Let's say that you have an investment in a stock with a large capital gain, and that the gain is long-term. The following chart illustrates the differences in stock price that would be required to achieve the same after-tax dollars if burdened by the different tax rates that could apply.

CHANGING TAX RATE

Capital Gains...............Stock................After Rate.................Price................Fed Tax

15%..................70.00................59.50 20%..................74.38................59.50 28%..................82.63................59.50 35%..................91.54................59.50

Consider the historic price range of the stock when contemplating this chart.

As you already know, the tax rate that is applied to an investment goes a long way towards determining the final return on that investment.

Let's put it another way - the cash that you realize from the investment after tax is what is available to you to reinvest in other opportunities, to pay for college costs, to pay for that once-in-a lifetime trip around the world, or to pay for medical care in your old age.

Think about it differently! Many of our clients have told us they have price targets which would cause them to pull the trigger on a sale. The chart illustrates that a change in tax rates can behave as the equivalent of a price decrease. It's the net "after tax" that matters.

If we build our investment portfolio upon certain assumptions, we have to be prepared to adjust our plans when the investment environment changes. As the chart makes clear, the tax rates that may someday soon apply to capital gains could greatly affect each of our personal financial plans.

If you wish to discuss your own personal situation in detail, please feel free to contact our office.

Tax Planning Memo

To:        Clients and Interested Third Parties

From:    Steven W. Pinto, CPA

Date:     November 6, 2006

We are often asked about the tax rules that apply to the deductibility of mortgage interest and interest arising from the use of Home Equity Credit Lines (HECL). The question generally arises when one of our clients is faced with the choice of re-financing their mortgage to take advantage of the appreciated equity in their home.

There are two basic rules that apply to deductible interest:

1. Acquisition indebtedness is the amount of money borrowed when the taxpayer buys, builds, or substantially improves their principal residence. The interest from acquisition indebtedness is deductible on a principal borrowing of up to $1,000,000.

2. The interest on a HECL up to $100,000 of principal borrowed.
The interest that is attributable to borrowings in excess of these two limits is considered non-deductible personal interest.

For example:

John purchased a home for $500,000, using a cash down payment of $100,000 and a first mortgage of $400,000. The $400,000 is considered acquisition indebtedness. The interest on this mortgage is fully deductible.

John later borrows $100,000 on a HECL secured by his home. The interest on the HECL is deductible even if John uses the borrowed money for personal reasons.

After several years, John’s home has appreciated to a fair market value of $750,000. The mortgage company offers to give John a new first mortgage of $600,000. The mortgage will be used to pay off the existing first mortgage of $400,000 (assume no principal amortization), the $100,000 HECL, and $100,000 of capital improvements that John wishes to do to his home.

Under the IRS rules, the interest paid on only $500,000 of the $600,000 borrowing will be deductible. The reason is that the acquisition indebtedness rule would only allow the original mortgage of $400,000 (acquisition indebtedness) plus the amount borrowed for substantial improvements (the $100,000 of capital improvements that John wishes to make).  Because the balance of the new first mortgage exceeds the total of acquisition indebtedness, and is not a qualified home equity credit line, that excess would be treated as non-deductible personal interest.

However, if John only borrowed $500,000 on the refinancing and kept his HECL in place, all of the interest would be considered qualified residence interest and deemed deductible.

Beyond the basic rules that I have outlined here, many of our clients have personal borrowings related to their investment portfolios (margin, hypo).

The interest expenses related to these borrowings are subject to the separate limitations under the Investment Interest Expense rules. Essentially, Investment Interest Expense is deductible to the extent that the taxpayer has qualified investment income (taxable interest income, dividends, and certain capital gains). Furthermore, the proceeds of the borrowing must be traceable to the actual purchase of qualified investments. The rules covering Investment Interest Expense are complex and should be reviewed with your tax advisor to determine if you will be able to claim the expense as a current deduction.

A special mention to those that have tax free investments – please discuss your total portfolio with your tax advisor. Under certain circumstances, otherwise deductible investment interest can be allocated to the tax free portion of your portfolio and therefore, deemed non-deductible.

