With a new administration in place Congress is working on a big package of tax cuts to stimulate the economy. The tax cuts are primarily aimed at low and middle income taxpayers.

 

 

To insure an increase immediately, single individuals who earn $75,000 or less and who earn at least $8,064 will receive a $500 tax credit, and married individuals who earn $150,000 and who earn at least $16,128 will receive a $1,000 tax credit.

 

 

It appears as though an increase in the 33% tax bracket to 36% and the 35% tax bracket to 39.6% will be put off until 2010 or 2011. This would affect single individuals who earn more than $200,000 and married individuals filing jointly who earn over $250,000.

 

The increase in the maximum rate on qualified dividends and long term capital gains from 15% to 20% will likely also be put off to 2010 or 2011.

 

 

A common ploy amongst S Corporations whose income is derived from personal services is to pay the owner a modest salary and to distribute a large dividend at year end. This results in a modest payment of social security tax and a modest income tax on salary while the dividend is taxed at the favorable 15% tax rate.

 

In a double hit proposed legislation will tax all the income as self employment income resulting in an added 15.3% employment tax while taxing the additional income at the highest tax bracket versus the 15% tax bracket. This could readily result in an increase of 25% or more on Personal Service S Corporations.

 

 

 

To some extent tax planning involves taking a law targeted for one purpose and using it, legally, for another purpose. When the College Savings Plan was first introduced years ago, its purpose was to set money aside that would accumulate on a tax free basis and that would be non taxable if used to pay for qualified higher education expenses.

 

The tax law indicated that if the funds were not ultimately used for higher education, that when they were used by the beneficiary for another purpose they would be subject to income tax plus a 10% penalty. The 10% penalty dissuaded many practitioners from recommending this plan to clients on the basis that if your child decided not to go to college18 years from now, that tax would be due on the accumulated income plus the 10% penalty.

 

With baby boomers experiencing high earnings many were contemplating early retirement and perhaps a return to college for a Master’s degree or Doctorate so that they could teach part time. But a lot could happen between today and expected retirement in 20 years. And as the amount that could be invested in a 401(k) plan was limited, many individuals were paying a significant income tax on their current investment income.

 

The amount that a couple could initially put into a 529 account was $240,000, per beneficiary, and the name of the beneficiary could change, at will.

 

In a joint venture one of the big accounting firms and a brokerage firm took the $240,000 amount and measured the net amount after taxes, if the funds were not used for higher education, after 10, 15, or 20 years of having the funds in a brokerage account versus a 529 account. The results indicated that net income after tax, including the 10% penalty, was 8% to 25% higher in the 529 account versus the brokerage account.

 

This led baby boomers to move their money from brokerage accounts to 529 plans as they were in a win/win situation. If they did go to college after retirement the income withdrawn was tax free. And if they did not, they still had a greater after tax return than if they had left the money in a brokerage account.

 

Apparently their have now been significant abuses of this tax planning idea and the Treasury is expected to issue regulations shortly to stop this abuse.

 

 

If you are 70 ½ or older the tax law requires that you take a minimum distribution from your plans and IRA’s each year. In light of the significant loss that individuals have taken in their retirement accounts in the past year the IRS has waived this requirement for 2009.

 

 

In 2009 $15,500 can be contributed to a 401(k) plan and taxpayers 50 and over can contribute an additional $5,500.

 

 

The estate tax exemption for 2009 is $3,500,000. Amounts above the exemption will be taxed at 45%.

 

 

We understand that in light of the economic downturn those IRS agents now have the authority to be more lenient where financial hardships exist.

 

 

In 2008 a first time homeowner was allowed a $7,500 credit, but the credit had to be repaid over 15 years. Current legislation will waive the payback requirement and allow the first time homeowner to keep the entire credit.  

 

 

The IRS will continue it’s free filing alliance with tax software firms wherein individuals with gross income less than $56,000 can file tax returns online for free at the IRS website, www.irs.gov.