Edward A. Lyon, JD
TaxTuneup.com, Inc.
3416 Shaw Ave #5
Cincinnati OH 45208
513.321.2821
elyon@taxtuneup.com
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Earned Income Tax Credit
The earned income tax credit is
a refundable tax credit for working families with dependent children and, in
some cases, childless workers. That means if the credit exceeds your actual
tax, the government will pay you the difference. You can claim it when you
file your return, or you can take it throughout the year in the form of
"advance EIC" payments. Here's how it works:
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Married couples filing jointly
can claim the credit if their total earned income from wages, salaries,
tips, and self-employment (but not including certain capital losses, trust
and estate losses, and business losses) does not exceed $15,880 (no
children), $36,995 (one qualifying
child) or $41,646 (with two or more qualifying children). A "qualifying
child" is your child, adopted child, grandchild, stepchild, or foster
child living with you for more than six months of the year and under age
19 (age 24 if a full-time student).
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Singles and heads of
households can claim the credit with earned income from wages, salaries, tips, and self-employment
(but not including certain capital losses, trust and estate losses, and
business losses) does not exceed $12,880 (no children), $33,995 (one qualifying
child) or $38,646 (with two or more qualifying children).
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You can't claim the credit if
you have more than $2,950 in interest, dividends, net rent or royalty
income, capital gains, or passive income.
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The IRS publishes a table each
year telling you what credit to take.
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If you know that you'll
qualify for the credit, you can file a
Form W-5 with your employer to get
a part of the credit paid with each paycheck. You have to include these
payments as income when you file your return, and you may have to refund a
part of the advance EITC if you get too much during the year.
The IRS has started cracking
down on people who file for advance EITC payments they don't deserve, and
penalizing them by denying them the credit for future years. So if you
choose this strategy, make sure to figure it properly. For more
information, see
IRS
Publication 596, "Earned Income Credit."
Education Assistance Plan
Education assistance plan
benefits your employer offers for you to complete your undergraduate or
graduate college education are nontaxable up to $5,250 per year.
Education
Education expenses, including tuition, books, supplies,
and fees plus transportation (including parking and tolls) may be deductible
under the following rules:
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Classes you take for your trade or business are deductible as a
Business Expense on
Schedule C,
Form 1065, or
your corporate return.
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Classes you take to maintain
or improve your present job skills are deductible as an
Employee
Business Expense subject to the 2% floor on
Miscellaneous
Itemized Deductions.
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Qualified educational
assistance from your employer is tax-free up to $5,250 per year.
-
There's no deduction for
education expenses intended to prepare you for a new trade or business.
For example, you can't deduct the cost of attending law school to prepare
you for a job as an attorney. However, you can write off education
expenses to maintain or improve your present job skills. For example, if
you practice law for a period of years, then go back to school to get an
advanced degree in taxation or labor law, you can deduct the cost of
getting the advanced degree. Similarly, if you go back to school for an
MBA to improve your skills for your existing job, you can deduct the cost
of the degree.
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Education expenses may also
qualify for the Lifetime Learning Tax Credit.
Education IRA
Coverdell Education IRAs are
a new type of investment account that let you save tax-deferred for college
tuition. Contributions themselves aren't tax-deductible. But earnings grow
tax-deferred, and withdrawals are tax free if you use them for "qualified
college costs." Here's how they work:
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Each child can accept $2,000
per year in contributions up through age 18.
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The child can accept money
from donors with "modified adjusted gross income" up to $110,000 ($160,000
for joint filers). "Modified adjusted gross income" equals regular
adjusted gross income plus foreign income excluded from your regular
taxable income. The deduction phases out ratably for adjusted gross
incomes between $95,000 and $110,000 ($150,000 and $160,000 for joint
filers).
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You can't put money into to a
child's education IRA in any year in which that child receives a
contribution to a Section 529 Plan.
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You can take out as much as
you need to pay your child's college costs, including reasonable room and
board, tax-free. If you take out more than your child's college costs,
your child will owe tax on whatever portion of the IRA's earnings equal
the percentage of the withdrawal used for college costs.
Example:
You stuff $5,000 into your child's education IRA. The account grows to
$10,000, and you withdraw the entire balance in a year when your child's
college costs are just $8,000. Eighty percent of the withdrawal is for
college costs ($8,000 of the $10,000 withdrawal), so your child owes tax
on $4,000 (80% of the $5,000 earnings). (This appears to be a mistake in
the law. It makes more sense to tax the percentage of the excess
withdrawal you don't use for college than the percentage you do.
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If the child dies before
withdrawing the money, you'll have to distribute the account balance to
his or her estate within 30 days of his or her death.
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If your child doesn't use the
money by his or her 30th birthday, the funds must be distributed and
taxed, along with a 10% penalty, or rolled over into another family
member's education IRA. This rule was accidentally left out of the law,
but should be added in the future.
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You can't claim the
Hope
Scholarship Tax Credit or
Lifetime Learning Tax Credit for a
student in any year in which you withdraw money from that student's
education IRA.