Let me conclude by stating that we often encounter clients that have an incomplete picture of these rules. It is troubling to us as tax advisors to have the unpleasant task of taking away a deduction that the client was counting on. On the other hand, if we blindly prepare the client’s tax return, and take a deduction that may be disallowed upon tax examination, the client hasn’t been properly served.

If you wish to discuss the application of these rules to your own tax situation, please contact us.

Depending on what you read, state-run Section 529 college savings plans are either the best thing since sliced bread or a trap for the unwary. Coverdells (formerly Education IRAs) are either better than ever or not ready for prime time. UTMAs (Uniform Transfers to Minors Act), UGMAs (Uniform Gifts to Minors Act) and other custodial accounts are hopelessly outdated or hopelessly underutilized.See the numbers that lenders see. Get a free credit report.

The reality is that no one college savings method works well for every family. The right way for you, personally, to save for college depends on several factors, including:

Your tax bracket Your child’s age How much control you want over your investments How much financial aid you expect to get Many people don’t realize that financial aid is based largely on income -- primarily that of the parent, but also that of the student. (Assets matter, too: The typical college will want the student to spend 35% of his savings on college costs, while the parent is expected to pony up 5% of certain assets each year.)

So the best way to figure out how to save for college is to use your income, and your tax rate, as a guide. Before we get into a bracket-by-bracket rundown, though, there are a few caveats you should understand:

Caveat #1: The following breakdowns assume that your child is relatively young. If you’ve got five years or fewer until your first tuition bill comes due, you may want to skip the tax-deferred options, said Kathy Kristof, author of “Taming the Tuition Tiger: Getting the Money to Graduate.”

That’s because you really don’t have enough time to earn much in the way of investment returns, so tax breaks on earnings are of little benefit. Saving in taxable accounts will give you more freedom, since you won’t have to deal with the restrictions that come with tax-deferred accounts. For more information, read on.

Caveat #2: Loans, not grants or scholarships, make up about 60% of financial aid packages. So even if your savings do reduce your ability to get financial aid for your child later, don’t sweat it overly: You’re simply sparing him or her future debt.

Caveat #3: These strategies assume the tax laws will remain pretty much the same until your kids are grown. That’s a pretty big if. Should Congress make major changes, you’ll need to revisit your strategies.

The lowest brackets This includes folks in the 10% and 15% brackets, which currently means taxable incomes below: $28,400 for single filers $38,050 for heads of household $56,800 for married filing jointly If you’re in the lowest brackets, you don’t benefit all that much from tax-deferred accounts because you don’t pay that much income tax to start with. You also probably won’t be able to save the huge amounts that might make tax deferral a better deal.

But you do have the best shot at getting significant financial aid. So your guiding principal should be to save in ways that don’t mess with your child’s ability to earn scholarships and grants later. Here are some dos and don’ts for your tax bracket:

Don’t invest in Coverdells or custodials. Coverdells used to be known as Education IRAs, while custodial accounts include UTMAs (Uniform Transfers to Minors Act) or UGMAs (Uniform Gifts to Minors Act). Colleges consider these accounts to be the students’ assets, which will count heavily against them when financial aid packages are calculated.

Think twice about 529 plans. These state-run, tax-deferred plans are a pretty great deal for higher-income parents, but they have a significant disadvantage: You can’t claim the valuable Hope or Lifetime credit for school expenses you pay with 529 plan funds. (These credits aren’t available to singles and heads of household with AGIs over $51,000 or marrieds with AGIs over $102,000.)

There’s also a lot of uncertainty about how these relatively new plans will impact financial aid, said 529 guru Joseph Hurley, a CPA who runs the Savingforcollege.com Web site (see link at left). Most colleges treat the money in 529 plans as the parents’ asset, which is good, but some count distributions from the plans as the student’s income -- which is bad, since each $1 of student income can reduce the next year’s financial aid package by up to 50 cents.

Finally, if you don’t end up spending the money on qualified college expenses, you’ll face taxes and penalties.

