Troy Van Sloten, CPA

AGI is the acronym for Adjusted Gross Income. It is generally the sum of a taxpayer's income less adjustments (before deductions and exemptions). Many tax benefits and allowances, such as credits, deductions, exemptions, etc., are limited by a taxpayer's AGI.

Some limits occur at a specific AGI level. For example, your ability to roll a conventional IRA into a Roth IRA is not allowed if your AGI is above $100,000. But, if the AGI is $100,000 or less, the rollover is allowed. This can best be described as a go-or-no-go limitation.

Other limits are based upon a percentage of AGI. Some deductions are reduced by a percentage of AGI until the deduction reaches zero. The two prime examples of this type of percentage limitation are medical itemized deductions (limited by 7.5% of AGI) and miscellaneous itemized deductions (limited by 2% of AGI). Others such as charitable contributions limit the deduction to a percentage of the AGI. Charitable contributions have three AGI limitations depending upon the type of contribution: 50%, 30% and 20%.

Many limitations phase in as the AGI increases between two specific AGI values, thereby "phasing out" (reducing) tax benefit to higher income taxpayers. These phase out levels are inflation adjusted and change every year. To further complicate matters, there are different phase out levels for different filing statuses. Examples of items subject to phase out provisions are:

• Personal Exemptions
• Itemized Deductions
• Education Credits
• Education Interest Deduction
• Active Rental Losses
• Educational IRA Contributions
• Roth IRA Contribution
• Conventional IRA Deduction
• Taxability of Social Security
• Earned Income Credit

Careful tax planning can sometimes avoid or minimize the loss of tax benefits due to AGI limits. If you have advance warning of a large increase in income, it may be appropriate to schedule an appointment to consider alternative approaches to your tax situation.

The IRS estimates that approximately 70 million Americans received or will receive tax refunds this year averaging around $1,700. If you are among those who received a refund, you are probably celebrating. While some consider a large refund cause for celebration, it's actually a financial mistake that becomes particularly costly for those who get refunds year after year.

What's wrong with a refund you ask? Well, it means you've overpaid your tax all year. That's actually your own money you are getting back and you made an interest-free loan to Uncle Sam. Such unintended generosity costs you more than you might imagine. Consider what would have happened had you instead invested $141.67 per month into an investment program such as a mutual fund, your credit union, an IRA, etc., rather than overpaying the IRS. For example, assuming your chosen investment returned 8% compounded monthly, Instead of waiting for a $1,700.00 refund check in April, you would have had about $1,803.60 in your investment account on April 1st. That's $103.60 more – with no waiting. And, if you are the type who gets refunds of this magnitude each year, you would have forgone even more in compound investment returns.

The alternative is to pre-plan your annual prepayments through withholding and quarterly estimate payments so they more closely match your projected tax liability for the year. Your withholding is generally adjusted by changing the number of allowances claimed on the W-4 Form you turn into your employer. The more allowances, claimed the less the withholding. However, be careful that you do not claim too many and end up owing Uncle Sam at the end of the year. You should always double check your payroll deductions once the change has taken effect to insure the proper adjustment has been achieved.

Let this firm assist you in projecting next year's taxes and adjust your withholding allowances. Please call for assistance.

The Child Credit was first introduced in 1998, when taxpayers were allowed to claim a $400 tax credit for their qualified children who were under the age of 17 at the end of the tax year. Per prior tax law changes, the child credit has been increased to $1,000 through 2010. Without further legislation, the credit will revert to $500 in 2011.

Your tax will be the higher of the tax computed the regular way or the Alternative Minimum Tax. Anticipating when the AMT will affect you is difficult, because it is usually the result of a combination of circumstances. In addition to those items listed above, watch out for transactions involving limited partnerships, depreciation and business tax credits only allowed against the regular tax. All of these can strongly impact your bottom line tax and raise a question of possible AMT. Tax Tip: If you were subject to the AMT in the prior year and had a state tax refund in that year, part or all of your state income tax refund from that year may not be includable in the regular tax computation. To the extent you received no tax benefit from the state tax deduction because of the AMT, that portion of the refund is not includable in the subsequent year’s income.

