October 31, 2005
Re:
Year-End Tax Planning
Dear Valued Client,
As the end of the
year approaches, it is a good time to consider tax planning. You should have a
good view of the year’s financial results now. In addition to the normal tax
planning strategies, law changes open up new opportunities to reduce your
income taxes.
A recent flurry of
tax legislation may have an impact on your year-end tax planning for 2005. For
example, the Energy Tax Incentives Act of 2005 provides a new tax credit for
making certain energy-saving improvements around the house. But the new credit
is not available until 2006, so you may want to hold off on the improvements if
possible. On the other hand, the Katrina Emergency Tax Relief Act of 2005
allows some taxpayers to claim bigger charitable deductions than in the past
because the Act lifts restrictions that limited the deductions. But it's only a
temporary reprieve; the restrictions return after December 31, 2005. So, if the restrictions apply to you, you may want
to consider accelerating your charitable donations from 2006 to 2005.
There are other tax
law changes taking effect at the beginning of 2006 that you should take into
account in your end-of-2005 planning. For example, a deduction for college
tuition is scheduled to go off the books unless Congress extends it. You may
want to prepay in 2005 tuition not due until early 2006 if that lets you
increase your tax savings from the expiring deduction.
Also, on January 1, 2006, the deduction for buying a hybrid automobile
converts to a tax credit that's probably more valuable to auto buyers than the
deduction. So if you are thinking about buying a hybrid, you may want to delay
your purchase until 2006. Also, whether you are buying a hybrid or a regular
car, you should think about the sales tax deduction. For 2005, you can deduct
state and local sales taxes in lieu of state and local income taxes. Unless the
law is changed, for 2006, you won't have the choice; you'll only be able to
deduct income taxes. So if you are deducting sales taxes this year and are
planning to buy a car soon, you may want to push the purchase into 2005 to
increase your sales tax deduction. This works because the deductible sales tax
amount from the IRS's optional sales tax table is increased (but only up to the
amount paid at the general sales tax rate) by the sales tax paid on a purchased
or leased motor vehicle (which not only includes cars, but also motorcycles,
motor homes, recreational vehicles, SUVs, trucks, vans, and off-road vehicles).
Also, you may add to the table amount, sales tax paid on an aircraft, boat,
home (including mobile or prefabricated), or home building materials, if the
tax rate is the same as the general sales tax rate. So these items also may be
suitable for purchase this year.
A summary of recent
legislation is enclosed to help you review the changes.
We have compiled a checklist of actions that
may help you to save taxes if you act before year-end. Not all actions will
apply in your particular situation, but you will likely benefit from many of
them. We can narrow down the specific actions that you can take if we speak
with you to tailor a particular plan. In the meantime, please review the
following list and contact us at your earliest convenience so that we can
advise you on which tax-saving moves to make:
- Increase the amount you set aside for next year
in your employer's health flexible spending account if you set aside too
little for this year. Don't forget you can set aside amounts to get
tax-free reimbursements for over-the-counter drugs, such as aspirin and
antacids. Also, new rules allow your plan to permit a grace period after
year-end for using remaining amounts.
- If you have any capital gains or losses from
sales of stock or other capital assets or you have stock or other capital
assets that are ripe for sale, it may be advisable for us to meet to
discuss how you can best coordinate timing your gains and losses to
minimize tax on your gains and maximize the tax benefit from your losses.
- It may be advantageous to try to arrange with
your employer to defer your bonus until 2006.
- If you own an interest in a partnership or S
corporation you may need to increase your basis in the entity so you can
deduct a loss from it for this year.
- Consider using a credit card to prepay expenses
that can generate deductions for this year.
- Business clients also should consider making
expenditures that qualify for the $105,000 business property expensing
option.
- You may be able to save taxes this year and next
year by applying a bunching strategy to “miscellaneous” itemized
deductions, medical expenses and other itemized deductions.
- Those facing a penalty for underpayment of
estimated tax may be able to eliminate or reduce it by increasing their
withholding.
- Self-employed individuals should consider setting
up a self-employed retirement plan.
- You can save gift and estate taxes by making
gifts sheltered by the annual gift tax exclusion before the end of the year.
You can give $11,000 in 2005 to an unlimited number of individuals but you
can't carry over unused exclusions from one year to the next. Note that
the annual exclusion amount increases to $12,000 for 2006.
- If you're thinking of donating a used auto to charity,
you may want to inquire whether the charity plans to sell the car or use
it in its charitable activities; the latter may yield a bigger deduction
for you.
- If you are receiving Social Security benefits,
there are a number of steps you can take to reduce or eliminate tax on
your benefits. Consider asking your employer to increase withholding of
state and local taxes to pull the deduction of those taxes into this year
(but only if doing so won't cause an AMT problem).
In addition to mentioning the items above, we
have enclosed a year-end tax planning pamphlet that presents ideas in more
detail.
