There are several requirements you must meet before taking earnings out of a Roth without being hit with fees and taxes.
By Kimberly Lankford
April 26, 2007
I opened my first Roth IRA in 1998 and have been making contributions every year since then. In 2003, I opened a Roth with another broker and started making contributions to that account instead. I'm retiring and would like to start withdrawing money from my Roths. I know you have to be at least 59½ and have had the Roth for five years to withdraw money without having to pay taxes or penalties. Does the five years start when you first open the Roth IRA or is it a separate five years for each account I own?
The five-year rule applies to your initial Roth contribution -- even if you end up opening other Roth accounts later. And you don't even need to have the Roth open for five full years. Actually, you must wait until four calendar years have passed after the tax year when you made your first contribution, regardless of the date within that year. For example, if you made your 1998 contribution by the tax-filing deadline -- even as late as April 15, 1999 -- the clock starts ticking on January 1, 1998. That means you could take tax- and penalty-free withdrawals in 2003.
However, for the withdrawal to be tax- and penalty-free, you also have to be at least age 59½, or the distribution must be due to death or disability, or you use the money (up to $10,000) to buy a first home.
But those rules only apply to the Roth's earnings. You can withdraw your contributions at any time and for any reason, and your withdrawals are considered to be from contributions before they're counted as earnings. The contribution amount is based on your total Roth contributions, not divided by each account. So if you contributed $5,000 to the first Roth you opened and $10,000 through the years to the Roth with the second broker, you can withdraw $15,000 from either account or a combination of the two, even though you didn't actually contribute that much money to that particular account.
For more information, see Everything You Need to Know About Roth IRAs.
Source: Kiplinger
Monday, April 30, 2007
Monday, April 23, 2007
Tax Tips for 2007
By Jennifer Openshaw
TheStreet.com Contributor
4/23/2007
OK, so this year's taxes are a done deal.
You've wrung every possible deduction out of your TurboTax program. You've spent endless hours with your tax advisor.
You're just not sure you did everything you could have.
You ask: "Could I have sheltered more income? Were there more deductions or credits I could have taken with just a little more planning? Could I have deducted part of that Florida Keys trip because I met a potential client in Miami?"
Gradually, as 2006 taxes fade into memory, your brain shifts gears.
Most of us tend to get back down to business, shifting planning for next year's taxes to the back burner.
The result? About this time next year you'll lay awake at night pondering the same questions.
So what can you do to pay less next year?
Restructure health care costs. As an entrepreneur you can usually deduct health insurance premiums. But by dividing your costs between a less expensive, high-deductible health insurance plan and a Health Savings Account, or HSA, you can keep more for yourself, and even use tax-free HSA growth to fund retirement.
If you own a "C" corporation, you can also pay for noncovered health care costs out of the corporation's coffers -- pretax. So if you're considering that Lasik eye surgery, have your company make out the check.
Put the family to work. Hire your kids, and you'll get a deduction -- and better yet, your money stays in the family. Those kids can clean windows, maintain computers, produce marketing materials or make widgets on the factory floor. Up to $5,350 of their earned income winds up tax-free. You can set up a personal deductible IRA for each to shelter still more.
You can also transfer some ownership to kids (which helps in estate planning, too). That transfers some income to kids who don't pay taxes on unearned income under $1,700.
Get the real estate right. You can purchase a building or place of business as a personal asset and lease it to the business. As a personal asset, it will receive more favorable capital-gains tax treatment, and you can adjust the lease rate to achieve other financial and tax needs.
If your business is home-based, you can use your home for business and deduct a portion of its cost and upkeep. The rules are complex but these deductions can add up -- why not deduct 10% or 20% of the cost of that new driveway?
Get credit where credit is due. The list of business credits available is longer than I can share here (but it is listed in IRS Publication 334). They're particularly helpful for businesses operating in disadvantaged communities or with hybrid vehicles or alternative fuels. Also, don't overlook the new domestic production activities deduction, a 6% break to domestic producers of anything from widgets to sound recordings to software.
Pay yourself wisely. If you own an "S" or "C" corporation, you can adjust salary and dividends received from the business to your advantage. "S" corporation owners can pay themselves modest but realistic salaries and larger dividends to reduce self-employment tax. "C" corporation owners can retain some earnings in the business at lower tax rates, especially if reinvested in the business later.
Combine business with pleasure. Most businesses take you away from home at least at some point. So you can make the most of this by mixing business and pleasure to write off at least a part of that vacation. Go meet a client or supplier or take in a seminar or trade show, and at least part of that trip is deductible.
These strategies aren't simple and will require some careful planning. And some, like defined-benefit pensions, health savings accounts and real estate moves, take some time to plan and put in place.
So the time to start is now, not a week before the 2007 tax deadline.
Source: The Street.com
TheStreet.com Contributor
4/23/2007
OK, so this year's taxes are a done deal.
You've wrung every possible deduction out of your TurboTax program. You've spent endless hours with your tax advisor.
You're just not sure you did everything you could have.
You ask: "Could I have sheltered more income? Were there more deductions or credits I could have taken with just a little more planning? Could I have deducted part of that Florida Keys trip because I met a potential client in Miami?"
Gradually, as 2006 taxes fade into memory, your brain shifts gears.
Most of us tend to get back down to business, shifting planning for next year's taxes to the back burner.
The result? About this time next year you'll lay awake at night pondering the same questions.
So what can you do to pay less next year?
Restructure health care costs. As an entrepreneur you can usually deduct health insurance premiums. But by dividing your costs between a less expensive, high-deductible health insurance plan and a Health Savings Account, or HSA, you can keep more for yourself, and even use tax-free HSA growth to fund retirement.
If you own a "C" corporation, you can also pay for noncovered health care costs out of the corporation's coffers -- pretax. So if you're considering that Lasik eye surgery, have your company make out the check.
Put the family to work. Hire your kids, and you'll get a deduction -- and better yet, your money stays in the family. Those kids can clean windows, maintain computers, produce marketing materials or make widgets on the factory floor. Up to $5,350 of their earned income winds up tax-free. You can set up a personal deductible IRA for each to shelter still more.
You can also transfer some ownership to kids (which helps in estate planning, too). That transfers some income to kids who don't pay taxes on unearned income under $1,700.
Get the real estate right. You can purchase a building or place of business as a personal asset and lease it to the business. As a personal asset, it will receive more favorable capital-gains tax treatment, and you can adjust the lease rate to achieve other financial and tax needs.
If your business is home-based, you can use your home for business and deduct a portion of its cost and upkeep. The rules are complex but these deductions can add up -- why not deduct 10% or 20% of the cost of that new driveway?
Get credit where credit is due. The list of business credits available is longer than I can share here (but it is listed in IRS Publication 334). They're particularly helpful for businesses operating in disadvantaged communities or with hybrid vehicles or alternative fuels. Also, don't overlook the new domestic production activities deduction, a 6% break to domestic producers of anything from widgets to sound recordings to software.
Pay yourself wisely. If you own an "S" or "C" corporation, you can adjust salary and dividends received from the business to your advantage. "S" corporation owners can pay themselves modest but realistic salaries and larger dividends to reduce self-employment tax. "C" corporation owners can retain some earnings in the business at lower tax rates, especially if reinvested in the business later.
Combine business with pleasure. Most businesses take you away from home at least at some point. So you can make the most of this by mixing business and pleasure to write off at least a part of that vacation. Go meet a client or supplier or take in a seminar or trade show, and at least part of that trip is deductible.
These strategies aren't simple and will require some careful planning. And some, like defined-benefit pensions, health savings accounts and real estate moves, take some time to plan and put in place.
So the time to start is now, not a week before the 2007 tax deadline.
Source: The Street.com
Wednesday, April 18, 2007
Mortgage insurance gaining steam
PMI is tax deductible in 2007, but that isn't the only reason it's getting popular
By Amy Hoak, MarketWatch
Apr 17, 2007
CHICAGO (MarketWatch) -- This time next year, some homeowners who pay mortgage insurance will have an extra deduction on their federal income tax returns. Under a new law, certain borrowers who take out a mortgage for purchase or refinance in 2007 are eligible to write off all or a portion of their mortgage insurance premiums for the year. It's a tax break many in the industry have sought for years because the insurance is often regarded as a cost akin to mortgage interest or points.
Mortgage insurance is required for borrowers who make less than a 20% down payment; its purpose is to protect lenders from losses if the borrower defaults on the loan. The insurance is cancelled when there is enough equity built up in the home. But premium deductibility aside, mortgage insurance has been gaining in popularity these days, some in the industry say.
According to the Mortgage Insurance Companies of America, 118,214 borrowers used private mortgage insurance while buying or refinancing a loan in February, an 8.5% increase compared with January's 108,980 borrowers. In February 2006, 104,146 borrowers used PMI, the group reported.
"The mortgage-insurance industry has had a very, very good first quarter," said David H. Katkov, president and chief operating officer of PMI Mortgage Insurance Co. "People are looking at mortgage insurance today as they haven't in previous years."
Katkov calls the tax break a "bonus" benefit to homeowners, adding that there have been other factors fueling the growth in the mortgage-insurance industry.
In recent years, many borrowers have opted to get around using the insurance by taking two loans: a primary mortgage as well as a second, "piggyback" loan in the form of a home equity loan or line of credit. The equity from the second loan fulfills the down payment of the first, and there are tax breaks on the interest of both loans.
But many piggyback mortgages have variable rates that fluctuate based on the prime rate, which has risen over the last year. The set rate for mortgage insurance has become attractive to homeowners aiming for predictable loan costs, Katkov said. There's also the lure of simplicity that the mortgage insurance offers, since borrowers only need to deal with one set of loan documents in that option, he added.
Tightened lending standards might also contribute to additional popularity of mortgage insurance; as lenders get more conservative in the aftermath of problems in the subprime market, the risk associated with a piggyback loan probably isn't as attractive, said Corey Carlisle, senior director for government affairs at the Mortgage Bankers Association. The cost of the second loan, along with the hard look at underwriting standards, could have a "double whammy effect" on piggyback loans, he said.
That said, piggyback loans are certainly not going away, he added. For some borrowers, the dual loan structure might still make sense, he said, adding "everyone needs to weigh their own financial needs separately and do what's best for them."
To help in the decision, PMI Mortgage Insurance Co. has an online calculator for determining which option is best suited to an individual borrower. Visit the calculator.
Deduction details
To qualify for the full mortgage insurance premium deduction in 2007, a homeowner needs an adjusted gross income of $100,000 or less; those with adjusted gross incomes of $109,000 or less are eligible for partial breaks. Currently, the deduction is limited to the 2007 calendar year, although there are efforts to extend it.
The tax deduction applies to coverage provided by the Veterans Administration, the Federal Housing Administration, or the Rural Housing Administration in addition to private mortgage insurance, according to the Internal Revenue Service's Web site. Some tax and consumer advocates, including Bruce Hahn, president of the American Homeowners Grassroots Alliance, think the deduction should have been available years ago.
"Finally, enough legislators came to recognize this is truly a cost of lending," he said. Low- and moderate-income homeowners stand to benefit the most, he added.
The cost of mortgage insurance varies based on the size of the down payment, type of mortgage and the amount of coverage. But insurance on a $224,500 home typically costs about $50 to $100 per month, according to Mortgage Insurance Companies of America. Annual tax savings for those using the deduction will range between $300 and $350, according to the group's estimates.
But is it enough?
Some argue, however, that the qualifications for the deduction are too restrictive. While middle-class homeowners in the middle of the country will benefit from the deduction, those living in areas where housing is more expensive might not, said Pete Sepp, vice president for communications for the National Taxpayers Union.
"Clearly this has to be made available to more homeowners," he said, adding that lawmakers need to "recognize the reality that $100,000 of income doesn't necessarily support a mansion." On the coasts, for example, homeowners' income doesn't stretch as far as it does in the Midwest, he said.
In addition, Sepp criticized the phase-out of the deduction for being too steep: Those with adjusted gross incomes up to $100,000 receive the full break, but the deduction reduces 10% for every $1,000 over $100,000 until it reaches zero at an adjusted gross income of $110,000.
"Congress has taken perhaps the toes of one foot through the door, and now we need to see them follow through and walk through all the way," he said.
If enough homeowners benefit from the deduction, there's a good chance lawmakers could move to extend it into future tax years, Sepp said. Carlisle has noticed a general support of extending the benefit on Capitol Hill; making it permanent is another issue, he said.
