for head of household status, the child tax credit, the earned income credit, and the dependent care credit). In addition to all of the usual requirements, the child must be younger than the taxpayer claiming the dependency exemption. This rule change could, for example, impact a sibling’s ability to claim the exemption for another sibling. This rule does not apply if the person being claimed as a dependent is permanently and totally disabled. The age of the disabled person does not count in determining whether this person is a dependent. An individual who is married and files a joint return cannot be considered a qualifying child unless the joint return is filed only as a refund claim. When two people are each potentially eligible to claim the child as a qualifying child, a so-called tie-breaker rule applies to determine which person gets the benefit. The tie-breaker rule says that if a parent and a nonparent (e.g., a grandparent) are both eligible to claim the child as a qualifying child but the parent does not claim the child, the nonparent can do so if the

PERSONAL AND DEPENDENCY EXEMPTIONS

TABLE 4.1

Phaseout Ranges for Personal Exemptions

Filing Status

2009 Beginning of Phaseout

End of Phaseout

2008 Beginning of Phaseout

End of Phaseout

Married filing jointly Head of household Single Married filing separately

$250,200 208,500 166,800 125,100

$372,700 331,000 289,300 186,350

$239,950 199,950 159,950 119,975

$362,450 322,450 282,450 181,225

nonparent’s adjusted gross income (AGI) is higher than the AGI of any eligible parent. PLANNING

If you claim your child as a dependent, he cannot be viewed as liberated for purposes of financial aid for college or graduate school. This means that your income and resources and his are taken into account in determining eligibility for the child’s financial aid. However, a child is viewed as emancipated for financial aid purposes when attending graduate school, married, having had previous service in the armed forces, or having dependents of his or her own.

Phaseout for High Earners If your adjusted gross income (AGI) exceeds a threshold amount, you may lose up to one-third of the benefit of claiming personal exemptions in 2009. Due to the increased exemption amount as well as cost-of-living changes to the threshold amount, the top exemption for anyone above the maximum phaseout amount in 2009 is $2,433 (up from $2,333 in 2008). The phaseout in 2009 starts at a higher income level than it did in 2008. Table 4.1 compares the phaseout ranges for 2009 with those for 2008 based on your filing status. Example In 2009, a married couple filing jointly claim their two children as dependents. Their AGI is $150,000. Their deduction for exemptions is $14,600 ($3,650 × 4). There is no phaseout because their AGI is below $250,200.

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Example Same facts as the preceding example except the couple’s AGI is $375,000. Here they deduct only two-thirds of their exemptions, or $9,733, because their AGI exceeds the phaseout limit of $372,700.

PLANNING

Starting in 2010, the partial reduction in personal and dependency exemptions is eliminated. This fact can impact planning for the exemption for a child when parents separate or divorce. Which parent should be entitled to the exemption? Usually, it makes sense for the parents to agree that the parent with the higher income should claim the exemption (and the divorce decree or separation agreement should reflect this designation). In the past several years, because of the phaseout for high-income taxpayers, it may not have made sense to award the exemption to the parent with the higher income; now it does. Even if a prior divorce decree or separation agreement awarded the exemption to one parent, that parent can waive in writing the right to claim the exemption to save taxes overall for the family. When in doubt about rights to the exemption and planning for it, work with a knowledgeable matrimonial attorney who understands tax implications.

Children of Divorced or Separated Parents The dependency exemption belongs automatically to the custodial parent (the parent who has physical custody of the child for the greater part of the year) unless the custodial parent waives in writing the right to claim the exemption. Typically, Form 8332, Release/Revocation of Release to Claim Exemption for Child by Custodial Parent, is used for this purpose; the noncustodial parent must attach the form to his or her return. For 2009 and later years, the custodial parent can revoke a release of the exemption by providing written notification to the noncustodial parent, but it will not be effective until the following year.

INCOME TAX BRACKETS

TABLE 4.2

2009 Tax Rate Schedule for Single Taxpayer

If Taxable Income Is Over

$

But Not Over

0 8,350 33,950 82,250 171,550 372,950

$

8,350 33,950 82,250 171,550 372,950 —

The Tax Is

Of the Amount Over

10% $835 + 15% $4,675 + 25% $16,750 + 28% $41,754 + 33% $108,216 + 35%

$

0 8,350 33,950 82,250 171,550 372,950

Example The custodial parent had signed a release for 2009 but later gives the noncustodial parent a written notice of revocation. The revocation is effective in 2010.

Income Tax Brackets The six income tax brackets—10 percent, 15 percent, 25 percent, 28 percent, 33 percent and 35 percent—have not changed for 2009. However, income for each of the brackets has been increased for inflation. This means you can have more income without being bumped into a higher tax bracket. Most taxpayers may not even realize that the brackets have increased because they take their tax liability from an IRS table for this purpose, as mentioned earlier in this chapter. They look down the column for their filing status until they see the range into which their taxable income falls. However, to give you an idea of the tax rate you’re actually paying on your income, it’s helpful to view the tax rate schedules. Tables 4.2 through 4.5 show the complete tax brackets for all filers in 2009. This bracket information for 2010 is in Appendix B. TABLE 4.3

2009 Tax Rate Schedule for Married Filing Jointly and Qualifying Widow(er)


$

0 16,700 67,900 137,050 208,850 372,950

But Not Over

The Tax Is

Of the Amount Over

$ 16,700 67,900 137,050 208,850 372,950 —

10% $1,670.00 + 15% $9,350.00 + 25% $26,637.50 + 28% $46,741.50 + 33% $100,894.50 + 35%

$

0 16,700 67,900 137,050 208,850 372,950

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TABLE 4.4

2009 Tax Rate Schedule for Head of Household


$

0 11,950 45,500 117,450 190,200 372,950

But Not Over

The Tax Is

Of the Amount Over

$ 11,950 45,500 117,450 190,200 372,950 —

10% $1,195.00 + 15% $6,227.50 + 25% $24,215.00 + 28% $44,585.00 + 33% $104,892.50 + 35%

$

0 11,950 45,500 117,450 190,200 372,950

Your Tax Bracket When someone says, “I’m in the 28 percent tax bracket,” what does this mean? Since we have a graduated income tax scheme, when you are in the 28 percent tax bracket, you pay some tax at 10 percent, some at 15 percent, some at 25 percent, and some at 28 percent. Reference to your tax bracket means the highest rate at which you pay any tax. It is helpful to understand your tax bracket. You can use it for tax planning purposes to estimate what additional income will cost you and what additional write-offs will save you. Example You are in the 28 percent bracket. You could earn an additional $1,000 this year. Doing so will cost you $280 in federal income taxes. In actuality, it could cost you even more if the additional income pushes you over the top of the 28 percent tax bracket and into the 33 percent bracket (and cost you as much as $330 in federal income taxes). Understanding the tax bracket you are in as well as the break points for the tax brackets enables you to plan for your income and deductions to minimize the impact of the tax brackets on what you pay in taxes.

TABLE 4.5

2009 Tax Rate Schedule for Married Filing Separately


$

0 8,350 33,950 68,525 104,425 186,475

But Not Over

$

8,350 33,950 68,525 104,425 186,475 —

The Tax Is

Of the Amount Over

10% $835.00 + 15% $4,675.00 + 25% $13,318.75 + 28% $23,370.75 + 33% $50,447.25 + 35%

$

0 8,350 33,950 68,525 104,425 186,475

INCOME TAX BRACKETS

INCOME AND DEDUCTION PLANNING STRATEGIES The tax brackets will likely be changed again in 2010—through inflation adjustments and perhaps new law for higher-income taxpayers. Recognizing this allows you to do tax planning that can reduce your taxes in both 2009 and 2010. Whether you use these planning strategies depends, of course, on your personal tax picture and on financial considerations.

Income Deferral Shifting income from the current year into a future year (effectively postponing the receipt of income that you would have received this year into next year) saves you money because it postpones the time when you pay the tax on the income. For example, if you receive income in December 2009, you owe the tax on that income by April 15, 2010. But if you defer that income to January 2010, you don’t owe the tax until April 15, 2011. Postponing taxes isn’t the only reason for deferring income. When the tax brackets for the following year are adjusted for inflation, income shifted from this year into next may be taxed at a lower rate. Inflation, in effect, increases the top end of the tax bracket so you can earn more income without being pushed into a higher tax bracket. Of course, whether income deferral results in any tax savings depends on whether you’ll be in a lower tax bracket.

Example You have $1,000 income that you can shift to 2010 instead of realizing it in 2009. (For example, you’re a self-employed person and wait until the end of December to bill $1,000 for services performed so that payment will be received in January 2010.) Assume that if you had received the payment in 2009, it would have exceeded the limit for the 15 percent tax bracket and so would have fallen into the 25 percent bracket. But because you receive the income in 2010 it is still in the 15 percent bracket because of adjustments made to the bracket that allow more income to be received at that rate. So instead of paying $250 tax on the $1,000 income ($1,000 × 25%), you pay only $150 tax on that same income ($1,000 × 15%), a $100 tax savings.

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How do you defer income into a later year? There are several proven strategies you can use to shift income from one year to the next. • Make investments that pay income after December 31 of the current year. Use certificates of deposit (CDs) and Treasury bills purchased that come due after the end of the year. To be tax deferred, the term of the CD or Treasury bill must be under one year and interest cannot be payable prior to maturity. Otherwise, the interest is reported throughout the term of the instrument rather than upon maturity. • If you are self-employed with a full-time or part-time business and you use the cash method of reporting for your income and expenses, you might want to delay year-end billing so that accounts receivable for work performed this year or goods sold this year will be paid next year. Of course this deferral strategy is not a good idea if your customers are financially shaky and you’re concerned about collecting payment; instead bill (and collect) as soon as possible.

What about longer deferral? If, for example, you have the option of deferring a bonus until retirement, should you do this? Usually, long-term deferral has proven to be an effective tax-saving strategy because of the annual adjustment to the tax brackets for cost-of-living changes. However, this strategy may not work for long. The current low rates are not permanent and are scheduled to sunset at the end of 2010, so that starting in 2011, the 10 percent bracket disappears and the rates above the 15 percent rate rise to 28 percent, 31 percent, 36 percent, and 39.6 percent (the rates that were in effect prior to the 2001 Tax Act) or even higher if Congress so decides. Because it is impossible to predict what tax rates may be in 10 years, 20 years, or longer, deferral probably doesn’t make sense for everyone. For younger workers, however, with a very long time before retirement, several reliable strategies can be used to defer income well into the future; the long deferral period in which no taxes are paid may very well offset any tax hike that could apply when taxes are eventually paid on the deferred income years from now. • Make contributions to tax-deferred accounts, such as 401(k) plans, 403(b) annuities, 457 plans, deductible IRAs, and commercial annuities. If you wait to take distributions until you retire and your income is lower at that

INCOME TAX BRACKETS

time, you may find yourself in a lower tax bracket then than you are now (even if tax rates increase). • Arrange for deferred compensation if you have a long time horizon and you are confident of the stability of your employer. You must agree to deferral before you earn the compensation or bonus. Again, having lower income following retirement when deferred compensation is received could mean that the deferred compensation is still taxed at a lower rate than it would be if received currently, even with higher tax rates in the future.

Once you decide you want to defer income, you have to do it correctly to gain the tax results you want. You can’t shift income merely by refusing to accept it this year. Under a tax rule called “constructive receipt,” if you have the right to the income now, it’s taxable to you even if you don’t accept it. For example, if you receive your paycheck at the end of December, it’s taxable to you even though you don’t cash or deposit it until January.

Deduction Acceleration The higher your tax bracket, the more valuable a deduction is to you. So you might want to accelerate deductions that you would otherwise have taken next year into this year if you expect to be in a lower tax bracket next year. Example You itemize deductions and are planning to make a $1,000 charitable contribution next year. Assume that you’re in the 25 percent tax bracket but expect to be in the 15 percent tax bracket next year because you won’t have the same profitable investment sales next year. If you accelerate your $1,000 contribution deduction to this year, you’ll save $250 in taxes; if you wait until next year, the contribution deduction will save you only $150. Acceleration creates an added $100 tax benefit.

Many deductions are dependent on timing that you can’t change; you really can’t change the mortgage payments and the interest deduction they generate (even if you pay additional principal, it won’t alter the interest payments for the

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year). But here are some strategies you can use to accelerate deductions into the current year: • Make discretionary expenditures—elective medical procedures that are not reimbursed by insurance or covered by flexible spending arrangements (FSAs) or health savings accounts (HSAs) but which are deductible (e.g., additional prescription sunglasses) and charitable contributions. Medical or charitable expenses that are charged by a major credit card no later than the end of the year are deductible in 2009 even though the credit card bill isn’t paid until 2010. • Prepay state and local income and real estate taxes, as long as you aren’t subject to the alternative minimum tax (AMT), because these taxes are not deductible for AMT purposes (as explained in Chapter 6). • If you are self-employed with a full-time or sideline business on the cash method of accounting, prepay certain expenses that can be deducted this year. Examples: Buy supplies needed for the coming year, pay off outstanding bills, and pay membership dues for the year. But don’t prepay multiyear items (e.g., three-year subscriptions or multiyear insurance premiums), since they are deductible only over the period to which they relate. Payments charged to a major credit card by the end of 2009 are deductible this year even though the credit card bill isn’t paid until 2010.

Other Strategies As the standard deduction amount rises each year, fewer taxpayers have enough personal deductions to itemize. As you approach the standard deduction amount limits, consider bunching itemized deductions. This means pushing deductions to or from the current year so that you itemize one year and claim the standard deduction the next year (see also Chapter 3). Example You are single and in 2009 your itemized deductions total $5,600. Next year you expect your itemized deductions to be about the same. You’re planning on making a $100 charitable contribution in 2009 and a $100 charitable contribution next year. If you make full $200 contribution in 2009, it will be

INCOME TAX BRACKETS

worthwhile for you to itemize (your deductions of $5,800 are more than the standard deduction amount of $5,700). If you follow the original plan to spread the contribution over two years, your deductions will not exceed the standard deduction in either year and you’ll receive no tax benefit for the charitable contribution.

Income Shifting Income shifting is yet another great strategy for saving taxes for a family. If you are in a high tax bracket, consider giving some income-producing property to your child. Even if the child is subject to the kiddie tax (see Chapter 6), he or she can receive unearned income up to $1,900 in 2009 and still pay tax at a low tax bracket (the first $950 of such income is tax free; the second $950 is taxed at only 10 percent, for a total tax on the $1,900 of $95). It would take $38,000 of investment dollars earning 5 percent (or $47,500 earning 4 percent) to generate $1,900 of investment income for your child.

Future Tax Brackets The current tax bracket percentages are set to expire after 2010. If Congress does nothing, they will revert to a 15 percent bracket, a 25 percent bracket, a 28 percent bracket, a 36 percent bracket, and a 39.6 percent bracket, and the 10 percent tax bracket will disappear. However, it is likely that Congress will retain the current 10 percent bracket while allowing the two upper tax brackets to revert to the former levels. For tax planning purposes, assuming Congress does not change the brackets for 2010, be sure to factor in possible bracket changes for 2011 and later years.

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CHAPTER 5

New Credits to Cut Taxes

ven though you’ve figured the tax liability, this isn’t necessarily the amount of tax you owe. Tax liability can be reduced by tax credits. There are an ever-growing number of tax credits. You can claim all of the credits to which you are entitled. Again, when reviewing the credits listed in this chapter, be sure to pay attention to effective dates and income limits to determine whether you are eligible to claim them. Remember that a tax credit is worth more than a deduction since it reduces your tax liability on a dollar-for-dollar basis. Some credits are worth even more than a tax reduction. They can be “refundable,” which means they can exceed your tax bill; you recoup the excess. In effect, refundable credits create a negative income tax because instead of you paying Uncle Sam, he pays you! Some credits have not changed from last year, including the dependent care credit and the credit for the elderly and permanently disabled. This chapter explains the credits that have changed and what opportunities these changes present to you. At the end of the chapter you’ll find some planning strategies to optimize credit opportunities and a list of credits (both changed and unchanged) for individuals.

E

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NEW CREDITS TO CUT TAXES

Making Work Pay Credit There is a new tax credit for 2009 and 2010 called the Making Work Pay credit. It is the cornerstone of the Obama administration’s recovery package, costing about one-third of the cost for all the tax breaks in the American Recovery and Reinvestment Act of 2009. The credit is 6.2 percent of earned income, up to a maximum of $400 for singles and $800 for joint filers per year.

Eligibility The credit can be claimed only by those with earned income (wages or selfemployment income). Earned income for purposes of this credit includes taxfree combat pay. Those who receive only investment income and/or pensions cannot claim the credit. Certain taxpayers cannot claim the credit, even if they have earned income: • Anyone who can be claimed as another person’s dependent. • Trusts and estates. • Nonresident aliens.

Payment Method The credit may not be new to you; you may have been receiving some or all of it in your paycheck. Starting in April 2009, employers were required to adopt new wage withholding tables reflecting the credit so employees could receive higher take-home pay. In effect, receipt of the credit for workers was automatic and they did not have to file any revised W-4 forms with employers to receive the credit. For self-employed individuals, receipt of the credit is a different matter. Because self-employed individuals do not receive a paycheck (regardless of the fact that they may take withdrawals from their company’s bank account), they cannot enjoy the credit through increased take-home pay. Instead, self-employed individuals have two ways of receiving the credit: 1. Reduce estimated taxes for the year to reflect the credit amount they expect to be entitled to.

MAKING WORK PAY CREDIT

2. Claim the credit on the tax return when it is filed. For example, the Making Work Pay credit for 2009 can be claimed on the 2009 return when it is filed in 2010.

Schedule M There is a new tax schedule to accompany Form 1040 or Form 1040A called Schedule M, Making Work Pay Credit (see Appendix C). The form is used to ensure that you obtain the full amount of the credit you’re entitled to.

Example You were unemployed from the start of 2009 until September of 2009. Your modified adjusted gross income (MAGI) for the year is below the limit. Your paychecks for 2009 did not advance the full amount of the credit to you. Using Schedule M will let you figure the shortfall so you can effectively claim the balance of the credit on your tax return.

MAGI Cap The credit is allowed only if modified adjusted gross income (MAGI) is below a set amount. MAGI for this purpose means adjusted gross income (AGI) without regard to the exclusions for foreign earned income and housing, so anyone who does not work outside the United States can base their income limit on AGI. Once MAGI exceeds an initial threshold, the credit is phased out at a rate of 2 percent. Table 5.1 shows the phaseout ranges for the Making Work Pay credit.

Example In 2009, you are a head of household with modified adjusted gross income of $60,000 (as a head of household, you are subject to the MAGI limits for singles). Because your MAGI is below the phaseout range, you are entitled to the full $400 credit. If your MAGI were $85,000, your credit would be limited to $200. Once your MAGI exceeds $95,000, no credit is allowed.

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MAGI Phaseout Ranges for the Making Work Pay Credit

TABLE 5.1

Filing Status

Phaseout Range


$75,000 to $95,000 $150,000 to $190,000

Figuring the Credit The Making Work Pay credit is figured on Schedule M (new for 2009) if you file Form 1040 or 1040A (see Appendix C); a special worksheet for figuring the credit is used by Form 1040EZ filers. Even though the credit has effectively been paid via an increase in take-home pay, the amounts received in this manner may be more or less than the credit amount you’re entitled to. Income limitations explained earlier may mean you aren’t entitled to the credit even though your employer paid it out to you through a hike in your take-home pay. The bottom line is that everyone potentially eligible for the credit needs to complete Schedule M (or the worksheet for Form 1040EZ) and then enter the allowable credit amount on the return. The Making Work Pay credit is reduced by the one-time payment for certain nonworkers (the payment is called an “economic recovery payment”) as well as the payment for certain government retirees (both of these payments are explained next).

One-Time Payment for Certain Nonworkers While the Making Work Pay credit is for workers, the government still wanted to encourage nonworkers to put money into the economy. Toward this end, there has been a $250 “recovery payment” to certain individuals: • Social Security benefit recipients • Railroad Retirement benefit recipients • Disabled veterans • SSI recipients

However, no payment was made to any recipient of these benefits who was incarcerated, a fugitive, or a probation or parole violator; who has committed a fraud; or who is no longer lawfully present in the United States.

FIRST-TIME HOMEBUYER CREDIT

For individuals eligible to receipt the payment, it was sent in May 2009. If a recipient has a representative payee for government benefits, then the payment was made to the representative payee. There is no additional payment for 2010. This one-time payment does not impact the recipient of any government benefits. It is not treated as a resource or income for purposes of federal, state, or local programs financed in whole or in part with federal funds.

Payment to Certain Government Retirees Individuals who receive a government pension or annuity from work that was not covered by Social Security or Railroad Retirement can claim a one-time $250 payment ($500 if both spouses were eligible) on Schedule M.

First-Time Homebuyer Credit To help get the American housing market out of the doldrums, Congress in 2008 introduced a new tax credit called the First-Time Homebuyer credit. In 2009, however, Congress revisited the credit and made it a whole lot better. The credit is 10 percent of the purchase price, with a dollar limit on the credit of $8,000. Thus, for homes costing $80,000 or more, the maximum credit is $8,000. For married persons filing separately, the credit limit is $4,000. The revised credit applies to homes purchased on or after January 1, 2009, and before December 1, 2009 (an 11-month window of opportunity). The credit applies only to the purchase of a principal residence and not a vacation home, rental property, or business property. Congress is considering an extension of the credit beyond November 30, 2009, and might even eliminate the principal residence requirement.

Eligibility To qualify for the credit, you must have modified adjusted gross income below a set amount and be a “first-time homebuyer.” The requirement of being a “first-time” homebuyer doesn’t mean you have never owned a home before. To be treated as a first-time homebuyer, you (and your spouse if you’re married) can’t have owned a home within three years of purchase. The credit can be claimed only by those with modified adjusted gross income (MAGI) below set limits. Table 5.2 shows the MAGI phaseout range; those with

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MAGI Phaseout Ranges for the First-Time Homebuyer Credit

TABLE 5.2

Filing Status

Phaseout Range


$75,000 to $95,000 $150,000 to $170,000

MAGI below the range can claim the full credit. Those with MAGI above the range cannot claim any credit. Example A married couple filing jointly has MAGI in 2009 of $160,000. They buy their first home in August 2009. They can claim a reduced credit of $4,000 (half the otherwise allowable credit) because they are midway through the phaseout range. If their MAGI were under $150,000, they could claim the full credit; if it were over $170,000, they could not claim any credit.

The credit applies without regard to the amount of financing on the home. For example, there is no minimum (or maximum) down payment required for the purchase of a home with respect to the First-Time Homebuyer credit. The credit can be claimed by an eligible homebuyer even if there is a co-signer who guarantees the mortgage.

Claiming the Credit The credit is refundable, which means you can receive the credit even though it is more than your tax liability for the year (see Form 5405 in Appendix C). Special rules apply when two or more unrelated buyers purchase a home. A single credit applies per residence, so if two or more unrelated buyers acquire a principal residence together, the credit must be allocated among those who qualify (i.e., meet the “first-time” homebuyer requirement and MAGI limits) using any “reasonable method.” The IRS says a reasonable method can be based on: • Contributions toward the purchase price of the home as tenants in common or joint tenants. • Ownership interest in the home as tenants in common.

FIRST-TIME HOMEBUYER CREDIT

Example Assume two people who aren’t married to each other and who are both first-time homebuyers with MAGI below the phaseout level buy a home together in October 2009. One contributes $45,000 and the other $15,000 toward the purchase price of $60,000. Each owns one-half of the residence as tenants in common. The top credit is $6,000 (10 percent of $60,000), which can be allocated three-fourths to the $45,000 contributor ($4,500) and one-fourth to the $15,000 contributor ($1,500), or one-half ($3,000) to each based on their ownership interests in the residence.

Example Same facts as the preceding example except that each owner’s contribution was merely part of a $60,000 down payment on a home costing $600,000. The maximum credit in this case is $8,000 (10 percent of $600,000, but no more than $8,000). The credit of $8,000 can be allocated three-fourths to the $45,000 contributor ($6,000) and one-fourth to the $15,000 contributor ($2,000), or one-half ($4,000) to each based on their ownership interests in the residence.

If any of the unrelated purchasers do not meet eligibility requirements (e.g., their MAGIs are too high), the entire credit can be allowed to the one or more purchasers who do meet the requirements. Example Same facts as the preceding example except that the person contributing $45,000 has MAGI of $100,000. Since this contributor is not eligible for the credit, the entire $8,000 can be claimed by the $15,000 contributor.

Anyone who purchases a residence in the first 11 months of 2009 and qualifies for the credit can opt to claim the First-Time Homebuyer credit on a 2008 return. Amending a 2008 return to take advantage of this option means receiving the tax benefits of the credit that much sooner. The 2009 credit amount and other 2009 rules apply even though the credit is claimed on a 2008 return and different rules applied to homes purchased in 2008.

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Recapture Generally, the credit does not have to be repaid to the federal government, as was the case for the 2008 version of the credit. If a home purchased during the qualifying period in 2009 for which a credit has been claimed is sold within 36 months or ceases to be used as a principal residence during that period, then the full amount of the credit must be repaid for the year that the home ceases to be a principal residence (except in the case of death). PLANNING

The IRS says that no credit can be claimed prior to purchasing the home, so a tax refund based on the credit cannot be used for a down payment. However, the Federal Housing Administration offers short-term bridge financing equal to the credit; this debt will be paid off in full when the tax credit is received (usually by filing an amended 2008 return). A purchase occurs when title closes on the residence. An execution of a contract for sale does not amount to a purchase, and you cannot claim the credit until title passes to you. If you build a home, occupancy is treated the same as closing on the home for purposes of the credit; you must move in before December 1, 2009, to be eligible for the credit. Homebuyers who live in the District of Columbia have another credit option: DC homebuyer credit. This credit, which is limited to $5,000 ($2,500 for married filing separately) applies if you buy a principal residence in the District of Columbia and you (and your spouse if married) have not owned a home within one year of the purchase. You cannot claim the credit if your MAGI is $90,000 or more ($130,000 or more if married filing jointly); a partial credit is allowed if MAGI is between $70,000 and $90,000 ($110,000 and $130,000 if married filing jointly). No credit is allowed if you previously claimed this credit for a different home. The DC homebuyer credit cannot be claimed if a homebuyer is eligible for the regular first-time homebuyer credit for a home purchased after 2008 and before December 1, 2009.