Very truly yours,
2005 Tax Legislation: Energy Act of 2005 -
Energy-Efficiency Tax Breaks for Individuals and Businesses
New Energy-Efficiency Tax Breaks
The recently-enacted Energy Tax Incentives Act of
2005 provides significant tax breaks for individual homeowners who spend
money in 2006 and 2007 to install specific energy-saving devices. In addition,
starting in 2006, a new tax credit will be available for the purchase of some
hybrid vehicles, as well as the purchase of some other, more exotic
"green" vehicles. Businesses that install energy savings equipment
will also be entitled to generous energy tax credits or deductions. Like all tax
laws, there are rules that must be followed to get the benefit of the new
energy tax breaks. Some of them are quite complex. This letter is intended to
introduce you to the basic energy tax credits and deductions that will be
available to you.
Impact on consumers
Three new energy credits are available for 2006 and
2007, only, to individual consumers for property placed in service in those tax
years:
- The residential energy efficient property credit;
- The home improvement energy credit; and,
- The alternative fuel vehicles credit.
Going solar. The
"residential energy efficient property credit" is all about
converting your home to solar energy. There are three ways take the credit, and
three separate amounts allowed for doing it. The new law makes available:
- A 30 percent credit up to a maximum $2,000 per year for the cost
of purchasing and installing of residential solar water heating;
- A 30 percent credit up to a maximum $2,000 per year for the cost
of purchasing and installing photovoltaic equipment for solar-generated
electricity; and,
- $500 for each 0.5 kilowatt of fuel cell property capacity.
Although there is some debate in Washington over exactly what Congress meant, apparently the
$2,000 credits for solar water and electricity apply to any residence, including
vacation homes, while the fuel cell credit is restricted to installation in
your principal residence.
Home improvement energy credit. Uncle Sam is offering you $500 to install certain
energy saving improvements in your home. Energy conservation property, such as
energy-efficient residential exterior doors and windows, insulation, heat
pumps, furnaces, central air conditioners and water heaters installed in 2006
and 2007, qualify.
The $500 credit may be taken in any one of two ways,
or in combination:
- A dollar-for-dollar credit for residential energy property
expenditures plus; and/or,
- 10 percent of the cost of qualified energy efficiency
improvements.
"Residential energy property
expenditures" include:
- Up to $50 for an advanced main air circulating fan;
- Up to $150 for any energy-efficient qualified natural gas,
propane, or oil furnace or hot water boiler; and,
- Up to $300 for energy-efficient building property, which includes
electric and geothermal heat pumps, open loop, direct expansion, central AC, and natural gas, propane or oil water
heaters.
2005 Tax Legislation: Energy Act of 2005
"Qualified energy efficiency improvements" for which 10 percent of your purchase and installation
costs are allowed to count toward the $500 home improvement energy credit)
consist of "energy-efficient envelope components satisfying the 2000IEC
Code." They include insulation materials; exterior doors; and metal roofs
with special pigmented coatings. Exterior windows, including skylights, are
also on the list, but they are subject to a special expense limit. The list
specifically does not include insulated drapes. It also does not include any
improvement that does not meet 2000IEC Code. The IRS is expected to come out
with a more detailed list soon.
Qualifying property must be installed in your
principal residence. Vacation, second homes, rental properties or a foreign
residence do not qualify for any part of this credit. And while most
do-it-yourself installations are allowed, you will need to prove date of
installation and you would not be able to add in the cost of your own
time.
"Green" vehicles. New
tax credits are available for hybrid, fuel cell, advanced lean burn diesel and
other alternative power vehicles, replacing the current deduction for clean
fuel (including hybrid) vehicles. The credits are collectively claimed under
the title of the "Alternative Motor Vehicle Credit." This credit is
equal to the sum of the four separate credit components:
- The new qualified fuel cell motor vehicle credit;
- The new advanced lean burn technology motor vehicle credit;
- The new qualified hybrid motor vehicle credit; and,
- The new qualified alternative fuel motor vehicle credit.
Most individuals will only be able to take advantage
of the qualified hybrid motor vehicle credit since only they are being mass
produced by the major automakers. Unlike the rules for 2005, however, a
qualified hybrid motor vehicle no longer includes many heavy SUVs. Nor will it
include many high-performance hybrids that do not appreciably decrease fuel
consumption from their smaller-engine gasoline counterparts. Also unlike the
2005 hybrid deduction, however, the new credit is available whether you buy or
lease.
The amount of the credit for a hybrid vehicle is based
upon the percentage increase in fuel economy from an all-gasoline model and
varies from $400 to $2,400, based on fuel savings ranging from 125 to 250
percent of a base amount. An additional conservation credit is awarded to
hybrid vehicles with certain lifetime fuel savings ratings, ranging from $250
to $1,000.
There is a limitation on the
number of qualified hybrid motor vehicles and advanced lean burn technology
motor vehicles sold by each manufacturer of these vehicles that are eligible
for the credit.
2005 Tax
Legislation: Energy Act of 2005
Impact on businesses
Deduction for energy-efficient
commercial property.