Source: Marketwatch
By Amy Hoak, MarketWatch
Apr 17, 2007
CHICAGO (MarketWatch) -- This time next year, some homeowners who pay mortgage insurance will have an extra deduction on their federal income tax returns. Under a new law, certain borrowers who take out a mortgage for purchase or refinance in 2007 are eligible to write off all or a portion of their mortgage insurance premiums for the year. It's a tax break many in the industry have sought for years because the insurance is often regarded as a cost akin to mortgage interest or points.
Mortgage insurance is required for borrowers who make less than a 20% down payment; its purpose is to protect lenders from losses if the borrower defaults on the loan. The insurance is cancelled when there is enough equity built up in the home. But premium deductibility aside, mortgage insurance has been gaining in popularity these days, some in the industry say.
According to the Mortgage Insurance Companies of America, 118,214 borrowers used private mortgage insurance while buying or refinancing a loan in February, an 8.5% increase compared with January's 108,980 borrowers. In February 2006, 104,146 borrowers used PMI, the group reported.
"The mortgage-insurance industry has had a very, very good first quarter," said David H. Katkov, president and chief operating officer of PMI Mortgage Insurance Co. "People are looking at mortgage insurance today as they haven't in previous years."
Katkov calls the tax break a "bonus" benefit to homeowners, adding that there have been other factors fueling the growth in the mortgage-insurance industry.
In recent years, many borrowers have opted to get around using the insurance by taking two loans: a primary mortgage as well as a second, "piggyback" loan in the form of a home equity loan or line of credit. The equity from the second loan fulfills the down payment of the first, and there are tax breaks on the interest of both loans.
But many piggyback mortgages have variable rates that fluctuate based on the prime rate, which has risen over the last year. The set rate for mortgage insurance has become attractive to homeowners aiming for predictable loan costs, Katkov said. There's also the lure of simplicity that the mortgage insurance offers, since borrowers only need to deal with one set of loan documents in that option, he added.
Tightened lending standards might also contribute to additional popularity of mortgage insurance; as lenders get more conservative in the aftermath of problems in the subprime market, the risk associated with a piggyback loan probably isn't as attractive, said Corey Carlisle, senior director for government affairs at the Mortgage Bankers Association. The cost of the second loan, along with the hard look at underwriting standards, could have a "double whammy effect" on piggyback loans, he said.
That said, piggyback loans are certainly not going away, he added. For some borrowers, the dual loan structure might still make sense, he said, adding "everyone needs to weigh their own financial needs separately and do what's best for them."
To help in the decision, PMI Mortgage Insurance Co. has an online calculator for determining which option is best suited to an individual borrower. Visit the calculator.
Deduction details
To qualify for the full mortgage insurance premium deduction in 2007, a homeowner needs an adjusted gross income of $100,000 or less; those with adjusted gross incomes of $109,000 or less are eligible for partial breaks. Currently, the deduction is limited to the 2007 calendar year, although there are efforts to extend it.
The tax deduction applies to coverage provided by the Veterans Administration, the Federal Housing Administration, or the Rural Housing Administration in addition to private mortgage insurance, according to the Internal Revenue Service's Web site. Some tax and consumer advocates, including Bruce Hahn, president of the American Homeowners Grassroots Alliance, think the deduction should have been available years ago.
"Finally, enough legislators came to recognize this is truly a cost of lending," he said. Low- and moderate-income homeowners stand to benefit the most, he added.
The cost of mortgage insurance varies based on the size of the down payment, type of mortgage and the amount of coverage. But insurance on a $224,500 home typically costs about $50 to $100 per month, according to Mortgage Insurance Companies of America. Annual tax savings for those using the deduction will range between $300 and $350, according to the group's estimates.
But is it enough?
Some argue, however, that the qualifications for the deduction are too restrictive. While middle-class homeowners in the middle of the country will benefit from the deduction, those living in areas where housing is more expensive might not, said Pete Sepp, vice president for communications for the National Taxpayers Union.
"Clearly this has to be made available to more homeowners," he said, adding that lawmakers need to "recognize the reality that $100,000 of income doesn't necessarily support a mansion." On the coasts, for example, homeowners' income doesn't stretch as far as it does in the Midwest, he said.
In addition, Sepp criticized the phase-out of the deduction for being too steep: Those with adjusted gross incomes up to $100,000 receive the full break, but the deduction reduces 10% for every $1,000 over $100,000 until it reaches zero at an adjusted gross income of $110,000.
"Congress has taken perhaps the toes of one foot through the door, and now we need to see them follow through and walk through all the way," he said.
If enough homeowners benefit from the deduction, there's a good chance lawmakers could move to extend it into future tax years, Sepp said. Carlisle has noticed a general support of extending the benefit on Capitol Hill; making it permanent is another issue, he said.
Source: Marketwatch
Monday, April 16, 2007
Taxes -- Buy More Time
Here's how to push back the deadline ... or simply ignore it, legally.
By Kevin McCormally
April 16, 2007
Thanks to a District of Columbia holiday almost no one -- including IRS deadline setters -- had ever heard of, the whole country gets until midnight Tuesday, April 17, to file 2006 tax returns. Despite the extra hours, though, millions of Americans simply won't manage to complete their tax returns on time.
If you're among the army of procrastinators still marching toward the deadline, take a break. Rather than stress out or rush into a costly error, your best bet today may be to simply cry "uncle" and join about 10 million of your fellow sufferers in asking the IRS for more time.
You do that by filing a Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return. Note that glorious word "automatic" in that mouthful of IRSese. This is a no-questions-asked deal. You don't have to offer any explanation or excuse for why your return will be overdue. File the 4868 by midnight Tuesday and you push your tax deadline back to October 15.
There is, alas, a catch. Although the extension gives you more time to fill out the forms, it doesn't put off the deadline for paying the tax you owe. That's what complicates the otherwise simple Form 4868. You have to make an educated guess about how much you'll owe when you finally finish you forms. That can be tough unless you already have done much of the work. If you don't have a clue how much you owe, a little history might help. If your tax situation -- income, deductions, marital status and family size -- was pretty much the same in 2006 as it was in 2005, use your 2005 return as a guide.
The 4868 asks for an estimate of your total tax bill for 2006 and how much you paid via withholding from paychecks or quarterly estimated payments. Subtracting one from the other provides a good idea of how much you'll owe when you get around to filing. You don't have to pay it all when you file your 4868, but the more you fork over, the less interest (currently 8% a year) and late-payment penalties (one-half of a percent of the balance due per month) will pile up between April 17 and when you file.
How to buy more time
There are three ways to push back the deadline.
The old fashioned, paper way might be the easiest ... and the cheapest. Go to the IRS Web site for a fill-in-the-blanks 4868. If you have your tax estimate and withholding amounts at hand, you can fill out the form in under a minute. Print it, stick it in an envelope with a check for what you can pay and get it in the mail by midnight April 17.
Some tax software programs allow you to electronically file the 4868, and you can authorize the IRS to dip into your bank account for the payment. But there may be a charge for this service. Only about a half-dozen of the programs available for free (for taxpayers with incomes under $52,000) via the IRS's Free File program offer electronic filing for an extension. And it can be tough slogging to go this route. TurboTax, the best-selling program for which Kiplinger provides expert advice, will prepare a 4868 for you, but won't file it electronically. You need to mail it in.
A third option is automatic filing of a 4868 when you pay what you owe with a credit or debit card, either on-line or over the phone. The 4868 instructions direct taxpayers to two credit card payment services, and each charges 2.49% of the amount paid as a fee. So, a $2,500 payment will cost you $62.25, plus any interest you rack up before you pay off your card. What the IRS doesn't tell you is that you can also get the automatic extension if you pay with a debit card. Incometaxpayment.com, for example, handles the transaction for a flat $2.95 fee, no matter how much tax you're paying.
A state tax deadline breathing down your neck, too? Some states automatically grant extra time to folks who file for a federal extension; others demand their own paperwork. Check out the rules for your state at the Federation of Tax Administrators Web site.
No-request extensions for some
Some don't have to worry about filing an extension -- they get one automatically
For military personnel serving in a combat zone on April 17, the tax deadline is six months after they leave the combat zone. U.S. citizens who are living or working at their main place of business outside the country on the deadline get an extra two months to file. Their deadline is June 15; only if they need more time do they need to file the 4868.
A sweet secret
Finally, here's one of our favorite tax tips. If you're among the majority of taxpayers who have a refund coming, you can ignore the April 17 deadline with impunity.
You see, the penalty for failing to meet the deadline is a percentage of the tax owed with your return. If you owe zero, the penalty is zero. Of course, you should file as soon as possible to get your money back. But there's no reason to lose any sleep, miss any tax breaks or risk life and limb rushing to the post office by midnight April 17.
One caveat: If you are making certain, rather arcane elections on your return (like declaring yourself a day trader for tax purposes), you do need to file by the deadline or ask for an extension, even if you have a refund coming. But if you're like most refund taxpayers, the deadline doesn't really matter.
What about that D.C. holiday?
By the way, the April 16 D.C. holiday that pushes the tax deadline to April 17 is Emancipation Day, commemorating the day in 1862 that President Lincoln signed a law to end slavery in the District of Columbia. That was nine months before the Emancipation Proclamation was issued on January 1, 1863.
Source: Kiplinger.com
By Kevin McCormally
April 16, 2007
Thanks to a District of Columbia holiday almost no one -- including IRS deadline setters -- had ever heard of, the whole country gets until midnight Tuesday, April 17, to file 2006 tax returns. Despite the extra hours, though, millions of Americans simply won't manage to complete their tax returns on time.
If you're among the army of procrastinators still marching toward the deadline, take a break. Rather than stress out or rush into a costly error, your best bet today may be to simply cry "uncle" and join about 10 million of your fellow sufferers in asking the IRS for more time.
You do that by filing a Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return. Note that glorious word "automatic" in that mouthful of IRSese. This is a no-questions-asked deal. You don't have to offer any explanation or excuse for why your return will be overdue. File the 4868 by midnight Tuesday and you push your tax deadline back to October 15.
There is, alas, a catch. Although the extension gives you more time to fill out the forms, it doesn't put off the deadline for paying the tax you owe. That's what complicates the otherwise simple Form 4868. You have to make an educated guess about how much you'll owe when you finally finish you forms. That can be tough unless you already have done much of the work. If you don't have a clue how much you owe, a little history might help. If your tax situation -- income, deductions, marital status and family size -- was pretty much the same in 2006 as it was in 2005, use your 2005 return as a guide.
The 4868 asks for an estimate of your total tax bill for 2006 and how much you paid via withholding from paychecks or quarterly estimated payments. Subtracting one from the other provides a good idea of how much you'll owe when you get around to filing. You don't have to pay it all when you file your 4868, but the more you fork over, the less interest (currently 8% a year) and late-payment penalties (one-half of a percent of the balance due per month) will pile up between April 17 and when you file.
How to buy more time
There are three ways to push back the deadline.
The old fashioned, paper way might be the easiest ... and the cheapest. Go to the IRS Web site for a fill-in-the-blanks 4868. If you have your tax estimate and withholding amounts at hand, you can fill out the form in under a minute. Print it, stick it in an envelope with a check for what you can pay and get it in the mail by midnight April 17.
Some tax software programs allow you to electronically file the 4868, and you can authorize the IRS to dip into your bank account for the payment. But there may be a charge for this service. Only about a half-dozen of the programs available for free (for taxpayers with incomes under $52,000) via the IRS's Free File program offer electronic filing for an extension. And it can be tough slogging to go this route. TurboTax, the best-selling program for which Kiplinger provides expert advice, will prepare a 4868 for you, but won't file it electronically. You need to mail it in.
A third option is automatic filing of a 4868 when you pay what you owe with a credit or debit card, either on-line or over the phone. The 4868 instructions direct taxpayers to two credit card payment services, and each charges 2.49% of the amount paid as a fee. So, a $2,500 payment will cost you $62.25, plus any interest you rack up before you pay off your card. What the IRS doesn't tell you is that you can also get the automatic extension if you pay with a debit card. Incometaxpayment.com, for example, handles the transaction for a flat $2.95 fee, no matter how much tax you're paying.
A state tax deadline breathing down your neck, too? Some states automatically grant extra time to folks who file for a federal extension; others demand their own paperwork. Check out the rules for your state at the Federation of Tax Administrators Web site.
No-request extensions for some
Some don't have to worry about filing an extension -- they get one automatically
For military personnel serving in a combat zone on April 17, the tax deadline is six months after they leave the combat zone. U.S. citizens who are living or working at their main place of business outside the country on the deadline get an extra two months to file. Their deadline is June 15; only if they need more time do they need to file the 4868.
