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2008 Year-End Estate and Gift Tax Planning

Use of Gift Tax Exemptions to Reduce Estate and Gift Tax

The current federal estate tax exemption is $2 million, increasing to $3.5 million in 2009. An important method of ensuring that your estate will not be subject to estate tax is to make sufficient gifts during your lifetime so that at your death your estate is smaller than the then-current exemption amount.

 

Your lifetime gifts are, however, subject to a gift tax that is imposed at the same rate as the estate tax. This “unified” system is intended to eliminate any tax advantage to making gifts. But certain types of lifetime transfers are not subject to gift tax, and the end of the year is a good time to make these tax-free gifts.

Annual Gift Tax Exclusion

The most commonly-used method for tax-free giving is the annual gift tax exclusion, which allows you to annually make a gift of up to $12,000 to each donee with no gift tax. There is no limit on the number of donees to whom you can make such gifts — if you make identical gifts to 10 donees, you can exclude up to $120,000 from tax. In addition, if you are married you can double the amount of the exclusion to $24,000 per donee, because you and your spouse can combine your exemptions in a single gift from either of you. It is expected that this annual exclusion will increase to $13,000 in 2009 to reflect inflation.

 

Your annual gift tax exclusion expires at the end of each year, so the year end is the appropriate time to take advantage of it. If you want to make a gift that exceeds the amount of the exclusion, you can effectively double the exclusion by making one gift in December and the second in January. For example, if you are married, you can make a tax-free gift of $50,000 to any individual by making a gift of $24,000 in December 2008 and another $26,000 gift in January 2009 (assuming an annual exclusion increase to $13,000).

 

The annual exclusion is applied on a per-donee basis. As a result, you can leverage the exclusion by making gifts to multiple members of the same family. For example, you could make $12,000 gifts to each of your son, his wife and his daughter, for a total of $36,000 in tax-free gifts. This tax-free amount can be doubled to $72,000 if your spouse joins in the gifts.

Tuition Payment Exclusion

In addition to the annual gift tax exclusion, you are allowed to make tax-free tuition payments for any individual. There is no limit on the amount that can be excluded, except that the payment must be to a tax-exempt school and for the purpose of education or training. The exclusion applies only to tuition — payments for room and board, books, or related expenses are not eligible.

 

Because there is no limit on the amount of the gift, its timing is less important than it is with the annual exclusion. Nevertheless, if you have the choice of making either a tuition payment or an annual exclusion gift for a particular beneficiary, it will usually be better to make the tuition payment, because that will give you the option of making an annual exclusion gift later in the year.

 

If the tuition payment is made on behalf of a dependent, and if your adjusted gross income is $160,000 or less (for a joint return), then you may also be entitled to an income tax deduction for the payment. Let us know if you think that you may qualify.

Section 529 College Savings Plans

Contributions to a section 529 college savings plan do not qualify for the exclusion for tuition payments, but can take advantage of the $12,000 annual gift tax exclusion. The contribution to the plan may also entitle you to a state income tax deduction.

 

Distributions from a 529 plan can be used for a wide range of educational expenses, including tuition, fees, books, supplies, and room and board. An added advantage of a gift to a 529 plan is that the income earned on the plan contributions is tax-free, as long as it is eventually used for educational purposes.

 

Thus, you can reduce your own income taxes by funding a 529 plan with savings that would have been used for college anyway. And because you can name yourself as the custodian of the account, you ensure that your beneficiary uses the account for educational purposes.

 

A special rule allows you to use up to five annual gift tax exclusions when funding a 529 college savings plan. You can fund a savings plan with up to $60,000 (5 x $12,000) this year and then file an election with the IRS to spread this gift over five years (2008 - 2012) for gift tax purposes. By using five annual exclusions, the entire gift becomes tax-free. If, as expected, the gift tax exclusion increases to $13,000 in 2009, you can make another gift of $5,000 to the same 529 plan in 2009, electing to spread that gift over 2009 - 2013.

Medical Payment Exclusion

The payment of a beneficiary's medical expenses is also excluded from the gift tax, with no limitation on the amount excluded. To qualify for this exclusion, the payment must be made directly to the provider, and it must be for medical expenses that would qualify for an income tax deduction. You can also claim an income tax deduction for the payment if it is made for your spouse or dependent.