Keep your savings in your own name. Parental assets count less heavily in financial aid calculations. Today’s lower tax rates on capital gains and dividends means you could pay as little as 5% on your savings. Plus, you have the flexibility to use the money any way you want.

Consider beefing up your home equity or retirement savings. Most colleges don’t count these assets at all. If your child makes it into an elite private school that does, you’ll still be expected to spend only a small portion of these savings on his education.

What if you already started saving in Coverdells or custodials? All is not lost. If you spend down your Coverdell or custodial account money before your child is a junior in high school, the money won’t count against her. (Coverdell money can be used for elementary, middle or high school education expenses or tutoring, while custodial account money can be spent on anything that benefits your child, from camp to a computer to a car.)

Only do this, though, if you would have incurred these expenses anyway and can put an amount equal to what you’ve spent into savings in your own name. As Kristof notes, you don’t want to throw away $1 in savings just because you might lose 35 cents in future financial aid.

You shouldn’t pull the plug on existing 529 savings. If your education expenses exceed your 529 savings, you may be able to use the tax credits for the expenses the 529 money doesn’t cover. But you’ll probably want to consider other savings strategies as well, including the home equity and retirement savings route.

Massed in the middle Folks in the 25% bracket include those with taxable incomes below: $68,800 for single filers $98,250 for heads of household $114,650 for marrieds filing jointly You’ve still got a shot at financial aid, but your higher income means you’ll be expected to chip in more of your own money. You also get more benefit from tax-deferred accounts than lower earners. That means it makes more sense for you to take advantage of tax-advantaged options, despite their restrictions on how and when you can spend the money.

Strategies for your bracket include:

Avoid custodial accounts such as UTMAs and UGMAs, which count heavily against your child in financial aid calculations.

Invest in a Coverdell only if you plan to use the money for private-school education or tutoring before college age.

Weigh the risks of 529 plans. As noted above, 529s can limit your ability to take valuable education credits and may be a factor in reducing financial aid awards. On the other hand, the money’s tax-free when used for education and your state may allow you to deduct your contributions. The tax breaks will outweigh the risks for many people in your bracket, particularly if you expect your income to continue growing.

Beef up savings in your own name as well as your home equity and retirement accounts, for the reasons noted above.

Consider savings bonds. If you don’t like risk, savings bonds offer a safe (if low return) way to save, plus a potential tax break: the interest on savings bonds is tax free under certain circumstances. (The owner of the bond can’t be the child, for example, and the money must be used for tuition or fees.) The ability to take advantage of this break disappears when single incomes exceed $72,600 and married incomes exceed $116,400. For more details, visit the U.S. Treasury’s Web site (see link at left).

Movin’ on up You’re in the 28% bracket when your taxable income is up to: $143,500 for single filers

$159,100 for heads of household

$174,700 for marrieds filing jointly It’s not impossible for you to get financial aid. After all, anyone can get loans, and your child may score some merit (rather than need-based) scholarships. If you’ve got more than one child at pricey schools, you also could get some help. Just don’t count on getting much.

Good strategies for you include:

Invest in Coverdells, particularly if you’ll have private school expenses before college. The ability to contribute ends for singles with AGIs over $110,000 and marrieds with AGIs over $220,000.

Definitely check out 529s. There are no income limitations to contribute, and you’ll reap significant tax advantages. You also can customize your investments as never before. Several states, including Nevada, Utah and Nebraska, give contributors a wide variety of funds and investment options from which to choose.

Choose tax-wise strategies if you save in your own name. You’ll pay 15% on dividends and long-term capital gains, but 28% on interest and short-term gains. Limiting your trading and investing to low-turnover mutual funds can help cut your tax bill, while tax-free municipal bonds might be an appropriate choice for the fixed-income portion of your savings.

Keep saving for your own retirement, and build up home equity.

Top of the heap You’re in the 33% bracket if your AGI, married, single or otherwise, is up to $311,950. Above that, you’re in the 35% camp.