A sweet secret
Finally, here's one of our favorite tax tips. If you're among the majority of taxpayers who have a refund coming, you can ignore the April 17 deadline with impunity.
You see, the penalty for failing to meet the deadline is a percentage of the tax owed with your return. If you owe zero, the penalty is zero. Of course, you should file as soon as possible to get your money back. But there's no reason to lose any sleep, miss any tax breaks or risk life and limb rushing to the post office by midnight April 17.
One caveat: If you are making certain, rather arcane elections on your return (like declaring yourself a day trader for tax purposes), you do need to file by the deadline or ask for an extension, even if you have a refund coming. But if you're like most refund taxpayers, the deadline doesn't really matter.
What about that D.C. holiday?
By the way, the April 16 D.C. holiday that pushes the tax deadline to April 17 is Emancipation Day, commemorating the day in 1862 that President Lincoln signed a law to end slavery in the District of Columbia. That was nine months before the Emancipation Proclamation was issued on January 1, 1863.
Source: Kiplinger.com
When Social Security Is Taxed
Here's how to know whether your benefits are taxable.
By Kevin McCormally
April 13, 2007
Are Social Security benefits taxable?
Kevin responds:
Most Social Security benefits are tax free, but for some taxpayers, 85% of their benefits are taxable. Here's a discussion from my book, Cut Your Taxes, that explains how it works:
Congress seems determined to make this issue more and more complicated. Not so long ago, the tax rules for social security benefits were the epitome of simplicity: Benefits were tax-free. Period. Now beneficiaries fall into one of three categories:
Those whose benefits remain totally tax-free.
Those who can have up to 50% of their benefits taxed.
Those who can have up to 85% of their benefits taxed.
If you're among the 10 million or so retirees whose benefits are hit, you need to know the rules.
The first step in determining whether or not your benefits are vulnerable is to find your "provisional income." That's basically your adjusted gross income plus any tax-exempt interest plus 50% of your social security benefits.
Your benefits are totally tax free if your provisional income is less than $25,000 if you file a single or head-of-household return or less than $32,000 if you file a joint return. (Unlike many other thresholds in the tax law, these figures are not indexed to rise with inflation. And, that's not an oversight. Congress did it deliberately so that, over time, more and more beneficiaries would be subject to this tax.)
If your provisional income exceeds the threshold for your filing status, what portion of your benefits can be taxed depends on how high your income is.
If it is between $25,000 and $34,000 on a single or head-of-household return or between $32,000 and $44,000 on a joint return no more than half of your benefits can be taxed. The amount included in taxable income is the lesser of half of your benefits or half of the amount by which provisional income exceeds the trigger point.
Assume you and your spouse file a joint return. Your AGI for the year is $30,000, and you have an extra $4,000 of tax-free interest from municipal bonds and $5,000 of social security benefits. Adding your AGI ($30,000), your tax-exempt interest ($4,000) and half of your benefits ($2,500) gives you $36,500. That's $4,500 over the $32,000 threshold for joint returns. Since half of that amount ($2,250) is less than half your benefits ($2,500), the smaller amount is the part of your social security that is taxed. In the 28% bracket, the extra $2,250 of taxable income will cost $630.
The 85% rule. When provisional income exceeds $34,000 on a single return or $44,000 on a joint return, things get more complicated, but the bottom line is this: In almost all cases, 85% of your benefits are taxed. The IRS has devised an 18-line worksheet for figuring how much of your benefits are taxable. You'll find it in the instructions for your tax return.
What about married couples who file separate returns? They can forget the $25,000/$32,000 and the $34,000/$44,000 thresholds. Their threshold is $0 -- and they can be certain that 85% of their social security benefits are taxable.
Strategies. If part of your benefits are threatened, some planning can help limit the bite. If your AGI will include amounts withdrawn from a regular IRA, for example, you may be able to stagger your withdrawals and vary your income so that your social security benefits are taxed only in alternate years. An advantage of the new Roth IRA is that, since qualified withdrawals are tax-free, that money can't push more of your social security benefits into the taxable range.
Timing the sale of stocks or other appreciated property can also pay off. You could take profits in years when 85% of your benefits will be taxed anyway, for example, and limit income in intervening years to reduce the amount of your social security that falls prey to the IRS.
If you have municipal bonds, you may consider unloading them since this "tax-free" income can trigger a tax on your social security benefits. That could backfire, however, because switching to a comparable taxable investment would probably give you a higher yield that could push even more of your benefits into the taxable range. Even though tax-exempt income is taken into account in the social security formula, the income itself is still not taxed.
Source: Kiplinger.com
By Kevin McCormally
April 13, 2007
Are Social Security benefits taxable?
Kevin responds:
Most Social Security benefits are tax free, but for some taxpayers, 85% of their benefits are taxable. Here's a discussion from my book, Cut Your Taxes, that explains how it works:
Congress seems determined to make this issue more and more complicated. Not so long ago, the tax rules for social security benefits were the epitome of simplicity: Benefits were tax-free. Period. Now beneficiaries fall into one of three categories:
Those whose benefits remain totally tax-free.
Those who can have up to 50% of their benefits taxed.
Those who can have up to 85% of their benefits taxed.
If you're among the 10 million or so retirees whose benefits are hit, you need to know the rules.
The first step in determining whether or not your benefits are vulnerable is to find your "provisional income." That's basically your adjusted gross income plus any tax-exempt interest plus 50% of your social security benefits.
Your benefits are totally tax free if your provisional income is less than $25,000 if you file a single or head-of-household return or less than $32,000 if you file a joint return. (Unlike many other thresholds in the tax law, these figures are not indexed to rise with inflation. And, that's not an oversight. Congress did it deliberately so that, over time, more and more beneficiaries would be subject to this tax.)
If your provisional income exceeds the threshold for your filing status, what portion of your benefits can be taxed depends on how high your income is.
If it is between $25,000 and $34,000 on a single or head-of-household return or between $32,000 and $44,000 on a joint return no more than half of your benefits can be taxed. The amount included in taxable income is the lesser of half of your benefits or half of the amount by which provisional income exceeds the trigger point.
Assume you and your spouse file a joint return. Your AGI for the year is $30,000, and you have an extra $4,000 of tax-free interest from municipal bonds and $5,000 of social security benefits. Adding your AGI ($30,000), your tax-exempt interest ($4,000) and half of your benefits ($2,500) gives you $36,500. That's $4,500 over the $32,000 threshold for joint returns. Since half of that amount ($2,250) is less than half your benefits ($2,500), the smaller amount is the part of your social security that is taxed. In the 28% bracket, the extra $2,250 of taxable income will cost $630.
The 85% rule. When provisional income exceeds $34,000 on a single return or $44,000 on a joint return, things get more complicated, but the bottom line is this: In almost all cases, 85% of your benefits are taxed. The IRS has devised an 18-line worksheet for figuring how much of your benefits are taxable. You'll find it in the instructions for your tax return.
What about married couples who file separate returns? They can forget the $25,000/$32,000 and the $34,000/$44,000 thresholds. Their threshold is $0 -- and they can be certain that 85% of their social security benefits are taxable.
Strategies. If part of your benefits are threatened, some planning can help limit the bite. If your AGI will include amounts withdrawn from a regular IRA, for example, you may be able to stagger your withdrawals and vary your income so that your social security benefits are taxed only in alternate years. An advantage of the new Roth IRA is that, since qualified withdrawals are tax-free, that money can't push more of your social security benefits into the taxable range.
Timing the sale of stocks or other appreciated property can also pay off. You could take profits in years when 85% of your benefits will be taxed anyway, for example, and limit income in intervening years to reduce the amount of your social security that falls prey to the IRS.
If you have municipal bonds, you may consider unloading them since this "tax-free" income can trigger a tax on your social security benefits. That could backfire, however, because switching to a comparable taxable investment would probably give you a higher yield that could push even more of your benefits into the taxable range. Even though tax-exempt income is taken into account in the social security formula, the income itself is still not taxed.
Source: Kiplinger.com
Tax scammers snag refunds
IRS says fraudsters are creating fake 'free file' Web sites, diverting money
By Andrea Coombes, MarketWatch
Apr 13, 2007
SAN FRANCISCO (MarketWatch) -- Just days before the tax-filing deadline, the IRS issued a warning late Friday afternoon that scammers are creating Web sites that, posing as an IRS "free file" site, gather taxpayers' return information and then snag their refunds.
"We're seeing Web sites out there that are saying they're part of the Free File Alliance when in fact they aren't," said Terry Lemons, an IRS spokesman, in a telephone interview.
The Free File Alliance is a group of tax-preparation companies approved by the IRS to offer free online tax-prep software and filing services to eligible taxpayers. This year, taxpayers with an adjusted gross income of $52,000 or less in 2006 -- that's about 95 million U.S. taxpayers, or 70% of individual filers -- are eligible to e-file their returns for free, according to the IRS.
The scam sites pose as a free-file site, Lemons said. "These are sites designed to trick taxpayers into putting personal information in, and then the sites take the information, file a tax return and change the bank routing number. Then, instead of the money going to the taxpayer's account, it goes into the [scammers'] bank account," he said.
"We learned about this a short while ago. We're working quickly to make sure people are aware of this scam given how late it is in the tax season," Lemons said.
The only way to reach a legitimate "free file" Web site is by first going to www.irs.gov and clicking on "free file." The IRS site will then offer you a selection of tax-prep providers from which to choose. When you click on a provider's name, you will be taken from the IRS Web site to the approved provider's free file site.
How to know?
If you haven't yet filed and are eligible to file for free, be sure to go through the IRS.gov Web site, Lemons said. "It's not IRS.com. It's not IRS-dot-anything except IRS.gov."
If you already e-filed your taxes, but did not attempt to use free file, this scam is unlikely to affect you. And, if you e-filed via the free-file program and went through the IRS.gov site, you're also fine, Lemons said.
However, if you used a free-file program that you found without going through the IRS Web site, you may want to check up on the status of your refund. Taxpayers can do that via the "check my refund" feature at IRS.gov. For e-filers using direct deposit, the refund should arrive in their account within two weeks. If it doesn't, you may want to call the IRS.
"There are legitimate online tax-preparation firms out there," Lemons said. "The combination here is: It's a red flag if [taxpayers] think they've gone through something advertising itself as a free-file site if they have not gone through IRS.gov."
Also, "we're working to identify the affected taxpayers and we will do everything we can to help them out, including making sure they get their refund," Lemons said. "We believe we're going to be able to identify taxpayers affected by this on our end."
Source: Marketwatch
By Andrea Coombes, MarketWatch
Apr 13, 2007
SAN FRANCISCO (MarketWatch) -- Just days before the tax-filing deadline, the IRS issued a warning late Friday afternoon that scammers are creating Web sites that, posing as an IRS "free file" site, gather taxpayers' return information and then snag their refunds.
"We're seeing Web sites out there that are saying they're part of the Free File Alliance when in fact they aren't," said Terry Lemons, an IRS spokesman, in a telephone interview.
The Free File Alliance is a group of tax-preparation companies approved by the IRS to offer free online tax-prep software and filing services to eligible taxpayers. This year, taxpayers with an adjusted gross income of $52,000 or less in 2006 -- that's about 95 million U.S. taxpayers, or 70% of individual filers -- are eligible to e-file their returns for free, according to the IRS.
The scam sites pose as a free-file site, Lemons said. "These are sites designed to trick taxpayers into putting personal information in, and then the sites take the information, file a tax return and change the bank routing number. Then, instead of the money going to the taxpayer's account, it goes into the [scammers'] bank account," he said.
"We learned about this a short while ago. We're working quickly to make sure people are aware of this scam given how late it is in the tax season," Lemons said.
The only way to reach a legitimate "free file" Web site is by first going to www.irs.gov and clicking on "free file." The IRS site will then offer you a selection of tax-prep providers from which to choose. When you click on a provider's name, you will be taken from the IRS Web site to the approved provider's free file site.
How to know?
If you haven't yet filed and are eligible to file for free, be sure to go through the IRS.gov Web site, Lemons said. "It's not IRS.com. It's not IRS-dot-anything except IRS.gov."
If you already e-filed your taxes, but did not attempt to use free file, this scam is unlikely to affect you. And, if you e-filed via the free-file program and went through the IRS.gov site, you're also fine, Lemons said.
However, if you used a free-file program that you found without going through the IRS Web site, you may want to check up on the status of your refund. Taxpayers can do that via the "check my refund" feature at IRS.gov. For e-filers using direct deposit, the refund should arrive in their account within two weeks. If it doesn't, you may want to call the IRS.