 

The exclusion for medical payments includes the payment of medical insurance premiums. If you have a child or grandchild who is paying for his or her own insurance, payment of their insurance premiums is an efficient means of making a tax-free gift that does not consume the $12,000 annual exclusion.

Gifts in Trust

Despite the tax savings, you may be uneasy about making outright gifts to your children or grandchildren, due to your loss of control over how they use the gift. This concern can be addressed by making the gifts in trust, which will allow you to determine when they receive the money and how it is to be used.

 

There are special requirements for ensuring that a gift in trust qualifies for the $12,000 annual exclusion. Usually, the trust is drafted to provide the beneficiary with temporary withdrawal rights over the gift (usually for 30 days), such that it is considered a present interest rather than one that vests in the future. Although this presents a risk of the beneficiary withdrawing the gift from the trust, the probability of your terminating any further gifts to the trust is usually sufficient to prevent this. If you are interested in making a gift in trust, we will be glad to explain how this can be done.

Charitable Gifts

The year end is a good time to review your charitable giving to ensure that it is being done in the most tax-efficient manner. Charitable giving is a form of estate planning, because a gift to charity will never be subject to estate or gift tax. If you are planning to make a large gift before January 1, we should review its impact on your 2008 income tax liability and whether it may make sense to defer all or a portion of the gift to 2009. If the gift is of property and will require an appraisal (usually required for gifts of property with a value in excess of $5,000, other than publicly traded stock), we should start the process as soon as possible so that the appraisal is available before year end.

In conclusion, we hope that the information in this letter is useful in your year-end gift planning. If you wish to take advantage of any of the planning techniques that we have described, please feel free to call.


Tax Planning for Individuals

As 2007 draws to a close, there is still time to reduce your 2007 tax bill and plan ahead for 2008. This article highlights several potential tax-saving opportunities for you to consider. We would be happy to meet with you to discuss specific strategies.
 
Basic Numbers You Need To Know
 
Because many tax benefits are tied to or limited by adjusted gross income (AGI)—IRA deductions, for example—a key aspect of tax planning is to estimate both your 2007 and 2008 AGI. Also, when considering whether to accelerate or defer income or deductions, you should be aware of the impact this action may have on your AGI and your ability to maximize itemized deductions that are tied to AGI. Your 2006 tax return and your 2007 pay stubs and other income- and deduction-related materials are a good starting point for estimating your AGI.
 
Another important number is your “tax bracket,” i.e., the rate at which your last dollar of income is taxed. The tax rates for 2007 are 10%, 15%, 25%, 28%, 33%, and 35%. Although tax brackets are indexed for inflation, if your income increases faster than the inflation adjustment, you may be pushed into a higher bracket. If so, your potential benefit from any tax-saving opportunity is increased (as is the cost of overlooking that opportunity).
 
IRA, Retirement Savings Rules for 2007
 
Tax-saving opportunities continue for retirement planning due to the availability of Roth IRAs, changes that make regular IRAs more attractive, and other retirement savings incentives. As discussed herein, even more changes began in 2007.
 
Traditional IRAs: Individuals who are not active participants in an employer pension plan may make deductible contributions to an IRA. The annual deductible contribution limit for an IRA for 2007 is $4,000. Individuals who are active participants in an employer pension plan also may make deductible contributions to an IRA, but their contributions are limited in amount depending on their AGI. For 2007, the AGI phase-out range for deductibility of IRA contributions is between $52,000 and $62,000 of modified AGI for single persons (including heads of households), and between $83,000 and $103,000 of modified AGI for married filing jointly. Above these ranges, no deduction is allowed. The $20,000 spread for joint returns is new for 2007 (up from $10,000).
 
For 2007, a $1,000 “catch-up” contribution deduction is allowed for taxpayers age 50 or older by the close of the taxable year who meet the other qualifications for IRA deductions. Thus, the total deductible limit for these individuals may be as high as $5,000.
 
In addition, an individual will not be considered an “active participant” in an employer plan simply because the individual's spouse is an active participant for part of a plan year. Thus, you may be able to take the full deduction for an IRA contribution regardless of whether your spouse is covered by a plan at work, subject to a phase-out if your joint modified AGI is $156,000 to $166,000 for 2007. Above this range, no deduction is allowed.
 