If
you own commercial building property, Uncle Sam is offering you an energy
deduction for improving your building's energy consumption. The maximum
deduction is $1.80 per square foot of the building. Several criteria must be
met:
- The property for which costs are claimed must be depreciable (or
amortizable) property, installed in a domestic building, and within the
scope of Standard 90.1-2001;
- The property must be installed as part of: the interior lighting
system, the heating, cooling, ventilation and hot water systems, or the
building envelope; and
- The property must be installed based on a plan to reduce total
annual energy and power costs by 50 percent or more when referenced
against a building meeting certain minimum requirements. (The IRS has been
instructed to issue rules to allow a reduced deduction if specific energy
efficiency targets are met but the 50-percent mark is not reached.)
2005 Tax Legislation: Energy Act of 2005
Business solar investment tax
credit. The business investment credit for solar energy
property is increased from 10 percent to 30 percent. The increased credit
applies to (1) equipment which uses solar energy to generate electricity, to
heat or cool (or provide hot water for use in) a structure, or to provide solar
process heat, and (2) equipment which uses solar energy to illuminate the
inside of a structure using fiber-optic distributed sunlight.
Credit for qualified fuel cell
property/stationary microturbines. Energy property includes qualified fuel cell property
and stationary microturbine property for purposes of
the business energy credit. The credit is 30 percent of the basis of qualified
fuel cell property placed in service during the tax year. The energy credit for
any qualified fuel cell property cannot exceed $500 for each 0.5 kilowatt of
capacity.
Homebuilder's credit for new
energy-efficient homes.
An
eligible contractor may claim a tax credit of $1,000 or $2,000 for a qualified
new energy-efficient home that a person acquires from the contractor during
2006 and 2007 for use as a residence during the tax year. An eligible
contractor is a person who constructs a new energy-efficient home or a manufacturer
that produces a qualified new energy-efficient manufactured home. The credit
applies to new homes and those substantially reconstructed. While the
contractor, rather than the homeowner, gets the credit, the purchasers may
benefit from a price reduction since the contractor's net costs are less if the
credit is factored in.
Effective dates
A word about effective dates. The energy tax incentives apply to equipment placed
in service after December 31, 2005 and before January 1, 2008. Some complex issues surround these 2006 and 2007
benefits. Time of installation rather than payment controls.
An installation taking place now might still qualify for the credit if it is
not completed sufficiently to be substantially ready for use until 2006.
2005 Tax Legislation: The Katrina
Emergency Relief Act of 2005
The recently enacted Katrina Emergency Tax
Relief Act of 2005 (KETRA) contains several tax incentives for stepping up
charitable giving. Here's a summary of these provisions.
Increased
charitable deduction limits.
KETRA eases the deduction limits on corporate and individual charitable gifts
in three ways.
First, to encourage cash contributions by
individuals, KETRA exempts cash donations to charities by individuals from the
50-percent-of-income limitation that would otherwise apply. To qualify, the
contributions must be made between Aug. 28, 2005 and Dec. 31, 2005. However, there is no requirement that the donation
be related to Hurricane Katrina.
Second, KETRA exempts cash contributions to
charities by individuals from the phaseout of
itemized deductions. Absent this provision, these contributions could be
subject to the provision which generally reduces a taxpayer's overall itemized
deductions by 3% of the amount of the taxpayer's AGI in excess of a certain
amount (generally $145,950 for 2005). To qualify, the contributions must be
made between Aug. 28, 2005 and Dec. 31, 2005. There is no requirement that the donations be
related to Hurricane Katrina.
Third, to encourage cash donations by corporations,
KETRA exempts cash donations to charities by corporations from the
10-percent-of-taxable-income limitation that would otherwise apply. To qualify,
however, the contributions must be for relief efforts related to Hurricane
Katrina, and corporations must substantiate that contributions are made for
this purpose. The contributions must be made between Aug. 28, 2005 and Dec. 31, 2005.
Temporary
enhanced charitable deduction for contributions of food inventories. Under KETRA, food donations by S corporations,
partnerships and sole proprietors after Aug. 27, 2005 and before Jan. 1, 2006 generally will be subject to the same deduction rules
that apply to food donations by C corporations (the deduction is equal to the
lesser of two times the basis or basis plus one-half of the appreciated value).
Charitable
standard mileage rate for Katrina relief increased to 70% of business mileage
rate. Under KETRA, a
taxpayer who uses a vehicle in providing donated services to a charity for
relief related to Hurricane Katrina during the period of Aug. 25, 2005 to Dec.
31, 2006 can compute his charitable mileage deduction using a standard mileage
rate equal to 70% of the business mileage rate in effect on the date of the
contribution (rounded to the next highest cent), rather than the charitable
standard mileage rate (14˘ per mile). The business standard mileage rate for
expenses incurred during the last four months of 2005 is 48.5˘ per mile. Thus,
from Sept. through Dec. of 2005, the charitable standard mileage rate for Katrina
relief is 34˘ (48.5˘ ×.7 = 33.95˘, rounded to 34˘).