"There are legitimate online tax-preparation firms out there," Lemons said. "The combination here is: It's a red flag if [taxpayers] think they've gone through something advertising itself as a free-file site if they have not gone through IRS.gov."
Also, "we're working to identify the affected taxpayers and we will do everything we can to help them out, including making sure they get their refund," Lemons said. "We believe we're going to be able to identify taxpayers affected by this on our end."
Source: Marketwatch
Small-business owners: Don't forget these tax deductions as you rush to file
By Andrea Coombes, MarketWatch
Apr 12, 2007
SAN FRANCISCO (MarketWatch) -- Just like other taxpayers, many small-business owners are coming down to the tax-filing wire, but they have a slew of additional deductions and credits they don't want to miss.
As small-business owners work on their returns the first place to find deductions is the business checkbook. Seeing what you've paid over the year reminds you about deductible expenses you might have forgotten.
But not all tax perks show up that way, said Keith Hall, a Dallas-based certified public accountant and national tax adviser with the National Association for the Self-Employed.
"The easiest deductions to miss are those that don't show up in the checkbook," he said.
But first: If you haven't completed your return, it makes sense to consider filing an extension. Of course, even if you get an extension, the IRS requires payment by the April 17 - Tuesday deadline.
"If you have time to do it correctly, do the calculations. You'll know exactly what you owe. You can pay that with your return on April 17," Hall said. "Then the headaches are over. It's behind you ... and then you can move on to the other 5,000 things you have to do in running your business."
NASE, a trade group, offers a step-by-step guide to Schedule C, plus e-mailed answers to tax questions, even to nonmembers, on its Web site. Go to the Web site and look under "business resources."
If you don't have time to file an accurate return by April 17, get an extension, Hall said. But, he said, "even if you're going to file an extension, the best thing to do is go through the process, make a list of the items that you're missing or unsure about so you can have a to-do list of information."
Close to home
So, which deductions won't be found by going through your business checkbook? The home-office deduction, for one, Hall said.
"If a small business owner operates their business out of their home, then there's probably a deduction there. If they're only looking in their business checkbook, they're going to miss it," Hall said.
Not all home offices will qualify. If you use a space regularly and exclusively for business, you might have a deduction on your hands.
"The two key words are regular and exclusive," Hall said. "The regular part most people don't have a problem with. The exclusive part is more difficult. It does indeed mean exclusive."
Still, exclusive does not mean an entirely separate room - the home-office space can be part of another room, as long as the specific area is solely for the use of the business.
"Make sure the kids don't play video games there. Make sure the baby crib is not also the desk," Hall said. See this IRS page for more information.
"Even if you don't have a home-office deduction for last year, now's the time to do a little advance planning for next year and find a way to set aside some piece of your home as an exclusive home office, so next year you'll have that deduction," Hall said.
Driving deduction
Another easy-to-miss deduction: The deduction for the business use of your car.
"Most small businesses don't have a unique vehicle that they can allocate just for their business. They're taking the kids to school but at the same time they go to the post office, Office Depot, they call on a couple of clients," Hall said.
"That expense may not show up in their business checkbook. If you don't pay attention to the fact that you do use that car for business, you can lose some money."
But taking that deduction requires some record-keeping, he said. "You're going to need a log to support the business miles versus the personal miles," he said. "From time to time, write down the miles you drive for business." See this IRS page for more information.
Retirement-plan contributions
This might be a good time consider your future retirement, Hall said. Businesses can choose among a variety of retirement plans, but only the Simplified Employee Pension plan, or SEP, has a particularly appealing characteristic around this time of year. Unlike other plans, a business owner can create a SEP now and count the money contributed as a deduction on his or her 2006 tax form.
And, if you file an extension, you have until your new filing date to create and fund a SEP. That means, if you file an extension, "you've got six months to save the money and make the contribution," Hall said.
"Many people think it's complicated. They think, 'I'm a small business, I can't set up some complicated retirement plan,' but the fact is a SEP plan is as easy to open as a bank account," Hall said.
"Go to your local bank or a brokerage house ... sign a few forms, give them a check, and your business has a SEP," he said. "Not only have you invested in your own future, but you save money at tax time."
Still, setting up a retirement plan is serious business, so do some research to assess which type of plan is the right one for you.
Domestic production activities
If you employ one or more people and your company produces goods, there's a chance you're eligible for the domestic production activities deduction, a relatively new tax perk.
For example, sole proprietors who are in the homebuilding business are one possible beneficiary, said Steven Hurok, a tax director in the Woodbridge, N.J. office of BDO Seidman.
"Let's assume you're a homebuilder. That's a typical sole proprietor activity. Guess what? You're in a domestic production activity business. If you're making money, you might be entitled to this deduction," Hurok said.
To claim the deduction, you do need to employ others. "It's not just for being self-employed," he said. "It's a job-creation incentive."
Still, this deduction can be complex to figure, and it's not "a huge amount of dollars," he said. "If you're paying a tax rate of 33%, this would reduce it potentially down to 32% ... It's not a home run. It might buy you some ice cream."
Go to this IRS page for more information.
Telephone excise tax refund
There's been a lot of news this year about how individuals can take the telephone excise tax refund, but some small-business owners may overlook that it applies to their business telephone costs as well.
The IRS created a simplified method for business owners to use in calculating this refund, so proprietors can avoid the task of figuring their excise tax on each phone bill going back a few years (the refund applies to telephone bills paid in a 41-month period).
However, business owners still need to know their total telephone bill costs for that period (individual taxpayers can take a standard refund amount to avoid all that figuring). See this IRS page for more information.
"If I had to pick one (tax perk) that's going to be the most overlooked item, it's going to be that one," Hurok said. "But then again, you're talking about, say, 2% of your phone bills. How much is that?"
Still, he added, "if you're a big phone user, it's a big calculation."
Source: Marketwatch
Apr 12, 2007
SAN FRANCISCO (MarketWatch) -- Just like other taxpayers, many small-business owners are coming down to the tax-filing wire, but they have a slew of additional deductions and credits they don't want to miss.
As small-business owners work on their returns the first place to find deductions is the business checkbook. Seeing what you've paid over the year reminds you about deductible expenses you might have forgotten.
But not all tax perks show up that way, said Keith Hall, a Dallas-based certified public accountant and national tax adviser with the National Association for the Self-Employed.
"The easiest deductions to miss are those that don't show up in the checkbook," he said.
But first: If you haven't completed your return, it makes sense to consider filing an extension. Of course, even if you get an extension, the IRS requires payment by the April 17 - Tuesday deadline.
"If you have time to do it correctly, do the calculations. You'll know exactly what you owe. You can pay that with your return on April 17," Hall said. "Then the headaches are over. It's behind you ... and then you can move on to the other 5,000 things you have to do in running your business."
NASE, a trade group, offers a step-by-step guide to Schedule C, plus e-mailed answers to tax questions, even to nonmembers, on its Web site. Go to the Web site and look under "business resources."
If you don't have time to file an accurate return by April 17, get an extension, Hall said. But, he said, "even if you're going to file an extension, the best thing to do is go through the process, make a list of the items that you're missing or unsure about so you can have a to-do list of information."
Close to home
So, which deductions won't be found by going through your business checkbook? The home-office deduction, for one, Hall said.
"If a small business owner operates their business out of their home, then there's probably a deduction there. If they're only looking in their business checkbook, they're going to miss it," Hall said.
Not all home offices will qualify. If you use a space regularly and exclusively for business, you might have a deduction on your hands.
"The two key words are regular and exclusive," Hall said. "The regular part most people don't have a problem with. The exclusive part is more difficult. It does indeed mean exclusive."
Still, exclusive does not mean an entirely separate room - the home-office space can be part of another room, as long as the specific area is solely for the use of the business.
"Make sure the kids don't play video games there. Make sure the baby crib is not also the desk," Hall said. See this IRS page for more information.
"Even if you don't have a home-office deduction for last year, now's the time to do a little advance planning for next year and find a way to set aside some piece of your home as an exclusive home office, so next year you'll have that deduction," Hall said.
Driving deduction
Another easy-to-miss deduction: The deduction for the business use of your car.
"Most small businesses don't have a unique vehicle that they can allocate just for their business. They're taking the kids to school but at the same time they go to the post office, Office Depot, they call on a couple of clients," Hall said.
"That expense may not show up in their business checkbook. If you don't pay attention to the fact that you do use that car for business, you can lose some money."
But taking that deduction requires some record-keeping, he said. "You're going to need a log to support the business miles versus the personal miles," he said. "From time to time, write down the miles you drive for business." See this IRS page for more information.
Retirement-plan contributions
This might be a good time consider your future retirement, Hall said. Businesses can choose among a variety of retirement plans, but only the Simplified Employee Pension plan, or SEP, has a particularly appealing characteristic around this time of year. Unlike other plans, a business owner can create a SEP now and count the money contributed as a deduction on his or her 2006 tax form.
And, if you file an extension, you have until your new filing date to create and fund a SEP. That means, if you file an extension, "you've got six months to save the money and make the contribution," Hall said.
"Many people think it's complicated. They think, 'I'm a small business, I can't set up some complicated retirement plan,' but the fact is a SEP plan is as easy to open as a bank account," Hall said.
"Go to your local bank or a brokerage house ... sign a few forms, give them a check, and your business has a SEP," he said. "Not only have you invested in your own future, but you save money at tax time."
Still, setting up a retirement plan is serious business, so do some research to assess which type of plan is the right one for you.
Domestic production activities
If you employ one or more people and your company produces goods, there's a chance you're eligible for the domestic production activities deduction, a relatively new tax perk.
For example, sole proprietors who are in the homebuilding business are one possible beneficiary, said Steven Hurok, a tax director in the Woodbridge, N.J. office of BDO Seidman.
"Let's assume you're a homebuilder. That's a typical sole proprietor activity. Guess what? You're in a domestic production activity business. If you're making money, you might be entitled to this deduction," Hurok said.
To claim the deduction, you do need to employ others. "It's not just for being self-employed," he said. "It's a job-creation incentive."
Still, this deduction can be complex to figure, and it's not "a huge amount of dollars," he said. "If you're paying a tax rate of 33%, this would reduce it potentially down to 32% ... It's not a home run. It might buy you some ice cream."
Go to this IRS page for more information.
Telephone excise tax refund
There's been a lot of news this year about how individuals can take the telephone excise tax refund, but some small-business owners may overlook that it applies to their business telephone costs as well.
The IRS created a simplified method for business owners to use in calculating this refund, so proprietors can avoid the task of figuring their excise tax on each phone bill going back a few years (the refund applies to telephone bills paid in a 41-month period).
However, business owners still need to know their total telephone bill costs for that period (individual taxpayers can take a standard refund amount to avoid all that figuring). See this IRS page for more information.
"If I had to pick one (tax perk) that's going to be the most overlooked item, it's going to be that one," Hurok said. "But then again, you're talking about, say, 2% of your phone bills. How much is that?"
Still, he added, "if you're a big phone user, it's a big calculation."
Source: Marketwatch
Friday, April 13, 2007
Tax Complexities of Rental Property
Tax Complexities of Rental Property
There's no simple formula for figuring depreciation and amortization on a vacation home or other residential rentals.
By Kevin McCormally
April 12, 2007
Is there an easy way to understand and figure out the depreciation and amortization on our vacation home, which we rent out six weeks of the year?
Come on ... you want taxes to be easy?
You figure your depreciation on Form 4562, basically, by dividing your tax basis in the property (purchase price, plus improvements, minus the cost of land) by 27.5 because a residential rental property is depreciated over 27½ years. First-year depreciation is reduced depending on when in the year you put the house in rental service.
Then you have to allocate the depreciation between personal (nondeductible) and rental (deductible) use on the Schedule E, where you report your rental income and rental expenses. Here's a section from my book, Cut Your Taxes, that explains the allocation methods available.
To figure your vacation-home deductions, you have to allocate expenses between personal and rental use. There are two ways to do this -- the IRS method and another approach that has been approved in court cases. The one that's best for you depends on your circumstances.
According to the IRS, you begin by adding up the total number of days the house was used for personal and business purposes. Your deductible rental expenses are the same proportion of the total as the number of rental days is to the total number of days the place was used.
For example, assume you have a cabin in the mountains that you use for 30 days during the year and rent out for 100 days. The 100 days of rental use equals 77% of the total 130 days the cabin was used According to the IRS formula, 77% of your expenses—including interest, taxes, insurance, utilities, repairs and depreciation—would be rental expenses.