Roth IRA: This type of IRA permits nondeductible contributions of up to $4,000 a year. Earnings grow tax-free, and distributions are tax-free provided no distributions are made until more than five years after the first contribution and the individual has reached age 591/2. Distributions may be made earlier on account of the individual's disability or death. The maximum contribution is phased out for persons with AGI above certain amounts: $156,000 to $166,000 for joint filers, and $99,000 to $114,000 for single filers (including heads of households). For 2007, a $1,000 “catch-up” contribution is allowed for taxpayers age 50 or older by the close of the taxable year, making the total limit $5,000 for these individuals.
 
Roth IRA Conversion Rule: Funds in a traditional IRA may be rolled over into a Roth IRA. Such a rollover, however, is treated as a taxable event, and you will pay tax on the amount converted. No penalties will apply if all the requirements for such a transfer are satisfied.
 
A taxpayer's AGI (whether married filing jointly or single) is limited to $100,000 to make such a conversion and the taxpayer must not be a married individual filing a separate return.
 
401(k) Contribution: The 401(k) elective deferral limit is $15,500 for 2007, up from $15,000 in 2006. If your 401(k) plan has been amended to allow for catch-up contributions for 2007 and you will be 50 years old by December 31, 2007, you may contribute an additional $5,000 to your 401(k) account, for a total maximum contribution of $20,500 ($15,500 in regular contributions plus $5,000 in catch-up contributions).
 
Catch-Up Contributions for Other Plans: If you will be 50 years old by December 31, 2007, you also may contribute an additional $5,000 to your 403(b) plan or SEP.
 
Maximize Retirement Savings: In many cases, employers will require you to set your 2008 retirement contribution levels before January 2008. You may want to increase your contribution to lower your AGI in order to take advantage of some of the tax breaks described above. In addition, maximizing your contribution is generally a good tax-saving move.
 
Deferring Income to 2008
 
If you expect your AGI to be higher in 2007 than in 2008, or if you anticipate being in the same or a higher tax bracket in 2007, you may benefit by deferring income into 2008. Deferring income will be advantageous so long as the deferral does not bump your income to the next bracket.
 
Delay Billing: If you are self-employed, delay year-end billing to clients so that payments will not be received until 2008.
 
Accelerating Income into 2007
 
In limited circumstances, you may benefit by accelerating income into 2007. For example, you may anticipate being in a higher tax bracket in 2008, or perhaps you will need additional income in order to take advantage of an offsetting deduction or credit that will not be available to you in future tax years. Note however that accelerating income into 2007 will be disadvantageous if you expect to be in the same or lower tax bracket for 2008. In any event, before you decide to implement this strategy, we should “crunch the numbers.”
 
If accelerating income will be beneficial, here are some ways to accomplish this:
 
Accelerate Collection of Accounts Receivable: If you are self-employed and report income and expenses on a cash basis, issue bills and attempt collection before the end of 2007. Also see if some of your clients or customers might be willing to pay for January 2008 goods or services in advance. Any income received using these steps will shift income from 2008 to 2007.
 
Year-End Bonuses: If your employer generally pays year-end bonuses after the end of the current year, ask to have your bonus paid to you before the beginning of 2008.
 
Retirement Plan Distributions: If you are over age 59 1/2 and you participate in an employer retirement plan or have an IRA, consider making any taxable withdrawals before 2008.
 
You may also want to consider making a Roth IRA rollover distribution, as discussed above.
 
Deduction Planning
 
Deduction timing is also an important element of year-end tax planning. Deduction planning is complex, however, due to factors such as AGI levels and filing status. If you are a cash-method taxpayer, remember to keep the following in mind:
 
Deduction in Year Paid: An expense is only deductible in the year in which it is actually paid.
 
Payment by Check: Date checks before the end of the year and mail them before January 1, 2008.
 
AGI Limits: The AGI limits on itemized deductions affect deduction planning. Normally, overall itemized deductions are reduced by 3% of the AGI exceeding $156,400 ($78,200 if married filing separately). However, for 2007, the reduction is itself reduced to two-thirds of what it otherwise would be. For 2008, the reduction is reduced by only one-third of what it otherwise would be, thus allowing for more deductions than in 2007. Similarly, certain deductions may be claimed only if they exceed a percentage of AGI: 7.5% for medical expenses, 2% for miscellaneous itemized deductions, and 10% for casualty losses.
 