Earned Income Credit Low-income earners may be eligible for a credit that encourages them to work. The credit is refundable—it can be paid to the taxpayer even if it exceeds the amount of tax for the year. In effect, it is a negative income tax designed to

EARNED INCOME CREDIT

TABLE 5.3

Maximum Earned Income Credits

Number of Qualifying Children

Top Credit 2009

Top Credit 2008

None One Two Three or more

$ 457 3,043 5,028 5,657

$ 438 2,917 4,824 4,824

put money back into the pockets of low earners. However, this credit is highly complicated and produces more errors on tax returns that just about any other provision in the tax law. For example, some taxpayers assume they must support a child in order to claim the credit, but in reality the credit is available to low earners regardless of whether they have a qualifying child. For 2009, there are a number of changes to the earned income credit; some are because of adjustments for inflation while others are due to law changes.

Maximum Credit The amount of the credit you can claim depends on the number of qualifying children you have, if any, and your income. For 2009, a higher credit can be claimed for having three or more qualifying children; in 2008, the top credit applied only for two or more qualifying children. Table 5.3 shows the top credit for 2009 as compared with the top credit for 2008.

Income Limits The top credit applies only for those with earned income or adjusted gross income (AGI) that is above a specified amount but does not exceed a threshold phaseout amount. For 2009, the phaseout range for all married filers is increased as relief from the so-called marriage penalty; thus they can have more income without losing the credit. In order to understand the phaseouts, you need to know the following definitions: • “Earned income amount” is the amount of earned income at or above which (up to the threshold phaseout amount) the maximum credit can be claimed. Earned income does not include any nontaxable benefits (for example, elective deferral contributions to 401(k) plans and employer-paid educational assistance). Effectively, earned income is the amount reported

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TABLE 5.4

Earned Income Credit Limits Number of Qualifying Children

Item

One

Two or More

Three or More

None

Earned income amount Threshold phaseout amount (single, head of household, surviving spouse) Completed phaseout amount (single, head of household, surviving spouse) Threshold phaseout amount (married filing jointly) Completed phaseout amount (married filing jointly)

$ 8,950 16,420

$12,570 16,420

$12,570 16,420

$ 5,970 7,470

35,463

40,295

43,279

13,440

21,420

21,420

21,420

12,470

40,463

45,295

48,279

18,440

as wages on an employee’s W-2 form or, for self-employed individuals, the amount reported as net earnings from self-employment. For those in the military, earned income can include combat pay if they so elect. • “Threshold phaseout amount” is the greater of AGI or earned income above which the maximum credit starts to phase out. • “Completed phaseout amount” is the greater of AGI or earned income at which no credit can be claimed.

Table 5.4 shows the earned income phaseout ranges for the earned income credit in 2009. These are higher than the ranges for 2008 and reflect the additional amount for joint filers. Phaseout ranges for 2010 are in Appendix B. PLANNING

The credit limits will be adjusted for inflation in the future (see Appendix B). The increased phaseout range for married filers applies in 2010, but not beyond unless Congress extends this break. Due to the complexity of the earned income credit rules, the IRS will compute the earned income credit for you if you ask. First make sure you’re eligible for the credit. Then, simply put “EIC” on the dotted line where the credit amount would be entered. Complete all other parts of the return, but omit the lines that relate to your total payments, overpayment, refund, or amount owed (these can be completed only after the IRS figures your EIC). If you have a qualifying child, also complete Form EIC and attach it to the return.

CHILD TAX CREDIT

The credit can be received by individuals with at least one qualifying child on an advanced basis; there is no advance payment for someone with no qualifying child. The employer must increase take-home pay to account for the advance payment of the credit. For 2009, the advance payment can be as much as $1,826.

Unearned Income Limit Increased The earned income credit cannot be claimed if you have unearned income—from interest, dividends, and other investments—that exceeds a set amount. For 2009, the unearned income limit is $3,100 (up from $2,950 in 2008). This limit also applies for 2010.

Definition of Qualifying Child The definition of a qualifying child has been restricted somewhat for 2009 and later years. This is explained in connection with the dependency exemption in Chapter 4.

Child Tax Credit The tax law provides taxpayers with a credit simply for having a child. You don’t have to show that you spent a particular amount of money or anything else other than the fact that you have a qualifying child or children (a child under age 17 who can be claimed as your dependent). The credit amount is $1,000 per eligible child (the same as it was in 2008). There is no limit on the number of children for whom this credit can be claimed. Taxpayers with income above a threshold amount may not claim the credit. The credit begins to phase out for singles with AGI of $75,000 and for married couples filing jointly of $110,000. This AGI threshold has not changed from 2008 and will not be adjusted for inflation in the future.

Refundable Child Tax Credit At least a portion of the child tax credit may be refundable—paid to you in excess of your tax liability. The refundable amount is 15 percent of earned income from wages or self-employment in excess of a set amount. For 2009, this set amount is $3,000 (it had been $8,500 in 2008 and was scheduled to be

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$12,550 in 2009 before legislation changed it). The $3,000 amount also applies for 2010.

Definition of Qualifying Child The definition of a qualifying child has been restricted somewhat for 2009 and later years. This is explained in connection with the dependency exemption in Chapter 4. PLANNING

The $3,000 amount for the refundable credit is set to remain the same for 2010. After 2010, it may revert to a higher amount and be adjusted for inflation.

Education Tax Credits The cost of attending college or graduate school can be staggering. Even with financial aid, many families still pay out of pocket to finance higher education. If you pay for higher education costs for yourself, your spouse, or your dependent, you may be eligible to claim an education credit. There are two credits available in 2009 and 2010: the American Opportunity credit (which replaces the former Hope credit) and the Lifetime Learning credit. In determining whether you are eligible for either credit and how much to claim, note that income limits apply. You can claim an education credit even if you borrow the money to pay education costs. Form 8863, the form used for education credits, is in Appendix C.

American Opportunity Credit This credit, which applies for 2009 and 2010, is a new and improved version of the Hope credit, which had applied in 2008 and prior years. The amount of the American Opportunity credit is 100 percent of qualified tuition and related fees of the first $2,000, plus 25 percent of the next $2,000 of such expenses, for a top credit of $2,500. The Hope credit had been limited to 100 percent of the first $1,200 of qualifying tuition and expenses, plus 50 percent of the next $1,200, for a total credit of $1,800. The American Opportunity credit applies for the first four years of higher education. The Hope credit had applied only to the first two years of higher

EDUCATION TAX CREDITS

education. The credit can be claimed each year as long the student has not exceeded the limit on the number of years of schooling. The credit continues to be figured on a per-student basis. Thus, if your older child is a junior in college and your younger child is a freshman in college and you are paying some or all of their education costs, you can claim a total credit of up to $5,000 for both of them combined. The items treated as qualified tuition and related expenses have been expanded to include course materials—books, supplies, and equipment needed for a course of study, whether or not the materials are purchased from the school. The American Opportunity credit is partially refundable. You can recoup 40 percent of the credit amount even though it exceeds your tax liability for the year.

Lifetime Learning Credit The Lifetime Learning credit is an alternative credit to the American Opportunity credit. It is not limited to the first four years of higher education and can be used for graduate school as well. The credit limit has not changed from 2008. It remains at 20 percent of the first $10,000 in qualified tuition and related fees, for a top credit of $2,000. The credit applies on a per-taxpayer basis, regardless of the number of students in your family who are in college or graduate school. Thus, if you claim the credit for expenses you paid for yourself to take a graduate-level course and for your child who is in his fifth year of college, your total credit is limited to $2,000.

Income Limits Either of the education credits may be claimed only if your modified adjusted gross income (MAGI) is below set limits. The MAGI phaseout ranges for both the American Opportunity Credit and the Lifetime Learning Credit for 2009 are in see Table 5.5. The phaseout ranges will be the same in 2010. TABLE 5.5

MAGI Phaseout Ranges for Higher Education Credits

Filing Status


American Opportunity Credit

$80,000 to $90,000 $160,000 to $180,000

Lifetime Learning

$50,000 to $60,000 $100,000 to $120,000

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PLANNING

If your MAGI prevents you from claiming the credit, your child may be able to claim the credit, even though you paid the education expenses. In order for your child to claim the credit, you must waive a dependency exemption for your student (an action that may not result in a significant tax cost to you if your exemptions are already subject to the partial phaseout because of your high income or if you are subject to the alternative minimum tax). A waiver doesn’t require you to fill out any special form or statement; just don’t claim the exemption on your return. To benefit from this strategy, your child must have tax liability (for example, resulting from mutual fund distributions). In deciding whether to let your child claim the credit, weigh the tax savings you’d receive from claiming the exemption against the tax savings to your child so you can then choose the option that provides the greater tax benefit for the family. If you decide to let your child claim the credit and it is the American Opportunity credit, your child cannot use it to obtain a tax refund in excess of his or her tax liability; the 40 percent refundable rule does not apply in this situation.

Credits for Certain Home Energy Improvements and Investments The tax law wants you to become more energy efficient and provides you with two different tax incentives for making improvements to your home: one for home energy improvements and another for alternative energy investments in the home. The credits apply only to qualified improvements and investments made to your principal residence. These credits cannot be claimed for improvements and investments made to a vacation home or rental property. If the property is used for business as well as your personal dwelling and the residential use is at least 80 percent, then the full cost of the expenditure can be taken into account in figuring the credit. If, however, residential use is less than 80 percent, then an allocation of the expenditure must be made in order to figure the credit. Form 5965, the form for claiming residential energy credits, is in Appendix C.

Home Energy Improvements For 2009 and 2010, there is a 30 percent credit for the cost of making certain energy improvements. The dollar limit on the credit is $1,500 in the aggregate,

CREDITS FOR CERTAIN HOME ENERGY IMPROVEMENTS

so if you use up the full $1,500 credit in 2009, you cannot claim any credit for improvements made in 2010. Example In 2009, you replace all the windows in your home with energy-efficient windows at a cost of $12,000. Your credit is $1,500 (30 percent of $12,000, but not more than the aggregate limit of $1,500). If you add insulation to your home in 2010, you cannot claim any credit because you’ve already used up the aggregate limit.

Prior to 2008 (there was no credit allowed in 2008), there had been a $500 lifetime cap on the credit for home energy improvements as well as certain dollar limits for various types of improvements, such as a $200 cap on storm windows; these limits no longer apply. Qualifying residential energy property includes: • Advanced main air-circulating fan. • Exterior doors. • Exterior windows (including skylights). • Insulation systems that reduce heat loss/gain. • Metal roofs treated with special paint that meets Energy Star requirements. • Qualified natural gas, propane, or oil furnace or hot water heater. For 2009, the property must have an energy factor of at least 0.80, or a thermal efficiency of at least 90 percent. • Stoves using renewable plant-derived fuel to heat the home or water for the home (“qualified biomass fuel property”). This type of expenditure is newly qualified for 2009 and was not qualified prior to 2008.

For purchases and installations after December 31, 2009, the energy standards must reflect the 2009 International Energy Conservation Code. But you don’t have to be an engineer to determine whether an improvement qualifies for the credit. The IRS says you can rely on a manufacturer’s certification that the improvement meets these energy standards. You don’t have to attach the certification to your tax return, but do retain it with your tax records.

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Alternative Energy Investments If you add renewable energy property to your home, you can claim a credit of 30 percent of the cost. There is no dollar cap for the credit (there had been a $2,000-per-system limitation in place before 2009). This credit is set to run through 2016. Qualifying alternative energy property includes: • Fuel cell power plant that converts a fuel into electricity using electrochemical means, has an electricity-only generation efficiency of more than 30 percent, and generates at least 0.5 kilowatts of electricity. • Geothermal heat pumps. • Small wind power investment. • Solar panels. • Solar water heating equipment.

No credit can be claimed for renewable energy improvements made to heat a swimming pool or hot tub. PLANNING

Again, you don’t have to be an engineer to determine whether an improvement qualifies for the credit. The IRS says you can rely on a manufacturer’s certification that the improvement meets these energy standards. For exterior windows and skylights installed before June 1, 2009, you can rely on the Energy Star label (check details at www.energystar.gov to determine whether the products you’ve purchased qualify for the credit). You don’t have to attach the manufacturer’s certification or the Energy Star label to your tax return, but do retain it with your tax records. You can claim a tax credit for improvements, even though they are financed in whole or in part with special grants or loan programs. You must reduce the basis of your home by the amount of the credits you claim. However, you cannot claim a credit for improvements that are paid for by your utility company (you are not taxed on the utility’s payment). Check to see whether you are also eligible for state tax breaks for making energy improvements to your home. There may be tax credits, deductions, breaks on sales and/or property taxes, or other incentives for adding energy-saving

RETIREMENT SAVERS CREDIT

improvements to your home. For details about breaks in your state, go to the Database of State Incentives for Renewable Energy (DSIRE) (www.dsireusa.org) and click on your state.

Retirement Savers Credit A special tax credit, called the Retirement Savings Contributions credit, encourages individuals to fund retirement plans. Low- and moderate-income individuals may be able to double-dip—enjoy a tax benefit from making the contribution (such as a deduction for an IRA contribution or tax deferral on salary contributed to a 401(k) or SIMPLE plan) as well as claiming a tax credit for the same contribution. The credit is figured on contributions or elective deferrals up to $2,000. The amount of the credit is your applicable percentage applied to the $2,000 limit—determined by your filing status and adjusted gross income in 2009, as shown in Table 5.6. (The amounts for 2010 are in Appendix B.) Thus, the maximum credit is $1,000 (50 percent of $2,000); the minimum credit for anyone eligible to claim a credit is $200 (10 percent of $2,000). Example In 2009, you added $2,500 to your employer’s 401(k) plan. You are single with adjusted gross income of $20,000 (after the elective deferral). Your credit is $200 (10 percent of $2,000, the limit taken into account in figuring the credit). If your AGI had been no more than $16,500, your credit would have been $1,000; if your AGI had been no more than $18,000, your credit would have been $400. If your AGI had been more than $27,750, you would not have been eligible for any credit.

The contribution amount for purposes of figuring the tax credit is reduced by any distributions you take from a qualified plan that are includible in income during a testing period. The contribution amount is also reduced by any Roth IRA rollover during the testing period that is not a qualified rollover. The testing period includes the two preceding years, the current year, and the following year through the due date of the return (including extensions). Thus, for purposes of figuring the credit for 2009, consider whether any distributions

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$

0 33,000 36,000 55,500

Over

$33,000 36,000 55,500 —

But Not Over

0 24,750 27,000 41,625

$

Over

$24,750 27,000 41,625 —

But Not Over

Heads of Households

Adjusted Gross Income

$ 0 16,500 18,000 27,750

Over

Applicable Percentages for the Retirement Savings Contribution Credit in 2009

Joint Filers

TABLE 5.6

$16,500 18,000 27,750 —

But Not Over

Other Filers

50% 20 10 0

Applicable Percentage

ADOPTION CREDIT

were taken in 2007, 2008, 2009, and up to April 15, 2010 (assuming there are no filing extensions obtained). PLANNING

Weigh very carefully whether to take withdrawals—for example, IRA withdrawals to pay for the purchase of your first home or to cover medical or educational expenses. Such distributions can be taken without incurring the 10 percent penalty on early withdrawals, but you’ll pay ordinary income taxes on the distribution, won’t be able to claim the retirement savers credit, and will lose out on tax deferral for earnings that could have been realized on the amount withdrawn.

Adoption Credit The tax law rewards by means of a tax credit a parent or parents who adopt a child. Alternatively, a parent may be eligible for an exclusion from income if his or her employer pays such expenses under a company adoption plan. These tax breaks (the credit and the exclusion) are designed to offset to some degree the high cost of adoption, which ranges up to $2,500 for public agency adoptions and can cost $40,000 or more for private agency fees. All of the qualified costs of adoption can be taken off your tax bill as a credit, up to a set amount. The set amount of the adoption credit increases in 2009 to $12,150 (up from $11,650 in 2008). Similarly, if your employer pays for or reimburses adoption costs under a company’s adoption assistance plan in 2009, you can exclude from income up to $12,150. The credit and exclusion limit for 2010 is in Appendix B. With respect to a special-needs child, the credit or exclusion can be claimed without regard to actual expenses; you get it just for making the adoption.

Income Limits The full credit and exclusion may be claimed only by taxpayers with modified AGI up to $182,180 in 2009 (up from $174,730 in 2008). The credit phases out so that no credit can be claimed once modified AGI exceeds $222,180 (up from $214,730 in 2008). The same MAGI limit applies to both singles and joint filers. The phaseout range for 2010 is in Appendix B.

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Health Coverage Credit for Displaced Workers Certain displaced workers may be eligible for a refundable tax credit to pay for health insurance coverage. The credit is 80 percent of premium costs for coverage months beginning on or after May 1, 2009, and before January 1, 2011, with no dollar limit. Before May 1, 2009, and after December 31, 2010, the credit is 65 percent of premium costs. Eligible workers include workers who qualify for trade adjustment assistance (TAA) as well as those age 55 or older who are not eligible for Medicare but are receiving payments from the Pension Benefit Guaranty Corporation (PBGC). For any eligible coverage month beginning after February 17, 2009, and before January 1, 2011, a TAA recipient need not participate in a training program in order to receive the health coverage credit. Family members of eligible workers can continue to be qualified as well even though an otherwise disqualifying event has occurred. For example, the spouse of an eligible worker is also eligible, even following divorce. The same is true following the death of an eligible worker. The credit can be used only to cover COBRA or obtain coverage under a spouse’s employer’s plan or a state-sponsored insurance program. The credit may not be used to pay for individual coverage unless the worker has had such coverage for at least 30 days prior to losing his or her job. The credit can be enjoyed on an advance payment basis, with the 80 percent amount paid directly to the health care provider for the qualified insurance.

Child and Dependent Care Credit You may be able to claim a tax credit for costs you incur to care for your child under age 13 or a disabled dependent or spouse of any age so you can work (or attend school). The basic rules for this credit have not changed from last year. The maximum amount of qualified expenses you can take into account in figuring the credit is $3,000 for one qualifying dependent ($6,000 for two or more qualifying dependents). The credit rate depends on your adjusted gross income (AGI). For those with AGI over $43,000, the credit rate is 20 percent, so your top credit amount is $600 for one dependent and $1,200 for two or more dependents.

CREDIT FOR EXCESS SOCIAL SECURITY TAX WITHHELD

Definition of Qualifying Child The definition of a qualifying child has been restricted somewhat for 2009 and later years. This is explained in connection with the dependency exemption in Chapter 4.

Credit for Plug-In Electric Vehicles There is a new credit for plug-in electric vehicles purchased and placed in use starting in 2009. The credit is up to $2,500 to $15,000 (Starting in 2010, up to $7,500, regardless of the weight of the vehicle). The credit applies even if the vehicle is used entirely for business (for special rules if the vehicle is used for business, see Chapter 7). For low-speed vehicles, motorcycles, and three-wheeled vehicles, the credit is limited to 10 percent of cost, up to $2,500. There is also a 10 percent credit (up to a maximum of $4,000) for the cost of converting a conventional-fuel vehicle to electric power. PLANNING

The Chevy Volt, the first U.S. plug-in electric car for general use, is scheduled to debut in 2010.

Credit for Excess Social Security Tax Withheld Wages and other taxable compensation are subject to withholding for FICA taxes, which are comprised of Social Security and Medicare taxes. If you work for more than one employer and earn a certain amount, you may find at the end of the year that you’ve paid more in Social Security (and Tier 1 Railroad Retirement) tax than you were required to. For 2009, the maximum Social Security tax is 6.2 percent of wages up to $106,800 (up from $102,000 in 2008), or $6,622. If you paid more than this limit, you treat the excess as a credit toward your tax payment when you file your return. Example In 2009, you worked for two employers. Your wages for one employer were $75,000 and wages for the other employer were $50,000 (total wages for the

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year were $125,000). You paid Social Security tax of $7,750, so you can claim $1,128 ($7,750 – $6,622) as a credit on your return (it counts as additional taxes you’ve paid).

Because there is no wage base limit for the Medicare taxes portion of FICA, you cannot claim any credit with respect to withholding for Medicare taxes.

PLANNING FOR TAX CREDITS Each dollar of tax credit saves you one dollar in federal income taxes. It doesn’t matter what tax bracket you’re in. While refundable credits can exceed your TABLE 5.7

Tax Credits for Individuals

Credit

Adoption credit Alternative energy improvements credit American Opportunity credit Child and dependent care credit Child tax credit

District of Columbia first-time homebuyer credit Earned income credit Elderly and permanently disabled credit Excess Social Security and Tier 1 Railroad Retirement tax withheld credit First-Time Homebuyer credit Foreign tax credit Health coverage credit Home energy improvements credit Lifetime Learning credit Making Work Pay credit Minimum tax credit Mortgage interest credit Plug-in electric vehicle credit Retirement savers credit

Fully/Partially Refundable

Form/Schedule

Form 8839 Form 5695 40% refundable Partially refundable

Form 8863 Form 2441 Form 8812 for the additional (refundable) child tax credit Form 8859

Fully refundable

Form EIC Schedule R

Fully refundable

Form 5405 Form 1116 Form 8885 Form 5695

Refundable in limited situations

Form 8863 Schedule M Form 8801 Form 8396 Form 8834 or Form 8936 Form 8880

CREDIT FOR EXCESS SOCIAL SECURITY TAX WITHHELD

tax bill for the year and you still receive the benefit from them, nonrefundable credits may not produce tax savings for you. If your tax bill is not large enough to absorb the credits, you lose nonrefundable credits; they do not carry over to a future year. For 2009, nonrefundable personal tax credits can offset both regular tax (which includes certain other taxes discussed in Chapter 6, such as selfemployment tax and the nanny tax) and alternative minimum tax. Whether this will be true after 2009 remains to be seen.

Credits for Individuals In Table 5.7 there is a list of all of the tax credits for individuals, the extent to which they are refundable, and the forms or schedules needed to claim them; changes to many of them have been discussed in this chapter.

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CHAPTER 6

Money-Saving Breaks for Other Taxes

he regular federal income tax may not be the only tax you need to be concerned about. There are several other taxes that can raise your total federal tax bill for the year. These include the alternative minimum tax (AMT); the tax on unearned income of children below a set age (the “kiddie tax”); a penalty on certain actions with respect to individual retirement accounts (IRAs), qualified retirement plans, and health savings accounts (HSAs) (additional tax); Social Security and Medicare taxes (FICA tax for employees, and self-employment tax for self-employed individuals); and taxes on household employees (the “nanny tax”). In addition, if your income taxes are not being paid throughout the year via withholding on wages and certain other payments, you’ll need to make quarterly estimated tax payments. This chapter explains these other taxes you need to handle and how best to do this.

T

Alternative Minimum Tax The alternative minimum tax (AMT) is a shadow tax system designed to ensure that all individuals—even those with substantial write-offs—pay at least some federal income tax. The AMT came about in 1969 when Congress learned that

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MONEY-SAVING BREAKS FOR OTHER TAXES

166 wealthy individuals paid no tax. Now, however, the AMT affects millions of middle-income taxpayers who are not trying to avoid regular income taxes. The reason: Unlike the tax brackets for the regular income tax, the two AMT rates of 26 percent and 28 percent are not indexed annually for inflation, so as the regular tax declines, more and more people become subject to the AMT. However, while the AMT rates have not been changed this year, because of changes in exemption amounts and allowing nonrefundable personal credits as an offset, millions of people will escape the AMT this year. Here is a brief overview of how the AMT works so you can understand where tax changes fit in and how you can plan to minimize or avoid the AMT. Essentially, after you’ve figured your regular tax (before taking credits into account), you then have to refigure your income for alternative minimum tax purposes. You figure alternative minimum taxable income (AMTI) by adding back deductions that are allowed for the regular tax but not for the AMT, such as state and local income taxes and miscellaneous itemized deductions (called adjustments). Some adjustments, such as income from a state tax refund, reduce AMTI. You also increase AMTI by tax preference items listed in the tax law, such as the spread between the exercise price and the strike price of an incentive stock option (ISO). Then you reduce AMTI by the exemption amount allowed for your filing status (exemption amounts are listed next). Then you apply the AMT tax rates of 26 percent and 28 percent. You can reduce the alternative minimum tax by certain credits explained at the end of our discussion of the AMT.

AMT Exemption Amount As just explained, you reduce alternative minimum taxable income by your AMT exemption amount, which depends on your filing status. The AMT exemption amounts have been increased for 2009, as shown in Table 6.1 (2008 amounts are included for comparison purposes). TABLE 6.1

AMT Exemption Amounts

Filing Status

Single and head of household Married filing jointly and surviving spouse Married filing separately

AMT Exemption 2009

AMT Exemption 2008

$46,700 70,950

$46,200 69,950

35,475

34,975

ALTERNATIVE MINIMUM TAX

For a child subject to the kiddie tax on unearned income, there is a special AMT exemption; this exemption amount is higher in 2009 than it was in 2008. The child’s AMT exemption amount in 2009 is limited to $6,700 (up from $6,400 in 2008), plus earned income. However, if the child also has substantial income, the child’s AMT exemption amount cannot exceed the exemption amount for a single individual—$46,700 in 2009. Example A child in 2009 has investment income (unearned income) of $7,000 and no earned income. The child’s AMT exemption amount is $6,700. If the child also has $5,000 of earned income, the AMT exemption amount is $11,700 ($6,700 + $5,000). If the child has earned income of $50,000, the AMT exemption amount is $46,700.