The IRS is particular about the order in which you deduct those expenses against your rental income. You deduct interest and taxes first, then expenses other than depreciation, and then depreciation. The sequence is important, and detrimental, because of the rule that limits rental deductions to the amount of rental income when personal use exceeds 14 days or 10% of total use. Remember that property taxes not assigned to rental use could be claimed as regular itemized deductions instead. But by requiring you to deduct those expenses against rental income -- that might otherwise be offset by depreciation you won't get to claim -- the law squeezes the write-off for taxes as an itemized deduction.
By using a different allocation formula, though, you can limit the interest and tax expenses used to offset rental income and thereby boost the write-off of other rental costs. Courts have allowed taxpayers to allocate taxes and interest over the entire year rather than over just the number of days a property is used. In the example above of 100 days of rental use, that method would allocate just 27% (100 ÷ 365) of the taxes and interest to rental income. That would leave more rental income against which other expenses can be deducted. The extra taxes and interest can be deducted as a regular itemized deduction.
Although the court-approved formula can pay off when the 14-day or 10% test makes the property a personal residence, the IRS version can be more appealing if the place qualifies as a business property. You need to look at the specifics of your situation to determine the best method for you.
Source: Kiplinger
There's no simple formula for figuring depreciation and amortization on a vacation home or other residential rentals.
By Kevin McCormally
April 12, 2007
Is there an easy way to understand and figure out the depreciation and amortization on our vacation home, which we rent out six weeks of the year?
Come on ... you want taxes to be easy?
You figure your depreciation on Form 4562, basically, by dividing your tax basis in the property (purchase price, plus improvements, minus the cost of land) by 27.5 because a residential rental property is depreciated over 27½ years. First-year depreciation is reduced depending on when in the year you put the house in rental service.
Then you have to allocate the depreciation between personal (nondeductible) and rental (deductible) use on the Schedule E, where you report your rental income and rental expenses. Here's a section from my book, Cut Your Taxes, that explains the allocation methods available.
To figure your vacation-home deductions, you have to allocate expenses between personal and rental use. There are two ways to do this -- the IRS method and another approach that has been approved in court cases. The one that's best for you depends on your circumstances.
According to the IRS, you begin by adding up the total number of days the house was used for personal and business purposes. Your deductible rental expenses are the same proportion of the total as the number of rental days is to the total number of days the place was used.
For example, assume you have a cabin in the mountains that you use for 30 days during the year and rent out for 100 days. The 100 days of rental use equals 77% of the total 130 days the cabin was used According to the IRS formula, 77% of your expenses—including interest, taxes, insurance, utilities, repairs and depreciation—would be rental expenses.
The IRS is particular about the order in which you deduct those expenses against your rental income. You deduct interest and taxes first, then expenses other than depreciation, and then depreciation. The sequence is important, and detrimental, because of the rule that limits rental deductions to the amount of rental income when personal use exceeds 14 days or 10% of total use. Remember that property taxes not assigned to rental use could be claimed as regular itemized deductions instead. But by requiring you to deduct those expenses against rental income -- that might otherwise be offset by depreciation you won't get to claim -- the law squeezes the write-off for taxes as an itemized deduction.
By using a different allocation formula, though, you can limit the interest and tax expenses used to offset rental income and thereby boost the write-off of other rental costs. Courts have allowed taxpayers to allocate taxes and interest over the entire year rather than over just the number of days a property is used. In the example above of 100 days of rental use, that method would allocate just 27% (100 ÷ 365) of the taxes and interest to rental income. That would leave more rental income against which other expenses can be deducted. The extra taxes and interest can be deducted as a regular itemized deduction.
Although the court-approved formula can pay off when the 14-day or 10% test makes the property a personal residence, the IRS version can be more appealing if the place qualifies as a business property. You need to look at the specifics of your situation to determine the best method for you.
Source: Kiplinger
Thursday, April 12, 2007
Reduce Taxes on S Corporation Dividends
Reduce Taxes on S Corporation Dividends
There's a trick to lowering your tax bill, but the IRS is watching S corporations closely.
By Peter Blank
April 11, 2007
My husband and I are the only shareholders of our S corporation. I have heard that we can pay ourselves dividends to reduce the tax imposed on a portion of the corporation's income.
Peter responds:
The trick is to pay yourself less salary and take more of the S corporation's profits as dividends. This way you avoid FICA and Medicare taxes on the dividends.
But be careful. IRS is currently auditing thousands of S firms whose owners took unreasonably low salaries (or no salaries) to maximize their payroll tax savings. Remember the old saying ... Pigs get fat, but hogs get slaughtered.
To learn more about the tax implications of owning a business, see the Kiplinger Taxopedia.
Source: Kiplinger.
There's a trick to lowering your tax bill, but the IRS is watching S corporations closely.
By Peter Blank
April 11, 2007
My husband and I are the only shareholders of our S corporation. I have heard that we can pay ourselves dividends to reduce the tax imposed on a portion of the corporation's income.
Peter responds:
The trick is to pay yourself less salary and take more of the S corporation's profits as dividends. This way you avoid FICA and Medicare taxes on the dividends.
But be careful. IRS is currently auditing thousands of S firms whose owners took unreasonably low salaries (or no salaries) to maximize their payroll tax savings. Remember the old saying ... Pigs get fat, but hogs get slaughtered.
To learn more about the tax implications of owning a business, see the Kiplinger Taxopedia.
Source: Kiplinger.
Wednesday, April 11, 2007
Where to Park Your Tax Refund?
Smart Places to Park Your Refund
You can earn 5% or more with these low-minimum, low-risk accounts.
By Joan Goldwasser
May 2007
Dreaming about how to spend your tax refund? Maybe this is the year to wake up and save some of it instead. If you haven't filed yet, you can still take advantage of the new split-refund option and request that your money be deposited electronically into as many as three separate accounts. But even if you're waiting for a check in the mail, you can squirrel away at least some of your windfall for the future.
With the average refund more than $2,000, you could be halfway to maxing out your IRA contribution for 2007. (If you are 50 or older, you can put an extra $1,000 into an IRA this year.) Or you could direct some or all of your refund to a 529 college-savings plan. Or you might just want to stash some cash in a low-minimum, high-yield savings account (many are paying more than 5% interest). That's money you could use to boost your emergency fund, pay off high-interest-rate credit-card debt -- or save for a small splurge.
Money-market funds. Deposits in taxable money-market mutual funds are not federally insured, but the funds maintain a $1 share price, so your principal is guaranteed to remain intact. For example, anyone can open an account in AARP Money Market fund (800-958-6457; www.aarpfunds.com) with as little as $100. The fund was recently yielding 5.14%, and you may write an unlimited number of checks as long as they're for at least $250. With TIAA-CREF Money Market (800-223-1200; www.tiaa-cref.org), yielding 5.09%, you may write only 24 checks a year and you might have to add to your refund check to meet the $2,500 minimum. At 5.08%, Transamerica Premier Cash Reserve (800-892-7587; www.transamericafunds.com) was yielding a smidgen less than the other funds. The minimum deposit is $1,000, and you may write as many checks as you like. Tax-free funds, which invest in municipal bonds, don't make sense now unless you are in the highest tax bracket or live in a high-tax state.
Bank money-market deposit accounts, particularly those offered by online banks, offer competitive rates these days, and your account is insured up to $100,000 by the Federal Deposit Insurance Corp. You could recently earn a 5.31% yield at UFBDirect.com or 5.30% at iGOBanking.com, with no minimum deposit. OneUnitedBank.com offers a yield of 5.30%, with a $1,000 minimum. With all three, you may make six preauthorized withdrawals a month.
Savings accounts. All bank savings accounts are insured up to $100,000 by the FDIC. HSBCDirect.com is offering a hefty 6% until April 30, after which your account will earn 5.05%. You can link your account to a checking account at any bank or use your HSBC ATM card. E*Trade.com and EmigrantDirect.com also offer no-minimum accounts that pay 5.05%. If you're willing to sacrifice a little return for ease of setup, a no-minimum Orange savings account from ING Direct yields 4.50%.
Online banks are also wooing depositors with generous yields on FDIC-insured certificates of deposit. For example, UmbrellaBank.com was recently offering a six-month CD with a 5.40% yield. Ascencia Bank was offering both six-month and one-year CDs yielding 5.40%. NetBank.com was offering six-month CDs at 5.40%, one-year CDs at 5.45% and five-year CDs at 5.40%.
Get smart. Although you may look forward to receiving a chunk of cash each spring, think again. You're giving Uncle Sam an interest-free loan. Wouldn't you rather get bigger paychecks all year long? You can. Just file a new W-4 form with your employer. To recompute the amount you send the government, use our calculator at kiplinger.com/tools/withholding.
Source: Kiplinger
You can earn 5% or more with these low-minimum, low-risk accounts.
By Joan Goldwasser
May 2007
Dreaming about how to spend your tax refund? Maybe this is the year to wake up and save some of it instead. If you haven't filed yet, you can still take advantage of the new split-refund option and request that your money be deposited electronically into as many as three separate accounts. But even if you're waiting for a check in the mail, you can squirrel away at least some of your windfall for the future.
With the average refund more than $2,000, you could be halfway to maxing out your IRA contribution for 2007. (If you are 50 or older, you can put an extra $1,000 into an IRA this year.) Or you could direct some or all of your refund to a 529 college-savings plan. Or you might just want to stash some cash in a low-minimum, high-yield savings account (many are paying more than 5% interest). That's money you could use to boost your emergency fund, pay off high-interest-rate credit-card debt -- or save for a small splurge.
Money-market funds. Deposits in taxable money-market mutual funds are not federally insured, but the funds maintain a $1 share price, so your principal is guaranteed to remain intact. For example, anyone can open an account in AARP Money Market fund (800-958-6457; www.aarpfunds.com) with as little as $100. The fund was recently yielding 5.14%, and you may write an unlimited number of checks as long as they're for at least $250. With TIAA-CREF Money Market (800-223-1200; www.tiaa-cref.org), yielding 5.09%, you may write only 24 checks a year and you might have to add to your refund check to meet the $2,500 minimum. At 5.08%, Transamerica Premier Cash Reserve (800-892-7587; www.transamericafunds.com) was yielding a smidgen less than the other funds. The minimum deposit is $1,000, and you may write as many checks as you like. Tax-free funds, which invest in municipal bonds, don't make sense now unless you are in the highest tax bracket or live in a high-tax state.
Bank money-market deposit accounts, particularly those offered by online banks, offer competitive rates these days, and your account is insured up to $100,000 by the Federal Deposit Insurance Corp. You could recently earn a 5.31% yield at UFBDirect.com or 5.30% at iGOBanking.com, with no minimum deposit. OneUnitedBank.com offers a yield of 5.30%, with a $1,000 minimum. With all three, you may make six preauthorized withdrawals a month.
Savings accounts. All bank savings accounts are insured up to $100,000 by the FDIC. HSBCDirect.com is offering a hefty 6% until April 30, after which your account will earn 5.05%. You can link your account to a checking account at any bank or use your HSBC ATM card. E*Trade.com and EmigrantDirect.com also offer no-minimum accounts that pay 5.05%. If you're willing to sacrifice a little return for ease of setup, a no-minimum Orange savings account from ING Direct yields 4.50%.
Online banks are also wooing depositors with generous yields on FDIC-insured certificates of deposit. For example, UmbrellaBank.com was recently offering a six-month CD with a 5.40% yield. Ascencia Bank was offering both six-month and one-year CDs yielding 5.40%. NetBank.com was offering six-month CDs at 5.40%, one-year CDs at 5.45% and five-year CDs at 5.40%.
Get smart. Although you may look forward to receiving a chunk of cash each spring, think again. You're giving Uncle Sam an interest-free loan. Wouldn't you rather get bigger paychecks all year long? You can. Just file a new W-4 form with your employer. To recompute the amount you send the government, use our calculator at kiplinger.com/tools/withholding.
Source: Kiplinger
Monday, April 9, 2007
Best Buys for Your IRA
Best Buys for Your IRA
By Richard Moore
RealMoney.com Contributor
4/9/2007
You can put anything in an IRA, from bank CDs or Treasury bills, which are virtually risk-free, to highly risky investments such as individual Chinese stocks. Where your own IRA investments fall in this range of risk parameters depends on:
The size and character of your overall investment portfolio.
Your individual attitude about taking risk in the financial markets.
How long you have been investing.
How much time you want to devote to managing your own investments.