Standard Deduction Planning: Deduction planning is also affected by the standard deduction. For 2007 returns, the standard deduction is $10,700 for married taxpayers filing jointly, $5,350 for single taxpayers, $7,850 for heads of households, and $5,350 for married taxpayers filing separately. If your itemized deductions are relatively constant and are close to the standard deduction amount, you will obtain little or no benefit from itemizing your deductions each year. But simply taking the standard deduction each year means you lose the benefit of your itemized deductions. To maximize the benefits of both the standard deduction and itemized deductions, consider adjusting the timing of your deductible expenses so that they are higher in one year and lower in the following year. You can do this by paying in 2007, deductible expenses, such as mortgage interest (including for 2007 mortgage insurance premiums), due in January 2008.
 
Medical Expenses: Medical expenses, including amounts paid as health insurance premiums, are deductible only to the extent that they exceed 7.5% of AGI. Consider bunching medical expenses into years when your AGI is lower.
State Taxes: If you anticipate a state income tax liability for 2007 and plan to make an estimated payment, consider making the payment before the end of 2007. Note that in 2007, you can choose to deduct as an itemized deduction state and local sales taxes instead of state and local income taxes.
 
Charitable Contributions: Consider making your charitable contributions at the end of the year. This will give you use of the money during the year and simultaneously permit you to claim a deduction for that year. You can use a credit card to charge donations in 2007 even though you will not pay the bill until 2008. A mere pledge to make a donation is not deductible, however, unless it is paid by the end of the year. Note, however, for claimed donations of cars, boats and airplanes of more than $500, the amount available as a deduction will significantly depend on what the charity does with the donated property, not just the fair market value of the donated property. If the organization sells the property without any significant intervening use or material improvement to the property, the amount of the charitable contribution deduction cannot exceed the gross proceeds received from the sale.
 
To avoid capital gains, you may want to consider giving appreciated property to charity.
 
Individuals who are at least age 70 1/2 may exclude from gross income qualified charitable distributions of up to $100,000 per year from an IRA. Distributions from SEPs and SIMPLE accounts do not qualify. The distribution must be made directly by the IRA trustee to a public charity or to a private operating or flow-through foundation described in §170(b)(1)(F). Distributions to other types of private foundations, to supporting organizations, and to donor-advised funds are not eligible. The distribution qualifies for the income exclusion only to the extent that the distribution would have been includible in gross income but for this special treatment. Although no charitable contribution deduction is allowed for the distribution, it is necessary that the entire amount of the distribution satisfy the requirements for a charitable contribution deduction without consideration of the percentage limitations. Thus, there can be no quid pro quo from the charity that would otherwise reduce the amount of the deduction. This exclusion is available only for distributions made before the end of 2007.
 
Education and Child Tax Benefits
 
Child Tax Credit: A tax credit of $1,000 per qualifying child under the age of 17 is available on this year's return. The credit is phased out at a rate of $50 for each $1,000 (or fraction of $1,000) of modified AGI exceeding the following amounts: $110,000 for married filing jointly; $55,000 for married filing separately; and $75,000 for all other taxpayers.
 
Credit for Adoption Expenses: For 2007, the adoption credit limitation is $11,390 of aggregate expenditures for each child, except that the credit for an adoption of a child with special needs is deemed to be $11,390 regardless of the amount of expenses. The credit ratably phases out for taxpayers whose income is between $170,820 and $210,820.
 
 
Coverdell Education Savings Account: For 2007, the aggregate annual contribution limit to a Coverdell education savings account is $2,000 per designated beneficiary of the account. This limit is phased out for individual contributors with modified AGI between $95,000 and $110,000 and joint filers with modified AGI between $190,000 and $220,000. The contributions to the account are nondeductible but the earnings grow tax-free.
 
Student Loan Interest: You may be eligible for an above-the-line deduction for student loan interest paid on any “qualified education loan.” The maximum deduction is $2,500. The deduction for 2007 is phased out at a modified AGI level between $110,000 and $140,000 for joint filers, and between $55,000 and $70,000 for individual taxpayers.
 