Strategies for people in your stratosphere include:

Invest in 529s. Besides the tax breaks, these college savings plans offer a big estate-planning advantage. Money contributed to a 529 plan is considered a completed gift, which means you don’t have to worry about paying estate taxes on your account should you die. But you retain control over who gets the money and can change beneficiaries any time you want. In addition, you can make a one-time contribution of up to $55,000 and not have to worry about gift taxes (as long as you make no other gifts to that beneficiary for five years). There are no income restrictions for contributors, and many plans allow you to contribute a total of over $200,000.

Consider UTMAs and UGMAs if 529s don’t do it for you. If you want even more choice over your investments, old-fashioned custodial accounts give you more control. You can invest in individual stocks and bonds, making all the buy-and-sell decisions yourself. Gains are taxed at your child’s presumably lower rate. The big disadvantage: you lose control over the money when your child reaches a certain age, typically 18 or 21, depending on the state.

Liz Pulliam Weston's column appears every Monday and Thursday, exclusively on MSN Money. She also answers reader questions in the Your Money message board.

College savers now can choose from more than 120 of these state-run plans, with more popping up all the time. You can invest in any state’s plan, no matter where you live. Regardless of what plan you choose, your beneficiary can attend any college or university in the country. And earnings in all of them grow tax-free. But there the similarities end. Each plan comes with investment options, cost structures, management teams and contribution rules of its own.

A review of these plans shows there’s not a single standout -- one plan that would best suit the needs of every investor. Which plan would work best for you depends on where you live, the type of investor you are and how many investment choices you need.

Some plans, for example, offer just a handful of investment options, while others present you with dozens of potential portfolios. A few plans are available only to brokers and financial planners, although most can be purchased directly by the public. And costs can range all over the map, from less than 0.25% of your portfolio to more than 2%.See the numbers that lenders see. Get a free credit report.

Then there are tax issues to consider. More than half of the states now use either a carrot or a stick in an effort to keep their residents from using other states’ plans:

The carrot. Twenty-four states and the District of Columbia give their residents some kind of tax break for contributions. (Those states are Colorado, Georgia, Idaho, Illinois, Iowa, Kansas, Louisiana, Maryland, Michigan, Mississippi, Missouri, Montana, Nebraska, New Mexico, New York, Ohio, Oklahoma, Oregon, Rhode Island, South Carolina, Utah, Virginia, West Virginia and Wisconsin. Vermont will offer a deduction beginning in 2004.) A few others, including Maine, Minnesota and Pennsylvania, offer some kind of matching grant for contributions.

The stick. Four states -- Illinois, Tennessee, Mississippi and Pennsylvania -- tax investment gains when their residents invest in other states’ plans. Another, New York, taxes rollovers when a resident moves money from the New York plan to another state’s plan.

If you live in one of the states that punish investments in out-of-state plans, you should probably think twice about investing elsewhere. These states offer decent, low-cost plans, so it’s not as if you’ll suffer unduly for staying at home.

You shouldn’t necessarily let a tax deduction keep you from roaming, however. Deductions offer a kind of guaranteed return in the year you make contributions, said 529 expert Joseph Hurley. But your money probably will be invested for a decade or more -- plenty of time for high fees or poor investment performance to outweigh that one-time break, said Hurley, author of “The Best Way to Save for College: A Complete Guide to 529 Plans.”

“If you are getting a deduction but paying the benefit back in terms of higher fees and expenses,” said Hurley, who also runs the Savingforcollege.com Web site, “you may end up behind, not ahead.”

Other factors you should consider:

A wide variety of options If you’re a conservative investor who wants someone else to make your investing decisions, you don’t need a lot of investment options. You choose an age-related option, which ratchets down your account’s exposure to stocks as the child gets closer to college.

If you’re an aggressive investor who likes to be in the driver’s seat, though, you’re going to want a plan with a wide variety of investment options.

Virginia’s flexible CollegeAmerica plan, for example, was far and away the top pick of financial planners polled by Bob Veres, editor of Inside Information newsletter, which caters to advisers.

The planners liked the fact they could craft portfolios from 21 different American Funds, which tend to have low expenses and good returns. The planners weren’t as keen on plans run by TIAA-CREF which, despite low fees and decent returns, tend to have fewer options from which to choose. Some even called TIAA-CREF’s approach “paternalistic,” Veres said.