The term "risk" is usually used to describe the volatility of investment returns. A high-risk investment might be up 100% one year but down 50% the next. This type of volatility is unacceptable to most investors. On the other end of the spectrum, a low-risk investment might increase in value at 3% to 5% per year for many years.
Generally, risk and return are positively correlated: Riskier or more volatile investments tend to produce higher returns over the long run. Investors demand this additional compensation for putting their money into more volatile investments. In general, common stocks tend to provide higher returns over the long term than bonds, and bonds tend to provide higher returns than money-market funds.
Perhaps you are very new to investing and this is the first year you have contributed to an IRA. Let's further assume that this new IRA is the only investment you own, other than a savings account at the local bank that you use as a reserve fund for emergencies. If you're nowhere near retirement, it probably makes sense to put your initial investment in a stock mutual fund or exchange-traded fund.
If, on the other hand, your IRA represents only a small part of your total investment portfolio, it can be much more concentrated. You can use it to house a single security or asset class. Assuming you have a choice about how to balance your investments, it would be advantageous to put the investments that generate the biggest tax bills in an IRA.
For example, if you want to allocate 60% of your portfolio to stocks and 40% to bonds, you should keep the bonds in an IRA. That's because the interest that bonds pay is taxed as ordinary income, whereas the long-term capital gains generated when you sell stocks held for more than a year are taxed at a lower rate. If, like me, you have substantial short-term capital gains due to investment activity, your IRA would be a good place to concentrate that activity.
Another advantage to putting your least tax-efficient investments in IRAs is that it simplifies your tax returns. It's not necessary to report gains and losses on the individual investments held in an IRA, so you won't have to spend hours slaving over Schedule D forms.
The conventional wisdom is that younger investors can tolerate more volatility than older investors because they have a longer-term time horizon. But that doesn't apply to everyone. If you're going to be pacing the floor all night because your portfolio is down 15%, you should only consider an investment approach that severely limits this possibility.
How can you do that? By owning enough short-term fixed-income instruments to dilute the impact of fluctuations in the more volatile segments of your portfolio, usually represented by common stocks.
I'm a strong believer in diversification. If you're just starting out, this means that you will probably want to use mutual funds or ETFs as investment vehicles. Personally, I would recommend going with a low-cost index fund such as those offered by Vanguard, or the use of Spyders (SPY) , an exchange-traded fund that tracks the S&P 500 index, for the equity portion.
There is no evidence that it's possible to pick an actively managed mutual fund that will outperform the overall market over time.
There are also mutual funds and ETFs that track bond indices.
Using index funds and ETFs satisfies a couple of important requirements. First, your portfolio will track the market, reducing your anxiety. You may still lose some sleep when the market is down, but you won't have to worry about your fund underperforming the market. Second, investing in index funds is easy and doesn't require much time. The only thing you need to worry about is occasional rebalancing to keep your portfolio in line with your asset-allocation objectives.
If you have a larger portfolio, you may still want to use index funds or ETFs. There are plenty of alternatives that allow you to track a wide range of assets, including foreign stock markets or individual industries. The more complex the approach, however, the more time you will probably have to spend monitoring your investments.
As I said, my own approach is to reserve my IRA for U.S. common stocks that I usually hold for less than a year. I have other investments outside my IRA, including real estate, fixed income and oil and gas royalties, so my total investment portfolio is well diversified. This approach keeps me very busy, and I spend a couple of hours each day following my stocks and looking for new ideas to invest in. It is time-consuming, but it is something I love to do, and the results so far have made the time spent worthwhile.
Source: The Street.com
By Richard Moore
RealMoney.com Contributor
4/9/2007
You can put anything in an IRA, from bank CDs or Treasury bills, which are virtually risk-free, to highly risky investments such as individual Chinese stocks. Where your own IRA investments fall in this range of risk parameters depends on:
The size and character of your overall investment portfolio.
Your individual attitude about taking risk in the financial markets.
How long you have been investing.
How much time you want to devote to managing your own investments.
The term "risk" is usually used to describe the volatility of investment returns. A high-risk investment might be up 100% one year but down 50% the next. This type of volatility is unacceptable to most investors. On the other end of the spectrum, a low-risk investment might increase in value at 3% to 5% per year for many years.
Generally, risk and return are positively correlated: Riskier or more volatile investments tend to produce higher returns over the long run. Investors demand this additional compensation for putting their money into more volatile investments. In general, common stocks tend to provide higher returns over the long term than bonds, and bonds tend to provide higher returns than money-market funds.
Perhaps you are very new to investing and this is the first year you have contributed to an IRA. Let's further assume that this new IRA is the only investment you own, other than a savings account at the local bank that you use as a reserve fund for emergencies. If you're nowhere near retirement, it probably makes sense to put your initial investment in a stock mutual fund or exchange-traded fund.
If, on the other hand, your IRA represents only a small part of your total investment portfolio, it can be much more concentrated. You can use it to house a single security or asset class. Assuming you have a choice about how to balance your investments, it would be advantageous to put the investments that generate the biggest tax bills in an IRA.
For example, if you want to allocate 60% of your portfolio to stocks and 40% to bonds, you should keep the bonds in an IRA. That's because the interest that bonds pay is taxed as ordinary income, whereas the long-term capital gains generated when you sell stocks held for more than a year are taxed at a lower rate. If, like me, you have substantial short-term capital gains due to investment activity, your IRA would be a good place to concentrate that activity.
Another advantage to putting your least tax-efficient investments in IRAs is that it simplifies your tax returns. It's not necessary to report gains and losses on the individual investments held in an IRA, so you won't have to spend hours slaving over Schedule D forms.
The conventional wisdom is that younger investors can tolerate more volatility than older investors because they have a longer-term time horizon. But that doesn't apply to everyone. If you're going to be pacing the floor all night because your portfolio is down 15%, you should only consider an investment approach that severely limits this possibility.
How can you do that? By owning enough short-term fixed-income instruments to dilute the impact of fluctuations in the more volatile segments of your portfolio, usually represented by common stocks.
I'm a strong believer in diversification. If you're just starting out, this means that you will probably want to use mutual funds or ETFs as investment vehicles. Personally, I would recommend going with a low-cost index fund such as those offered by Vanguard, or the use of Spyders (SPY) , an exchange-traded fund that tracks the S&P 500 index, for the equity portion.
There is no evidence that it's possible to pick an actively managed mutual fund that will outperform the overall market over time.
There are also mutual funds and ETFs that track bond indices.
Using index funds and ETFs satisfies a couple of important requirements. First, your portfolio will track the market, reducing your anxiety. You may still lose some sleep when the market is down, but you won't have to worry about your fund underperforming the market. Second, investing in index funds is easy and doesn't require much time. The only thing you need to worry about is occasional rebalancing to keep your portfolio in line with your asset-allocation objectives.
If you have a larger portfolio, you may still want to use index funds or ETFs. There are plenty of alternatives that allow you to track a wide range of assets, including foreign stock markets or individual industries. The more complex the approach, however, the more time you will probably have to spend monitoring your investments.
As I said, my own approach is to reserve my IRA for U.S. common stocks that I usually hold for less than a year. I have other investments outside my IRA, including real estate, fixed income and oil and gas royalties, so my total investment portfolio is well diversified. This approach keeps me very busy, and I spend a couple of hours each day following my stocks and looking for new ideas to invest in. It is time-consuming, but it is something I love to do, and the results so far have made the time spent worthwhile.
Source: The Street.com
Thursday, April 5, 2007
How to Avoid an IRS Audit
Avoid That Audit
By Jennifer Openshaw
I know you've heard it before, all the usual advice about keeping the IRS away.
Avoid tax shelters. Make sure your side business earns money, at least once in a while. Make sure its deductions and the home office are legit. Don't refile your return.
But you know what? Even without a side business or any special deductions, you still might be in the IRS cross hairs. Now, full disclosure: I strongly support paying the taxes you're legally required to pay. But no more. And if you're paying what you should be, and can explain it, an audit shouldn't be a problem.
Read the rest here.
By Jennifer Openshaw
I know you've heard it before, all the usual advice about keeping the IRS away.
Avoid tax shelters. Make sure your side business earns money, at least once in a while. Make sure its deductions and the home office are legit. Don't refile your return.
But you know what? Even without a side business or any special deductions, you still might be in the IRS cross hairs. Now, full disclosure: I strongly support paying the taxes you're legally required to pay. But no more. And if you're paying what you should be, and can explain it, an audit shouldn't be a problem.
Read the rest here.
Roth 401(k) rah-rah chorus
Meet one dissenter from Roth 401(k) rah-rah chorusBy Robert Powell, MarketWatch
Last Update: 8:40 PM ET Apr 4, 2007
BOSTON (MarketWatch) -- To many, the newly introduced Roth 401(k) is the greatest retirement account (along with the Roth IRA) ever created. With a Roth 401(k), one contributes after-tax dollars into an employer-sponsored retirement account in which the money grows (as it does in a traditional IRA) tax-free and (unlike a traditional IRA) is distributed tax-free too.
But while many experts praise the benefits of Roth 401(k)s, there's a lone wolf out there with a contrary point of view, penning articles under such headlines as "Roth 401(k): Dumb and Dumber" and "Roth 401(k): Still Dumber."
What doesn't Lawrence Starr, president of Qualified Plan Consultants, like about Roth 401(k)s? Let us count the reasons.
For starters, Starr says workers have to evaluate which is better from a tax standpoint -- the Roth 401(k) or the traditional 401(k). Typically the experts, including Starr, say that workers who are in a low tax bracket when they contribute to a tax-deferred retirement account and expect to be in a higher tax bracket when they withdraw their funds are better off using a Roth account.
But, according to Starr, very few fit into this category. Those include young workers with little or no income, those in a low income tax bracket because of large deductions for child care and homeownership or those whose income will be significantly higher in retirement.
Most workers, he says, will likely be in a lower or the same tax bracket when they retire. And those folks, he says, are better off with the current tax deduction, the traditional 401(k) contribution.
Yes, there are some experts (and regular Americans as well) who say that tax rates are historically low and are likely to rise over time. And given that prediction, the experts say workers should give up the current tax deduction in the hopes that tax rates will be higher later on.
"That is what I call a dumb solution," wrote Starr in the Journal of Pension Benefits. "The (worker) has to give up a sure thing (the current deduction) for what is just a chance that the future benefit will be more valuable -- dumb move, if you ask me."
Do you trust Congress?
Starr is also not fond of Roth-type accounts for this reason: Congress, he predicts, will likely change the laws in midstream and tax Roth distributions at some point. What's more, he predicts that Congress won't even give Roth account owners the courtesy of being grandfathered.
"We have to count on Congress not to change the laws between now and then that provide Roth-type distributions are tax free," he wrote. And that, he says, is just not a "wise bet" anytime.
Consider, he notes, how Congress has often changed tax laws once thought to be unchangeable. For instance, Congress decided to tax up to 50% of Social Security benefits and no one had the luxury of being grandfathered.
For Roth contributions to be better than traditional 401(k) contributions, you have to give up the deduction in hand, hope to be in a higher tax bracket when you take the money out of the retirement account and hope that Congress doesn't change the rules in between. Says Starr: "There are just too many unknowns for this decision to be sensible for most people."
To be fair, Starr does say Roth IRAs have one big advantage over traditional IRAs. With a Roth IRA, he says, account owners never have to take a required minimum distribution as do owners of traditional IRAs and they can contribute to a Roth IRA well past the usual cut-off age of 701/2. "So, substantially more assets can be socked away for oneself and one's heirs," he wrote.
But in the main, Starr says there are other devil-is-in-the-details issues that make Roth-type accounts dumb and dumber. For instance, workers who contribute to a Roth 401(k) will have a higher adjusted gross income than if they put the money in a traditional 401(k) and that could result in the loss of other tax benefits that have phase out limits, such as child-care tax credit. In addition, a higher adjusted gross income could bring the alternative minimum tax into play.
In addition, it's not yet known how Roth 401(k)s will affect divorce agreements that split retirement accounts in two, the Qualified Domestic Relations Order or QDRO. The lawyers will have to calculate the net present after-tax value of the Roth 401(k) and the traditional 401(k).
Plus, there are some questions about the death benefits when there are multiple beneficiaries and Roth and traditional 401(k) accounts. Will someone get the account with the taxable distributions and someone get the account with the tax-free distributions?
Headaches for employers
What else? Well, for employers, especially small businesses, the problems with Roth 401(k)s are many. For one, small business owners would have to change what's called summary plan documents, adding the Roth option. Payroll records would have to be modified.