PLANNING

The fate of the AMT in the future is uncertain. The AMT now raises too much revenue for it to be eliminated easily, but this tax could affect many millions more if Congress doesn’t do something. For the past several years, Congress has applied a patch to the problem by annually raising the exemption amount. Despite promises to revamp the AMT system, Congress has been unable to reach an agreement on how to do this. Expect to see continued increases in the exemption amount (perhaps adjusting the current amount for inflation each year) until a permanent solution can be found. In any event, you need to control adjustments and preference items to the extent possible. If you have too many adjustments and preferences, you may find yourself subject to AMT. It’s virtually impossible to estimate the point at which adjustments and preferences will trigger AMT (computer programs are needed for fairly precise estimates). As a rule of thumb, however, if you have over about $20,000 of adjustments and preferences, you could be subject to the AMT. Planning with respect to these adjustments and preferences can reduce or eliminate any AMT liability.

Deductions and AMT No deduction is allowed for AMT purposes for state and local income taxes, so the timing of your state and local income and property tax payments is critical.

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Before you make any year-end payments of these taxes otherwise due in January of next year (a move that could save regular taxes this year but cause you to effectively lose any benefit from them because of the AMT), determine whether you’ll owe AMT this year. No deduction is allowed for AMT purposes for the standard deduction and personal exemptions. However, you can deduct for AMT purposes the additional standard deduction for state and local sales and excise taxes on the purchase of a motor vehicle and the additional standard deduction for disaster losses. If you itemize deductions and add the sales tax to your otherwise allowable sales tax deduction or deduct the sales tax in addition to your state and local income taxes, you do lose the benefit of this write-off. No deduction is allowed for AMT purposes for miscellaneous itemized deductions. If, for example, you have substantial legal expenses, unreimbursed employee business expenses, investment expenses, or other miscellaneous expenses, you lose the benefit of their deduction if they trigger or increase AMT. To avoid this result, watch your miscellaneous deductions.

• Check to see that your employer uses an accountable plan to cover employee business expenses. Under an accountable plan, employer advances or reimbursements for travel and entertainment costs are not treated as income to you (you merely substantiate your business expenses to your employer and return any excess reimbursements). In contrast, with a nonaccountable plan, employer reimbursements for your business expenses are treated as additional income to you. Then you can deduct your business expenses, but only as a miscellaneous itemized deduction. Such expenses become deductible only to the extent that the total exceeds 2 percent of your adjusted gross income. But this itemized deduction is not allowed for AMT purposes. • If you have a legal action involving a contingency fee, be sure that the arrangement creates an interest for the attorney in the recovery under your state’s law so that you’ll report only the net recovery (the amount you receive after the attorney receives his or her share). If you do not, or if state law does not create such an interest, then you’ll have to report the recovery in full and claim any legal fees as a miscellaneous itemized deduction in

ALTERNATIVE MINIMUM TAX

excess of 2 percent of adjusted gross income (but no deduction for AMT purposes). • Think twice about which individual should benefit under a multiple support arrangement that allows anyone who contributes at least 10 percent of someone else’s support to claim the dependency exemption (provided the group contributes more than 50 percent of the person’s support). Because personal and dependency exemptions are not deductible for AMT purposes, it usually makes sense to award the dependency exemption to a supporter who is not subject to AMT. • Watch the timing for exercising incentive stock options (ISOs). When you exercise the options to buy a set number of shares of your employer stock at a set price within a set time, this does not produce any income for regular tax purposes. However, the spread between the option price and the stock price on the date the ISOs are exercised is an adjustment to alternative minimum taxable income. In effect, even though the exercise of ISOs does not produce any regular income tax consequences, such action may trigger AMT. Generally it is advisable to spread the exercise of ISOs over a number of years rather than exercising them all at once. This will minimize any adverse tax impact. But tax considerations may have to take a backseat to other factors. Consider moves in the stock prices as well as the availability of cash to exercise the options, and watch out for expiration dates on the options.

Private Activity Bond Interest Private activity bonds are municipal securities issued to finance a private activity such as a sports stadium. The interest on private activity bonds is not taxed for regular tax purposes (although it is taken into account for purposes of determining taxation on Social Security benefits). Usually interest on most private activity bonds issued after August 7, 1986, is treated as a tax preference for AMT purposes. However, there is an exception from the AMT preference rule for interest on private activity bonds issued in 2009 and 2010. This exception also applies to bonds issued to refund bonds issued after December 31, 2003, and before January 1, 2009. The exception also applies to distributions from private activity bond funds to the extent of interest on bonds issued in 2009 and 2010.

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PLANNING

The new exception is in addition to exceptions for interest on the following types of bonds: • Qualified 501(c)(3) bonds. • New York Liberty bonds. • Qualified Gulf Opportunity bonds. • Qualified mortgage bonds. • Veterans’ mortgage bonds. • Qualified student loan bonds. • Exempt-facility bonds issued after July 30, 2008.

Small Business Stock The exclusion for gain on the sale of small business stock acquired after February 17, 2009, and before January 1, 2011 and held for more than 5 years, has increased to 75 percent instead of the usual 50 percent limit. A portion of the gain from the sale of this small business stock that is excludable from income for regular tax purposes is includable in alternative minimum taxable income. The inclusion amount for AMT is 46 percent. This produces an effective maximum AMT tax rate of 12.88 percent (46 percent inclusion multiplied by the 28 percent maximum AMT rate).

Tax Credits Just because you have a tentative AMT liability doesn’t mean you’ll have to pay any AMT. This liability can be offset by nonrefundable personal tax credits, such as the dependent care credit and education credits. Starting in 2009, it can also be offset by the alternative motor vehicle credit for buying a hybrid vehicle or a plug-in electric vehicle to the extent used for personal purposes. PLANNING

After 2009, unless Congress takes further action, the use of nonrefundable personal credits to offset AMT (as well as the regular tax) is limited to the child tax credit, the adoption credit, the retirement savers credit, the foreign tax

KIDDIE TAX

credit, and the alternative motor vehicle credit. This means you could lose the benefit of your other tax credits if you are subject to the AMT.

Kiddie Tax The government was concerned that families were putting investments in a child’s name so that income received by the child would be taxed at rates lower than those if the parent had kept the investments and received the income. Congress created a so-called kiddie tax on unearned income over a set amount. It is not a separate tax. Rather, the child is taxed on unearned income over a set amount at the parent’s highest marginal tax rate.

Example A child subject to the kiddie tax has $3,000 of investment income above the threshold. The child is in the 10 percent bracket; the parents are in the 28 percent bracket. Under the kiddie tax, the child pays $840 on this income (28 percent of $3,000).

Who Is Subject to the Kiddie Tax For 2009, a “child” for purposes of the kiddie tax means a child who is age 18 or under at the end of the year if he or she does not have earned income exceeding half the child’s support for the year. It also includes a child who is 19 through 23 as of December 31 if the child is a full-time student during the year and does not have earned income exceeding half of his or her support for the year. The definition of a child for kiddie tax purposes has not changed from 2008. A child who is born on January 1 is treated as having his or her birthday on December 31 of the previous year. Thus, a girl born on January 1, 1986, who has her 24th birthday on January 1, 2010, is treated as being born on December 31, 1985, so that she is considered to be 23 years old in 2009. If a child otherwise subject to the kiddie tax because of age and income is orphaned, then the kiddie tax does not apply. Also, it does not apply if the child is married and files a joint return with his or her spouse.

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Threshold Amounts The kiddie tax applies only if the child has unearned income above a threshold amount. For 2009, the threshold is $1,900 (and will remain the same in 2010); this is, up from $1,800 in 2008. Unearned income includes interest on bank savings accounts, stock dividends, capital gain distributions from mutual funds, and capital gains from the sale of property. While the 2009 threshold amount for the kiddie tax is $1,900, the first $950 of unearned income is tax free to the child and the next $950 is taxed to the child at a rate of 10 percent. Only unearned income over $1,900 is taxed to the child at the parent’s rate. PLANNING

If a child has unearned income over $950 for 2009, a tax return must be filed for the child; the parent usually is the person to do this and signs the return as follows: “By [your signature], parent [or guardian] for minor child.” However, a parent can elect to include the child’s unearned income on the parent’s own return and avoid the need to file a separate return for the child. In order to make this election and report the child’s income on the parent’s return, all of the following conditions must be met: • The child’s only income for the year is from interest and dividends (including capital gain distributions from mutual funds and Alaska Permanent Fund dividends). • This unearned income totals more than $950 but not more than $9,500. • No estimated taxes were paid on behalf of the child for the year and there was no tax overpayment from the previous year applied to estimated taxes for the year. • The child is not subject to backup withholding.

Just because you are eligible to report your child’s unearned income on your return does not mean it’s a good idea to do so. Adding the child’s unearned income to your own will increase your adjusted gross income by the amount of the child’s unearned income, which can limit or prevent you from qualifying for many tax breaks (see Chapter 2). The only two instances in which it may be helpful are if you need to boost your investment income in order to increase your itemized deduction for investment interest and/or charitable contributions.

TAX PENALTIES ON IRAS, 401(K) PLANS, AND CERTAIN OTHER ACCOUNTS

A child’s earnings from a job or self-employment are not subject to the kiddie tax. Parents who have businesses may employ their children, enabling the family to reap several tax benefits: • Wages for a child in 2009 up to $5,700 are tax free. • The child can contribute his or her earnings (up to $5,000) to an IRA or Roth IRA. • The parent can deduct wages paid to the child as a business expense. • If the parent is self-employed and the child is under the age of 18, then wages paid by the parent are exempt from payroll taxes (FICA [Federal Insurance Contributions Act] and FUTA [Federal Unemployment Tax Act]).

Tax Penalties on IRAs, 401(k) Plans, and Certain Other Accounts The tax law can impose an additional tax (called a penalty) for certain actions with respect to these accounts. Acts that are frowned upon and can be subject to an additional tax include a 6 percent penalty for making excess contributions, a 10 percent penalty for withdrawing funds prematurely, and a 50 percent penalty for failing to take required minimum distributions (RMDs) (although there are no RMDs for 2009, as explained in Chapter 1).

Early IRA/401(k) Distributions The tax law is designed to make sure that money you contribute to an IRA, a 401(k), or other retirement plan stays there and is available for retirement income purposes. However, things come up and you may want or need the money earlier. There are some reasons recognized by the tax law for making withdrawals; these are not subject to an additional tax. However, there are a number of other reasons that are not recognized, and taking money out of your retirement account for one of these purposes could result in a penalty. Approved reasons for withdrawing funds early. If you take money out for any of the following reasons, there is no additional tax. Note that some penalty exceptions apply only to IRAs and not to 401(k)s or other similar plans. • You are 591/2 . • You are disabled.

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• You use money to pay qualified higher education costs for yourself, your spouse, or a dependent (this applies only to IRAs). • You pay substantial medical expenses for yourself, your spouse, or a dependent (this applies only to IRAs). • You pay health insurance and you are unemployed at least 12 consecutive weeks (if self-employed you would have been eligible for unemployment benefits for this period but for the fact that you were not an employee) (this applies only to IRAs). • You take out funds up to $10,000 to pay first-time home-buying expenses (this applies only to IRAs). • You are eligible for a qualified reservist distribution because you are called to active duty in the military. • You take a distribution of substantially equal periodic payments. • You leave your job and are at least age 55 (this exception applies only to 401(k)s and other similar plans and not to IRAs). • You withdraw funds incident to a divorce (this applies only to IRAs). • Your 401(k) or other qualified retirement plan benefits are paid to a spouse or other alternate payee under the terms of a qualified domestic relations order issued by a court (this applies only to 401(k)s and other similar plans and not to IRAs). • The IRS imposes levies on your account to cover back taxes (this applies only to IRAs). • Your company plan closes down and makes a distribution to you (this exception applies only to 401(k)s and other similar plans and not to IRAs).

Reasons for withdrawing funds that could result in a penalty. If you take money out for the following reasons before age 591/2 and you are not disabled, then the IRS will impose an additional tax because the tax law does not recognize these reasons as an exception to the penalty: • You have a financial hardship. If you do have a financial hardship, your 401(k) may allow you to take a withdrawal, but it is fully taxable and subject to the 10 percent penalty unless you’re at least 591/2 years old or disabled. • You use the money to pay down your mortgage.

FICA

Other Account Actions Subject to Penalty Your IRA and/or 401(k) plan are not the only types of accounts for which the tax law sets penalties for certain actions. Here is a listing of some other costly penalties to avoid: • Health savings accounts (HSAs)—a 10 percent penalty for nonmedical withdrawals before age 65 (unless disabled or on account of the death of the annuity holder). Even an IRS levy on the account to pay back taxes is subject to a penalty if the account owner is under age 65. • Commercial annuities—a 10 percent penalty for withdrawing earnings from the annuity prior to age 591/2 (unless disabled or on account of the death of the annuity holder). • Coverdell education savings accounts (ESAs)—a 6 percent penalty on contributions in excess of the $2,000 annual limit that are not withdrawn by June 1 of the following year. There is also a 10 percent penalty on taxable distributions from these accounts (essentially, distributions for noneducational purposes for which there is no exception to this penalty).

FICA Social Security and Medicare taxes collectively are referred to as FICA. The employer and employee each pay a like amount on compensation for the year. The tax rates on the Social Security and Medicare portions of FICA tax for employers and employees remain unchanged for 2009. The Social Security tax rate is 6.2 percent and the Medicare tax rate is 1.45 percent. However, the wage base limit on which the Social Security portion of the tax is figured is limited to $106,800 in 2009 (up from $102,000 in 2008). There is no wage base limit for the Medicare portion of the tax. Example In 2009, you receive a salary of $110,000 from X Corp. You pay $6,622 in Social Security tax ($106,800 × 6.2%) and $1,595 in Medicare tax ($110,000 × 1.45%) for a total FICA payment of $8,217. (Your employer pays the same amount.)

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Self-Employment Tax Self-employed individuals do not receive wages or compensation because they are not employees, so they do not pay FICA. Instead, they are subject to Social Security and Medicare taxes on their net earnings from self-employment (profits). This is called self-employment tax. Self-employment tax effectively equals both the employer and employee share of FICA. Thus, self-employed individuals pay a Social Security tax rate of 12.4 percent and a Medicare tax rate of 2.9 percent. One-half of this tax is deductible as an adjustment to gross income. The basis on which the Social Security portion of the self-employment tax is figured—net earnings from self-employment—also is set in 2009 at $106,800 (up from $102,000 in 2008). As in the case of FICA, there is no limit on net earnings from self-employment for the Medicare portion of selfemployment tax. Again, self-employed individuals can deduct one-half of their self-employment tax as an adjustment to gross income.

Grandparents Providing Child Care Grandparents who look after their grandchildren so parents can work may receive payments from the state under a state-sponsored child care program, such as the Illinois Child Care Assistance Program (CCAP). While the payments are taxable income to the grandparents, the Tax Court has decided that such income is not subject to self-employment tax. The grandparents who care solely for their own grandchildren (and not for additional children) are not in the business of providing child care services and, thus, are not subject to selfemployment tax.

Tax on Household Employees If you engage workers in your home who are not in their own businesses or are not employees of a company, such as an agency, then you may be obligated to pay employment taxes for your household employees. Employment tax on household employees is referred to as the “nanny tax.” The nanny tax imposed on wages paid to household employees isn’t limited to nannies. It can apply to

ESTIMATED TAXES

housekeepers, au pairs, cooks, drivers, gardeners, and anyone else who works for you or your family full-time or part-time. The nanny tax is comprised of Social Security and Medicare (FICA) taxes and federal unemployment (FUTA) tax. FICA is required for a household employee only if cash wages exceed a threshold amount. For 2009, the threshold amount is $1,700, up from $1,600 in 2008. Once wages exceed the threshold, then all wages for the year are subject to FICA; there is no exemption for the first $1,700. FICA taxes are explained earlier in this chapter. FUTA taxes apply if you pay cash wages of $1,000 or more during any calendar quarter in 2009 or 2008. The FUTA rate is 6.2 percent of the first $7,000 of cash wages; there is usually a credit of 5.4 percent, so the actual rate for taxpayers in most states is 0.8 percent (top FUTA payment per worker usually is $56). PLANNING

Certain workers are exempt, meaning you don’t owe FICA on their wages regardless of amount. These include your spouse, your parent, your child under age 21, or any individual under age 18 if providing household services is not his or her principal occupation. For FUTA, no tax is due on wages paid to a spouse, parents, or your child under age 21. If you are liable for any nanny tax, you’ll need an employer identification number (EIN); you can’t use your Social Security number for tax reporting purposes. You can easily obtain one (at no cost) from the IRS at www.irs.gov/businesses/small/article/0,,id=102767,00.html. You may also owe state unemployment insurance and need to pay workers’ compensation for household employees. Contact your state labor department for details—find a link to your state’s department through the American Federation of State, County and Municipal Employees (AFSCME) at www.afscme.org/publications/11820.cfm.

Estimated Taxes Since federal income taxes are on a pay-as-you-go basis, you must pay your taxes for the current year through withholding and/or estimated taxes. If mandatory withholding on wages and certain retirement plan distributions and voluntary withholding on Social Security benefits and unemployment benefits do not cover

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enough of your taxes for the year, you’ll need to make quarterly estimated tax payments in order to avoid penalties. Estimated taxes are not an additional tax; they are a method of tax payment. Estimated taxes cover: • Regular income tax (including income taxes on your share of business income). • Alternative minimum tax for high-income taxpayers. • Self-employment tax. • Household employment tax (nanny tax).

You must pay estimated taxes if you expect your tax liability for the year to be at least $1,000 and you do not (1) meet a safe harbor test or (2) file your return and pay the tax in full by January 31. The safe harbor test means that your withholdings and any excess tax payment from last year toward this year’s taxes is less than the smaller of: • 90 percent of the tax shown to be on this year’s return (662/3 percent for farmers and commercial fishermen), or • 100 percent of the tax shown on last year’s return (110 percent if your adjusted gross income last year was more than $150,000, or $75,000 if married filing separately).

Special Rule for Small Business Owners There is a special estimated tax rule for small business owners for 2009 designed to allow them to retain more cash throughout the year by minimizing estimated taxes without penalty. If your adjusted gross income in 2008 was under $500,000 and you derived more than half of your gross income from a business with 500 or fewer employees, you are not subject to estimated tax penalties if your payments for 2009 are at least 90 percent of the 2008 tax. While this break applies only to 2009 estimated taxes, it may be extended for 2010 taxes. There is another special estimated tax rule for farmers and commercial fishermen. No estimated tax penalties are owed if the income tax return is filed and any taxes paid by February 28. If you don’t file by this date, then any estimated tax penalties will be figured from only one payment date— January 15.

ESTIMATED TAXES

PLANNING

Estimated taxes are due on April 15, June 15, and September 15 of the current year and January 15 of the following year (the due date is extended to the next business day if any payment date falls on a Saturday, Sunday, or legal holiday). Estimated taxes can be paid in several ways: by check made payable to the U.S. Treasury along with Form 1040-ES, by charging the payment to a major credit card, or by transferring funds using the Electronic Federal Tax Payment System (EFTPS) at www.eftps.gov.

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CHAPTER 7

Tax-Saving Changes for Small Businesses

f you are self-employed with a full-time or part-time business, you may be eligible for a number of business-related tax breaks. Most of the business deductions are a direct offset to your business income, reducing the profits that are subject to tax. Some of the business deductions, however, are claimed as personal deductions; they are reported as an adjustment to gross income. While they have the same impact for income tax purposes, effectively reducing the amount of business income you’ll pay tax on, they are not a reduction for self-employment tax purposes (see Chapter 6). There are also special businessrelated tax credits you may be eligible for. If you are an employee and you are not reimbursed for your business expenses, some of the breaks in this chapter may apply to you. For example, if you drive your personal car for business, you too can deduct the cost of business driving. If you use a home office for convenience of your employer, you too can claim a home office deduction. This chapter explains the changes in business deductions and credits you may be eligible for in 2009 and what lies ahead. Use this information to help yourself plan for tax savings on your return for 2009 as well as for 2010. Many tax rules have not changed for 2009; these can be found in J.K. Lasser’s Small Business Taxes 2010.

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TAX-SAVING CHANGES FOR SMALL BUSINESSES

First-Year Expensing A small business can elect to expense the cost of buying equipment—computers, office furniture, machinery, and the like—instead of depreciating the cost over a period fixed by law, typically five to seven years. This is sometimes referred to as the Section 179 deduction because this is the section in the Internal Revenue Code governing the rule. There is a set dollar limit on the amount that can be expensed annually. For 2009, that limit generally is $250,000, the same limit that had been permitted for 2008. An additional $35,000 (or a total of $285,000) can be expensed if the property is placed in service in an empowerment zone or on an Indian reservation. The $250,000 limit phases out once a business’s annual equipment purchases exceed the basic $800,000 (higher limits apply for empowerment zones and Indian reservations). For every dollar over $800,000, the expense limit is reduced by $1 so that once equipment purchases exceed $1,050,000 in 2009, no expensing is permitted. PLANNING

First-year expensing applies whether you pay cash or finance your equipment purchase over time. It applies to property that is new as well as pre-owned. It does not apply to property you lease. However, in some cases it may make more tax sense to lease rather than buy, even with the $250,000 write-off opportunity. You can deduct lease payments even if you’re not profitable; they effectively add to your net operating loss, which can be carried back to generate a tax refund. If you want to use expensing and make the most of it when purchasing more than $250,000 worth of equipment, it is advisable to elect expensing for the property with the longest depreciation recovery period. First-year expensing must be elected; it is not automatic. Whether it makes sense to make the election depends on your tax picture this year and looking ahead. To benefit from first-year expensing, you must have taxable income at least equal to the amount you want to expense. You cannot use first-year expensing to create or increase a net operating loss. If 2009 is not a profitable year, then you won’t benefit from an expensing election. In this case it makes more sense not to make the election and instead claim depreciation in future years when you can benefit from the write-offs. If you own a pass-through entity

BONUS DEPRECIATION

(e.g., an S corporation or a partnership), both the dollar limit and the taxable income test apply at both the entity level and the owner level, but the expensing election is made at the entity level alone. You make the first-year expensing election in Part I of Form 4562, Depreciation and Amortization (see Appendix C). Looking ahead, the $250,000 limit is scheduled to revert to the former limit of $125,000. The lower dollar limit, however, can be adjusted for inflation; The 2010 is in Appendix B. Congress may extend the higher limit beyond 2009. For 2011, the limit is set to revert to a mere $25,000, with no adjustment for inflation (unless Congress changes this limit, as it could well do to stimulate the economy).

Bonus Depreciation Bonus depreciation, a rule first introduced in 2002 for property purchased after September 10, 2001, affects the timing of depreciation allowances; it does not increase the total amount that can be written off for depreciable property. The provision had expired (it applied only to property placed in service before 2005, or before 2006 in some cases) but was reinstated for 2008 and has been continued for 2009. The bonus depreciation rate is 50 percent, which means you can write off half the cost of eligible property purchased in 2009. Bonus depreciation can be claimed in addition to any first-year expensing that may be claimed. Regular depreciation can also be claimed. Bonus depreciation is applied to the adjusted basis of the property. Generally this is the cost of the property minus any first-year expensing.

Example In 2009, your business places in service new equipment costing $300,000 (assume the property has a five-year recovery period, which results in a 20 percent depreciation allowance for the first year). You elect first-year expensing and apply bonus depreciation. Your total write-off for the year is $280,000, or about 93 percent of the cost: $250,000 first-year expensing, $25,000 bonus depreciation (50 percent of $50,000), and $5,000 regular depreciation (20 percent of $25,000).

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As mentioned earlier, bonus depreciation is designed merely to accelerate the write-off for equipment. It does not increase the total write-offs that may be claimed—this continues to be limited to the property’s basis (generally cost).

Qualifying Property Most types of depreciable property qualify for bonus depreciation. For example, it may be claimed for software that has a three-year recovery period. Bonus depreciation also applies to qualified leasehold improvement property (improvements to the interior of nonresidential property made under a lease by the lessee, sublessee, or lessor); qualified restaurant improvements; and qualified retail improvements. Further, it applies to property elected to be depreciated under the alternative depreciation system (ADS). Nonqualifying property includes the following items: • Intangibles (e.g., trademarks and goodwill) that you acquire, which are required to be amortized over 15 years. • Property that must be depreciated under the alternative depreciation system (ADS), such as cell phones and other listed property not used more than 50 percent for business and any property used predominantly outside the United States.

Bonus depreciation applies only to new property and not to used property. But financing the purchase does not impede the write-off.

Midquarter Convention In the tax law there is a special depreciation rule called the midquarter convention. This rule says that if the total cost basis of business equipment placed in service during the last three months of the year exceeds 40 percent of the total basis of all property placed in service during the year, then all equipment is treated as having been placed in service in the middle of the quarter. However, bonus depreciation is not taken into account in determining the basis of property for purposes of the midquarter convention. Thus, the basis of property placed in service in the last quarter of the year is determined without regard to bonus depreciation.

BONUS DEPRECIATION

Example In June 2009, your business places in service equipment costing $30,000. In December 2009, you also place in service more equipment costing $125,000. The determination of whether the midquarter convention applies to these items is based on the cost of the items without regard to any bonus depreciation.