The bad news is that CollegeAmerica is only available to planners and brokers. (That means you may pay a sales load if your adviser works on a commission basis. American Funds has created a no-load class of shares for fee-only planners.)

The five plans below, however, are available directly to the public.

Performance is hard to gauge You can review recent performance data, as well as other details about each plan, at Hurley’s Web site. (See link at left under Related Sites.) Using raw returns, however, is probably the least effective way of picking a 529 plan.

Most states’ plans are less than five years old -- meaning a bear market chewed on stock market returns for most of their short lives. If you base your decision on performance alone, you may opt for the most conservative funds, which could leave you far behind the pack for the long run.

Look for plans that offer a mix of stocks, bonds and cash, with the allocation becoming more conservative as the child nears college age. This middle-of-the-road investment philosophy increases the odds you’ll have the money when you need it, but it won’t generate headline-making returns.

I looked for plans that offered index funds, so investors could at least be confident of matching the market. The following plans combine low expenses, index funds and flexibility, with a number of investment options. In alphabetical order, they are:

Iowa College Savings. This plan uses Vanguard Funds to keep expenses down to an admirable 0.65% annually. Investors have a choice of four age-related options keyed to different risk tolerances. In-state residents get a tax deduction of up to $2,230 per beneficiary in 2003.

Michigan Education Savings Program. TIAA-CREF runs this plan on a tight budget; as with Iowa, the expense ratio is 0.65% annually. In addition to an age-related option, the plan offers a 100% equity option and a fixed-rate option that guarantees principal plus a minimum 3% annual gain.

In addition, state residents get some nice benefits, including hefty deductions (up to $5,000 for single filers per year and $10,000 for joint filers) and matching grants of up to $200 for contributors with incomes under $80,000.

Minnesota College Savings Plan. Think Michigan, the sequel. Minnesota’s plan is also run by TIAA-CREF with a 0.65% annual expense ratio, a 100% equity option and a guaranteed option. What Minnesota doesn’t offer is a tax break, although qualifying families can apply for a $300 matching contribution.

Nevada Upromise College Fund. Nevada has no fewer than seven college savings plans, each run by different investment companies, including American Skandia, Strong Capital Management, Vanguard Group and USAA. The plan that’s getting the most favorable attention, though, is the one operated by Upromise Investments, using Vanguard and Strong funds.

The planners Veres polled liked this program for its versatility: three age-related options geared to risk tolerance, plus 14 custom portfolios with a mix of asset allocations. The Vanguard funds have a 0.65% annual expense ratio, while the Strong funds range from 1% to 1.59%.

Utah Education Savings Plan Trust. Here’s another plan favored by Veres’ financial planners for its flexibility. Utah offers five age-related investment options for different risk tolerances, plus four other investment options that include a money-market choice, a 100% bond fund and two all-stock funds. All use Vanguard funds.

Those frugal Utahans keep the fees low, too. Accounts over $5,000 pay $25 annually plus 0.25% of their portfolios in management fees, in addition to underlying investment fees that range from 0.0275% for the equity index fund to 0.65% for the international funds. State residents may deduct contributions up to $1,435 per beneficiary in 2003.

Liz Pulliam Weston's column appears every Monday and Thursday, exclusively on MSN Money. She also answers reader questions in the Your Money message board.

The New York Department of Taxation and Finance has issued a memorandum regarding the New York sales and use tax exemption for clothing, footwear, and items used to make or repair exempt clothing or footwear, costing less than $110 per item (this memorandum supercedes TSB-M-01(02)S, February 12, 2001, regarding the same exemption). Beginning June 1, 2003, and ending May 31, 2004, vendors must collect and remit the total New York state and local sales and use taxes (including the 0.25% tax imposed by the state in the Metropolitan Commuter Transportation District (MCTD)) on sales of clothing, footwear, and items used to make or repair such clothing or footwear, regardless of price.

However, two seven-day exemption periods have also been enacted. The first seven-day exemption period begins August 26, 2003, and ends September 1, 2003. The second seven-day exemption period begins on January 26, 2004, and ends February 1, 2004. The Department announced that detailed information about these exemption periods will be provided in a future memorandum.