Plus, the plan's service provider would need to put in place separate tracking and record-keeping for the Roth and traditional 401(k) contributions. And the costs associated with those activities are not insignificant, Starr says.
"These small businesses don't have a personnel staff" as do large employers, he said. What's more, employers must establish rules for hardship distributions and participant loans.
And last, Starr notes that small-business owners will have the unenviable task of trying to educate workers about Roth 401(k)s. And on this point, he says, the center does not hold.
"Employee communication which is already overwhelming many plans and participants, is going to find a significant new challenge in explaining the Roth 401(k) plan in a manner that is easy to understand for employees," he wrote. "Good luck."
Robert Powell has been a journalist covering personal finance issues for more than 20 years, writing and editing for publications such as The Wall Street Journal, the Financial Times, and Mutual Fund Market News.
Source: Marketwatch.
Last Update: 8:40 PM ET Apr 4, 2007
BOSTON (MarketWatch) -- To many, the newly introduced Roth 401(k) is the greatest retirement account (along with the Roth IRA) ever created. With a Roth 401(k), one contributes after-tax dollars into an employer-sponsored retirement account in which the money grows (as it does in a traditional IRA) tax-free and (unlike a traditional IRA) is distributed tax-free too.
But while many experts praise the benefits of Roth 401(k)s, there's a lone wolf out there with a contrary point of view, penning articles under such headlines as "Roth 401(k): Dumb and Dumber" and "Roth 401(k): Still Dumber."
What doesn't Lawrence Starr, president of Qualified Plan Consultants, like about Roth 401(k)s? Let us count the reasons.
For starters, Starr says workers have to evaluate which is better from a tax standpoint -- the Roth 401(k) or the traditional 401(k). Typically the experts, including Starr, say that workers who are in a low tax bracket when they contribute to a tax-deferred retirement account and expect to be in a higher tax bracket when they withdraw their funds are better off using a Roth account.
But, according to Starr, very few fit into this category. Those include young workers with little or no income, those in a low income tax bracket because of large deductions for child care and homeownership or those whose income will be significantly higher in retirement.
Most workers, he says, will likely be in a lower or the same tax bracket when they retire. And those folks, he says, are better off with the current tax deduction, the traditional 401(k) contribution.
Yes, there are some experts (and regular Americans as well) who say that tax rates are historically low and are likely to rise over time. And given that prediction, the experts say workers should give up the current tax deduction in the hopes that tax rates will be higher later on.
"That is what I call a dumb solution," wrote Starr in the Journal of Pension Benefits. "The (worker) has to give up a sure thing (the current deduction) for what is just a chance that the future benefit will be more valuable -- dumb move, if you ask me."
Do you trust Congress?
Starr is also not fond of Roth-type accounts for this reason: Congress, he predicts, will likely change the laws in midstream and tax Roth distributions at some point. What's more, he predicts that Congress won't even give Roth account owners the courtesy of being grandfathered.
"We have to count on Congress not to change the laws between now and then that provide Roth-type distributions are tax free," he wrote. And that, he says, is just not a "wise bet" anytime.
Consider, he notes, how Congress has often changed tax laws once thought to be unchangeable. For instance, Congress decided to tax up to 50% of Social Security benefits and no one had the luxury of being grandfathered.
For Roth contributions to be better than traditional 401(k) contributions, you have to give up the deduction in hand, hope to be in a higher tax bracket when you take the money out of the retirement account and hope that Congress doesn't change the rules in between. Says Starr: "There are just too many unknowns for this decision to be sensible for most people."
To be fair, Starr does say Roth IRAs have one big advantage over traditional IRAs. With a Roth IRA, he says, account owners never have to take a required minimum distribution as do owners of traditional IRAs and they can contribute to a Roth IRA well past the usual cut-off age of 701/2. "So, substantially more assets can be socked away for oneself and one's heirs," he wrote.
But in the main, Starr says there are other devil-is-in-the-details issues that make Roth-type accounts dumb and dumber. For instance, workers who contribute to a Roth 401(k) will have a higher adjusted gross income than if they put the money in a traditional 401(k) and that could result in the loss of other tax benefits that have phase out limits, such as child-care tax credit. In addition, a higher adjusted gross income could bring the alternative minimum tax into play.
In addition, it's not yet known how Roth 401(k)s will affect divorce agreements that split retirement accounts in two, the Qualified Domestic Relations Order or QDRO. The lawyers will have to calculate the net present after-tax value of the Roth 401(k) and the traditional 401(k).
Plus, there are some questions about the death benefits when there are multiple beneficiaries and Roth and traditional 401(k) accounts. Will someone get the account with the taxable distributions and someone get the account with the tax-free distributions?
Headaches for employers
What else? Well, for employers, especially small businesses, the problems with Roth 401(k)s are many. For one, small business owners would have to change what's called summary plan documents, adding the Roth option. Payroll records would have to be modified.
Plus, the plan's service provider would need to put in place separate tracking and record-keeping for the Roth and traditional 401(k) contributions. And the costs associated with those activities are not insignificant, Starr says.
"These small businesses don't have a personnel staff" as do large employers, he said. What's more, employers must establish rules for hardship distributions and participant loans.
And last, Starr notes that small-business owners will have the unenviable task of trying to educate workers about Roth 401(k)s. And on this point, he says, the center does not hold.
"Employee communication which is already overwhelming many plans and participants, is going to find a significant new challenge in explaining the Roth 401(k) plan in a manner that is easy to understand for employees," he wrote. "Good luck."
Robert Powell has been a journalist covering personal finance issues for more than 20 years, writing and editing for publications such as The Wall Street Journal, the Financial Times, and Mutual Fund Market News.
Source: Marketwatch.
How to get a filing extension
How to get a filing extension
By Marshall Loeb, MarketWatch
Last Update: 12:01 AM ET Apr 5, 2007
NEW YORK (MarketWatch) -- You promised yourself you'd file your tax returns in January this year. Then, February rolled around and you told yourself you still had time. March passed in a blur. Now, it's April, and the filing deadline (April 17) is just days away.
If you don't have enough time to get everything together by then, there is a way to save your hide -- get an automatic filing extension. It will allow you six extra months; you must file by Oct. 15.
Just remember, an extension to file a return does not also mean an extension of time to pay your tax liability. If you don't pay the tax shown when you file for the extension, you're going to be subject to interest and penalties.
According to J.K. Lasser's "Your Income Tax 2007," here's how to buy some extra time:
Mail it in. Download and complete Form 4868 from IRS.gov and mail it in by Tuesday, April 17.
File online. You can electronically file the extension through tax-preparation software, online filing services or with your tax preparer.
Because the IRS doesn't directly accept payments via credit card, you will have to use a third party, such as online software, to make the payment. You'll probably be charged a fee for the service.
Marshall Loeb, former editor of Fortune, Money, and the Columbia Journalism Review, writes for MarketWatch.
Source: Marketwatch
By Marshall Loeb, MarketWatch
Last Update: 12:01 AM ET Apr 5, 2007
NEW YORK (MarketWatch) -- You promised yourself you'd file your tax returns in January this year. Then, February rolled around and you told yourself you still had time. March passed in a blur. Now, it's April, and the filing deadline (April 17) is just days away.
If you don't have enough time to get everything together by then, there is a way to save your hide -- get an automatic filing extension. It will allow you six extra months; you must file by Oct. 15.
Just remember, an extension to file a return does not also mean an extension of time to pay your tax liability. If you don't pay the tax shown when you file for the extension, you're going to be subject to interest and penalties.
According to J.K. Lasser's "Your Income Tax 2007," here's how to buy some extra time:
Mail it in. Download and complete Form 4868 from IRS.gov and mail it in by Tuesday, April 17.
File online. You can electronically file the extension through tax-preparation software, online filing services or with your tax preparer.
Because the IRS doesn't directly accept payments via credit card, you will have to use a third party, such as online software, to make the payment. You'll probably be charged a fee for the service.
Marshall Loeb, former editor of Fortune, Money, and the Columbia Journalism Review, writes for MarketWatch.
Source: Marketwatch
Wednesday, April 4, 2007
More IRA Informaiton
Check out these articles from TheStreet.com.
The Power of Tax-Deferred Savings
By Richard Moore
RealMoney.com Contributor
4/3/2007 11:03 AM EDT
URL: http://www.thestreet.com/funds/maxira/10345909.html
Americans are terrible savers, and most people approaching retirement age don't have enough assets to maintain a comfortable lifestyle once they leave the workforce.
Add to this the potential looming problems with Social Security and Medicare and you can see that any attempt to save for retirement is probably a good thing.
IRAs and other retirement plans give the investor a great advantage -- tax-free or tax-deferred savings. Over long time periods, this can really boost wealth creation. For example, a portfolio growing at 10% a year that isn't taxed will grow substantially faster than a taxed portfolio growing at the same rate. If the tax rate on a portfolio's return is 25%, the portfolio will be 25% bigger after 10 years if it is not taxed.
Traditional IRAs have the added advantage that contributions to it are not subject to tax if your income falls below a certain threshold. This gives investors the ability to use money that would otherwise go to the government to partially finance their own retirement portfolios. The higher the tax rate, the better the bargain for the traditional IRA investor.
While withdrawals from traditional IRAs are taxed at ordinary income tax rates, many people are in lower income tax brackets when they retire than when they're in the workforce. If your income is low enough (less than $50,000 for joint filers for 2006), Uncle Sam may give you a direct credit on income tax of up to $1,000 if you invest $2,000 in an IRA.
One critical requirement for contributing to an IRA is that the IRA's owner must have earned income. If you spend most of your time sitting on the veranda clipping municipal bond coupons and adding up your oil and gas royalty checks, you probably won't qualify. Then again, you probably won't need one.
However, if you're like most people who go to work every day or toil at your own business, you should be eligible. (For those who are self-employed in a business with no other employees, I have found that the self-employed 401(k) is a better option.) By the way, husbands and wives can each have their own IRA even if only one has earned income.
The other limitations to IRA contributions relate to income level and whether the participants are already covered by a retirement plan at work. There is no income restriction on deductible contributions to a traditional IRA if neither husband nor wife is covered by a plan at work. However, you can't contribute to a Roth IRA if your joint income exceeds $160,000, and traditional IRA contributions are not deductible for plan participants if joint income exceeds $85,000, and are not deductible for spouses of plan participants if joint income exceeds $160,000.
Nondeductible contributions to traditional IRAs can still be made at any income level, though. Those nondeductible contributions will still grow tax-free until withdrawals commence, at which time there is a formula for deciding how much of any withdrawal is taxable. Speaking of formulas, the details of all aspects relating to IRAs are available in IRS Publication 590. If your situation is complex, IRS publications or a good tax adviser are other places to look for answers.
For tax year 2006, total IRA contributions are limited to $4,000 per person (or $5,000 per person if age 50 or more). If your earned income is below the appropriate threshold, then this earned income would be the limit for any IRA contribution. IRA contributions can be made to traditional IRAs or Roth IRAs in any combination up to the total contribution limit.
Converting to a Roth IRABy Richard Moore
RealMoney.com Contributor
4/4/2007 12:16 PM EDT
URL: http://www.thestreet.com/funds/maxira/10345911.html
Let's assume that you like the idea of saving for retirement and using a tax-deferred or tax-free method of doing so. Let's further assume that you are married, that you and your spouse are both around 40 years old, and that your total income is less than $150,000 per year. Which IRA, traditional or Roth, would be better?
First we'll discuss the basic differences. Contributions to a traditional IRA are tax-deductible in the year made. That means that our hypothetical couple can reduce their adjusted gross income by $8,000 by making the maximum contributions to their individual IRAs. If they are in the 25% tax bracket, then they will save one-quarter of the total contributed, or $2,000, on their taxes due for the year. Therefore, in addition to that savings, they only need $6,000 to fund their contributions.
There are a couple of negatives here, however. Uncle Sam requires that taxes be paid eventually and, in the case of the traditional IRA, these taxes will be paid when withdrawals are made, usually in retirement years over the age of 59 1/2. There are penalties associated with making early withdrawals (usually 10% of the amount withdrawn), but these penalties are waived in certain circumstances, such as the taxpayer becoming disabled, various financial calamities or when the withdrawal is being used to make a first-time home purchase.
Also, at age 70 1/2, withdrawals are mandated on a schedule that roughly coincides with standard mortality life-expectancy tables.
The Roth IRA reverses the timing of tax liability for the contributions and withdrawals. Contributions are not deductible in the year made. So our couple would need to have $8,000 available to make the maximum contribution. But the huge advantage of a Roth IRA, especially for younger people, is that withdrawals are not subject to tax. Over a period of 20 years, the $8,000 contribution could easily appreciate to $25,000 at a 6% rate of return. None of that amount would be subject to tax.