Education IRAs sound like a
great idea--but the reality is usually disappointing. The main problem is
the miserly $2,00 annual contribution limit. If you earn 10% per year on
that contributions, you'll turn your $9,000 into just $25,080. That's less
than a single year's tuition at the nation's most prestigious colleges.
And at this writing, the tax saving appears less valuable than
Hope
Scholarship and
Lifetime Learning tax credits (if, of course,
you qualify). For a better tax-advantaged college savings strategy,
consider Section 529 Plans.
Elderly or Disabled Tax Credit
The elderly and disabled credit
is a credit against your tax for senior citizens and disabled taxpayers with
less than $7,500 in Social Security and federal pension income. You qualify
if you were 65 years old before the beginning of the tax year or you're
retired because of permanent and total disability. To claim the credit, file
Schedule R on your Form 1040.
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First, figure your "base
amount": $5,000 for single filers and joint filers with one eligible
spouse, $7,500 for joint filers with two eligible spouses, and $3,750 for
married couples filing separately.
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Next, reduce the "base amount"
by any nontaxable Social Security, railroad retirement, or veterans'
administration pension benefits.
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Next, reduce the "base amount"
by one-half of any adjusted gross income exceeding $7,500 if you are
single, head of household, or qualifying widower.
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Finally, take a credit of 15%
of any remaining "base amount."
For more information, see
IRS
Publication 554, "Older Americans' Tax Guide," and
IRS Publication
524, "Credit for the Elderly or the Disabled."
Employment Agency Fees
Employment agency fees you pay
to find a new position in your same field are deductible as a
Job-Hunting Expense subject to the 2% floor on miscellaneous itemized
deductions.
Employee Business Expenses
Expenses you pay on behalf of
your employer may be
a deductible
Miscellaneous Itemized Deduction
subject to the 2% floor.
If your employer reimburses
your expenses under an "accountable plan" that requires you to report all
expenses and return any excess reimbursement or allowance, those expenses
aren't deductible and the reimbursements aren't taxable. That means that
if your employer reimburses all your
expenses, you don't have to bother reporting them. If your employer
reimburses some, but not all, of your expenses, report them on
Form
2106, then subtract any partial reimbursement and carry the
unreimbursed balance to
Schedule A. If your employer reimburses
you under a "nonaccountable" plan, the reimbursement will be reported as
income. Report your expenses on
Form
2106, subtract the reimbursements, then carry any unreimbursed balance to Schedule A. Specific deductible expenses
include:
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briefcase
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office decor (frames for
diplomas, artwork for walls, etc.)
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stationery/office supplies you
purchase personally
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business/greeting cards for
business associates
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Subscriptions to
professional publications
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Dues for unions or professional
associations
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bonding costs and professional
liability malpractice insurance
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Computer costs, if your
employer requires you to buy it and use it for your job.
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business
Gifts (up to $25 per
recipient)
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business transportation (cabs,
auto mileage, parking and tolls, etc.), plus airfare, lodging, and 50% of
meals and entertainment for trips out of town. If your employer reimburses
your personal auto travel for less than 50.5 cents per mile (2008), you
can deduct the difference directly.
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educational programs intended
to enhance your skills in your current job
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Uniforms and Work Clothes
(including laundry and maintenance) for clothing and protective gear not
suitable for ordinary street wear)
For more information, see
IRS
Publication 535, "Business Expenses."
Employee Discount
Employee discounts your employer
gives you on goods and services are nontaxable up to these limits:
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Discounts on goods and
property are nontaxable up to the business's gross profit margin.
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Discounts on services are
nontaxable up to 20% of the regular price.
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No-additional-cost services,
such as free tickets for airline employees and free rooms for hotel
employees, are nontaxable.
Employee Stock Ownership Plan
Employee stock ownership plans,
or ESOPs, are corporate retirement plans that own shares in the corporation
itself. You can establish an ESOP as a retirement plan for yourself and your
employees and deduct contributions you make to the plan. You can also sell
shares in your business to an ESOP without paying any tax on the sale.
Here's how to qualify:
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You have to have owned the
business for at least three years.
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You have to sell at least 30
percent of the company to the plan.
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You have to reinvest your
proceeds in domestic corporate securities
.
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You can't sell those
securities during your lifetime.
Employer Retirement Plan
(See
Qualified Plan)
Entertainment Expenses
(See
Meals and Entertainment)
Equipment Leasing
Equipment leasing
programs are one of the few remaining "tax shelters" that still work.
Program sponsors buy equipment such as computers, machine tools, airplanes,
railroad cars, and ships, to lease to users. They then pass along the income
to you, the investor, along with healthy
Depreciation deductions that
shelter the income from tax. The Modified Accelerated Cost Recovery System
introduced in 1986 lets equipment buyers "front-load" their depreciation
deduction for fatter deductions their first few years of ownership. This
depreciation, along with up-front costs and interest on any borrowed
capital, shelters your income the first years of the lease.