Electing Out of Bonus Depreciation You are not required to use bonus depreciation even though you are qualified to use it. Bonus depreciation applies automatically unless you elect out of it. It may make sense to elect out of bonus depreciation if your current income is not enough to benefit from the added write-off but you expect income to improve in coming years. However, unlike first-year expensing, bonus depreciation can be used to create or increase a net operating loss, so think twice before letting it go. If you do decide to opt out of bonus depreciation, note that the election out applies to all property within the same recovery class. Thus, for example, if you want bonus depreciation to apply to some five-year property, it must apply to all five-year property. By the same token, if you want to elect out of bonus depreciation for some seven-year property, the election out prohibits bonus depreciation for any other seven-year property. The election out of bonus depreciation is made in Part II of Form 4652, Depreciation and Amortization (see Appendix C). It must be made no later than the due date of the return (including extension) for the year the property is placed in service (for example, by April 15, 2010, plus any filing extensions, for 2009 property). Caution: If you want to make the election out but fail to do so properly, you must reduce the property’s basis by the amount that you could have claimed as bonus depreciation, even if you didn’t take the deduction. This will affect the amount of your gain (or loss), including depreciation recapture, when you dispose of the property. PLANNING

Determine whether it’s advisable to elect not to claim bonus depreciation, as explained earlier.

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Looking ahead, there is no bonus depreciation allowed for 2010 unless Congress extends the break.

Dollar Limits on Car Deductions If you buy a car, light truck, or van used for business, you can deduct your actual costs, including an allowance for depreciation or first-year expensing. However, there is a dollar limit on depreciation write-offs for cars weighing no more than 6,000 pounds gross vehicle weight as rated by the manufacturer that are considered luxury cars (cars costing over a set amount). Heavier vehicles, such as certain SUVs, are exempt from the dollar limits but can be expensed only up to $25,000. For new vehicles placed in service in 2009, there is an added dollar limit of $8,000 reflecting bonus depreciation. The added limit can be claimed only for a qualifying vehicle (i.e., a new passenger car and not a pre-owned one). Table 7.1 shows the dollar limit on depreciation (and first-year expensing) for passenger cars placed in service in 2009: The full dollar limit applies only to cars used 100 percent for business. If you use your car 80 percent for business and 20 percent for personal purposes, you must allocate the dollar limit.

Example You buy a $25,000 car in March 2009. (Assume the car weighs less than 6,000 pounds and it qualifies for bonus depreciation.) You use it 80 percent for business and 20 percent for personal reasons. The most you can deduct in the first year of car ownership is $8,768 ($10,960 × 80%).

TABLE 7.1

Deduction Limit on Passenger Cars Placed in Service in 2009

Year

Dollar Limit with Bonus Depreciation

Dollar Limit without Bonus Depreciation

2009 2010 2011 2012 and later years

$10,960 4,800 2,850 1,775

$2,960 4,800 2,850 1,775

STANDARD MILEAGE RATE

TABLE 7.2

Deduction Limit on Light Trucks and Vans Placed in Service in 2009

Year

Dollar Limit with Bonus Depreciation

Dollar Limit without Bonus Depreciation

2009 2010 2011 2012 and later years

$11,060 4,900 2,950 1,775

$3,060 4,900 2,950 1,775

Dollar Limits on Trucks and Vans Light trucks and vans weighing no more than $6,000 pounds are subject to the special dollar limits. Table 7.2 shows the dollar limit on depreciation (and first-year expensing) for light trucks and vans placed in service in 2009. Again, only new trucks and vans qualify for bonus depreciation; used vehicles do not. There is no dollar limit on the purchase of non-personal-use vehicles. These include vehicles not likely to be purchased for other than business (e.g., a van equipped with special shelving for the business).

Standard Mileage Rate Instead of deducting your actual expenses for the business use of your car, you can opt to claim an IRS standard mileage allowance. This standard mileage rate applies to both owned and leased cars used for business. The standard mileage rate takes the place of deducting gas and oil, insurance, depreciation on purchased cars (or lease payments on leased cars), and repairs and maintenance. For 2009, the standard mileage rate is 55 cents per mile; in 2008 it was 50.5 cents per mile for the first six months of the year and 58.5 cents per mile for the second six months of the year (the IRS made the adjustment following the spike in gasoline prices in the middle of the year). As mentioned earlier, the IRS’s standard mileage rate may be claimed whether you own or lease the car. However, it may not be claimed if you deducted actual expenses for the car in a prior year.

Deemed Depreciation If you deduct your actual costs for a vehicle you own, you reduce the basis of the vehicle by the applicable depreciation allowance. If you claim the standard

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mileage rate, you must reduce the basis of your car by a “deemed depreciation amount” fixed by the IRS. The reduction in basis is necessary for determining how long to claim the standard mileage rate (it cannot be claimed after the car has been fully depreciated according to deemed depreciation). The basis reduction is also necessary for determining gain or loss on the sale of the car. For 2009, the deemed depreciation rate is 21 cents per mile (the same deemed depreciation rate as in 2008). Example You buy a $25,000 car in 2009. You drive it 30,000 miles on business. You must reduce the basis of the car by $6,300 (30,000 × $0.21). Assuming the deemed depreciation rate remains unchanged in the coming years and you continue to drive 30,000 miles a year, your car will be fully depreciated within four years—and no additional standard mileage rate may be claimed after that.

PLANNING

If you buy or lease a car for business in 2009, decide whether it’s better to use the actual expense method or the IRS standard mileage rate to deduct the car’s operating costs. Remember that the standard mileage rate replaces write-offs for depreciation (or lease costs on leased cars), gas, oil, repairs, licenses, and insurance. If you use the standard mileage rate in the first year, you can switch to the actual expense method in a subsequent year—but you are limited to claiming straight-line depreciation if you own the car (no accelerated depreciation is permitted). Again, if you use the actual expense method in the first year, you cannot later switch to the standard mileage rate. The choice of which method to select depends on a couple of factors: • Records for actual costs. Using the standard mileage rate eliminates the need to keep receipts for gas, oil, and so on. It does not eliminate the requirement to substantiate business use of the car (keeping a written or electronic record of the business use). • Amount of miles. The more you drive, the greater the standard mileage rate proves to be, especially for modestly priced cars since the same rate applies regardless of the car’s sticker price. For example, if a car is driven 40,000 miles for business in 2009, the deduction under the standard mileage rate is $22,000. This same deduction applies whether the car is a low-priced Toyota Yaris or an expensive Mercedes.

LEASED CARS

Cents-per-Mile Valuation Rule If you have an employee who works for your business and the business provides him or her with a passenger car for personal and/or business use, the value of such personal use is a taxable fringe benefit. You can opt to value personal use using the vehicle cents-per-mile value rule if the car’s fair market value on the date it is first made available to the employee does not exceed $15,000 ($15,200 for a small truck or van).

Leased Cars In order to roughly equate the write-offs allowed for leased cars with cars that are owned and depreciated, a special amount must be added back to income for leased cars. This is called an inclusion amount. For 2009, it applies when the original cost of the car exceeds $18,500. Table 7.3 shows some of the inclusion amounts for passenger cars first leased in 2009 (a complete list can be found in Rev. Proc. 2009–24). Example You lease a car in January 2009 that cost $50,000. For 2009, the first year of the lease, you must add to income $78. In 2010, the inclusion amount is $171.

For cars first leased for business before 2009, inclusion amounts to be reported in 2009 and later years can be found in IRS Publication 463, Travel, Entertainment, Gift, and Car Expenses, at www.irs.gov. TABLE 7.3

Sample Inclusion Amounts for Passenger Cars First Leased in 2009

Fair Market Value

Tax Year during Lease

Over

But Not Over

1st

2nd

3rd

4th

Later

$18,500 19,000 20,000 22,000 25,000 30,000 35,000 40,000 45,000 50,000

$19,000 19,500 20,500 23,000 26,000 31,000 36,000 41,000 46,000 51,000

$ 9 10 12 17 24 35 47 58 69 80

$ 19 21 27 38 52 77 102 127 151 176

$ 28 32 39 56 78 115 151 188 225 262

$ 34 38 46 66 93 137 181 225 269 313

$ 38 43 54 76 107 157 208 259 311 361

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Plug-In Electric Vehicles If, in 2009, you purchase a plug-in electric vehicle used for business, you can claim a tax credit. The credit amount is explained in Chapter 5 and can be claimed for an eligible vehicle whether it is used for personal driving or for business. However, the extent to which the credit is claimed for business becomes part of the general business credit. The general business credit is not a separate credit. Rather, it is an overall limitation on the amount of credits a business can claim in any one year. The general business credit limit is your net income tax (regular tax liability plus alternative minimum tax), minus the greater of (1) your tentative minimum tax or (2) 25 percent of your net regular tax liability that is more than $25,000 ($12,500 for married persons filing separately).

High-Low Substantiation Rates If you have employees who travel on business, instead of deducting the actual cost of their lodging, meals, and incidental travel expenses, employees can substantiate business travel using a special high-low substantiation method. This method provides standard rates for travel to specific locations—the locations are either high-cost areas or not. The rates apply only to travel within the continental United States. On October 1, 2008, rates took effect for the fiscal year ending September 30, 2009 (the federal government uses this fiscal year even though you probably report on a calendar-year basis). The rate for travel to any high-cost locality is $256 a day, which takes into account $58 a day for meals. The rate for travel to any other locality within the continental United States is $158 a day, which takes into account $45 a day for meals. New rates apply starting October 1, 2009, through September 30, 2010. See Appendix B. PLANNING

You may elect to use the high-low rates that became effective on October 1, 2008, for the final quarter of 2009. Alternatively, you may use the old rates through September 30, 2009, and the not-yet-announced new rates for the final quarter of 2009.

SELF-EMPLOYED RETIREMENT PLANS

Instead of using the high-low rates set by the IRS, you can use the federal perdiem rates fixed by the General Services Administration. Again, the rates vary with location and the date of the travel. You can find these rates at www.gsa.gov (click on “per diem rates”). Even though employees are on the road, their meals are still subject to the 50 percent limitation. Thus, of the $58 per day for meals for travel to high-cost areas, only $29 is deductible.

Self-Employed Retirement Plans Self-employed individuals can shelter some of their profits and save for their retirement on a tax-advantaged basis by using a qualified retirement plan, such as a profit-sharing plan or a 401(k) plan. Other retirement plan options for self-employed individuals include simplified employed pensions (SEPs) and savings incentive match plans for employees (SIMPLEs). Contributions you make on your own behalf are deductible as an adjustment to gross income (see Chapter 2); contributions you make for employees are deductible as a business expense that reduces your net earnings from self-employment. For 2009, you can contribute to a profit-sharing plan (for self-employed individuals this is also referred to as a Keogh plan) or SEP up to a maximum of $49,000. The effective contribution rate for these plans cannot exceed 20 percent of your net earnings from self-employment; only net earnings from self-employment up to $245,000 can be taken into account in figuring your contribution. Example You are a consultant working alone and file a Schedule C to report your net earnings from self-employment. In 2009, you net $200,000 and set up an SEP to contribute the maximum. Your deductible contribution for 2009 is $40,000 (20% of $200,000). If you had earned $245,000 or more, you could have contributed $49,000, the maximum amount allowed for 2009.

If you use a 401(k) or SIMPLE plan, you can make both elective deferrals and employer contributions on your own behalf even though you are not an employee or your employer. Elective deferral limits for 401(k) plans and SIMPLE plans are explained in Chapter 1.

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If you have employees, you may have to make contributions on their behalf (depending on their eligibility to participate); these contributions are deductible as a business expense. For 2009, if you have a SEP, you’ll need to include employees who meet certain service and age requirements and earn at least $550 for the year (up from $500 in 2008). PLANNING

Contributions for yourself (not your employees) are entered as an adjustment to gross income. They do not reduce your net earnings subject to self-employment tax. However, small business advocates have been pushing for a change that would allow the deduction directly from your net earnings (the change could mean a tax savings of 15.3 percent of your contribution, the amount of selfemployment tax that would otherwise be due). You can make your retirement plan contributions up to the extended due date of the return for the year to which they relate (e.g., October 15, 2010, for a 2009 contribution if you’ve obtained a filing extension). However, to use this rule for a profit-sharing or other qualified retirement plan, the plan must have been opened (i.e., you signed the necessary paperwork) by the end of the year for which you are making contributions. With a SEP, you can both set up and fund the plan as late as the extended due date of the return.

Home Office Deduction If your home is your principal place of business or a place to regularly meet and deal with customers, clients, or patients in the normal course of your business, you may qualify for a home office deduction. As long as you use the space regularly and exclusively for business, expenses for the allocable portion of the space are added together to make a home office deduction. There have been proposals to create a standard home office deduction instead of figuring the actual costs allocable to your home office space. One proposal pending in Congress when this book went to press was a standard home office deduction of $1,500 annually.

Incentives for Hiring New Employees If you own a business and have people working for you, the tax law encourages the hiring of certain workers by allowing you to take a tax credit for a portion of

INCENTIVES FOR HIRING NEW EMPLOYEES

their wages. The type of credit depends on who you hire and where your business is located.

Work Opportunity Credit The work opportunity credit is designed to encourage the employment of workers from certain targeted groups, such as former felons and those who are economically disadvantaged. The credit is generally up to 40 percent of a targeted employee’s first-year wages up to $6,000 for those who work at least 400 hours. For 2009 and 2010, there are two new targeted groups: • Unemployed veterans discharged from active duty within five years of being hired by you and who received unemployment compensation for not less than four weeks during the one-year period prior to the hiring date. • Disconnected youths at least age 16 but under age 25 who lack education (have not attended any high school, technical school, or postsecondary school during the six-month period ending on the hiring date) and basic skills. An eligible youth is someone who has not been regularly employed during the six-month period prior to the hiring date.

Empowerment Zone and Renewal Community Employment Credit This credit helps employers who hire workers for a business located within an empowerment zone or a renewal community as long as the workers also live in the zone. These areas are economically challenged and have received special designation from the federal government. The credit is 20 percent of empowerment zone wages up to $15,000 or 15 percent of renewal community wages up to $10,000. Empowerment zones and renewal communities are listed in the instructions to Form 8844, Empowerment Zone and Renewal Community Employment Credit, or at www.hud.gov/crlocator. The credit is set to expire at the end of 2009 unless Congress extends it.

D.C. Enterprise Zone The credit is the same as the empowerment zone employment credit except that workers can live anywhere in the District of Columbia. The credit is set to expire at the end of 2009 unless Congress extends it.

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Indian Employment Credit This credit is for hiring a worker who lives on or near a reservation. The credit is 20 percent of the excess of the current qualified wages and qualified employee health insurance costs (not to exceed $20,000) over the sum of the corresponding amounts that were paid or incurred during the calendar year of 1993 (yes, this isn’t a typo). The credit is set to expire at the end of 2009 unless Congress extends it.

Wage Differential Payments Credit While not a credit to induce hiring, it is a reward for small employers who continue to pay some or all of a worker’s wages when he or she is called to active duty for a period of more than 30 days. The credit is new for 2009 and applies only for wage differential payments made after 2008 and before 2010 (i.e., only in 2009). It applies only to businesses that regularly employ fewer than 50 employees. The business must adopt a written plan for making wage differential payments. The credit is 20 percent of the first $20,000 of qualified differential wage payments made to each qualified employee. Again, the credit applies only to eligible payments made in 2009, unless Congress extends this break.

Meal Allowance for Day Care Providers If you care for children or others in your home, you can deduct the actual cost of providing meals and snacks to them. Alternatively, you can use a standard food program reimbursement rate set by the U.S. Department of Agriculture. The rates in effect for 2009 can be found in Table 7.4. The rates for 2010 can be found in Table 7.5. Knowing these rates in advance can help you set your fees for day care services in 2010. TABLE 7.4

Food Rates for Day Care Providers for 2009

Location

Breakfast

Lunch/Supper

Snacks

Continental U.S. Alaska Hawaii

$1.17 1.86 1.36

$2.18 3.53 2.55

$0.65 1.05 0.76

ENERGY CREDITS

TABLE 7.5

Food Rates for Day Care Providers for 2010

Location

Breakfast

Lunch/Supper

Snacks

Continental U.S. Alaska Hawaii

$1.19 1.89 1.38

$2.21 3.59 2.59

$0.66 1.07 0.77

PLANNING

Keep good records of the food you provide (without itemizing allocations for each individual in your care). You can deduct up to one breakfast, one lunch, one supper, and three snacks per day per child or other person, if your records show that you serve them.

Qualified Disaster Costs If your business suffered property damage because of an event declared to be a federal disaster, you may qualify for special tax treatment. Instead of capitalizing certain costs related to a federally declared disaster, you can opt to deduct (i.e., expense) the costs when they are paid or incurred. This election applies to disasters declared after December 31, 2007, and before January 1, 2010. Expenses eligible for this deduction include costs for the abatement or control of hazardous substances released on account of the disaster, the removal of debris from structures or the demolition of structures damaged by the disaster, and the repair of business-related property damaged by the disaster. This expensing deduction effectively is treated as a depreciation allowance because it reduces the basis of the property and is subject to recapture when the property is sold or otherwise disposed of.

Energy Credits There are several business-related energy credits to which you may be entitled. The credits are highly complex, so you may need the help of an energy expert. The energy credits are subject to the general business credit limitations discussed earlier in this chapter (see the section Plug-In Electric Vehicles earlier in this chapter).

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Employment Tax Returns If you have an employee (even if you’re the only employee of your corporation), you are required to file certain federal and state returns for employment taxes. The type of return depends on your firm’s size and the taxes involved. Federal employment tax returns include: • Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return. • Form 941, Employer’s Quarterly Federal Tax Return. • Form 943, Employer’s Annual Federal Tax Return for Agricultural Employees. • Form 944, Employer’s Annual Federal Tax Return.

Amended Returns If you discover an error in your federal quarterly employment tax return, you can correct the error using Form 941-X, Adjusted Employer’s Quarterly Federal Tax Return or Claim for Refund. For small employers who file an annual return, Form 944, use Form 944-X, Adjusted Employer’s Annual Federal Tax Return or Claim for Refund, to adjust errors. Employers of farm workers use Form 943-X, Adjusted Employer’s Annual Federal Tax Return for Agricultural Employees or a Claim for Refund, to adjust errors on a previously filed Form 943. If you discover an error on Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return, there is no special amended return to correct errors. Simply file a new Form 940 and check the box marked “Amended Return.”

CHAPTER 8

Planning Opportunities for Estate, Gift, and Generation-Skipping Transfer Taxes hile much of the focus of this book has been on income taxes, don’t ignore the other taxes that may affect your financial picture. These include estate, gift, and generation-skipping transfer taxes. In 2009, there have been dramatic changes affecting each of these taxes, which are levied on transferring wealth. This chapter explains the changes in these transfer taxes for 2009 and what may lie ahead. This area of tax law is about to experience additional changes that will certainly affect your estate planning for years to come. There may also be state estate or inheritance taxes to deal with; they are not covered in this chapter. This chapter also covers the modified carryover basis rules that are set to take effect for property inherited after 2009.

W

Estate Tax Changes If your property (called your estate) at the time of your death is worth a certain amount, you probably have to file a federal estate tax return and your estate may owe federal estate taxes. If you’re married, you can arrange it so that the estate tax may be postponed until the death of whichever spouse dies second, but eventually some transfer tax will be paid if the value of assets remaining at the death of the second spouse exceed a certain amount.

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PLANNING OPPORTUNITIES

Exemption Amount How rich do you have to be in order to be concerned about the federal estate tax? That figure increased dramatically in 2009. For 2009, there is no federal estate tax if your estate is valued at no more than $3.5 million (up from $2 million in 2008). This exemption is accomplished by permitting your estate to claim a credit (called the unified credit) against the tax liability that effectively exempts $3.5 million from tax. Thus, in 2009, the tax credit reflecting the $3.5 million exemption amount is $1,455,800; this compares with a tax credit for the $2 million exemption amount in 2008 of $780,800. In 2010, as the law stands at the time this book was published, there is no exemption amount because there is no federal estate tax. The estate of anyone dying in 2010, whether he or she is a billionaire or a middle-income person, is entirely free of federal estate tax. (Many expect that the 2009 rules, including the $3.5 million exemption amount, will be extended for 2010.) Starting in 2011, the old federal estate tax rules that had applied prior to the Economic Growth and Tax Relief Reconciliation Act of 2001 are scheduled to reappear. However, it is highly likely that before 2011 (and perhaps even for 2010), Congress will change the estate tax rules. A likely but not yet certain scenario is a generous exemption amount, $3.5 million or more, which could be indexed annually for inflation. PLANNING

The increase in the exemption amount can affect you in one of two ways—either you no longer need to be concerned with federal estate tax because your assets are below the increased taxable threshold or you can pass on a greater amount without the imposition of federal estate tax. But don’t be too quick to dismiss the federal estate tax out of hand because you think the rules don’t apply to you—your estate may be larger than you think. In adding up your estate, be sure to consider all your assets, including your IRAs and retirement benefits and any inheritances you may come into. By making a thorough inventory of your assets (based on their present value), you’ll get a better idea of whether you should be planning to reduce your federal estate tax liability or whether you’re home free. Just remember that things can change—you may think you’re currently exempt from worrying about the federal

ESTATE TAX CHANGES

estate tax, but if you come into money (for example, an insurance settlement, lottery winnings, or an inheritance), you may then find yourself vulnerable to the federal estate tax. Or if the value of your assets rises (for example, the stock market recovers and increases the value of your stocks and stock mutual funds held both personally and in retirement accounts), again you may find that the size of your estate is large enough to fall victim to estate tax—or at least there is a need to plan to minimize or avoid it. Until now, a common estate planning strategy for married couples with sufficient assets to be subject to the federal estate tax was to set up a credit shelter or bypass trust so that the exemption amount could be fully used in the estate of the first spouse to die. It worked like this: A will provided that a credit shelter trust (also called a bypass trust) would be created with an amount equal to the maximum exemption amount. The surviving spouse would be named as the income beneficiary of that trust, enjoying income for life (and some principal if necessary to maintain the surviving spouse’s lifestyle), with assets of the trust passing at the surviving spouse’s death to other named beneficiaries (typically the couple’s children). Assets in excess of the exemption amount placed in the trust would pass outright to the surviving spouse (or through a qualified terminable interest trust, or QTIP). Result: At the death of the first spouse there would be no estate tax—the assets passing directly to the surviving spouse would be shielded by the marital deduction and the assets passing into the credit shelter trust would be shielded by the exemption amount. At the death of the surviving spouse, the assets in the trust would not be included in her estate—they pass directly (untaxed) to the named beneficiaries. If your existing will or a trust contains a formula clause for funding a credit shelter or bypass trust based on the maximum federal exemption amount or maximum unified credit, you may wish to revise these documents. You may be passing on to that trust more than you intended to the detriment of other heirs. For example, if your estate is $3.7 million and you die in 2009 with an old will providing for a credit shelter trust based on the maximum exemption amount ($3.5 million), almost the entire estate will be in that trust—this may be more than you’d envisioned. Discuss with your tax or legal adviser new ways to limit the amount of assets passing into a credit shelter or bypass trust. For example, you may wish to limit the funding of a credit shelter trust to a set dollar amount or a percentage of the estate or some combination of these two limits.

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Most important, you’ll need to build sufficient flexibility into your documents to allow for changes after 2009. The exemption amount after 2009 may be smaller, larger, or the same as in 2009, and you’ll want to be able to take advantage of whatever the exemption amount may be without adversely affecting charitable bequests and other heirs.

Miscellaneous Estate Tax Changes There are a number of changes that can affect the computation of the federal estate tax. Some of these changes are minor or merely technical in nature, but others can have a significant impact on the amount of taxes that will be paid by an estate.

Special Use Valuation If an estate includes a farm or property used in a business, it can be valued for estate tax purposes at its special use rather than at its highest and best use (assuming certain conditions are met). However, the reduction in the size of the gross estate through special use valuation cannot exceed a set dollar amount. For 2009, the limit has increased to $1 million (up from $960,000 in 2008).

Interest on the Portion of the Estate Tax Payable in Installments Certain estates can qualify to pay federal estate in installments over 14 years. This payout option is designed to permit estates heavily comprised of business interests to avoid liquidating those interests (often at fire sale prices) to pay the estate tax. If the estate is eligible and elects this installment payment option, then a portion of the federal estate tax is subject to a favorable interest rate of only 2 percent. The dollar amount used to determine the 2 percent portion increased in 2009 to $1,330,000 (up from $1,280,000 in 2008). As a result, the maximum amount of tax that can be deferred at 2 percent interest increases to $598,500 in 2009, up from $576,000 in 2008.

Gift Tax Changes You probably know that giving or receiving a gift has no impact for income taxes. Someone can give you a small birthday gift or $1 million and you won’t pay any income tax on the gift; the giver doesn’t pay any income taxes, either.

GIFT TAX CHANGES

Gift tax, however, is another story. Gift tax is a tax that can be imposed on the giver (called the donor). More than a quarter of a century ago, the federal estate and gift taxes were unified, meaning they were subject to the same tax rates and the same exemption amount. Then, starting in 2002, they were decoupled, so that different rates and exemption amounts apply. Looking ahead, beyond 2010 (or possibly in 2010 if Congress takes action), the estate and gift taxes could again be unified, but no one knows for sure yet.

Annual Gift Tax Exclusion Each year you can give away a set amount to as many people as you choose without any gift tax—without even having to file a gift tax return, if the gift to each person does not exceed an annual exclusion amount. In 2009, the annual exclusion has been increased to $13,000 per beneficiary (up from $12,000 per beneficiary in 2008). Thus, you can give away $13,000 to as many people as you wish. If you keep all of your gifts under the annual exclusion amount, you don’t even have to tell the IRS about them; no gift tax return is required in this case. The annual exclusion remains $13,000 in 2010. Example In 2009, you give each of your four grandchildren $13,000 cash. Your gifts totaling $52,000 are gift tax free.

Married couples can agree to make split gifts, thereby doubling the annual gift tax exclusion. In other words, together they can give any person $26,000 in 2009—even if the gifted money or property is owned by one spouse. However, if split gifts are made, a gift tax return must be filed—even though no tax is due. Example In 2009, a husband gives each of his four grandchildren $26,000 in cash. His gifts total $104,000. If his wife agrees to split the gifts, even though they were made with his money, there is no gift tax. The couple, however, must file a gift tax return to report the split gifts.