There are still penalties associated with early withdrawals, but those penalties are only assessed on the earnings withdrawn -- not the original contributions. There are also penalties on any withdrawals made during an initial five-year holding period. However, there are no age-related withdrawal requirements, so assets can continue to grow tax-free for life and then will pass to heirs. While the Roth IRA is part of the estate and may trigger estate taxes, the beneficiary of a Roth IRA can avoid any income taxes by following very simple rules.
Clearly, to me at least, the Roth IRA is the preferred vehicle for most people and especially for younger investors. However, there are lots of variables to be considered, including current tax rates, future tax rates and the age of the investors. And, as a practical matter, availability of capital to invest has to be considered.
In most cases, I would rather maximize a contribution to a traditional IRA than invest a smaller amount in a Roth IRA. For that reason, and also because I like to take my tax breaks now rather than later, my own personal IRA is currently totally a traditional IRA. I'm expecting, though, that I may have a future opportunity to have the best of both worlds by converting my traditional IRA into a Roth IRA.
Converting to a Roth IRA
The ramifications of converting a traditional IRA into a Roth IRA are complex and different for each individual. There are a couple of constants, however. First, we know that taxes on the amount converted will be due immediately. If those taxes must be paid from the amount withdrawn from the traditional IRA, it is almost impossible to make a case for conversion unless there is a lengthy time between conversion and retirement to make up the taxes paid.
However, if assets are available from other sources to pay the tax bill, a conversion makes much more sense. Conversion is even more attractive if tax rates in retirement are the same or higher than current rates. While it may seem unlikely that your tax rate will be higher in retirement than while you are working, inheritances could boost the size of your investment portfolio substantially. Also, let's not forget, politicians who insist on growing the government instead of the economy have a way of increasing tax rates whenever possible.
There is an income restriction on IRA conversions. Currently, adjusted gross income must be less than $100,000 (not including the conversion amount) before a conversion is allowed. Fortunately, there is good news on this limitation due to last year's tax bill. Starting in 2010, this limitation will no longer apply, and conversions that occur in 2010 will be able to have half of the taxable converted amount taxed in 2011 and the other half taxed in 2012.
Personally, because my earned income is low and most of my other income is capital gains, I might get an opportunity to convert my own traditional IRA into a Roth if the market goes against me for a year, thus keeping my taxable income at a low level. It should be noted that, in order to avoid any penalties, assets have to be held in a Roth IRA for at least five years after conversion.
The Power of Tax-Deferred Savings
By Richard Moore
RealMoney.com Contributor
4/3/2007 11:03 AM EDT
URL: http://www.thestreet.com/funds/maxira/10345909.html
Americans are terrible savers, and most people approaching retirement age don't have enough assets to maintain a comfortable lifestyle once they leave the workforce.
Add to this the potential looming problems with Social Security and Medicare and you can see that any attempt to save for retirement is probably a good thing.
IRAs and other retirement plans give the investor a great advantage -- tax-free or tax-deferred savings. Over long time periods, this can really boost wealth creation. For example, a portfolio growing at 10% a year that isn't taxed will grow substantially faster than a taxed portfolio growing at the same rate. If the tax rate on a portfolio's return is 25%, the portfolio will be 25% bigger after 10 years if it is not taxed.
Traditional IRAs have the added advantage that contributions to it are not subject to tax if your income falls below a certain threshold. This gives investors the ability to use money that would otherwise go to the government to partially finance their own retirement portfolios. The higher the tax rate, the better the bargain for the traditional IRA investor.
While withdrawals from traditional IRAs are taxed at ordinary income tax rates, many people are in lower income tax brackets when they retire than when they're in the workforce. If your income is low enough (less than $50,000 for joint filers for 2006), Uncle Sam may give you a direct credit on income tax of up to $1,000 if you invest $2,000 in an IRA.
One critical requirement for contributing to an IRA is that the IRA's owner must have earned income. If you spend most of your time sitting on the veranda clipping municipal bond coupons and adding up your oil and gas royalty checks, you probably won't qualify. Then again, you probably won't need one.
However, if you're like most people who go to work every day or toil at your own business, you should be eligible. (For those who are self-employed in a business with no other employees, I have found that the self-employed 401(k) is a better option.) By the way, husbands and wives can each have their own IRA even if only one has earned income.
The other limitations to IRA contributions relate to income level and whether the participants are already covered by a retirement plan at work. There is no income restriction on deductible contributions to a traditional IRA if neither husband nor wife is covered by a plan at work. However, you can't contribute to a Roth IRA if your joint income exceeds $160,000, and traditional IRA contributions are not deductible for plan participants if joint income exceeds $85,000, and are not deductible for spouses of plan participants if joint income exceeds $160,000.
Nondeductible contributions to traditional IRAs can still be made at any income level, though. Those nondeductible contributions will still grow tax-free until withdrawals commence, at which time there is a formula for deciding how much of any withdrawal is taxable. Speaking of formulas, the details of all aspects relating to IRAs are available in IRS Publication 590. If your situation is complex, IRS publications or a good tax adviser are other places to look for answers.
For tax year 2006, total IRA contributions are limited to $4,000 per person (or $5,000 per person if age 50 or more). If your earned income is below the appropriate threshold, then this earned income would be the limit for any IRA contribution. IRA contributions can be made to traditional IRAs or Roth IRAs in any combination up to the total contribution limit.
Converting to a Roth IRABy Richard Moore
RealMoney.com Contributor
4/4/2007 12:16 PM EDT
URL: http://www.thestreet.com/funds/maxira/10345911.html
Let's assume that you like the idea of saving for retirement and using a tax-deferred or tax-free method of doing so. Let's further assume that you are married, that you and your spouse are both around 40 years old, and that your total income is less than $150,000 per year. Which IRA, traditional or Roth, would be better?
First we'll discuss the basic differences. Contributions to a traditional IRA are tax-deductible in the year made. That means that our hypothetical couple can reduce their adjusted gross income by $8,000 by making the maximum contributions to their individual IRAs. If they are in the 25% tax bracket, then they will save one-quarter of the total contributed, or $2,000, on their taxes due for the year. Therefore, in addition to that savings, they only need $6,000 to fund their contributions.
There are a couple of negatives here, however. Uncle Sam requires that taxes be paid eventually and, in the case of the traditional IRA, these taxes will be paid when withdrawals are made, usually in retirement years over the age of 59 1/2. There are penalties associated with making early withdrawals (usually 10% of the amount withdrawn), but these penalties are waived in certain circumstances, such as the taxpayer becoming disabled, various financial calamities or when the withdrawal is being used to make a first-time home purchase.
Also, at age 70 1/2, withdrawals are mandated on a schedule that roughly coincides with standard mortality life-expectancy tables.
The Roth IRA reverses the timing of tax liability for the contributions and withdrawals. Contributions are not deductible in the year made. So our couple would need to have $8,000 available to make the maximum contribution. But the huge advantage of a Roth IRA, especially for younger people, is that withdrawals are not subject to tax. Over a period of 20 years, the $8,000 contribution could easily appreciate to $25,000 at a 6% rate of return. None of that amount would be subject to tax.
There are still penalties associated with early withdrawals, but those penalties are only assessed on the earnings withdrawn -- not the original contributions. There are also penalties on any withdrawals made during an initial five-year holding period. However, there are no age-related withdrawal requirements, so assets can continue to grow tax-free for life and then will pass to heirs. While the Roth IRA is part of the estate and may trigger estate taxes, the beneficiary of a Roth IRA can avoid any income taxes by following very simple rules.
Clearly, to me at least, the Roth IRA is the preferred vehicle for most people and especially for younger investors. However, there are lots of variables to be considered, including current tax rates, future tax rates and the age of the investors. And, as a practical matter, availability of capital to invest has to be considered.
In most cases, I would rather maximize a contribution to a traditional IRA than invest a smaller amount in a Roth IRA. For that reason, and also because I like to take my tax breaks now rather than later, my own personal IRA is currently totally a traditional IRA. I'm expecting, though, that I may have a future opportunity to have the best of both worlds by converting my traditional IRA into a Roth IRA.
Converting to a Roth IRA
The ramifications of converting a traditional IRA into a Roth IRA are complex and different for each individual. There are a couple of constants, however. First, we know that taxes on the amount converted will be due immediately. If those taxes must be paid from the amount withdrawn from the traditional IRA, it is almost impossible to make a case for conversion unless there is a lengthy time between conversion and retirement to make up the taxes paid.
However, if assets are available from other sources to pay the tax bill, a conversion makes much more sense. Conversion is even more attractive if tax rates in retirement are the same or higher than current rates. While it may seem unlikely that your tax rate will be higher in retirement than while you are working, inheritances could boost the size of your investment portfolio substantially. Also, let's not forget, politicians who insist on growing the government instead of the economy have a way of increasing tax rates whenever possible.
There is an income restriction on IRA conversions. Currently, adjusted gross income must be less than $100,000 (not including the conversion amount) before a conversion is allowed. Fortunately, there is good news on this limitation due to last year's tax bill. Starting in 2010, this limitation will no longer apply, and conversions that occur in 2010 will be able to have half of the taxable converted amount taxed in 2011 and the other half taxed in 2012.
Personally, because my earned income is low and most of my other income is capital gains, I might get an opportunity to convert my own traditional IRA into a Roth if the market goes against me for a year, thus keeping my taxable income at a low level. It should be noted that, in order to avoid any penalties, assets have to be held in a Roth IRA for at least five years after conversion.
Income Limits on IRA Deductions
Income Limits on IRA Deductions
You might not be able to write off your full contribution if you earn too much and already participate in a retirement plan at work.
By Kevin McCormally
April 3, 2007
I am trying to reduce the amount of money I have to pay the IRS this year. I thought about opening an IRA. Is there an income limit for contributions to be deductible?
Kevin responds:
That depends on whether you are covered by a retirement plan -- such as a 401(k), 403(b) or pension plan -- at work. If so, there are income limits for deducting traditional IRA contributions.
The right to deduct such contributions is phased out as income rises between $50,000 and $60,000 on a individual return and between $75,000 and $85,000 on a married-filing-jointly return. If your income is less than the bottom figure, you can deduct up to the maximum contribution level of $4,000 ($5,000 if you were 50 or over at the end of 2006) for 2006. And, you have until April 17 to make that 2006 contribution. The deduction will reduce what you owe in tax for 2006.
If you are not covered by a retirement plan at work, there are no income limits on IRA deductibility.
From Kiplinger.com.
You might not be able to write off your full contribution if you earn too much and already participate in a retirement plan at work.
By Kevin McCormally
April 3, 2007
I am trying to reduce the amount of money I have to pay the IRS this year. I thought about opening an IRA. Is there an income limit for contributions to be deductible?
Kevin responds:
That depends on whether you are covered by a retirement plan -- such as a 401(k), 403(b) or pension plan -- at work. If so, there are income limits for deducting traditional IRA contributions.
The right to deduct such contributions is phased out as income rises between $50,000 and $60,000 on a individual return and between $75,000 and $85,000 on a married-filing-jointly return. If your income is less than the bottom figure, you can deduct up to the maximum contribution level of $4,000 ($5,000 if you were 50 or over at the end of 2006) for 2006. And, you have until April 17 to make that 2006 contribution. The deduction will reduce what you owe in tax for 2006.
If you are not covered by a retirement plan at work, there are no income limits on IRA deductibility.
From Kiplinger.com.
Monday, April 2, 2007
2007 Saturn Aura Certified As Qualified Hybrid Vehicle
2007 Saturn Aura Certified As Qualified Hybrid Vehicle
IR-2007-64, March 19, 2007
WASHINGTON — The Internal Revenue Service has acknowledged the certification by General Motors Corp. that its 2007 Saturn Aura Hybrid vehicle meets the requirements of the Alternative Motor Vehicle Credit as a qualified hybrid motor vehicle.
The credit amount for the hybrid vehicle certification of the 2007 Saturn Aura Hybrid is $1,300.
You can read the rest here.
IR-2007-64, March 19, 2007
WASHINGTON — The Internal Revenue Service has acknowledged the certification by General Motors Corp. that its 2007 Saturn Aura Hybrid vehicle meets the requirements of the Alternative Motor Vehicle Credit as a qualified hybrid motor vehicle.
The credit amount for the hybrid vehicle certification of the 2007 Saturn Aura Hybrid is $1,300.
You can read the rest here.
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