Kiddie Tax: 2007 is the last year that you can avoid the kiddie tax rules for your dependent children who are age 18 or over by year end. Beginning in 2008, the kiddie tax will apply to 18-year old children who have unearned income in excess of the threshold amount, do not file a joint return and who have earned income, if any, that does not exceed one-half of the amount of the child's support. The tax also may apply to children between the ages of 19 and 23 and if, in addition to the above rules, they are full-time students. For 2007, the kiddie tax threshold amount is $1,700.
 
Energy Incentives
 
Alternative Motor Vehicle Credit: For 2007, a credit is available for purchases of motor vehicles powered by certain alternative fuels. The dollar amount of the credit depends on fuel savings and weight of the vehicle. The most popular vehicles subject to the credit are hybrids. However, when a particular manufacturer sells in the United States its 60,000th of the particular hybrid, a phaseout period kicks in. The phaseout will reduce the credit from fully available to nothing being available. The phaseout begins in the second calendar quarter following the calendar quarter where the manufacturer sold its 60,000th hybrid vehicle following December 31, 2005. Credits are also available for lean-burn technology vehicles (subject to the same phaseout), qualified fuel cell motor vehicles, and qualified alternative fuel motor vehicles. If you have an interest in purchasing a hybrid vehicle before the end of 2007, please contact me and I can calculate the allowable credit. The amount of the credit could affect your decision on which vehicle to purchase.
 
Residential Energy Efficient Property Credit: Tax incentives are available to taxpayers who install certain energy efficient property, such as photovoltaic, solar water heating or fuel cell property. In 2007, a credit is available for the expenditures incurred for such property up to a specific dollar limitation. The property purchased cannot be used to heat swimming pools or hot tubs. The credit is set to expire for property placed in service after 2008. If you have made improvements to your home or plan to by the end of 2007, please contact me to discuss the amount of the credit you may qualify for.
 
Nonbusiness Energy Property Credit: Tax incentives are available to taxpayers who remodel their home and/or incorporate specific energy efficient property. In 2007, a credit is allowed for the purchase of qualified energy efficiency improvements. Such property includes advanced main air circulating fans, natural gas, propane, oil furnace or hot water boiler, windows, insulation material, exterior doors, etc. that meet certain energy efficiency standards. The credit is capped in dollar amounts per item of property. The credit is set to expire for property placed in service after 2007.
 
Investment Planning
 
The following rules apply for most capital assets in 2007:
 
• Capital gains on property held one year or less are taxed at an individual's ordinary income tax rate.
 
• Capital gains on property held for more than one year are taxed at a maximum rate of 15% (5% if an individual is in the 10% or 15% marginal tax bracket).
 
Timing of Sales: You may want to time the sale of assets so as to have offsetting capital losses and gains. Capital losses may be fully deducted against capital gains and also may offset up to $3,000 of ordinary income ($1,500 for married filing separately). In general, when you take losses, you must first match your long-term losses against your long-term gains, and short-term losses against short-term gains. If there are any remaining losses, you may use them to offset any remaining long-term or short-term gains, or up to $3,000 (or $1,500) of ordinary income. When and whether to recognize such losses should be analyzed in light of the changes in the capital gains rates applicable to your specific investments.
 
Alternative Minimum Tax
 
In 2007, the alternative minimum tax exemption amounts are: (1) $45,000 for married individuals filing jointly and for surviving spouses; (2) $33,750 for unmarried individuals other than surviving spouses; and (3) $22,500 for married individuals filing a separate return. These exemption amounts are significantly lower than in 2006. Also, for 2007, nonrefundable personal credits cannot offset an individual's regular and alternative minimum tax. This is another change from 2006. Unless Congress acts, many more people will be subject to the AMT. We should carefully discuss your situation to see if this reduction of exemption amounts brings you into the AMT.
 
Some of the standard year-end planning ideas will not reduce tax liability if you are subject to the alternative minimum tax (AMT) because different rules apply. Because of the complexity of the AMT, it would be wise for us to analyze your AMT exposure.
 
If you have any questions, please do not hesitate to call us. We would be happy to meet with you at your convenience to discuss the strategies outlined above. There is still time to implement these strategies to minimize your 2007 tax liability.


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