For purposes of the annual exclusion, gifts of property are based on the value of the property on the date of the gift. For example, if you give shares of XYZ

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stock to your child on December 1, 2009, determine their value on December 1 (not what you paid for the stock) to see if the value of the shares is no more than the annual exclusion.

PLANNING

If you can give away cash or property without any concern that the transfer may impact your standard of living today or in the future, you may wish to adopt a gifting program as a means of benefiting your loved ones today, saving income taxes, and cutting your future estate taxes. Consider these strategies: • You can make an unlimited amount of direct payments to a school or medical provider for the same beneficiary. For example, you can give your grandchild $13,000, and also pay his college tuition of $30,000 by writing a check directly to the college. • You can fund a beneficiary’s 529 plan using five times the annual gift tax exclusion, or $65,000, in 2009. This gift is treated as having been made to the beneficiary in equal amounts over five years, so no additional gift can be made to the same beneficiary within the five-year period if your 529 plan contribution is $65,000 or more. • You can shift income to family members in a lower tax bracket to save taxes for the family. For example, if you are in a tax bracket of 25 percent or higher but your elderly parent is in the 10 percent or 15 percent tax bracket, a transfer of dividend-paying stock or mutual fund shares can enable your parent to receive the dividends tax free. If you hold appreciated property, such as a stock or bond, rather than giving cash gifts, consider giving the property to such relative. Again, a sale of the appreciated property will result in tax-free income for the relative in the 10 percent or 15 percent tax bracket. • You can combine the annual gift tax exclusion with your lifetime exemption amount (explained next). Thus, even though an annual gift exceeds the exclusion, it does not necessarily mean that you’ll owe any gift tax. • Charitable donations you make are not subject to gift tax, regardless of your income or whether you itemize deductions for income tax purposes.

GENERATION-SKIPPING TRANSFER TAX CHANGES

The exclusion is a use-it-or-lose-it break; you cannot bank the exclusion for a later year. If you give only $5,000 in 2009, for example, you can’t add the unused $8,000 of the exclusion to your 2010 exclusion.

Lifetime Gift Tax Exemption Amount You may give away in your lifetime a set amount without any gift tax. For 2009, the gift tax exemption amount is $1 million (the same exemption amount that applied in 2008 and is set to apply in 2010). It is not indexed for inflation. The exemption amount translates into a tax credit of $345,800.

Gifts to Non-U.S. Citizen Spouses While gifts to spouses who are U.S. citizens can be made in any amount—there is no percentage or dollar limit—a dollar limit is imposed on transfers to non–U.S. citizen spouses (including spouses who are permanent U.S. residents). In 2009, the limit increases to $133,000, up from $128,000 in 2008. The 2010 limit is in Appendix B.

Generation-Skipping Transfer Tax Changes Wealthy individuals whose children don’t need an inheritance to improve their standard of living may give their money directly to their grandchildren, skipping over the intervening generation of the children. This strategy effectively saves estate tax on one generation (the children’s generation), allowing grandchildren to inherit more property on an after-tax basis. However, making a generationskipping transfer—from grandparent to grandchild—may result in a special transfer tax, called the generation-skipping transfer (GST) tax. The GST tax is a way for the government to collect the revenue that is otherwise lost by avoiding estate tax on the skipped generation. The GST tax is imposed in addition to any other transfer tax (estate or gift tax). While the basic GST rules remain unchanged for 2009, the exemption amount is different for 2009.

GST Exemption Amount The exemption amount that can be transferred across the generations without imposition of the GST tax is the same as the estate tax exemption amount. This means the GST exemption for 2009 is $3.5 million, up from $2 million in 2008.

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As in the case of the estate tax, there is no GST exemption amount for 2010 because there is no GST set for 2010. However, if the rules for the estate tax are changed for 2010, the rules for GST likely will be changed as well in tandem with the estate tax changes.

Modified Carryover Basis Rule When you inherit property from someone who dies before 2010, you receive a “stepped-up basis.” This means that the basis you use for determining gain or loss when you sell the inherited property is the value of the property on the date of the person’s death (if the person’s estate files an estate tax return, it’s the value used for estate tax purposes). The person who dies is called a “decedent.”

Example In 2009, your aunt dies, leaving you 100 shares of X Corp. On the date of her death, the shares were worth $100 each; she paid $20 each for them. Your inheritance has a total basis of $10,000 (your basis is “stepped up” to the value on the date of death). If you sell all the shares, no one—not your aunt, her estate, or you—will ever pay tax on the appreciation she had on her stock purchase during her life.

For heirs and beneficiaries of people who die after 2009, the basis rules are set to change. Instead of stepping up the basis to the value at the time of death, there is a modified carryover basis. Those who inherit property take over the decedent’s basis, with certain modifications. In the example above, you would use your aunt’s $20 per share basis and pay capital gains tax on the $80 per share appreciation when you sell (assuming the modification explained below does not apply). Here’s where the modification comes in. The carryover basis rule applies only to assets above $3 million inherited by the U.S. citizen-spouse of the person who died (for spouse who is not a U.S. citizen, the step up is much smaller) and assets of more than $1.3 million that are inherited by anyone other than the surviving spouse. The basis of an asset in most situations can be increased by unused capital losses, net operating losses, and certain “built-in” losses, but not

MODIFIED CARRYOVER BASIS RULE

above the asset’s fair market value. The old stepped-up basis rule continues to apply to inheritances below these limits. Here are the types of property subject to the modified carryover basis rule: • Property acquired by bequest, devise, or inheritance. • Property acquired from a decedent’s estate. • Property transferred by the decedent during his or her lifetime to a revocable living trust. • Property transferred by a decedent during his or her lifetime to a trust in which he or she had the right to income for life and reserved the right at all times before death to make changes to the enjoyment of the trust through the exercise of a power to alter, amend, or terminate the trust. • Property passing from the decedent by reason of his or her death without any payment on the part of the recipient (e.g., property passing to a joint tenant under rights of survivorship. • The surviving spouse’s one-half interest in community property (for those in community property states).

Here are the types of property that are not eligible for a step up: • Property obtained by the decedent as a gift within three years of death. • Property that is income in respect of a decedent (income earned by the decedent before death but was paid after death). • Stocks or other securities in foreign personal holding companies.

For estates small enough to be fully covered by the stepped-up basis amount ($4.3 million for a decedent who was married to a U.S. citizen-spouse at the time of death), the old stepped-up basis rules essentially continue to apply. Thus, the heir of a decedent with a $1 million estate comprised of securities would receive a stepped-up basis for all of these securities. For estates that are above the limits for the stepped-up basis amount, it will usually be up to the executor to select the assets that will receive a stepped-up basis; assets not selected for the step up will have a carryover basis. For jointly-owned property, only the portion of the property that would be included in the decedent’s estate is eligible for any step up. For example, if a husband and wife jointly own a vacation home, one half of the property can

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be stepped up (the survivor uses his or her own basis for the other half). For property jointly owned with anyone other than a spouse, the portion of the property that the decedent paid for is eligible for a step up. PLANNING

Many tax professionals believe that the modified carryover basis rule will be repealed before it has a chance to become effective. Congress had enacted a carryover basis rule that was to apply for property inherited from a decedent after 1976, only to be postponed several times and finally repealed less than two years after the rule was to have taken effect. If that is so, then all the information in this section can be ignored; however, Congress has not yet mentioned (much less enacted) repeal at the time this book went to press, so planning is advisable. If the rule is allowed to become effective, what does this mean? For heirs of modest estates, nothing will change; these heirs will continue to use a steppedup basis. For wealthier individuals passing more than the limits described above, the modified carryover basis rule will herald a new age of planning. The executor will have to select assets for the step-up. Heirs who inherit property that has declined in value since it was acquired by the decedent will be able to obtain deductible tax losses. Good records will be required for heirs so they can obtain some basis for their inheritances. If, in the example above, the aunt passes more than $1.3 million to heirs (none of whom are her husband) so that the carryover basis rule applies, you would have no basis unless you had records to show the aunt’s basis (usually what she paid for the property) was available to you.

APPENDIX A

Expiring Laws

ccording a report from the Joint Committee on Taxation, there are 73 provisions expiring in 2009 and 40 set to expire in 2010. Many of the provisions are expected to be extended as they have been in the past. Some may be extended unchanged, whereas others may be extended with modifications. Here are some of the key provisions to note, their expiration dates, and the likelihood of action so you can include these provisions in your tax plans.

A

Provisions for Individuals Income and Exclusions Tax rate on long-term capital gains and qualified dividends. The favorable rates of 15 percent (zero on taxpayers in the 10 percent or 15 percent tax bracket) expire at the end of 2010. The likelihood of an extension is small. Expiration date: December 31, 2010. Suspension of the required minimum distribution (RMD) rule. The requirement to take minimum distributions, which was suspended in 2009, could be extended for another year, but this is not certain. Expiration date: December 31, 2009.

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EXPIRING LAWS

Individual retirement account (IRA) rollover to charity for those 701/2 and older. The opportunity to transfer up to $100,000 per year to charity and avoid taxation is likely to be extended. Expiration date: December 31, 2009. Exclusion for unemployment benefits. The exclusion for up to $2,400 of unemployment benefits could be extended if unemployment remains high. Expiration date: December 31, 2009. Transportation benefits. The parity for monthly transit passes with free parking could be extended. Expiration date: December 31, 2010. Exclusion for benefits to emergency responders. The exclusion for property tax breaks received by volunteer firefighters and emergency medical responders could be extended. Expiration date: December 31, 2010. Exclusion for 529 plan distributions for computer technology. The exclusion for disbursements from 529 plans to pay for computer technology and equipment could be extended. Expiration date: December 31, 2010.

Adjustments to Gross Income IRA contributions by employees of bankrupt companies. It is unclear whether the additional $3,000 contribution limit will be extended. Expiration date: December 31, 2009. Deduction for educator costs. The $250 above-the-line deduction for out-ofpocket costs by primary and secondary school teachers is likely to be extended. Expiration date: December 31, 2009. Deduction for tuition and fees. This above-the-line deduction up to $4,000 is likely to be extended. Expiration date: December 31, 2009.

Itemized Deductions Premiums for mortgage insurance. The treatment of mortgage insurance premiums as deductible mortgage interest is likely to be extended. Expiration date: December 31, 2010. Deduction of state and local general sales taxes. The option to itemize these taxes in lieu of state and local income taxes is likely to be extended. Expiration date: December 31, 2009.

PROVISIONS FOR INDIVIDUALS

Tax Computation (Including Standard Deduction) Tax brackets. The 10 percent bracket is set to expire at the end of 2010. The top two tax brackets of 33 percent and 35 percent are set to revert to their former limits of 36 percent and 39.6 percent. While the 10 percent bracket may be retained, it is unlikely that the higher two brackets will be retained at their current levels. Expiration date: December 31, 2010. Additional standard deduction for state and local property taxes. The deduction of up to $500 ($1,000 on a joint return) is likely to be extended. Expiration date: December 31, 2009. Deduction for state and local sales and excise tax on the purchase of a motor vehicle. This deduction could be extended as a way to spur new car sales. Expiration date: December 31, 2009.

Tax Credits Making Work Pay credit. The $400 ($800 on a joint return) credit for workers was created to stimulate the economy. Whether the credit will run beyond 2010 depends on the state of the economy at that time. Expiration date: December 31, 2010. First-Time Homebuyer credit. The $8,000 credit applies only to primary residences purchased before December 1, 2009. As long as the housing market remains depressed, it is likely that Congress will extend the credit. There have been proposals to increase the credit limit and to allow the credit for the purchase of any residence, including vacation homes. Expiration date: November 30, 2009. D.C. home buyer credit. The special credit for first-time home buyers in the District of Columbia is likely to be extended. Expiration date: December 31, 2009. American Opportunity tax credit. This credit of up to $2,500 for tuition and other qualified expenses for the first four years of higher education replaced the Hope credit for two years; it could become a permanent replacement. Expiration date: December 31, 2010. Home energy improvements. The credit for adding insulation, storm windows, and certain other approved property to a main residence could be extended, but this is not certain. The credit had been allowed to lapse for 2008. Expiration date: December 31, 2010.

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EXPIRING LAWS

Earned income credit. The enhanced credit for those with three or more qualifying children, as well as marriage penalty relief, could be extended. Expiration date: December 31, 2010. Enhanced credit for health insurance costs of certain individuals. The increased credit amount could be extended, but this is not certain. Expiration date: December 31, 2010.

Other Taxes Alternative minimum tax (AMT). The 2009 exemption amounts may be increased or adjusted for inflation in 2010 and possibly 2011. Congress is looking for a more permanent fix to the AMT problem, but will certainly provide some relief until the fix is done. Also, the ability to offset both regular tax and AMT with nonrefundable credits will also likely be extended. Expiration date: December 31, 2009. Estimated taxes. The safe harbor rule exception for small business owners applies only for 2009. It is unclear whether Congress will extend this break. Expiration date: December 31, 2009. Estate, gift, and generation-skipping transfer taxes. The estate tax is scheduled to disappear for 2010; previous rules are set to reapply in 2011. It is likely that Congress will act to make changes before the expiration date. Many expect the 2009 rules to be extended through 2010 (so that there is an estate and generation-skipping transfer tax for 2010 for those above the $3.5 million exemption amount). What will happen in 2011 is unclear but expect that changes will be made. Expiration date: December 31, 2010.

Provisions for Businesses Deductions Bonus depreciation. The 50 percent first-year allowance could be extended, but this is far from certain. Expiration date: December 31, 2009. First-year expensing. The $250,000 limit could be extended; if it is not, then the former $125,000 limit adjusted for inflation will reapply. Expiration date: December 31, 2009. Enhanced charitable contribution deductions. Higher write-offs for donations of books, food, and computer equipment could be extended as they have been in the past. Expiration date: December 31, 2009.

PROVISIONS FOR BUSINESSES

Expensing of environmental remediation costs. The ability to deduct such costs rather than amortize them is likely to be extended as it has been in the past. Expiration date: December 31, 2009. Five-year depreciation for farming business equipment and machinery. It is unclear whether this break will be extended. Expiration date: December 31, 2009. Fifteen-year recovery for qualified leasehold, restaurant, and retail improvements. This faster write-off is likely to be extended as it has been several times in the past. Expiration date: December 31, 2009.

Tax Credits Research credit. This credit for businesses to increase research activities has been subject to perennial extensions and modifications. Many are calling for action to make the credit permanent so businesses can plan ahead. Expiration date: December 31, 2009. Indian employment credit. This break for hiring workers on Indian property has been extended several times and is likely to be extended again. Expiration date: December 31, 2009. Work opportunity credit. This incentive to hire the targeted groups of unemployed veterans and disconnected youth could be extended. Expiration date: December 31, 2010. New markets credit. This credit for equity investments in qualified community development entities is likely to be extended. Expiration date: December 31, 2009. Employer wage credit for activated military reservists. This credit for making wage differential payments to these military personnel is likely to be extended as long as military deployments continue. Expiration date: December 31, 2009. Credit for building energy-efficient homes. In view of the Obama administration’s support of green efforts, this credit is likely to be extended. Expiration date: December 31, 2009.

Other Business Breaks Basis of S corporation stock for charity donations. The favorable basis adjustment to the stock for property donations could be extended as it has been in the past. Expiration date: December 31, 2009.

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Empowerment zone and renewal community breaks. A number of breaks, including an additional first-year expensing limit, an employment credit, and an exclusion of gain for empowerment zone business stock, could be extended, but this is not certain. Expiration date: December 31, 2009. District of Columbia breaks. A number of breaks, including designation as an enterprise zone qualifying for the employment credit and increasing expensing, could be extended. Expiration date: December 31, 2009. Reduced estimated tax for small business owners. The lower estimated tax payment requirement for 2009 could be extended for 2010, but this is uncertain. Expiration date: December 31, 2009.

APPENDIX B

2010 Inflation Adjustments

ore than two dozen tax items can be adjusted annually to reflect increases in inflation. The measuring period for most of these inflation adjustments ends of August 31. This year’s inflation adjustment period ending August 31, 2009, had only a very modest increase of 0.19%; this compares to 4.26% for the period ending August 31, 2008. The following amounts are not the official figures, which the IRS had not released by the time this book went to press. However, the adjustments are based on statutory guidelines that the IRS must follow. The adjustments are laid out for you in the order of the chapters to which they relate.

M

Chapter 1: New Rules for Income and Exclusions Elective Deferrals The maximum employee contribution that can be made via elective deferrals can be adjusted annually for inflation based on cost-of-living data ending at the end of the third quarter (September 30). At the time this book when to press, there were indications that the $16,500 elective deferral limit for 2009 could be reduced in 2010. The same could be true for elective deferrals under SIMPLEs.

147

148

2010 INFLATION ADJUSTMENTS

Transportation Fringe Benefits While the IRS has the authority to adjust the exclusion amounts for free parking, transit passes and van pooling, there is no adjustment for 2010. The exclusion for transportation fringe benefits in 2010 remain the same as 2009: $230 per month for free parking, transit passes, and commuter van pooling. The exclusion for bicycling cannot be adjusted for inflation; it remains at $20 per month.

Foreign Earned Income Exclusion Income earned abroad can be excluded by those who meet certain foreign residency tests. The exclusion in 2010 will be $91,500 (up from $91,400 in 2009). The foreign earned income housing exclusion, which is based on the foreign earned income exclusion, will be $27,450 in 2010 (up from $27,420 in 2009). Higher exclusion amounts apply to certain high-cost areas.

Interest on Savings Bonds Interest on U.S. savings bonds (Series EE and I) redeemed to pay qualified higher education costs is tax free for those with modified adjusted gross income below a set level. The level and the phaseout range for 2010 has been adjusted for inflation. The exclusion for interest on savings bonds will be phased out for married couples filing jointly in 2010 with modified adjusted gross income (MAGI) between $105,100 to $131,100 (up from $100,650 to $130,650 in 2009). For singles, the phaseout range is $70,100 to $85,100 for singles (up from $69,950 to $84,950 in 2009).

Exclusion of Benefits Paid from Long-Term Care Policies Payments under a long-term care policy at a fixed daily dollar amount can be excluded up to a dollar limit. The per diem exclusion for long-term insurance proceeds in 2010 is $290 per day (up from $280 in 2009).

Exclusion for Accelerated Death Benefits Payments from a life-insurance policy to an insured who is chronically ill can be excluded up to a dollar limit per day. The daily exclusion amount for life

CHAPTER 2: CHANGES IN FIGURING YOUR ADJUSTED GROSS INCOME

insurance proceeds used for long-term care needs in 2010 is $290 per day (up from $280 in 2009).

Chapter 2: Changes in Figuring Your Adjusted Gross Income Individual Retirement Accounts Individuals who are active participants in a qualified retirement plan can make tax-deductible IRA contributions only if their modified adjusted gross income (MAGI) is below set limits; a partial deduction is allowed for those with MAGI within a phaseout range. A full IRA deduction of up to $5,000 ($6,000 if at least 50 years old by December 31, 2010), is allowed if MAGI does not exceed $1657,000 for joint filers, and $56,000 for singles. The phaseout range for 2010 increases for joint filers to $167,000 to $177,000 (up from $166,000 to $176,000 in 2009). For singles, the phaseout range increases to $56,000 to $66,000 (up from $55,000 to $65,000 in 2009). Married persons filing separately have the same phaseout range in 2010 as they did in 2009: zero to $10,000.

Roth IRAs While the income limitation on making Roth IRA conversions in 2010 has been lifted (as explained in Chapter 1), there continues to be a modified adjusted gross income (MAGI) limit on adding new funds to a Roth IRA. The contribution amount for 2010 remains the same: $5,000 ($6,000 if at least 50 years old by December 31, 2010. A full Roth IRA contribution for 2010 is allowed if MAGI does not exceed $167,000 for joint filers or $105,000 for singles. The phaseout range for 2010 is $167,000 to $177,000 (up from $166,000 to $176,000 in 2009). For singles, the phaseout range is unchanged at $105,000 to $120,000. Married persons filing separately also have the same phaseout range from zero to $10,000.

Health Savings Accounts Increases to annual contributions as well as the definition of a high-deductible health plan for 2010 were announced early and can be found in Chapter 2.

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150


Archer Medical Savings Accounts Those who set up Archer MSAs prior to 2008 and who have not rolled the funds into a Health Savings Account can continue to make tax-deductible contributions to the plans in 2010. For self-only coverage, the term “high deductible health plan” will require an annual deductible of not less than $2,000 and not more than $3,000 (the same range as in 2009). The maximum out-of-pocket cannot exceed $4,050 (up from $4,000 in 2009). For family coverage, the term “high deductible health plan” will require an annual deductible of not less than $4,050 and not more than $6,050 (up from $4,000 to $6,000 in 2009). The maximum out-of-pocket cannot exceed $7,400 (up from $7,350 in 2009).

Student Loan Interest Deduction Those who are repaying student loans can deduct interest up to $2,500 in 2010 only if modified adjusted gross income (MAGI) does not exceed $60,000 for singles and $120,000 for joint filers. The deduction phases out for MAGI between $60,000 and $75,000 for singles, and between $120,000 and $150,000 for joint filers. These figures have not been increased from 2009.

Chapter 3: New Breaks for the Standard Deduction and Itemized Deductions Standard Deduction The standard deduction amounts for all filers other than heads of households remain unchanged from 2009. For singles and married persons filing separately, the exemption is $5,700; for married persons filing jointly and qualifying widow(er)s it is $11,400. For heads of households, the standard deduction increases to $8,400 (up from $8,350 in 2009).

Additional Standard Deduction Amounts The additional standard deduction amounts for taxpayers age 65 or older or blind remain unchanged at $1,400 for single taxpayers and heads of households and $1,100 for married persons, whether filing jointly or separately.

CHAPTER 4: NEW WAYS TO TRIM YOUR TAX COMPUTATION

A person who can be claimed as another taxpayer’s dependent will be able to claim a basic standard deduction equal to the greater of (1) $950 or (2) the dependent’s earned income plus $300 (but no more in total than the standard deduction for the dependent’s filing status). These amounts will not increase for 2010.

Long-Term Care Insurance The dollar amount of long-term care insurance that can be treated as a deductible medical expense in 2010 will range from $330 for those age 40 or younger to $4,110 for those over age 70 (in 2009, the range is $320 to $3,980).

Chapter 4: New Ways to Trim Your Tax Computation Personal and Dependency Exemptions The exemption amount for 2009 is $3,650; there will be no increase in the personal and dependency exemption amount for 2010. However, because of a law change, there is no phase-out of exemptions for high-income taxpayers starting in 2010; for 2009, high-income taxpayers can lose up to one-third of their exemptions.

Income Tax Brackets A modest inflation boost increases the tax brackets for all filers. For example, the 10% bracket will include taxable income in 2010 up to $8,375 for singles (up from $8,350 in 2009) and $16,750 for joint filers (up from $16,700 in 2009). The top bracket of 35% will apply to taxable income in 2010 over $373,650 for all filers other than married filing separately (up from $372,950 in 2009). Tables B.1 and B.2 show the tax bracket ranges for singles and joint filers. TABLE B.1

2010 Tax Brackets for Singles

Tax Bracket

Taxable Income

10% bracket 15% bracket 25% bracket 28% bracket 33% bracket 35% bracket

Not over $8,375 Over $8,375 but not over $34,000 Over $34,000 but not over $82,400 Over $82,400 but not over $171,850 Over $171,850 but not over $373,650 Over $373,650

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152


TABLE B.2

2010 Tax Brackets for Joint Filers

Tax Bracket

Taxable Income

10% bracket 15% bracket 25% bracket 28% bracket 33% bracket 35% bracket

Not over $16,750 Over $16,750 but not over $68,000 Over $68,000 but not over $137,300 Over $137,300 but not over $309,250 Over $209,250 but not over $373,650 Over $373,650

Chapter 5: New Credits to Cut Your Taxes Earned Income Credit The maximum amount of earned income taken into account in figuring the credit for 2010 increases slightly to $5,980 for a taxpayer with no qualifying child (up from $5,970 in 2009), $8,970 for a taxpayer with one qualifying child (up from $8,950 in 2009), and $12,590 for a taxpayer with two or more qualifying children (up from $12,570 in 2009). The phaseout of the earned income credit begins at $12,490 for joint filers with no child (up from $12,470 in 2009); for one or more qualifying child the phaseout starts at $21,460 (up from $21,420 in 2009). For taxpayers other than joint filers, the phaseout of the credit begins at $7,480 (up from $7,470 in 2009); for one more qualifying child the phaseout starts at $16,450 (up from $16,420 in 2009). The amount of investment income that a taxpayer can receive before losing the earned income credit remains unchanged at $3,100.

Child Tax Credit The child tax credit remains unchanged at $1,000 per eligible child. The credit can be refundable (payable even if it exceeds tax liability) to the extent of 15% of a set amount of earned income or, for taxpayers with three or more qualifying children, the excess of Social Security taxes for the year over earned income. For 2010, the earned income limit remains at $3,000.

Education Credits By statute, the American Opportunity credit in 2010 remains the same as in 2009: $80,000 to $90,000 for singles and $160,000 to $180,000 for joint filers.

CHAPTER 6: MONEY SAVING BREAKS FOR OTHER TAXES

TABLE B.3

Applicable Percentage for Retirement Savings Contribution Credit in 2010 Adjusted gross income

Joint filers

Heads of households

Other filers

Over

Not Over

Over

Not Over

Over

Not Over

Applicable %

$ 0 33,500 36,000 55,500

$33,500 36,000 55,500

$ 0 25,125 27,000 41,625

$25,125 27,000 41,625

$ 0 16,750 18,000 27,750

$16,750 18,000 27,750

50 20 10 0

The phaseout range for the Lifetime Learning credit could have been adjusted for inflation, but it remains the same in 2010: $50,000 to $60,000 for singles and $100,000 to $120,000 for joint filers.