Most equipment leasing
ventures are organized as
Limited Partnerships,
which means they're treated as
Passive Activities. The general partner will
supply you with a Form K-1 reporting your share of income and deductions
from the program. You report those items on Schedule E, and pass them
through to
Equity Swaps
(See
Tax-Engineered Products)
Equity Index Annuity
(See Annuity)
ESOP
(See Employee Stock Ownership
Plans)
Estimated Taxes
Estimated taxes are the
alternative to withholding for taxpayers without employers to pay their
taxes throughout the year. If you don't get a regular paycheck, you pay
taxes with quarterly estimates. These are even more painful than withholding
because you actually write those checks. You might also file quarterly
estimates for income not subject to withholding.
The quarterly estimate system
works a bit like withholding, but more precisely. To figure your quarterly
estimates, simply take a "dry run" at figuring your final bill. Then
divide the total by four and send your checks to the IRS. Form 1040-ES
includes a worksheet for figuring your estimates and vouchers for your
payments. The general rule is that you have to pay 90% of your final bill
to avoid underpayment penalties. But quarterly estimates are more complex
than withholding because you need to pay specific percentages by specific
dates. For 2008, these are:
If you don't pay by the right
dates, you can face a penalty even if the total estimates for the year are
enough. However, if your income fluctuates during the year, you can use
the annualized income method to determine estimated payments. For more
information, see
IRS
Publication 505, "Tax Withholding and Estimated Tax."
Exchange Student
Expenses you pay to host a
foreign exchange student in your home are deductible up to $50 per month for
as a
Charitable Gift to the
sponsoring organization.
Exchange-Traded Funds
Exchange-traded funds, or ETFs,
are a new class of index unit investment trusts that trade on an exchange,
such as the American Stock Exchange. These have become the most popular new
investment vehicle since the variable annuities. ETFs are giving traditional
mutual funds a run for their money--as well as enriching thousands of
investors without unduly enriching the U.S. Treasury.
There are hundreds of
exchange-traded funds available today. State Street Global Advisors was
first out the chute with their popular SPDRs (Standard & Poors Depository
Receipts), which track the S&P 500; Diamonds, which track the Dow Jones;
and QQQs (pronounced "cubes"), which track the NASDAQ 100. State Street
also sponsors midcap SPDRS tracking the S&P mid-cap index and select
sector SPDRs tracking specific industry groups.
Since then, Barclays Global
Investors has introduced "iShares," which track international indexes, as
well as domestic sectors such as large-cap growth, large-cap value, and
the like. And Merrill Lynch has introduced HOLDRS (Holding Company
Depository Receipts), which track specific industries such as
biotechnology and broadband communications.
Exchange-traded funds
generally trade on the American Stock Exchange, and can account for more
than half of the AMEX's daily trading volume. The trusts are as good as
permanent for today's investors--they're generally not scheduled to
terminate until sometime in the 22nd century. Annual expenses
are generally lower than similar open-end index funds. For example, you
can currently invest $100,000 in the S&P 500 for a management fee of just
$80. You probably can't buy a decent pair of shoes for that
much--let alone world-class investment management.
Exchange-traded funds have
several advantages over their traditional open-end cousins:
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You can buy and sell during
the trading day without waiting for daily closing prices.
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You can sell short to profits
from falling markets. Exchange-traded funds are exempt from the "uptick"
rule (which keeps you from shorting stocks except after a price uptick);
this lets you short them following a downtick.
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You can hold ETFs with
full-service brokerage firms that don't carry no-load mutual funds.
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When other shareholders sell
their shares, there's no liquidation forcing the fund to distribute
built-in capital gains, as there is with traditional open-end index funds.
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ETFs are particularly good for
investing in smaller foreign markets such as Austria and Spain.
Previously, your choices were limited to closed-end country funds with
higher expenses.
Exchange-traded funds carry
disadvantages, too, but none so serious to avoid them:
-
You'll have to pay brokerage
commissions to buy and sell them.
-
You can't automatically
reinvest ETF dividends as you can with traditional open-end funds.
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ETFs themselves can't
immediately reinvest their own dividend income. They generally deposit
dividends into noninterest-bearing accounts and reinvest them quarterly.
This "dividend cash drag" causes ETFs to lag behind a traditional index
fund. However, some ETF sponsors may solve this problem by lending
securities to short-sellers and investing undistributed dividends into
income-paying repurchase agreements and futures.
Your mother always told you
that you can judge someone by the company they keep. In the case of
exchange-traded funds, that company includes Morgan Stanley, Citibank,
J.P. Morgan, Bessemer Trust, and similar institutional investors.
Executor's Fees
Fees you collect for administering an estate are taxable as ordinary income.
However, they're not subject to Self-Employment Tax
unless you're regularly engaged in the business of being an executor.
If you're administering a
taxable estate (generally, greater than $2 million), and the marginal tax
rate on the estate is higher than the marginal rate on your income, you can
use your executor's fee to hold down estate taxes.
Example:
You're administering an estate in the 50% tax bracket, and you pay 28% on
your income. If you collect a $50,00 fee, you'll save the estate $25,000
in taxes, but pay just $14,000 on the income. The $50,000 executor's fee
saves $11,000 in taxes.
Eyeglasses
Deductible
Medical Expense subject
to the 7.5% floor (prescription only).
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