Congress has procrastinated for several years on AMT reform.  Each year, they temporarily increase the exemption amount for inflation, leaving taxpayers in doubt about the future years.  Without these annual patches, the IRS estimates that an additional 14% of the nation’s taxpayers will be affected by the AMT and hit with an unexpected tax increase.  For 2008, Congress has patched the AMT with increased exemption amounts as shown in the table below.   We will have to wait and see what happens for 2009.

AMT EXEMPTION PHASE OUT

Filing Status	Exemption Amount	Income Where Exemption Is Totally Phased Out
Married Filing Jointly	$69,950	$330,000
Married Filing Separate	$34,975	$165,000
Unmarried	$46,200	$247,500

AMT TAX RATES

AMT Taxable Income 0 – 175,000(1) Over 175,000(1)

Tax Rate 26% 28%

Anticipating when the AMT will affect you is difficult, because it is usually the result of a combination of circumstances. In addition to those items listed above, watch for transactions involving incentive stock options, limited partnerships, and tax-free income from private activity bonds, depreciation, and tax credits. All of these can strongly impact your bottom line tax and raise a question of possible AMT.

According to a recent news article in a large metropolitan newspaper, the IRS may be auditing fewer returns but they are getting smarter about choosing those they do audit. Their goal, of course, is to focus scrutiny on the most "audit worthy" returns-those with potential for big adjustments. As taxpayers, all of us would like to avoid an audit. But how does one avoid being "chosen"? While there's no sure way, experts do offer advice on what to look for to help cut audit risk.

Are deductible expenses out of line with income? When a return goes through the IRS computer, it's "graded" with a score that indicates how that return differs from an IRS norm for other returns in the same income level. For example, if your income was $32,000 and you claimed charitable contributions of over $20,000, the IRS system would very likely show more than a slight bleep when your return was processed. The chance of an audit would go up appreciably!

Where's the hidden income? The IRS questions how savings can go up without a general increase in income from all sources. Thus, returns that show low income but indicate ever-increasing amounts of interest and dividend income can be high audit risk.

Do we have a mismatch? The IRS is expert in matching information on tax returns to what has been reported to them by employers, banks, brokerages, etc. To head off unwanted correspondence with the government, your tax return needs to accurately reflect the 1099s and W-2s you receive. Keep careful records of your accounts to ensure against mismatches.

Does the IRS understand your business better than you think? The IRS now has special audit guides that help their personnel understand the ins and outs of various kinds of businesses. If you're in an occupation targeted by one of the guides, an audit may be more likely. Dozens have already been published zeroing in on a variety of occupations including truckers, innkeepers, lawyers, musicians, taxi drivers, and many others.

Are you a sole proprietor? If so, watch out. Sole proprietors stand out over others when it comes to being audited. Those with incomes over $100,000 "enjoy" a high audit rate. However, business owners with less than $25,000 annual income has one of the highest audit rates. One in twenty are "favored."

If you get an IRS Notice: If you ever receive any communication from the IRS, don't panic. However, your timely response will be one of the main keys to finding a satisfactory solution. To be certain, call us at once. Together, we will determine exactly what course of action needs to be made.

Ever wonder what the term “tax bracket” means? It refers to the top marginal tax rate that individuals are being taxed, not the average. Knowing your marginal rate is important, because any increase or decrease in your taxable income will affect your tax at your top marginal rate. Thus, if you are in the 25% marginal bracket and plan on signing up for your employer’s 401(k) plan, you will generally save $250 ($1,000 x .25) in federal taxes for each $1,000 contributed to the 401(k) plan. The reason we say “generally” is because sometimes a tax deduction can actually drop you into a lower marginal tax bracket.

The table below reflects the marginal tax bracket for various taxable incomes. Keep in mind that not all of your income is taxed. The amount equal to the sum of your deductions and exemptions is not taxed at all. If your income is below the sum of your deductions and exemptions, you would not have a taxable income, and your marginal rate would be zero.

However, once your income exceeds the sum of your deductions and exemptions, you will have taxable income and your marginal tax rate can be determined from the table. For example, let’s assume that your income for the year is $50,000. You are married with two dependent children and will take the standard deduction. The standard deduction in 2008 for a married couple is $10,900. The exemptions for 2008 are $3,500. Thus, your taxable income would be $25,100 ($50,000 - $10,900 – ($3,500 x 4)). For a taxable income of $25,100, the marginal tax rate from the table (table values illustrated are the top of each bracket) is 15%.