Retirement Savers Credit Those who contribute to an IRA or 401(k) or similar plan may claim a tax credit of up to 10%, 20%, or 50% of $2,000 if their MAGI is below set amounts. The ranges for eligibility for these credit percentages have been increased slightly. The phaseout ranges are in Table B.3.

Adoption Credit The adoption credit increases slightly for 2010 to $12,170 (up from $12,150 in 2009). Those who adopt a child with special needs can claim the full amount without regard to their actual adoption costs. The phaseout range for the adoption credit also rises a bit in 2010 to $182,520 to $222,520 (up from $182,180 to $222,180 in 2009).

Chapter 6: Money Saving Breaks for Other Taxes Kiddie Tax The kiddie tax, which taxes a child’s unearned income over a set amount at the parent’s highest tax rate, remains unchanged for 2010. The threshold is $1,900 of unearned (investment) income.

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Chapter 7: Tax-Saving Changes for Small Businesses First-Year Expensing The cost of business equipment and machinery can be expensed in the year of purchase rather than depreciated over a number of years. The $250,000 expensing limit for 2009, which is set by a statute, expires. For 2010, the limit will be $134,000, which is a base amount of $125,000 as adjusted for inflation. The dollar limit on expensing is reduced dollar for dollar when purchases for the year exceed a set amount. The limit for 2010 is set to be $530,000 (it is $800,000 in 2009 because of a special law). In view of this threshold, a business will be unable to claim any first-year expensing deduction when equipment purchases in 2010 exceed $664,000. Caution: Congress is considering an extension of the 2009 limit.

High-Low Substantiation Rates The rates that can be used to substantiate employee business travel from October, 1, 2009, through September 30, 2010, have been increased slightly from the prior 12-month period. The rate for travel to any high-cost locality is $258 per day, which takes into account $65 a day for meals. The rate for travel to any other locality within the continental United States is $163 a day, which takes into account $52 a day for meals.

Meal Allowance for Day Care Providers Those who care for children in their homes can deduct a fixed dollar amount per meals and snacks rather than the actual cost of this food. The cost-ofliving increase to the dollar limits on breakfast, lunch/dinner, and snacks was announced previously and can be found in Chapter 7.

Chapter 8: Planning Opportunities for Estate, Gift, and Generation-Skipping Transfer Taxes Annual Gift Tax Exclusion The annual gift tax exclusion for 2010 will remain the same as in 2009: $13,000 per recipient.

CHAPTER 8: PLANNING OPPORTUNITIES FOR ESTATE

Gifts to Non-U.S. Citizen Spouses For gifts to a noncitizen spouse, the annual exclusion in 2010 will be $134,000 (up from $133,000 in 2009).

Gifts from Foreign Sources For a U.S. person receiving foreign gifts, if the aggregate for the year exceeds $14,165 in 2010, an information return must be filed; for 2009, the threshold was $14,139.

155

APPENDIX C

Other Forms and Worksheets

T

he following pages contain forms and worksheets referred to throughout the book. Exhibit C.1 Recapture of COBRA premium assistance for high-income taxpayers Exhibit C.2 Form 982 Reduction of Tax Attributes Due to Discharge of Indebtedness Exhibit C.3 Figuring Your Reduced IRA Deduction for 2009 Exhibit C.4 Schedule A Itemized Deductions Exhibit C.5 Schedule M Making Work Pay and Government Retiree Credits Exhibit C.6 Form 5405 First-Time Homebuyer Credit and Repayment of the Credit Exhibit C.7 Form 8863 Education Credits (American Opportunity, Hope, and Lifetime Learning Credits) Exhibit C.8 Form 5695 Residential Energy Credits Exhibit C.9 Form 4562 Depreciation and Amortization

157

158

OTHER FORMS AND WORKSHEETS

Recapture of COBRA Premium Assistance for Higher Income Taxpayers Keep for Your Records Instructions: Use the following worksheet to figure the taxable portion of your COBRA premium if your modified AGI (line 3 below) is more than $125,000 ($250,000 if married filing jointly) but less than $145,000 ($290,000 if married filing jointly).

1. Enter your AGI (Form 1040, line 38 or Form 1040NR, line 35) . . . . . . . . . . . 1. 2. Enter the total of any amounts from Form 2555, lines 45 and 50; Form 2555-EZ, line 18; and Form 4563, line 15, and any exclusion of income from American Samoa and Puerto Rico . . . 2. 3. Modified AGI. Add lines 1 and 2 . . . . . 3. 4. Enter $125,000 ($250,000 if married filing jointly) . . . . . . . . . . . . . . . . . . . . 4. 5. Subtract line 4 from line 3 . . . . . . . . . 5. 6. Enter $20,000 ($40,000 if married filing jointly) . . . . . . . . . . . . . . . . . . . . . . . . 6. 7. Divide line 5 by line 6. Enter the result as a decimal (rounded to at least 3 places) . . . . . . . . . . . . . . . . . . . . . . . 7. 8. Enter the amount of the COBRA premium assistance* you received in 2009 . . . . . . . . . . . . . . . . . . . . . . . . . 8. 9. Multiply line 8 by line 7. Enter result here and include it on Form 1040, line 60 or Form 1040NR, line 57. On the dotted line next to that line, enter the amount shown on line 9 and identify it as “COBRA.” . . . . . . . . . . . . . . . . . . . 9. *Contact your former employer or health insurance plan to obtain the total premium assistance, if unknown. EXHIBIT C.1 Recapture of COBRA premium assistance for highincome taxpayers


Form

982

(Rev. March 2009)

Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment)

Department of the Treasury Internal Revenue Service

Part I 1 a b c d e f 2 3

OMB No. 1545-0046 Attachment Sequence No.

Attach this form to your income tax return.

Name shown on return

General Information (see instructions)

Yes

No

Reduction of Tax Attributes. You must attach a description of any transactions resulting in the reduction in basis under section 1017. See Regulations section 1.1017-1 for basis reduction ordering rules, and, if applicable, required partnership consent statements. (For additional information, see the instructions for Part II.)

Enter amount excluded from gross income: 4 For a discharge of qualified real property business indebtedness, applied to reduce the basis of depreciable real property 5 That you elect under section 108(b)(5) to apply first to reduce the basis (under section 1017) of depreciable property 6 Applied to reduce any net operating loss that occurred in the tax year of the discharge or carried over to the tax year of the discharge 7 8

Applied to reduce any general business credit carryover to or from the tax year of the discharge Applied to reduce any minimum tax credit as of the beginning of the tax year immediately after the tax year of the discharge 9 Applied to reduce any net capital loss for the tax year of the discharge including any capital loss carryovers to the tax year of the discharge 10a Applied to reduce the basis of nondepreciable and depreciable property if not reduced on line 5. DO NOT use in the case of discharge of qualified farm indebtedness b Applied to reduce the basis of your principal residence. Enter amount here ONLY if line 1e is checked 11 For a discharge of qualified farm indebtedness, applied to reduce the basis of: a Depreciable property used or held for use in a trade or business, or for the production of income, if

4 5 6 7 8 9 10a 10b

11a

not reduced on line 5

b Land used or held for use in a trade or business of farming

11b

c Other property used or held for use in a trade or business, or for the production of income

11c

12

Applied to reduce any passive activity loss and credit carryovers from the tax year of the discharge

12

13

Applied to reduce any foreign tax credit carryover to or from the tax year of the discharge

13

Part III

94

Identifying number

Amount excluded is due to (check applicable box(es)): Discharge of indebtedness in a title 11 case Discharge of indebtedness to the extent insolvent (not in a title 11 case) Discharge of qualified farm indebtedness Discharge of qualified real property business indebtedness Discharge of qualified principal residence indebtedness Discharge of certain indebtedness of a qualified individual because of Midwestern disasters 2 Total amount of discharged indebtedness excluded from gross income Do you elect to treat all real property described in section 1221(a)(1), relating to property held for sale to customers in the ordinary course of a trade or business, as if it were depreciable property?

Part II

159

Consent of Corporation to Adjustment of Basis of Its Property Under Section 1082(a)(2)

Under section 1081(b), the corporation named above has excluded $ from its gross income for the tax year beginning , and ending . Under that section, the corporation consents to have the basis of its property adjusted in accordance with the regulations prescribed under section 1082(a)(2) in effect at the time of filing its income tax return for that year. The corporation is organized under the laws of . (State of incorporation)

Note. You must attach a description of the transactions resulting in the nonrecognition of gain under section 1081. For Paperwork Reduction Act Notice, see page 5 of this form.

EXHIBIT C.2

Cat. No. 17066E

Form

982

(Rev. 3-2009)

Form 982 Reduction of Tax Attributes Due to Discharge of Indebtedness

160


Figuring Your Reduced IRA Deduction for 2009

Keep for Your Records

(Use only if you or your spouse is covered by an employer plan and your modified AGI falls between the two amounts shown below for your coverage situation and filing status.) Note. If you were married and both you and your spouse contributed to IRAs, figure your deduction and your spouse’s deduction separately. Certain employer bankruptcies. See Catch-up contributions in certain employer bankruptcies earlier, for instructions to complete lines 4 and 6 of this worksheet.

AND your filing status is ...

IF you ... are covered by an employer plan

are not covered by an employer plan, but your spouse is covered

AND your modified AGI THEN enter on is over ... line 1 below ...

single or head of household

$55,000

$65,000

married filing jointly or qualifying widow(er)

$89,000

$109,000

married filing separately

$0

$10,000

married filing jointly

$166,000

$176,000

married filing separately

$0

$10,000

1. Enter applicable amount from table above . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1. 2. Enter your modified AGI (that of both spouses, if married filing jointly) . . . . . . . . . . . . . . . . . . . 2. Note. If line 2 is equal to or more than the amount on line 1, stop here. Your IRA contributions are not deductible. See Nondeductible Contributions. 3. Subtract line 2 from line 1. If line 3 is $10,000 or more ($20,000 or more if married filing jointly or qualifying widow(er) and you are covered by an employer plan), stop here. You can take a full IRA deduction for contributions of up to $5,000 ($6,000 if you are age 50 or older) or 100% of your (and if married filing jointly, your spouse’s) compensation, whichever is less . . . 3. 4. Multiply line 3 by the percentage below that applies to you. If the result is not a multiple of $10, round it to the next highest multiple of $10. (For example, $611.40 is rounded to $620.) However, if the result is less than $200, enter $200.

• Married filing jointly or qualifying widow(er) and you are covered by an employer plan, multiply line 3 by 25% (.25) (by 30% (.30) if you are age 50 or older).

• All others, multiply line 3 by 50% (.50) (by 60% (.60) if you are age 50 or older).

}

. . . . 4.

5. Enter your compensation minus any deductions on Form 1040, line 27 (one-half of self-employment tax) and line 28 (self-employed SEP, SIMPLE, and qualified plans); or on Form 1040NR, line 27 (self-employed SEP, SIMPLE, and qualified plans). If you are filing a joint return and your compensation is less than your spouse’s, include your spouse’s compensation reduced by his or her traditional IRA and Roth IRA contributions for this year. If you file Form 1040 or Form 1040NR, do not reduce your compensation by any losses from self-employment . . . . . . . . 5. 6. Enter contributions made, or to be made, to your IRA for 2009 but do not enter more than $5,000 ($6,000 if you are age 50 or older). If contributions are more than $5,000 ($6,000 if you are age 50 or older), see Excess Contributions, later. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6. 7. IRA deduction. Compare lines 4, 5, and 6. Enter the smallest amount (or a smaller amount if you choose) here and on the Form 1040, 1040A, or 1040NR line for your IRA, whichever applies. If line 6 is more than line 7 and you want to make a nondeductible contribution, go to line 8 . . . . . 7. 8. Nondeductible contribution. Subtract line 7 from line 5 or 6, whichever is smaller. Enter the result here and on line 1 of your Form 8606 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8.

EXHIBIT C.3

Figuring Your Reduced IRA Deduction for 2009


SCHEDULE A (Form 1040)

Itemized Deductions

Department of the Treasury Internal Revenue Service (99)

Attach to Form 1040.

OMB No. 1545-0074

Attachment Sequence No. 07 Your social security number

Name(s) shown on Form 1040

Medical and Dental Expenses Taxes You Paid (See page A-2.)

Interest You Paid (See page A-5.) Note. Personal interest is not deductible.

Gifts to Charity If you made a gift and got a benefit for it, see page A-7.

Caution. Do not include expenses reimbursed or paid by others. Medical and dental expenses (see page A-1) . . . . . 2 Enter amount from Form 1040, line 38 Multiply line 2 by 7.5% (.075) . . . . . . . . . . Subtract line 3 from line 1. If line 3 is more than line 1, enter -0- . State and local (check only one box): a Income taxes, or . . . . . . . . . . b General sales taxes 6 Real estate taxes (see page A-5) . . . . . . . . . 7 New motor vehicle taxes from line 11 of the worksheet on back. Skip this line if you checked box 5b . . . . . . 8 Other taxes. List type and amount 1 2 3 4 5

9 Add lines 5 through 8 . . . . . . . . . . . . . . 10 Home mortgage interest and points reported to you on Form 1098

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11 Home mortgage interest not reported to you on Form 1098. If paid to the person from whom you bought the home, see page A-6 and show that person’s name, identifying no., and address 11 12 Points not reported to you on Form 1098. See page A-6 for special rules . . . . . . . . . . . . . . . . 13 Qualified mortgage insurance premiums (see page A-6) . 14 Investment interest. Attach Form 4952 if required. (See page A-6.) 15 Add lines 10 through 14 . . . . . . . . . . . . . 16 Gifts by cash or check. If you made any gift of $250 or more, see page A-7 . . . . . . . . . . . . . 17 Other than by cash or check. If any gift of $250 or more, see page A-8. You must attach Form 8283 if over $500 . . . 18 Carryover from prior year . . . . . . . . . . . 19 Add lines 16 through 18 . . . . . . . . . . . . .

12 13 14 . . 16 17 18 . .

Casualty and Theft Losses 20 Casualty or theft loss(es). Attach Form 4684. (See page A-8.). . . . . . . . . Job Expenses 21 Unreimbursed employee expenses—job travel, union dues, job and Certain education, etc. Attach Form 2106 or 2106-EZ if required. (See Miscellaneous 21 page A-9.) Deductions 22 Tax preparation fees . . . . . . . . . . . . . 22 (See page A-9.)

Other Miscellaneous Deductions

2009

See Instructions for Schedule A (Form 1040).

20

23 Other expenses—investment, safe deposit box, etc. List type and amount 24 25 26 27 28

23 24 Add lines 21 through 23 . . . . . . . . . . . . 25 Enter amount from Form 1040, line 38 26 Multiply line 25 by 2% (.02) . . . . . . . . . . . Subtract line 26 from line 24. If line 26 is more than line 24, enter -0Other—from list on page A-10. List type and amount

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27

28

29 Is Form 1040, line 38, over $166,800 (over $83,400 if married filing separately)? Total No. Itemized Your deduction is not limited. Add the amounts in the far right column for lines 4 through 28. Also, enter this amount on Form 1040, line 40a. Deductions

29

Yes. Your deduction may be limited. See page A-10 for the amount to enter. 30 If you elect to itemize deductions even though they are less than your standard deduction, check here . . . . . . . . . . . . . . . . . . . For Paperwork Reduction Act Notice, see Form 1040 instructions.

EXHIBIT C.4

Schedule A Itemized Deductions

Cat. No. 17145C

Schedule A (Form 1040) 2009

161

162


Page 2

Schedule A (Form 1040) 2009

Worksheet for Line 7— New motor vehicle tax deduction

Use this worksheet to figure the amount to enter on line 7.

(Keep a copy for your records.)

Before you begin:

You cannot take this deduction if the amount on Form 1040, line 38, is equal to or greater than $135,000 ($260,000 if married filing jointly). See the instructions for line 7 that begin on page A-6.

1 Enter the state or local sales or excise taxes you paid in 2009 for the purchase of a new motor vehicle after February 16, 2009 . . . . . . . . . . . . . .

1

2 Enter the purchase price (before taxes) of the new motor vehicles

2

3 Is the amount on line 2 more than $49,500? No. Enter the amount from line 1. Yes. Enter the portion of the tax from line 1 that is attributable to the first $49,500 of the purchase price of each new motor vehicle (see instructions). 4 Enter the amount from Form 1040, line 38 .

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3

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5 Enter the total of any— ● Amounts from Form 2555, lines 45 and 50; Form 2555-EZ, line 18; and Form 4563, line 15, and ● Exclusion of income from Puerto Rico 6 Add lines 4 and 5 .

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6

7 Enter $125,000 ($250,000 if married filing jointly) .

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8 Is the amount on line 6 more than the amount on line 7? Enter the amount from line 3 above on No. Schedule A, line 7. Do not complete the rest of this worksheet. Yes.

Subtract line 7 from line 6

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8

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9 Divide line 8 by $10,000. Enter the result as a decimal (rounded to at least three places). If the result is 1.000 or more, enter 1.000 . . . . . . . . . . . . . . 10 Multiply line 3 by line 9

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11 Deduction for new motor vehicle taxes. Subtract line 10 from line 3. Enter the result here and on Schedule A, line 7 . . . . . . . . . . . . . . . . . . .

11 Schedule A (Form 1040) 2009

EXHIBIT C.4

(Continued )


SCHEDULE M (Form 1040A or 1040) Department of the Treasury Internal Revenue Service (99)

OMB No. 1545-0074

Making Work Pay and Government Retiree Credits

Attach to Form 1040A, 1040, or 1040NR.

2009


See separate instructions.


166


1a Important: See the instructions if you can be claimed as someone else’s dependent, you have a net loss from a business, your wages include pay for work performed while an inmate in a penal institution, or you are filing Form 1040NR, 2555, or 2555-EZ. Residents of Puerto Rico or American Samoa, see Pub. 570. Do you (and your spouse if filing jointly) have 2009 wages of more than $6,451 ($12,903 if married filing jointly)? Yes. Skip lines 1a through 3. Enter $400 ($800 if married filing jointly) on line 4 and go to line 5. 1a No. Enter your earned income (see instructions) b Nontaxable combat pay included on line 1a (see instructions) Multiply line 1a by 6.2% (.062)

1b 2

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3

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Enter $400 ($800 if married filing jointly)

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Enter the smaller of line 2 or line 3 (unless you checked “Yes” on line 1a)

5

Enter the amount from Form 1040, line 38*, or Form 1040A, line 22

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6

Enter $75,000 ($150,000 if married filing jointly)

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Is the amount on line 5 more than the amount on line 6? No. Skip line 8. Enter the amount from line 4 on line 9 below. Yes. Subtract line 6 from line 5

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Multiply line 7 by 2% (.02)

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Subtract line 8 from line 4. If zero or less, enter -0-

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Did you (or your spouse, if filing jointly) receive an economic recovery payment in 2009? You may have received this payment if you received social security benefits, supplemental security income, railroad retirement benefits, or veterans disability compensation or pension benefits (see instructions). No. Enter -0- on line 10 and go to line 11. Yes. Enter the total of the payments received by you (and your spouse, if filing jointly). Do not enter more than $250 ($500 if married filing jointly)

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12 13 14

其

10

Did you (or your spouse, if filing jointly) receive a pension or annuity in 2009 for services performed as an employee of the U.S. Government or any U.S. state or local government from work not covered by social security? Do not include any pension or annuity reported on Form W-2. No. Enter -0- on line 11 and go to line 12. Yes. ● If you checked “No” on line 10, enter $250 ($500 if married filing jointly and the answer on line 11 is “Yes” for both spouses) ● If you checked “Yes” on line 10, enter -0- (exception: enter $250 if filing jointly and the spouse who received the pension or annuity did not receive an economic recovery payment described on line 10) Add lines 10 and 11 Subtract line 12 from line 9. If zero or less, enter -0-

其

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12 13

Making work pay and government retiree credits. Add lines 11 and 13. Enter the result here and on Form 1040, line 63; Form 1040A, line 40; or Form 1040NR, line 60

14

*If you are filing Form 2555, 2555-EZ, or 4563 or you are excluding income from Puerto Rico, see instructions. For Paperwork Reduction Act Notice, see Form 1040A, 1040, or 1040NR instructions.

EXHIBIT C.5

Cat. No. 52903Q

Schedule M (Form 1040A or 1040) 2009

Schedule M Making Work Pay and Government Retiree Credits

163


164

Form

5405

OMB No. 1545-0074

First-Time Homebuyer Credit and Repayment of the Credit

2009

Attach to Form 1040

Department of the Treasury Internal Revenue Service



58


Skip Parts I and II and go to Part III if you are filing this form to report a disposition or change of your main home for which you claimed the credit for 2008.

Part I

General Information

A

Address of home qualifying for the credit (if different from the address shown on page 1 of Form 1040)

B

Date acquired (MM/DD/YYYY) (must be after December 31, 2008, and before December 1, 2009) (see instructions)

Part II 1

2 3

4 5 6

Part III 7 8 a b c d e

f

h

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X

4 5 6

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Disposition or Change of Main Home /

My home was destroyed, condemned, or disposed of under threat of condemnation and I do not plan to acquire a new home within 2 years of the event. Go to Part IV below. The taxpayer who claimed the credit died in 2009. No repayment of the credit is required of the deceased taxpayer. If the decedent is filing a joint return, see instructions. Otherwise, stop here.

Part IV

10

1

/ Enter the date the home for which you claimed the credit ceased to be your main home (MM/DD/YYYY) Check the box below that applies to you. See the instructions for the definition of “related person.” I sold the home to an unrelated person and had a gain on the sale (as figured after reducing the basis of my home by the credit I claimed). Go to Part IV below. I sold the home to an unrelated person and did not have a gain on the sale (as figured after reducing the basis of my home by the credit I claimed). No repayment of the credit is required. Stop here. I sold the home to a related person. Go to Part IV below. I converted the home to a rental or business use OR I still own the home but no longer use it as my main home. Go to Part IV below. I transferred the home to my ex-spouse as part of my divorce settlement. The full name of my ex-spouse is The responsibility for repayment of the credit is transferred to your ex-spouse. Stop here. My home was destroyed, condemned, or disposed of under threat of condemnation and I acquired or plan to acquire a new home within 2 years of the event. Repayment of the credit over a 15-year period will begin next year if you purchased your home in 2008. If you purchased your home in 2009, you do not have to repay the credit. Stop here.

g

9

Credit

Enter the smaller of: ● $8,000 ($4,000 if married filing separately), or ● 10% of the purchase price of the home. If someone other than a spouse also held an interest in the home, enter only your share of this amount (see instructions) 2 Enter your modified adjusted gross income (see instructions) Is line 2 more than $75,000 ($150,000 if married filing jointly)? No. Skip lines 3 through 5 and enter the amount from line 1 on line 6. Yes. Subtract $75,000 ($150,000 if married filing jointly) from the 3 amount on line 2 and enter the result Divide line 3 by $20,000 and enter the result as a decimal (rounded to at least three places). Do not enter more than 1.000 Multiply line 1 by line 4 Subtract line 5 from line 1. This is your credit. Enter here and on Form 1040, line 67

Repayment of Credit

Enter the amount of the credit you claimed on line 6 of your 2008 Form 5405. See instructions if you filed a joint return for 2008. If you checked box 8a above, go to line 10. Otherwise, skip line 10 and enter the amount from line 9 on line 11 Enter the gain on the sale of your main home (as figured after reducing your basis by the amount on line 9 above) Enter the smaller of line 9 or line 10 here and include it on Form 1040, line 60. On the dotted line to the left of line 60, enter “FTHCR”

For Paperwork Reduction Act Notice, see page 3.

EXHIBIT C.6

Cat. No. 11880I

9 10 11 Form

5405

Form 5405 First-Time Homebuyer Credit and Repayment of the Credit

(2009)


Form

Education Credits (American Opportunity, Hope, and Lifetime Learning Credits)

8863

OMB No. 1545-0074

2009

See separate Instructions to find out if you are eligible to take the credits. Attach to Form 1040 or Form 1040A.




Caution: You cannot take both an education credit and the tuition and fees deduction (see Form 8917) for the same student for the same year.

Part I

American Opportunity Credit Use Part II if you are claiming the Hope credit for a student attending school in a Midwestern disaster area and elect to waive the computation method in this part for all students. Caution: You cannot take the American opportunity credit for more than 4 tax years for the same student.

1

(a) Student’s name (as shown on page 1 of your tax return) First name Last name

(b) Student’s social security number (as shown on page 1 of your tax return)

(c) Qualified expenses (see instructions). Do not enter more than $4,000 for each student.

(d) Subtract $2,000 from the amount in column (c). If zero or less, enter -0-.

(e) Multiply the amount in column (d) by 25% (.25)

2 Tentative American opportunity credit. Add the amounts on line 1, column (f). Skip Part II if line 2 is more than zero. If you are taking the lifetime learning credit for a different student, go to Part III; otherwise, go to Part IV . . . . . . . . . . . . . . . . . . . . . . . . .

Part II

(f) If column (d) is zero, enter the amount from column (c). Otherwise, add $2,000 to the amount in column (e).

2

Hope Credit Use this part if you are claiming the Hope credit for a student attending school in a Midwestern disaster area and elect to waive the computation method in Part I for all students. Caution: You cannot take the Hope credit for more than 2 tax years for the same student.

3

(a) Student’s name (as shown on page 1 of your tax return) First name Last name


(c) Qualified expenses (see instructions). Do not enter more than $2,400* for each student.

(d) Enter the smaller of the amount in column (c) or $1,200**

(e) Add column (c) and column (d)

(f) Enter one-half of the amount in column (e)

*For each student who attended an eligible educational institution in a Midwestern disaster area, do not enter more than $4,800. **For each student who attended an eligible educational institution in a Midwestern disaster area, enter the smaller of the amount in column (c) or $2,400.

