| | 2008 Tax Planning |
| | Published - October 15, 2007 |
| | While the summer is not normally a time when one thinks about 2008 tax planning while lying on the beach with a rum swizzle in hand, the United States Congress and the United States Treasury continue to enact new laws and regulations to increase your income tax.
Kiddie Tax
While it is difficult for one to think of a 24 year old child as a “kiddie”, Congress and the Treasury have no problem in doing so. For years, wealthy parents have moved their investment income to their children who would pay an income tax of 5%, 10% or 15% on investment income, versus a potential 35% tax rate at the parent’s tax bracket. In an ongoing effort to not allow a parent to use a child as a “tax shelter” for investment income, in 2008 the “kiddie tax” age is raised from 18 to 19 years of age, and if the child is a full time student, in some situations it is raised to 24 years of age. So before investment income is transferred to a child that will be realized in 2008, one should first determine whether this will be a futile effort. There is still some time left in 2007 to gift children appreciated stock, if the sale will take place in 2007.
Capital Gains and the Alternative Minimum Tax
Many individuals understand how the regular income tax works, but few have taken the time to understand how the alternative minimum tax works. In computing the alternative minimum tax, about 25 “tax preference items” are added back to income to arrive at the alternative minimum taxable income. If an individual is married and has income of less than $150,000, the tax law allows an additional exemption of about $63,000 to offset the “tax preference items.” But when the come is over $150,000 the exemption phases out until it disappears at about $400,000. The decrease in the exemption is similar to the phase out of the personal exemption amount when your taxable income is over a certain level. But the effect of the phase out is to increase the tax being paid on the underlying income.
For example, suppose that you have taxable salary of $150,000 and long term capital gains of $250,000. While neither of these is a “tax preference item”, the combined income will reduce the alternative minimum tax exemption to zero. The net effect is a capital gains tax of $250,000 x 15% = $37,500 and an alternative minimum tax of about $17,500. The combined tax of $55,000 results in an effective tax rate of 22% on the long term capital gains.
So while in theory there is a maximum 15% tax rate on long term capital gains, the effective tax rate could be almost 50% higher in 2008 given the right circumstances.
Is Bermuda Your Tax Home and Your Family Lives in the United States?
To qualify for the foreign earned income and housing exclusions, your tax home and your abode must be in Bermuda. If you live and work in Bermuda, and frequently visit your family in the United States, and your employer pays for your trips back and forth to the United States, you are receiving a taxable benefit that must either be reported on your Form W-2, or as a taxable benefit when you file your personal tax return.
Realtor’s Commissions and Rebate’s to the Buyer
A real estate agent will typically receive a 6% commission on the sale of a residence that is spit between the selling agent and the listing agent. With more individuals shopping “on line’ versus riding around in an agent’s car for days at a time, it apparently has become common for a selling agent to refund apportion of the commission to the buyer. The IRS was asked to rule on whether the “rebate” was taxable income to the buyer or a reduction of the basis in the underlying property. The IRS has ruled that it is the latter.
Tax Deferred Swaps
It is becoming increasingly common for individuals who are selling their home or investment property to enter into a “tax deferred swap” to avoid paying income tax on the sale of a property. For example, suppose you bought your principal residence in Marblehead, Massachusetts in 1970 for $250,000 and it is now worth $2,000,000. You are ready to retire and move to Florida where you intend to buy another property for $2,000,000. If you sell your home in Massachusetts, and qualify for the housing exclusion of $500,000, you will still pay over $250,000 in Federal and State income tax, leaving you to sell some of your investments in order to buy the Florida home.
In simplicity, what you need to do is have the potential buyer of your Massachusetts home, buy the Florida property instead, and then “swap” homes with you. The buyer eventually ends up with your Massachusetts home and a tax basis of $2,000,000 and you end up with a Florida home with a tax basis of $250,000. The “tax” is deferred until your Florida home is sold in a taxable transaction.
While this “swap” is common among homes in resort areas along the Eastern Seaboard, companies are now being formed whose sole business is to act as the intermediary in arranging these deals.
Corporate Cell Phone
The IRS has ruled that if an individual uses a cell phone for both business and personal calls, the entire cost of the cell phone will be considered taxable income to the employee, unless the employee accounts to the employer for the business and personal use. This ruling is analogous to an employer allowing an employee to use a company owned car for both business and personal use. Thus, personal use of a car and cell phone are considered taxable income to the employee.
IRS and State Audit Cooperation
In a pilot program, States such as Massachusetts, Maryland, New Jersey, New York and California have agreed to furnish the IRS with data on individual and corporate tax returns and sales tax information to help the IRS catch nonfilers and underreporting.
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