2008 MARGINAL TAX RATES TAXABLE INCOME BY FILING STATUS (Values shown are the top of each marginal tax bracket.)
Marginal Tax Rate	Single	Head of Household	Joint*	Married Filing Separately
10.0% 15.0% 25.0% 28.0% 33.0%	8,025 32,550 78,850 164,550 357,700	11,450 43,650 112,650 182,440 357,700	16,050 65,100 131,450 200,300 357,700	8,025 32,550 65,725 100,150 178,850
35.0%	Over 357,700			Over 178,850

2009 MARGINAL TAX RATES TAXABLE INCOME BY FILING STATUS (Values shown are the top of each marginal tax bracket.)
Marginal Tax Rate	Single	Head of Household	Joint*	Married Filing Separately
10.0% 15.0% 25.0% 28.0% 33.0%	8,350 33,950 82,250 171,550 372,950	11,950 45,500 117,450 190,200 372,950	16,700 67,900 137,050 208,850 372,950	8,350 33,950 68,525 104,425 186,475
35.0%	Over 372,950			Over 186,475

* Also used by taxpayers filing as Surviving Spouse

Taxpayers often question how long records must be kept and the amount of time IRS has to audit a return after it is filed.

It all depends on the circumstances! In many cases, the federal statute of limitations can be used to help you determine how long to keep records. With certain exceptions, the statute for assessing additional tax is 3 years from the return due date or the date the return was filed, whichever is later. However, the statute of limitations for many states is one year longer than the Federal. The reason for this is that the IRS provides state taxing authorities with Federal audit results. The extra time on the state statute gives states adequate time to assess tax based on any federal tax adjustments.

In addition to lengthened state statutes clouding the recordkeeping issue, the Federal 3-year rule has a number of exceptions:

• The assessment period is extended to 6 years instead of 3 years if a taxpayer omits from gross income an amount that is more than 25 percent of the income reported on a tax return.
  
  
• The IRS can assess additional tax with no time limit if a taxpayer: (a) doesn't file a return; (b) files a false or fraudulent return in order to evade tax, or (c) deliberately tries to evade tax in any other manner.
  
  
• The IRS gets an unlimited time to assess additional tax when a taxpayer files on an unsigned return.

 

If no exception applies to you, for Federal purposes, you can probably discard most of your tax records that are more than 3 years old; add a year or so to that if you live in a state with a longer statute.

Examples: Sue filed her 2006 tax return before the due date of April 17, 2007. She will be able to safely dispose of most of her records after April 15, 2010. On the other hand, Don filed his 2006 return on June 1, 2007. He needs to keep his records at least until June 1, 2010. In both cases, the taxpayers may opt to keep their records a year or two longer if their states have a statute of limitations longer than 3 years.

Important note: Even if you discard backup records, never throw away your file copy of any tax return (including W-2s). Often the return itself provides data that can be used in future tax return calculations or to prove amounts related to property transactions, social security benefits, etc. You should keep certain records for longer than 3 years. These records include:

• Stock acquisition data. If you own stock in a corporation, keep the purchase records for at least 4 years after the year you sell the stock. This data will be needed in order to prove the amount of profit (or loss) you had on the sale.
  
  
• Stock and mutual fund statements where you reinvest dividends. Many taxpayers use the dividends they receive from a stock or mutual fund to buy more shares of the same stock or fund. The reinvested amounts add to basis in the property and reduce gain when it is finally sold. Keep statements at least 4 years after final sale.
  
  
• Tangible property purchase and improvement records. Keep records of home, investment, rental property, or business property acquisitions AND related capital improvements for at least 4 years after the underlying property is sold.

The only interest that is still deductible as an itemized deduction is home mortgage interest and investment interest. If you are like so many others with large consumer debt such as credit cards, car payments, etc., you are paying interest that is not deductible. If the amount of consumer interest you pay each year is substantial and you itemize your deductions, you may want to consider converting that non-deductible interest into deductible interest by paying off the consumer debt with a home equity line of credit. Generally, current law allows individual taxpayers to borrow up to $100,000 of home equity and deduct the interest on that loan as home mortgage interest. This would also apply to planned large consumer purchases such as a car or motor home. Using a home equity line to purchase these items will make the interest deductible.