4 Tentative Hope credit. Add the amounts on line 3, column (f). If you are taking the lifetime learning credit for another student, go to Part III; otherwise, go to Part V . . . . . . . . . . .

Part III

4

Lifetime Learning Credit. Caution: You cannot take the American opportunity credit or the Hope credit and the lifetime learning credit for the same student in the same year.

5

(a) Student’s name (as shown on page 1 of your tax return)

First name

Last name


6 7a

Add the amounts on line 5, column (c), and enter the total . . . . . . . . . . . . . . Enter the smaller of line 6 or $10,000 . . . . . . . . . . . . . . . . . . . . b For students who attended an eligible educational institution in a Midwestern disaster area, enter the smaller of $10,000 or their qualified expenses included on line 6 (see special rules on page 3 of the instructions) . c Subtract line 7b from line 7a . . . . . . . . . . . . . . . . . . . . . . . 8a Multiply line 7b by 40% (.40) . . . . . . . . . . . . . . . . . . . . . . . b Multiply line 7c by 20% (.20) . . . . . . . . . . . . . . . . . . . . . . . c Tentative lifetime learning credit. Add lines 8a and 8b. If you have an entry on line 2, go to Part IV; otherwise go to Part V For Paperwork Reduction Act Notice, see page 4 of separate instructions.

Cat. No. 25379M

(c) Qualified expenses (see instructions)

6 7a 7b 7c 8a 8b 8c Form 8863 (2009)

EXHIBIT C.7 Form 8863 Education Credits (American Opportunity, Hope, and Lifetime Learning Credits)

165

166


Page 2

Form 8863 (2009)

Part IV 9 10 11 12 13 14

Refundable American Opportunity Credit

Enter the amount from line 2 . . . . . . . . . . . . . . . . . . . Enter: $180,000 if married filing jointly; $90,000 if single, head of 10 household, or qualifying widow(er) . . . . . . . . . . . . . 11 Enter the amount from Form 1040, line 38,* or Form 1040A, line 22 . . . Subtract line 11 from line 10. If zero or less, stop; you cannot take any 12 education credit . . . . . . . . . . . . . . . . . . . Enter: $20,000 if married filing jointly; $10,000 if single, head of household, 13 or qualifying widow(er) . . . . . . . . . . . . . . . . . If line 12 is: ● Equal to or more than line 13, enter 1.000 on line 14 . . . . . . . . . .

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● Less than line 13, divide line 12 by line 13. Enter the result as a decimal (rounded to at least three places) . . . . . . . . . . . . . . . . . . . . . 15

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19 20 21 22 23

24 25 26 27

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Multiply line 9 by line 14. Caution: If you were under age 24 at the end of the year and meet the conditions in the instructions, you cannot take the refundable American opportunity credit. Skip line 16, enter the amount from line 15 on line 17, and check this box . . Refundable American opportunity credit. Multiply line 15 by 40% (.40). Enter the amount here and on Form 1040, line 66, or Form 1040A, line 43. Then go to line 17 below . . . . . . . . .

Part V 17 18

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14

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15 16

Nonrefundable Education Credits

Subtract line 16 from line 15 . . . . . . . . . . . . . . . . . . . . . . . Add line 4 and line 8c. If you have no entry on these lines, skip lines 19 through 24, and enter the amount from line 17 on line 25 . . . . . . . . . . . . . . . . . . . . . . . Enter: $120,000 if married filing jointly; $60,000 if single, head of 19 household, or qualifying widow(er) . . . . . . . . . . . . . 20 Enter the amount from Form 1040, line 38,* or Form 1040A, line 22 . . . Subtract line 20 from line 19. If zero or less, skip lines 22 and 23, and enter zero on line 24 . . . . . . . . . . . . . . . . . . . . 21 Enter: $20,000 if married filing jointly; $10,000 if single, head of household, 22 or qualifying widow(er) . . . . . . . . . . . . . . . . . If line 21 is: ● Equal to or more than line 22, enter the amount from line 18 on line 24 and to line 25 . . . . ● Less than line 22, divide line 21 by line 22. Enter the result as a decimal (rounded to at least three places) . . . . . . . . . . . . . . . . . . . . . Multiply line 18 by line 23 . . . . . . . . . . . . . . . . . . . . . Add line 17 and line 24. If zero, stop; you cannot take any nonrefundable education credit Enter the amount from Form 1040, line 46, or Form 1040A, line 28 . . . . . . . . Enter the total, if any, of your credits from: ● Form 1040, lines 47, 48, and the amount from Schedule R (Form 1040) entered on line 53 . . . . . . . . . . . . . . . . . . . . . . . . . . ● Form 1040A, lines 29 and 30 . . . . . . . . . . . . . . . . . . Subtract line 27 from line 26. If zero or less, credit . . . . . . . . . . . . . Nonrefundable education credits. Enter the line 49, or Form 1040A, line 31 . . . . .

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stop; you cannot take any nonrefundable education . . . . . . . . . . . . . . . . . . smaller of line 25 or line 28 here and on Form 1040, . . . . . . . . . . . . . . . . . .

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*If you are filing Form 2555, 2555-EZ, or 4563, or you are excluding income from Puerto Rico, see Pub. 970 for the amount to enter. Form 8863 (2009)

EXHIBIT C.7

(Continued )


Version A, Cycle 3

Form

Residential Energy Credits

5695

OMB No. 1545-0074

2009

See instructions. Attach to Form 1040 or Form 1040NR.

Department of the Treasury Internal Revenue Service Name(s) shown on return


Before You Begin Part I: Figure the amount of any credit for the elderly or the disabled you are claiming. Part I 1

Nonbusiness Energy Property Credit (See instructions before completing this part.)

Were the qualified energy efficiency improvements or residential energy property costs for your main home located in the United States? (see instructions) . . . . . . . . . . . .

1

Yes

No

Caution: If you checked the “No” box, you cannot claim the nonbusiness energy property credit. Do not complete Part I. 2 a

Qualified energy efficiency improvements (see instructions). Insulation material or systems specifically and primarily designed to reduce heat loss or gain in your home . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

b Exterior windows including skylights . . . . . . . . . . . . . . . . . . . . . c Exterior doors . . . . . . . . . . . . . . . . . . . . . . . . . . . . d Metal or asphalt roof with appropriate pigmented coatings or cooling granules that meet the Energy Star program requirements and is specifically and primarily designed to reduce heat gain in your home . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2a 2b 2c

2d

3 a b c

Residential energy property costs (see instructions). Energy-efficient building property . . . . . . . . . . . . . . . . Qualified natural gas, propane, or oil furnace or hot water boiler . . . . . . Advanced main air circulating fan used in a natural gas, propane, or oil furnace .

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3a 3b 3c

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Add lines 2a through 3c .

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Multiply line 4 by 30% (.30) .

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Maximum credit amount. (If you jointly occupied the home, see instructions) .

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Enter the smaller amount of line 5 or line 6 .

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Enter the amount from Form 1040, line 46, or Form 1040NR, line 43

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Enter the total, if any, of your credits from Form 1040, lines 47 through 50, and Schedule R, line 24; or Form 1040NR, lines 44 through 46 . .

9

Subtract line 9 from line 8. If zero or less, stop. You cannot take the nonbusiness energy property credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Nonbusiness energy property credit. Enter the smaller of line 7 or line 10 . . . . . . . .

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For Paperwork Reduction Act Notice, see instructions.

EXHIBIT C.8

Form 5695 Residential Energy Credits

.

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Cat. No. 13540P

$1,500

Form 5695 (2009)

167

168


Version A, Cycle 3

Form 5695 (2009)

Page

2

Before You Begin Part II: Figure the amount of any of the following credits you are claiming. ● Credit for the elderly or the disabled. ● District of Columbia first-time homebuyer credit. ● Alternative motor vehicle credit.

Part II

● Qualified plug-in electric vehicle credit. ● Qualified plug-in electric drive motor vehicle credit.

Residential Energy Efficient Property Credit (See instructions before completing this part.)

Note. Skip lines 12 through 21 if you only have a credit carryforward from 2008. 12

Qualified solar electric property costs

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Qualified solar water heating property costs

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Qualified small wind energy property costs .

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Qualified geothermal heat pump property costs

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Add lines 12 through 15 .

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18

Qualified fuel cell property costs

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19

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Kilowatt capacity of property on line 18 above

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Enter the smaller of line 19 or line 20 .

22

Credit carryforward from 2008. Enter the amount, if any, from your 2008 Form 5695, line 28

23

Add lines 17, 21, and 22 .

24

Enter the amount from Form 1040, line 46, or Form 1040NR, line 43

25

1040 filers: Enter the total, if any, of your credits from Form 1040, lines 47 through 50; line 11 of this form; line 12 of the Line 11 worksheet in Pub. 972 (see instructions); Form 8396, line 11; Form 8839, line 18; Form 8859, line 11; Form 8834, line 22; Form 8910, line 21; Form 8936, line 14; and Schedule R, line 24. 1040NR filers: Enter the amount, if any, from Form 1040NR, lines 44 through 46; line 11 of this form; line 12 of the Line 11 worksheet in Pub. 972 (see instructions); Form 8396, line 11; Form 8839, line 18; Form 8859, line 11; Form 8834, line 22; Form 8910, line 21; and Form 8936, line 14.

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Subtract line 25 from line 24. If zero or less, enter -0- here and on line 27 .

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26

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Residential energy efficient property credit. Enter the smaller of line 23 or line 26 .

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Credit carryforward to 2010. If line 27 is less than line 23, subtract line 27 from line 23 . . . . . . . . . . . . . . . . . . .

Add lines 11 and 27. Enter the result here and on Form 1040, line 52, or Form 1040NR, line 48, and check box c on that line . . . . . . . . . . . . . . . . . . . . . . .

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Part III 29

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Current Year Residential Energy Credits

Form 5695 (2009)

EXHIBIT C.8

(Continued )


Form

4562


See separate instructions.

1 2 3 4 5

2009

Identifying number

Election To Expense Certain Property Under Section 179 Note: If you have any listed property, complete Part V before you complete Part I.

Maximum amount. See the instructions for a higher limit for certain businesses . . . . Total cost of section 179 property placed in service (see instructions) . . . . . . Threshold cost of section 179 property before reduction in limitation (see instructions) . Reduction in limitation. Subtract line 3 from line 2. If zero or less, enter -0- . . . . . Dollar limitation for tax year. Subtract line 4 from line 1. If zero or less, enter -0-. If separately, see instructions . . . . . . . . . . . . . . . . . . . . (a) Description of property

6

(b) Cost (business use only)

. . . . . . . . . . . . married . . .

. . . . . . . . filing . .

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$800,000

5

8 9 10 11 12

Special Depreciation Allowance and Other Depreciation (Do not include listed property. ) (See instructions.)

14 Special depreciation allowance for qualified property (other than listed property) placed in service during the tax year (see instructions) . . . . . . . . . . . . . . . . . . . . . . 15 Property subject to section 168(f)(1) election . 16 Other depreciation (including ACRS) . . .

Part III

$250,000

1 2 3 4

(c) Elected cost

7 Listed property. Enter the amount from line 29 . . . . . . . . . 7 8 Total elected cost of section 179 property. Add amounts in column (c), lines 6 and 7 . . . 9 Tentative deduction. Enter the smaller of line 5 or line 8 . . . . . . . . . . . . 10 Carryover of disallowed deduction from line 13 of your 2008 Form 4562 . . . . . . . . 11 Business income limitation. Enter the smaller of business income (not less than zero) or line 5 (see instructions) 12 Section 179 expense deduction. Add lines 9 and 10, but do not enter more than line 11 . . 13 Carryover of disallowed deduction to 2010. Add lines 9 and 10, less line 12 13 Note: Do not use Part II or Part III below for listed property. Instead, use Part V.

Part II

Attachment Sequence No. 67

Attach to your tax return.

Business or activity to which this form relates


Part I

OMB No. 1545-0172

Depreciation and Amortization (Including Information on Listed Property)

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MACRS Depreciation (Do not include listed property. ) (See instructions.)

Section A 17 17 MACRS deductions for assets placed in service in tax years beginning before 2009 . . . . . . . If you are electing to group any assets placed in service during the tax year into one or more general 18 asset accounts, check here . . . . . . . . . . . . . . . . . . . . Section B—Assets Placed in Service During 2009 Tax Year Using the General Depreciation System (a) Classification of property

(b) Month and year placed in service

(c) Basis for depreciation (business/investment use only—see instructions)

(d) Recovery period

(e) Convention

(f) Method

(g) Depreciation deduction

19a 3-year property b 5-year property c 7-year property d 10-year property e 15-year property f 20-year property 25 yrs. S/L g 25-year property 27.5 yrs. MM S/L h Residential rental property 27.5 yrs. MM S/L Nonresidential real 39 yrs. MM S/L i property MM S/L Section C—Assets Placed in Service During 2009 Tax Year Using the Alternative Depreciation System 20a Class life b 12-year c 40-year

Part IV

12 yrs. 40 yrs.

S/L S/L S/L

MM

Summary (See instructions.)

21 Listed property. Enter amount from line 28 . . . . . . . . . . . . . . . . . . . . 22 Total. Add amounts from line 12, lines 14 through 17, lines 19 and 20 in column (g), and line 21. Enter here and on the appropriate lines of your return. Partnerships and S corporations—see instructions

23 For assets shown above and placed in service during the current year, enter the portion of the basis attributable to section 263A costs . . . . . . . For Paperwork Reduction Act Notice, see separate instructions.

EXHIBIT C.9

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22

23

Cat. No. 12906N

Form 4562 Depreciation and Amortization

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21

Form 4562 (2009)

169

170


Page 2 Listed Property (Include automobiles, certain other vehicles, cellular telephones, certain computers, and property used for entertainment, recreation, or amusement.)

Form 4562 (2009)

Part V

Note: For any vehicle for which you are using the standard mileage rate or deducting lease expense, complete only 24a, 24b, columns (a) through (c) of Section A, all of Section B, and Section C if applicable. Section A—Depreciation and Other Information (Caution: See the instructions for limits for passenger automobiles.) 24b If “Yes,” is the evidence written? 24a Do you have evidence to support the business/investment use claimed? Yes No Yes (a) Type of property (list vehicles first)

(c) (d) Business/ investment use Cost or other basis percentage

(b) Date placed in service

(e) Basis for depreciation (business/investment use only)

(f) Recovery period

(g) Method/ Convention

(h) Depreciation deduction

No

(i) Elected section 179 cost

25 Special depreciation allowance for qualified listed property placed in service during the tax year and used more than 50% in a qualified business use (see instructions) . . .

. 25 26 Property used more than 50% in a qualified business use: % % % 27 Property used 50% or less in a qualified business use: S/L – % S/L – % S/L – % 28 Add amounts in column (h), lines 25 through 27. Enter here and on line 21, page 1 . . . 28 29 Add amounts in column (i), line 26. Enter here and on line 7, page 1 . . . . . . . . . . . . . . 29 Section B—Information on Use of Vehicles Complete this section for vehicles used by a sole proprietor, partner, or other “more than 5% owner,” or related person. If you provided vehicles to your employees, first answer the questions in Section C to see if you meet an exception to completing this section for those vehicles. 30 Total business/investment miles driven during the year (do not include commuting miles) . . . . . . .

(a) Vehicle 1

(b) Vehicle 2

(c) Vehicle 3

(d) Vehicle 4

(e) Vehicle 5

(f) Vehicle 6

31 Total commuting miles driven during the year 32 Total other personal (noncommuting) miles driven .

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33 Total miles driven during the year. Add lines 30 through 32 .

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34 Was the vehicle available for personal use during off-duty hours?

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.

Yes

No

Yes

No

Yes

No

Yes

No

Yes

No

Yes

No

.

35 Was the vehicle used primarily by a more than 5% owner or related person?

36 Is another vehicle available for personal use? .

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Section C—Questions for Employers Who Provide Vehicles for Use by Their Employees Answer these questions to determine if you meet an exception to completing Section B for vehicles used by employees who are not more than 5% owners or related persons (see instructions). Yes No 37 Do you maintain a written policy statement that prohibits all personal use of vehicles, including commuting, by your employees? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38 Do you maintain a written policy statement that prohibits personal use of vehicles, except commuting, by your employees? See the instructions for vehicles used by corporate officers, directors, or 1% or more owners

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.

39 Do you treat all use of vehicles by employees as personal use? . . . . . . . . . . . . . . . 40 Do you provide more than five vehicles to your employees, obtain information from your employees about the use of the vehicles, and retain the information received? . . . . . . . . . . . . . . . . . . 41 Do you meet the requirements concerning qualified automobile demonstration use? (See instructions.)

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Note: If your answer to 37, 38, 39, 40, or 41 is “Yes,” do not complete Section B for the covered vehicles.

Part VI

Amortization (a) Description of costs

(b) Date amortization begins

(c) Amortizable amount

(e) Amortization period or percentage

(d) Code section

(f) Amortization for this year

42 Amortization of costs that begins during your 2009 tax year (see instructions):

43 Amortization of costs that began before your 2009 tax year . . . . . . 44 Total. Add amounts in column (f). See the instructions for where to report .

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. .

. .

. .

. .

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43 44 Form 4562 (2009)

EXHIBIT C.9

(Continued )

Glossary

A above-the-line deductions Deductions subtracted from gross income to arrive at adjusted gross income (AGI). accelerated death benefits Benefits paid under a life insurance policy to someone who is chronically or terminally ill. Special tax treatment applies to these benefits. adjusted basis The cost basis of property reduced by any allowable adjustments such as first-year expensing and depreciation. adjusted gross income (AGI) Gross income less allowable adjustments, such as deductions for IRA contributions, alimony payments, and one-half of selfemployment tax. AGI determines eligibility for various tax benefits (e.g., certain itemized deductions, making IRA contributions if you’re a plan participant, deducting $25,000 rental loss allowance, and converting a traditional IRA to a Roth IRA). alternative minimum tax (AMT) A tax triggered if certain tax benefits reduce your regular income tax below the tax computed on Form 6251 for AMT purposes.

171

172

GLOSSARY

B basis Generally, the amount paid for property (cost basis). You need to know your basis to figure gain or loss on a sale or, in the case of business or investment property, the depreciation that can be claimed. bonus depreciation An additional 50 percent depreciation allowance for the first year business property is acquired and placed in service after December 31, 2007, and before January 1, 2010. C capital gains rates Special tax rates imposed on sales or exchanges resulting in long-term capital gains. carryback A tax technique for receiving a refund of taxes in prior years by applying a deduction or credit from a current year to a prior tax year. For example, a business net operating loss incurred in 2009 may be carried back for two years in most situations. carryforward A tax technique of applying a loss or credit from a current year to a later tax year. For example, a business net operating loss incurred in 2009 may be carried forward for 20 years. carryover basis The basis of the person from whom property was acquired. Carryover basis is used for gifts (with some limitations); it is set to be used for inheritances after 2009 (with some modifications). cash method of accounting Reporting income when actually or constructively received and deducting expenses when paid. charitable organizations Tax-exempt organizations to which contributions can be made on a tax-deductible basis. Charitable organizations may not be treated as designated beneficiaries of IRAs or qualified retirement plan benefits. child For tax purposes, different age limits apply for different purposes. child and dependent care credit A credit of up to 35 percent of certain care expenses incurred to allow you to work. child tax credit A credit in 2009 of up to $1,000 per eligible child (under the age of 17) if your income does not exceed certain limits. conservation easement A right given to a charitable organization or government body to use land for recreation, the preservation of open space, or plant or wildlife refuges.

GLOSSARY

constructive receipt A tax rule that taxes income that is not actually received by you but that you may draw upon. cost-of-living adjustment An increase in a tax item due to changes in the rate of inflation. Coverdell education savings account (ESA) A special savings account to fund certain education expenses (formerly called an education IRA). credit A reduction of tax liability on a dollar-for-dollar basis.

D decedent A person who dies. deductions Items directly reducing income. Personal deductions, such as medical expenses, are allowed only if you itemize them on Schedule A. Other deductions, such as alimony and student loan interest, are subtracted from gross income (even if other deductions aren’t itemized). deemed depreciation A basis adjustment for vehicles used in business for which the IRS’s standard mileage rate is used to figure annual deductions for driving. deferred compensation A portion of earnings withheld by an employer (or put into a retirement plan) for distribution to the employee at a later date. If certain requirements are met, the deferred amounts are not currently taxable but are taxed when received at that later time (typically retirement). defined benefit plan A retirement plan that pays fixed benefits based on actuarial projections. defined contribution plan A retirement plan that pays benefits based on contributions to individual accounts, plus accumulated earnings. Contributions generally are based on a percentage of salary or net earnings from selfemployment. dependency exemption A fixed deduction allowed to every taxpayer, except anyone who may be claimed as a dependent on another taxpayer’s return. Extra dependency exemptions are allowed for a spouse on a joint return and for each qualifying dependent. dependent A person supported by another person. If certain tests are met, a dependency exemption may be claimed for the dependent.

173

174

GLOSSARY

designated beneficiary A person (or trust) in existence on September 30 of the year following the death of an IRA owner or employee who is named in an IRA or qualified retirement plan to receive distributions. dividends Payments by corporations to shareholders from earnings and profits (qualified dividends are taxed at capital gains rates).

E earned income Compensation for performing personal services. You must have earned income to make an IRA contribution or claim the earned income credit. earned income credit A tax credit allowed to a taxpayer with earned income (or AGI) below certain thresholds. education credit A credit for paying certain qualified higher education costs. There are two credits for 2009: the American Opportunity credit and the lifetime learning credit. educator For purposes of the deduction for educator expenses, educators are teachers, aides, counselors, and principals in grades K–12 who work at least 900 hours during the school year. elective deferral A portion of an employee’s salary withheld and contributed to a 401(k) or other retirement plan. These amounts are not currently taxed as salary. empowerment zones Economically-disadvantaged areas designated by the federal government to qualify for special tax incentives. estate tax A tax imposed on the value of a decedent’s taxable estate, after deductions and credits. estimated tax Advance payment of current tax liability based either on wage withholding or on installment payments of estimated tax liability. Payments must meet certain requirements to avoid an underpayment penalty. exclusion A rule allowing income to be tax free. exemption For AMT purposes it is an amount subtracted from alternative minimum taxable income. For estate, gift, and generation-skipping transfer tax purposes, it is an amount that is translated into a credit to offset the applicable tax. See also dependency exemption.

GLOSSARY

F fair market value What a willing buyer would pay to a willing seller when neither is under any compulsion to buy or sell. fellowships See scholarships. first-year expensing A deduction up to a set dollar limit for the cost of business equipment placed in service in the year. This deduction is also called a Section 179 deduction. 529 plan See qualified tuition plan. flexible spending arrangement (FSA) A salary reduction plan that allows employees to pay for medical coverage or dependent care expenses on a pretax basis. foreign child A child who is not a U.S. citizen or resident at the time adoption efforts commence. foreign earned income exclusion In 2009, up to $91,400 of foreign earned income is exempt from tax if a foreign residence or physical presence test is met. 401(k) plan A deferred-pay plan authorized by Section 401(k) of the Internal Revenue Code under which a percentage of an employee’s salary is withheld (called an elective deferral) and placed in a qualified retirement plan. Income on the elective deferrals accumulates on a tax-deferred basis until withdrawn by the employee (generally when he or she retires or leaves the company). G generation-skipping transfer (GST) tax A tax on a transfer that skips a generation (e.g., from grandparent to grandchild) in excess of an exemption amount ($3.5 million in 2009). gift tax Gifts in 2009 in excess of $13,000 per donee annual exclusion are subject to gift tax, but the tax may be offset by a person’s lifetime gift tax exemption amount. gross income The total amount of income received from all sources before exclusions and deductions. H head of household Generally, an unmarried person who maintains a household for dependent(s) and is allowed to compute income tax based on

175

176

GLOSSARY

head of household rates (which are more favorable than single person rates). health reimbursement arrangement An employer-funded account that can be tapped tax free to pay for medical expenses. health savings accounts (HSAs) A savings plan for health expenses that can be funded by those covered by a high-deductible health plan. high deductible health plan Medical insurance that has minimum deductibles and limits on out-of-pocket expenses set annually by the IRS for self-only coverage and for family coverage. high-income taxpayers Taxpayers with AGI over a set limit who are subject to certain phaseouts or reductions in benefits. They are also subject to a different estimated tax safe harbor. home sale exclusion A portion of gain on the sale of a main home that can be received tax free if certain conditions are met. hybrid car A car powered by both gas and electricity. The purchase of a hybrid car may be eligible for a tax credit. I incentive stock options (ISOs) Options meeting tax law tests that defer regular income tax on the option transaction until the obtained stock is sold (but the exercise of ISOs may give rise to AMT). inclusion amount In the case of cars leased for business, an amount that must be added back to income for cars that initially have a fair market value over a set dollar amount. income shifting A tax technique designed to shift income among family members from one who is in a higher tax bracket to another in a lower tax bracket. indexing See cost-of-living adjustment. individual retirement account (IRA) A retirement account to which a limited contribution is permitted annually from earned income (or alimony), but deductions are restricted for active participants in qualified retirement plans who earn over set amounts. installment sale A sale of property that allows for tax deferment if at least one payment is received after the year in which the sale occurs. The installment method does not apply to year-end sales of publicly traded securities. Dealers

GLOSSARY

may not use the installment method. Investors with very large installment balances could face a special tax. irrevocable trust A trust that cannot be changed by the creator once it comes into existence. itemized deductions Items, such as medical expenses, home mortgage interest, and state and local taxes, that are claimed as write-offs on Schedule A of Form 1040 in lieu of claiming the standard deduction. Itemized deductions are subtracted from AGI to arrive at taxable income. The amount of itemized deductions is subject to a reduction when AGI exceeds certain limits. J joint return A return filed by a married couple reporting their combined income and deductions. Joint return status generally provides tax savings for married couples over filing separate returns. K kiddie tax The tax on investment income in excess of $1,900 in 2009 of a child under a certain age, based on the parents’ top marginal tax rate and computed on Form 8615. L long-term capital gain or loss Gain or loss on the sale or exchange of a capital asset held more than one year. luxury cars Cars costing more than a certain amount that are subject to dollar limits on depreciation, trigger inclusion amounts if leased, and result in excise taxes. M marital deduction An estate and gift tax deduction for assets passing to a spouse. In the case of a spouse who is a U.S. citizen, it allows for completely tax-free transfers. marriage penalty The additional tax paid by a married couple that would not be owed if they had remained single. miscellaneous itemized deductions Generally, itemized deductions for job and investment expenses subject to a limit of 2 percent of AGI.

