LogoMotive January 2007

Tax Planning for 2007

By: Calvin E. Mackey

Mackey & Mackey, CPAs and Advisors

With the start of a new year, you should already be thinking about actions you can take in 2007 to reduce your taxes. Congress has provided significant incentives for individuals and businesses. Here is a "top 10" list of some of the opportunities that may be especially valuable to you in this New Year.

Take advantage of lower rates on long-term capital gains and dividends.

Dividends and capital gains are taxed at a maximum of 15 percent. That's quite a difference from most individual regular tax rate brackets, which typically range from 25 to 35 percent. While this tax advantage has been around since May 2003, many individuals have not capitalized fully on its advantages. With this special benefit set to end after 2010, however, there's not that much time left to map out a comprehensive strategy. While investment strategies should reflect financial goals, there are opportunities to maximize income. Consider purchasing dividend-paying stocks if you want current income taxed at the lower 15 percent rates. If you decide to sell appreciated stocks or other capital assets, you can take advantage of the lower rates on capital gains. You must hold the assets for at least one year. Again, these provisions are not permanent, so keep an eye on Congress for developments after 2007.

Use a flexible spending account.

The itemized deduction for medical expenses is reduced by 7.5 percent of your adjusted gross income. One way to avoid the effect of this reduction is to contribute salary to a flexible spending arrangement maintained by your employer. This reduces your taxable wages and allows you to take out funds tax-free to reimburse your medical expenses. An FSA can also be used to pay child care expenses; the potential benefit is greater than the credit that is provided. The downside is that you must elect to contribute to an FSA by December 31 of the preceding year, and any contributions to the FSA are lost if not used within 2 ½ months of the next plan year.

Install energy-saving property.

Congress wants to encourage home-owners to use energy-saving property - windows, doors, insulation, heat pumps, and other items. For these items, you are entitled to a life-time credit of $500, including a maximum of $200 for windows. The credit reaches $2,000 for solar energy equipment - water heaters, solar electric, and electricity from fuel cells.

Track sales tax expenses.

Congress restored the state and local sales tax deduction at the last minute for 2006 and 2007. If you live in a state without an income tax, you can take an itemized deduction for sales tax. Even if you live with a state income tax, you may find that your purchases in one or more particular years may generate enough sales tax for you to consider the deduction, too. The IRS provides tables, but you can also track your actual expenses. You may want to make big-ticket purchases in 2007, such as cars and home improvement, since the sales taxes can be deducted even if you use the tables.

Buy a hybrid car.

Depending on the make and model, you may be able to take a credit as high as $3,400 for the purchase of a hybrid car or truck from Honda, Ford or General Motors. Congress changed the law to provide a more advantageous credit instead of a deduction. Buying a hybrid car may never be as cost-effective. If you want to buy a Toyota, you should move fast. The credit for Toyotas is 50 percent of prescribed amount, and the credit will be reduced to zero beginning October 1, 2007.

Invest for college.

It's never too early to start saving for college. A parent (or a grandparent) can establish a "529" plan that builds up income tax free and pays no income taxes on distributions used for college expenses. Many states also allow a deduction on the state income tax return for contributions to the 529 plan. Contributions are subject to the gift tax, but you can make a single contribution up to $60,000 ($120,000 for a married couple) that will be covered by five years of the gift tax credit. Education IRAs are another option, as are regular investment accounts that take advantage of post-kiddie tax rules.

Make nontaxable gifts.

A painless way to do some estate planning is to make gifts to your children or potential beneficiaries. You can make a gift of up to $12,000 per recipient tax-free. You and your spouse together can transfer up to $24,000. Transfers of income-producing assets to a beneficiary in a lower tax-bracket will reduce your income taxes and create an overall tax saving.

Consider the new manufacturing deduction.

If you run a business, the manufacturing deduction is a "must" to investigate. The range of activities is much broader than the term "manufacturing" implies -- it includes construction, engineering, architecture, and farming, for example. Congress's goal was to provide a broad benefit for business taxpayers. Code Sec. 199 contains the specifics on taking the deduction for qualifying manufacturing activities. The deduction is available to self-employed individuals and to businesses.

Make a charitable contribution from your IRA.

New rules allow those 70 ½ and older a one-time opportunity to make a charitable contribution directly from your IRA. The distribution is nontaxable, although the contribution is not deductible. This benefit is only available for 2006 and 2007. You must be age 70 ½ to take advantage of this provision. This provision would not help owners of Roth IRAs, since distributions from a Roth IRA already are nontaxable.

Plan for retirement.

You can reduce your taxable income by making contributions to salary reduction plans such as a 401(k) plan or, for nontaxable employers, a tax-sheltered annuity. If you're not covered by a retirement plan, consider making contributions to an IRA. If you are covered, you can still make nondeductible contributions to an IRA. With tax-free build-up of earnings, the sooner you contribute, the more your account will appreciate. Uncle Sam wants you to save for retirement and he is throwing in more and more tax incentives for you to do so.

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