Before borrowing against the home, you should consider the following:

• Treat the home equity loan like a consumer loan and pay it off over the same period of time you would have had to pay the consumer loan. Otherwise, you may reach retirement age without having the home paid for.
  
  
• When buying a car, you can sometimes get very favorable interest rates or a rebate. It is good practice to make sure the benefit of making the interest deductible is greater than the benefit of the low interest consumer loan.
  
  
• If there is any chance of defaulting on the loan, the repercussions from defaulting on a home loan are far more serious than on consumer debt.

Caution: Taxpayers who are affected by the Alternative Minimum Tax (AMT) may not be able to benefit from the home equity interest deduction. Please call this office for more information.

Congress considers our tax system as a "pay-as-you-go" system. To facilitate that concept, the government has provided several means of assisting taxpayers in meeting the "pay-as-you-go" requirement. These include: 

• Payroll withholding for employers; 
• Pension withholding for retirees; and 
• Estimated tax payments for self-employed individuals and those with other sources of income not covered by withholding.

When a taxpayer fails to prepay a safe harbor (minimum) amount, they can be subject to the underpayment penalty. This penalty is 2% higher than the prime rate and the penalty is computed on a quarter-by-quarter basis. 

Federal tax law does provide ways to avoid the underpayment penalty. If the underpayment is less than a de-minimis amount, no penalty is assessed. The de-minimis amount is $1,000. This means, if you owe $1,000 or less on your tax return, you will not be subject to the federal underpayment penalty. In addition, the law provides "safe harbor" prepayments. There are two safe harbors:

1. The first safe harbor is based on the tax you owe in the current year. If your payments equal or exceed 90% of what you owe in the current year, you can escape a penalty. 

2. The second safe harbor is based on the tax you owed in the immediately preceding tax year. If your payments equal or exceed 110% of what you owed in the prior year, you can escape a penalty.

Example: Suppose your 2008 tax is $10,000, and your 2008 prepayments total $5,800. The result is that you owe an additional $4,400 on your 2008 tax return. To find out if you owe a penalty, see if you meet the first safe harbor exception. Since 90% of $10,000 is $9,000, your prepayments fell short of the mark. You can't avoid the penalty under this exception. 

However, in the above example, the safe harbor may still apply. Assume your 2007 tax was $5,000. Since you prepaid $5,800, which is greater than the 110% of the prior year's tax (110% = $5,500), you qualify for this safe harbor and can escape the penalty. 

This example underscores the importance of making sure your prepayments are adequate, especially if you have a large increase in income. This is common when there is a large gain from the sale of stocks, sale of property, when large bonuses are paid, when a taxpayer retires, etc.

Our "pay-as-you-go" tax system requires that you make payments of your tax liability evenly throughout the year. If you don't, it's possible you could owe an underpayment penalty. Some taxpayers meet the "pay-as-you-go" requirements by making quarterly estimated payments. However, when your income is primarily from wages, you meet the requirements through wage withholding and you rely on your employer's payroll department to take out the right amount of tax. Unfortunately, what payroll withholds may not be enough!

For instance, your employer may be using information about your income that is no longer current. Employers compute withholding for their employees using IRS Form W-2, Withholding Allowance Certificate. To make sure W-4 data is accurate, you need to fill it out based on the latest data available about your income and deductions.

Mid-year is a good time to review the withholding situation and forecast your tax liability because there's still time to make adjustments if you're under-withheld. It's especially vital to plan ahead if you've had any of the following:

• A gain from the sale of property, e.g. stocks, bonds, or real property;
• Income from a second job;
• Other income from which there is no withholding (for example, a pension, alimony, IRA, interest or dividends);
• A change in marital status.

All of the above can cause problems as far as your withholding is concerned and the only way to know for sure is to compute a projection. To be on the safe side, why not give us a call? This office will be happy to assist you in determining safe withholding or estimated tax levels, or help you with long-range tax planning.