177

178

GLOSSARY

modified adjusted gross income (MAGI) Generally, adjusted gross income increased by certain items (e.g., tax-free foreign earned income). MAGI is used to determine the phaseouts for certain deductions and credits. moving expenses Certain expenses of moving to a new job location are deductible if distance and time tests are met. N nanny tax Employment tax on household employees. net operating loss (NOL) A business loss that exceeds current income may be carried back against income of prior years and carried forward as a deduction from future income until eliminated. O ordinary income Income other than capital gains. ordinary loss A loss other than a capital loss. P personal exemption A deduction of $3,650 in 2009 that every taxpayer may claim for him/herself (other than someone who can be claimed as a dependent of another taxpayer). placed in service The time when a depreciable asset is ready to be used in business. The date fixes the beginning of the depreciation period or eligibility for first-year expensing. probate estate Property held in a decedent’s name passing by will (or under the terms of state laws of intestacy). profit-sharing plan A defined contribution plan under which the amount contributed to employees’ accounts is based on a percentage of the employer’s profits. Q qualified plan A retirement plan that meets tax law tests and allows tax deferment and tax-free accumulation of income until benefits are withdrawn. Pension plans, profit-sharing plans, SEPs, and SIMPLEs are qualified plans. qualified tuition plan A higher education savings plan sponsored by a state or private institution.

GLOSSARY

qualifying widow or widower A filing status entitling the taxpayer with a dependent to use joint tax rates (and the standard deduction for joint filers) for up to two years after the death of a spouse. R refundable tax credit A credit that entitles you to receive a refund even if the amount exceeds your tax for the year. required minimum distributions (RMDs) Annual withdrawals from IRAs and qualified plans designed to avoid a 50 percent penalty. Retirement Savings Contributions credit A credit for elective deferrals or IRA contributions that may be claimed by a person with income below a set limit (in addition to any other tax benefit related to the elective deferrals or IRA contributions). revocable trust A trust that may be changed or terminated by its creator (e.g., a living trust). Such trusts generally do not provide any income tax savings to the creator. rollover A tax-free reinvestment of a distribution from a qualified retirement plan or IRA into another plan or IRA within 60 days. Roth IRA A nondeductible IRA that allows for tax-free accumulations of earnings. S salary reduction agreement Consent to have an employer withhold a portion of wages that will be contributed to a qualified retirement plan or flexible spending arrangement. Such amounts are not currently taxed as wages. savings incentive match plan for employees (SIMPLE) A type of retirement plan funded by elective deferrals and employer matching contributions. scholarships Grants to degree candidates receiving tax-free treatment if used for tuition and course-related expenses. Section 179 deduction See first-year expensing. Section 457 plan A deferred compensation plan set up by a state or local government or tax-exempt organization that allows tax-free deferrals of salary. Section 1244 stock Stock in a small operating corporation (capitalization no more than $1 million) acquired by purchase.

179

180

GLOSSARY

self-employed person An individual who operates a business or profession as a proprietor or independent contractor and reports self-employment income on Schedule C. self-employment tax Social Security and Medicare taxes paid by a selfemployed person. The Social Security portion is 12.4 percent on net earnings from self-employment up to $106,800 in 2009. The Medicare portion is 2.9 percent on all net earnings from self-employment. One-half of the total self-employment tax is deductible. separate returns Returns filed by married persons who do not file a joint return. Filing separately may save taxes where each spouse has separate deductions, but certain tax benefits require joint filing. short-term capital gain or loss Gain or loss on the sale or exchange of a capital asset held one year or less. simplified employee pension (SEP) plan An IRA-type plan set up by an employer or self-employed person rather than an employee. single The filing status of a person who is unmarried on December 31 of the year for which a return is filed. special-needs child For purposes of a Coverdell ESA, a child who needs more time to complete his or her education because of a physical, mental, or emotional condition. For purposes of the adoption credit, a child under age 18 who is physically or mentally incapable of self-care. standard deduction A fixed deduction allowed to those who do not itemized deductions. The amount depends on filing status, age, and whether a person is blind. standard mileage rate A fixed rate set by the IRS for deducting auto expenses in lieu of deducting actual costs. stepped-up basis A basis used for inherited property prior to 2010 (and after 2009 in some cases) determined by the property value at the time of the decedent’s death. T taxable income Net income after claiming all deductions (including personal exemptions).

GLOSSARY

tax bracket In 2009, there are six individual federal income tax brackets— 10 percent, 15 percent, 25 percent, 28 percent, 33 percent, and 35 percent. tax-free exchange A trade of property that defers the recognition of gain until the property received in the transaction is later disposed of (but only if qualified property is involved). tax preference items Items that may subject a taxpayer to the alternative minimum tax (AMT). trust An arrangement under which one person transfers legal ownership of assets to another person or corporation (the trustee) for the benefit of one or more parties (beneficiaries). U unearned income Investment income or other income that is not derived from performing personal services. V vesting The process of accruing an interest in contributions that are treated as earned. Employee contributions are always 100 percent vested. Employer contributions may be immediately vested or are vested over a set schedule. W withholding An amount taken from income as a prepayment of tax liability for the year. In the case of wages, the employer withholds part of every wage payment for this purpose.

181

Index

A “Above-the-line” deductions, 31 taking advantage of, 43–44 Accelerated death benefits, 26 Adjusted gross income (AGI), 1, 15, 63, 65, 77, 83, 94 changes in figuring, 31–44 individual retirement accounts, 32–35 limits for phaseout of itemized deductions, 51 planning, 41–44 strategies for controlling, 42–44 Adoption credit, 93 income limits, 93 Age and/or blindness, standard deductions and, 47 Alaska Permanent Fund dividends, 106 Alternative depreciation system (ADS), 118 Alternative energy investments, credits for, 90–91 Alternative minimum taxable income (AMTI), 100 Alternative minimum tax (AMT), 72, 99–105, 124 deductions and, 101–3 exemption amount, 100–101

laws and, 144 planning, 101, 104–5 private activity bond interest, 103–4 small business stock, 104 tax credits, 104 American Federation of State, County, and Municipal Employees (AFSCME), 112 American Opportunity and Lifetime Learning credit, 42 American Opportunity tax credit, 86–87, 88, 143 American Recovery and Reinvestment Act, 9, 76 Annual gift tax exclusion, 135–36 Automatic enrollment plan, 3 B Bankrupt employers, IRA contributions for, 32–33 Bonds, savings, 9–10 Bonus depreciation, small businesses and, 117–20, 144 electing out of, 119–20 midquarter convention, 118 qualifying property, 118

183

184

INDEX

Build America Bonds (BAB), 9 planning, 9 Bunching deductions, 60–61 Businesses, provisions for, 144–46 breaks, 145–46 deductions, 144–45 tax credits, 145 Business-related adjustments, IRAs and, 40 C California registered warrants, interest on, 10 Capital gains and losses, year-end strategies for, 28–29 Cars deductions, dollar limits on, 120 leased, 123 Cash for clunkers buying incentive, 23, 50 Casualty and theft losses, 55–57 in federal disaster areas, 56 limits, 55 Ponzi schemes, 56–57 Cents-per-mile valuation rule, 123 Certificates of deposit (CD), 70 Charitable contributions, 54–55, 136 religious school tuition, 55 Child and dependent care credit, 94–95 qualifying child, 95 Childcare, provided by grandparents, 110 Children of divorced or separated parents, 66 qualifying, 64–65, 85, 86 Child tax credit, 85–86 qualifying child and, 86 refundable, 85–86 COBRA subsidy, 8–9, 94 planning, 8–9 Combat pay, 7 planning, 7 Commercial annuities, penalties on, 109 Compensation, 2 Computer technology, education and, 22 Consolidated Omnibus Budget Reconciliation Act (COBRA). See COBRA subsidy Consumer Assistance to Recycle and Save (CARS) Act, 50 Contribution limits for elective deferrals, 2–4 for IRAs, 32 for SIMPLEs, 4

Convenience fees for charging tax payments, itemized deductions and, 59–60 Coverdell education savings accounts (ESA), penalties on, 109 Credit card processors, IRS-approved, 60 Credits adoption, 93 American Opportunity tax credit, 143 for businesses, 145 child and dependent care credit, 94–95 child tax credit, 85–86 D.C. home buyer credit, 143 earned income credit, 82–85, 144 education tax credit, 86–88 empowerment zone and renewal community employment, 127 energy, 129 enhanced credit for health insurance costs, 144 for excess Social Security tax withheld, 95–96 first-time homebuyer, 79–82, 143 health coverage credit for displaced workers, 94 for home energy improvement and investments, 88–91, 143 Indian employment, 128 for individuals, 96, 97 Making Work Pay credit, 76–78, 143 one-time payment for nonworkers, 78–79 planning for tax, 96–97 for plug-in electric vehicles, 95 refundable, 75 retirement savers, 91–93 tax cuts and, 75–97 wage differential payments, 128 work opportunity, 127 D Damages, 23–24 Day care providers foods rates for, 128, 129 meal allowance for, 128–29 D.C. breaks, 146 D.C. enterprise zone, 127 D.C. home buyer credit, 143 Debt, cancellation of, 19–20, 23

INDEX

Deductions “above-the-line,” 31 acceleration, 71–72 alternative minimum planning and, 101–3 bunching, 60–61 for businesses, 144–45 charitable contributions, 54–55 defined, 45 dollar limits on car, 120 enhanced charitable contribution, 144 home office, 126 interest expenses and, 54 itemized, 45–73 planning strategies, 69–73 record keeping, 61 standard, 45–73 taxes and, 53–54 tax planning for, 60–61 Deemed depreciation, 121–22 Deferrals, income, 69–71 Defined benefit (pension) plan, 4 Dependency exemptions, 64–66 children of divorced or separated parents, 66 qualifying child, 64–65 Disabled children, reimbursements to parents of, 26 Dividends, 9–11 tax on qualified, 10–11 Dollar limits on cars, 120 on trucks and vans, 121 Donations. See Charitable contributions Dual payment test, 55 E Earned income credit, 82–85, 144 income limits, 83–84 maximum credit, 83 planning, 84–85 qualifying child and, 85 unearned income limit and, 85 Economic Growth and Tax Relief Reconciliation Act, 132 Education, 20–22 changing investments, 22 computer technology, 22

savings bond interest, 20–21 section 529 plans, 21–22 Education tax credit, 86–88 American Opportunity credit, 86–87 income limits, 87 Lifetime Learning credit, 87 planning, 88 Elective deferrals, 2–4 contribution limits, 2–4 contribution limits for SIMPLEs, 4 planning, 3–4 Electronic Federal Tax Payment System (EFTPS), 60, 113 Employer identification number (EIN), 112 Employment tax returns, 130 Empowerment zone, 12, 116 Empowerment zone and renewal community employment credit, 127, 146 Energy credits, 129 Environmental remediation costs, expensing, 145 Estate exemption amount, taxes and, 132 interest on portion of tax payable in installments, 134 laws and, 144 planning, 131–40 special use valuation, 134 tax changes, 131–34 Estimated taxes, 112–13 laws and, 144 planning, 113 for small businesses, 112, 146 Excise taxes, 49–50 Exclusions, 1–30 for accelerated death benefits, 26 for benefits paid from long-term care policies, 25 damages, 23–24 foreign earned income, 1, 6–7 home sale, 18–19 life insurance policies, 24–25 Exemptions, 1 alternative minimum tax and, 100–101 estate taxes and, 132 generation-skipping transfer tax and, 137–38 personal and dependency, 64–66 Expiring laws, 141–46

185

186

INDEX

F Farming business equipment and machinery, depreciation for, 145 Federal disaster areas, losses in, 50, 56 Federal Insurance Contributions Act (FICA), 107, 109, 111 Federal Unemployment Tax Act (FUTA), 107, 111, 130 First-time homebuyer credit, 79–82, 143 claiming, 80–81 eligibility, 79–80 recapture, 82 First-year expensing, 144 planning, 116–17 small businesses and, 116–17 Flexible spending arrangements (FSA), 43, 72 Food rates, for day care providers, 128, 129 Foreclosure, 19 Foreign earned income exclusion, 1, 6–7 housing expenses, 7 planning, 6–7 Foreign physical presence test, 6 Foreign residence test, 6 Fostering Connections to Success and Increasing Adoptions Act, 64 401(k) plans small business and, 125 tax penalties on, 107–8 Free parking, 5

Government retirees, payment to, 79 Grandparents, providing childcare, 110 Gross income, adjustments to, 40–41

G Gains, capital, 28 Gambling winnings and losses, 26–27 General capital gains rates, 11–12 planning, 11–12 General Services Administration, 125 Generation-skipping transfer tax changes, 137–38 exemption amount, 137–38 laws and, 144 Gift taxes annual exclusion, 135–36 changes in, 134–37 laws and, 144 lifetime gift exemption amount, 137 non-U.S. citizen spouses and, 137 planning, 136–37

I Illinois Child Care Assistance Program (CCAP), 110 Incentives D.C. enterprise zone, 127 empowerment zone and renewal employment credit, 127 for hiring new employees, 126–28 Indian employment credit, 128 wage differential payments credit, 128 work opportunity credit, 127 Incentive stock options (ISO), 103 Income cancellation of debt, 23 cash for clunkers buying incentive, 23 deferral, 69–71 gambling winnings and losses, 26–27

H Health coverage credit for displaced workers, 94 Health savings accounts (HSA), 37–39, 72 penalties on, 109 planning, 38–39 High-deductible (low-cost) health plan (HDHP), 37–38 limits for 2009, 37 limits for 2010, 38 High earners, phaseout for, 65–66 High-low substantiation rates, 124–25 planning, 124–25 Home, 18–20 cancellation of debt, 19–20 losses on sale of, 20 nonqualified use of, 18 sale exclusion, 18–19 Home energy improvements and investments, credits for, 88–91, 143 Home mortgage interest, 54 Home office deduction, 126 Hope credit, 86 Household employees, tax on, 110–11 Housing expenses, 7

INDEX

planning strategies, 69–73 reimbursements to parents of disabled children, 26 retirement, 14–17 rules for, 1–30 shifting, 73 taxable, 28, 63 tax strategies for, 27–30 Income limits, on earned income credit, 83–84 Income tax brackets, 67–68 Indian employment credit, 128, 145 Individual retirement accounts (IRA), 7, 32–35, 99 adjustments to gross income, 40–41 business-related adjustments, 40 contribution limit, 32 contributions of workers of bankrupt employers, 32–33 damages for mismanaged, 33 eligibility for deductible contributions, 33–34 health savings accounts, 37–39 moving expenses, 39–40 nondeductible, 35 planning for, 35–41 rollovers, 17, 142 Roth conversions, 15–16 rules, 33 student loan interest deduction, 40 tax penalties on, 107–8 tax savings, 36 traditional versus Roth, 35 working couples and, 35–36 Individuals, provisions for, 141–44 Individuals with Disabilities Education Improvement Act, 26 Installment sales, 29 Interest, 9–11 Build America Bonds (BAB), 9 on California registered warrants, 10 expenses, 54 home mortgage, 54 private activity bond, 103–4 savings bond, 9–10, 20–21 Internal Revenue Code, 30 International Energy Conservation Code, 89

Investments, 11–14 changing, 22 general capital gains rates, 11–12 home energy, 88–91 losses in passive activities, 13–14 losses in Ponzi schemes, 13 mark-to-market reporting, 13 small business stock, 12–13 Itemized deductions AGI limits for phaseout of, 51 average for 2007, 50 breaks for, 45–73 convenience fees for charging tax payments, 59–60 laws and, 142 miscellaneous, 57–60 J J.K. Lasser’s Small Business Taxes 2010, 115 Job-related benefits, 2 COBRA subsidy, 8–9 combat pay, 7 elective deferrals, 2–4 foreign earned income exclusion, 6–7 transportation fringe benefits, 4–6 unemployment, 7–8 Joint Committee on Taxation, 141 K Kiddie tax, 44, 73, 99, 105–7 planning, 106–7 subject to, 105 threshold amounts, 106 L Laws, expiring, 141–46 adjustments to gross income, 142 income and exclusions, 141–42 itemized deductions, 142 provisions for businesses, 144–46 provisions for individuals, 141–44 tax computation, 143 tax credits, 143–44 Leased cars, 123 Life insurance policies planning, 25 surrendering or selling, 24–25

187

188

INDEX

Lifetime gift tax exemption amount, 137 Lifetime Learning credit, 87 Limited liability companies (LLC), 14 Limited liability partnerships (LLP), 14 Living trust, 10 Local sales tax, 49–50 Long-term care insurance, 52–53 benefits paid from, 25 deductible portion of premiums, 52 Losses capital, 28–29 casualty and theft, 55–57 in federal disaster areas, 50 gambling, 26–27 on sale of residence, 20 Losses, investment in passive activities, 13–14 in Ponzi schemes, 13 M Madoff, Bernard, 13, 56 Making Work Pay credit, 36, 76–78, 143 eligibility, 76 figuring, 78 MAGI cap, 77–78 MAGI phaseout ranges for, 77 payment method, 76–77 schedule M, 77 Mark-to-market reporting, 13 Maximum credit, 83 Meal allowance, for day care providers, 128–29 Medical driving, 52 Medical expenses, 51–53 long-term care insurance, 52–53 medical driving, 52 Medicare Part B premiums, for 2009, 42 Midquarter convention, 118 Modified adjusted gross income (MAGI), 1, 8, 20–21, 31, 49 cap, 77–78 education tax credit and, 87 first-time homebuyer credit and, 79 phaseout ranges for higher education credits, 87 phaseout ranges for IRAs, 34 planning, 41–44 strategies for controlling, 42–44

Modified carryover basis rule, 138–40 planning, 140 Monthly transit passes, 5 Mortgage workout, 19 Motor vehicle purchases, taxes on, 49–50, 53–54 Moving expenses, 39–40 planning, 39–40 Mutual funds, 106 N Nanny tax, 110 New markets credit, 145 Nondeductible IRAs, 35 Nonqualified use, of home, 18 military service and, 18 relocation and, 19 temporary absences and, 19 Nonworkers, one-time payment for, 78–79 O One-time payment for nonworkers, 78–79 government retirees, 79 P Passive activity loss (PAL), 13–14 Penalties account actions subject to, 109 on commercial annuities, 109 on coverdell education savings accounts, 109 on health savings accounts, 109 on IRAs, 107–8 on 401(k) plans, 107–8 Pension Benefit Guaranty Corporation (PBGC), 94 Personal exemptions, 64–66 phaseout for high earners, 65–66 phaseout ranges for, 65 Planning opportunities estate tax changes, 131–34 generation-skipping transfer tax changes, 137–38 gift tax changes, 134–37 modified carryover basis rule, 138–40 Plug-in electric vehicles credit for, 95 small businesses and, 124

INDEX

Ponzi schemes, losses in, 13, 56–57 Private activity bond interest, 103–4 Q Qualified disaster costs, 129 Qualified dividends, taxes on, 10–11 Qualified terminable interest trust (QTIP), 133 Qualifying child, 64–65 defined, 85, 95 R Real estate taxes, standard deductions and, 47, 49 Receipts, retaining, 61 Record keeping, deductions and, 61 Religious school contributions, 55 Required minimum distribution (RMD), 14–15, 141 planning, 15 Retirement income, 14–17 IRA rollovers, 17 required minimum distributions, 14–15 Roth IRA conversions, 15–16 Retirement Savings Contributions credit, 91–93 applicable percentages for, 92 planning, 93 Revocable trust, 10 Rollovers, IRA, 17 planning, 17 Roth IRA conversions, 15–16 planning, 16 Roth IRAs eligibility for contributions, 34–35 MAGI phaseout ranges for, 34 traditional versus, 35 S Salary reduction simplified employee pension (SARSEP), 2 Sales, installment, 29 Sales taxes, on vehicle purchases, 53–54 Savings bonds interest on, 9–10, 20–21 interest phaseout ranges, 21 planning, 10

Savings incentive match plan for employees (SIMPLE), 2, 91 contribution limits for, 4 planning, 4 small business and, 125 Schedule L, 48 Schedule M, 77 Section 529 plans, 21–22 prepaid tuition plan, 21 savings plan, 21 Section 1244 stock, 29–30 Securities Investor Protection Corporation (SIPC), 57 Self-employed retirement plans, 125–26 Self-employment tax, 110 Short sale, 19 Simplified employed pensions (SEP), 125 Small business bonus depreciation, 117–20 cents-per-mile valuation rule, 123 dollar limits on car deductions, 120 dollar limits on trucks and vans, 121 employment tax returns, 130 energy credits, 129 estimated taxes and, 112 first-year expensing, 116–17 high-low substantiation rates, 124–25 home office deduction, 126 incentives for hiring new employees, 126–28 leased cars, 123 meal allowance for day care providers, 128–29 plug-in electric vehicles, 124 qualified disaster costs, 129 self-employed retirement plans, 125–26 standard mileage rate, 121–22 tax-saving changes for, 115–30 Small business stock, 12–13 alternative minimum tax and, 104 planning, 12–13 Social Security benefits, 16 credit for excess tax withheld, 95–96 disability, 1 retirement, 1 Social Security and Medicare, 2, 95 Special use valuation, 134

189

190

INDEX

Standard deductions additional amounts, 46–50 age and/or blindness, 47 basic, 46 breaks for, 45–73 losses in federal disaster areas, 50 real estate taxes, 47, 49 state and local sales and excise taxes, 49–50 Standard mileage rate, 121–22 deemed depreciation, 121–22 planning, 122 State sales tax, 49–50 Stocks, section 1244, 29–30 Student interest deduction, 40 MAGI phaseout ranges for, 40 T Taxable income, 28, 63 Tax brackets, 143 future, 73 Tax breaks, 31 alternative minimum tax, 99–105 estimated taxes, 112–13 FICA, 109 household employees, 110–11 money-saving, 99–113 penalties and, 107–9 self-employment tax, 110 Tax computation, trimming, 63–73 income tax brackets, 67–68 personal and dependency exemptions, 64–66 Tax credits, 143–44 alternative minimum tax and, 104 Taxes credit to cut, 75–97 deductions and, 53–54 estate, changes in, 131–34 estimated, 112–13 generation-skipping transfer changes, 137–38 gift, 134–37 on household employees, 110–11 kiddie, 105–7 penalties on IRAs, 107–8 penalties on 401(k) plans, 107–8 planning for credits, 96–97

on qualified dividends, 10–11 real estate, 47, 49 self-employment, 110 Taxpayer statement for revenue procedure, 58–59 Tax planning, for deductions, 60–61 Tax rate schedule for head of household, 68 for married filing jointly and qualifying widow(er), 67 for married filing separately, 68 for single tax payer, 67 Tax savings, IRAs and, 36 Tax shelters, 13 Tax strategies for income, 27–30 installment sales, 29 section 1244 stock, 29–30 worthless securities, 29 year-end strategies for capital gains and losses, 28–29 Threshold amounts, kiddie tax and, 106 Trade adjustment assistance (TAA), 94 Transportation fringe benefits, 4–6 free parking, 5 monthly transit passes, 5 planning, 5–6 van pooling, 5 Trucks, dollar limits on, 121 U Unemployment benefits, 7–8 planning, 8 V Van pooling, 5 Vans, dollar limits on, 121 Voluntary withholding, 8 W Wage differential payments credit, 128 Working couples, IRAs and, 35–36 Work opportunity credit, 127, 145 Worthless securities, determining, 29 Y Year-end strategies for capital gains and losses, 28–29

Tax/Personal Finance

Straightforward explanations of the new tax laws Things have changed radically in our economy and our finances. Everything has been affected: from housing and education, to employment, and beyond. These changes are complex and will have a dramatic effect on taxpayers. But all is not lost. J.K. Lasser provides the tips and tools needed to gain a better understanding of what is going on and help you save money on your 2009 return. Perhaps more importantly, this book will help you plan ahead for future tax savings. Written by the recognized authority in taxes, J.K. Lasser’s New Tax Law Simplified 2010 transforms the complex new tax laws into plain English that any taxpayer can understand. Filled with up-to-the-minute facts and figures, this book makes it easier for you to learn about—and profit from—the laws that govern your taxes. Informative and accessible, this reliable resource: • Outlines various tax relief strategies that will help you benefit from the American Recovery and Reinvestment Act • Contains numerous examples and tables that highlight the issues addressed • Helps you understand and utilize the new tax programs and regulations for this year and next year • Details new tax breaks that will improve your family’s education • Reveals easy-to-do planning strategies • And much, much more! While you may be concerned with the current state of the economy and financial world, this can be a time of great opportunity—if you take advantage of the guidance found in J.K. Lasser’s New Tax Law Simplified 2010.

BARBARA WELTMAN, an attorney, is a nationally recognized expert in taxation for small businesses and is the top-selling author of books on tax and finance, including J.K. Lasser’s 1001 Deductions and Tax Breaks. She is an experienced writer and is quoted regularly in major publications, including the New York Times and Money magazine. Visit her at www.barbaraweltman.com.

J.K. Lasser—Practical Guides for All Your Financial Needs Please visit our Web site at www.jklasser.com Cover Design : Paul McCar thy Cover Illustration : © iStock

$14.95 USA /$17.95 CAN

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