Special Transitional Rules

Orders for clothing and footwear: Merchandise that is ordered by mail or telephone, or by using the Internet or e-mail, is taxed at the rate in effect on the date the order is accepted by the vendor regardless of when the order will be delivered. If the order is accepted on or after June 1, 2003, but before June 1, 2004, the sale is subject to the total New York state, MCTD, and local sales tax in effect on that date.

Rain checks: The sales and use tax exemption in place prior to June 1, 2003, will not apply to purchases made on or after June 1, 2003, but before June 1, 2004, even though the purchaser uses a rain check that was issued prior to June 1, 2003.

Layaway sales: If a vendor and a customer enter into a contract for a layaway sale prior to June 1, 2003, the exemption will apply as long as the customer makes a deposit of at least 10% of the order price and the merchandise is segregated from other inventory.

Exchanges: Where a customer makes a purchase prior to June 1, 2003, and later returns the merchandise for an exchange on or after June 1, 2003, but before June 1, 2004, the vendor need not charge sales tax on the exchanged item as long as it is similar to the item returned. Where a customer returns an item and receives a credit to purchase a different item in the future, or is allowed to purchase a different item at the time of the return, the appropriate sales tax will apply to the sale of the new item.

TSB-M-03(2)S, Technical Services Bureau, Taxpayer Services Division,New York Department of Taxation and Finance, May 22, 2003,

The IRS has released much-anticipated temporary and proposed regulations on the capitalization of costs incurred for tangible property. They impact how virtually any business writes off costs that repair, maintain, improve or replace any tangible property used in the business, from office furniture to roof repairs to photocopy maintenance and everything in between. They apply immediately, to tax years beginning on or after January 1, 2012.

These so-called “repair regulations” are broad and comprehensive. They apply not only to repairs, but to the capitalization of amounts paid to acquire, produce or improve tangible property. They are intended to clarify and expand existing regulations, set out some bright-line tests, and provide some safe harbors for deducting payments.

The regulations are an ambitious effort to address capitalization of specific expenses associated with tangible property. The regulations affect manufacturers, wholesalers, distributors, and retailers—everyone who uses tangible property, whether the property is owned or leased. The rules provide a more defined framework for determining capital expenditures.

Most taxpayers will have to make changes to their method of accounting to comply with the temporary regulations and will need to file Form 3115. Taxpayers who filed for a change of accounting method following the issuance of the 2008 proposed regulations will probably have to change their accounting method again.

The IRS has promised to issue two revenue procedures that will provide transition rules for taxpayers changing their method of accounting, including the granting of automatic consent to make the change. The regulations require taxpayers to make a Code Sec. 481(a) adjustment; this means that taxpayers will have to apply the regulations to costs incurred both prior to and after the effective date of the regulations.

The new regulations provide rules for materials and supplies that can be deducted, rather than capitalized. The rules provide several methods of accounting for rotable and temporary spare parts, and allow taxpayers to apply a de minimis rule so that they can deduct materials and supplies when they are purchased, not when they are consumed.

Costs to acquire, produce or improve tangible property must be capitalized. The regulations address moving and reinstallation costs, work performed prior to placing property into service, and transaction costs. Generally, costs of simply removing property can be deducted, but costs of moving and then reinstalling property may have to be capitalized.

To determine whether a cost incurred for property is an improvement, it is necessary to determine the unit of property. Generally, the larger the unit of property, the easier it is to deduct expenses, rather than have to capitalize them. The regulations provide detailed rules for determining the unit of property for buildings and for non-building tangible property. For buildings, the IRS identified eight component systems as separate units of property, requiring more costs to be capitalized. However, the new rules also provide for deducting the costs of property taken out of service, by treating the retirement as a disposition.

The new regulations require virtually every business to review how repairs, maintenance, improvements and replacements are handled for tax purposes, with both mandatory and optional adjustments made to past treatment as appropriate.

Please feel free to call this office for a more targeted explanation of how these new regulations impact your business operations.

The fate of the employee-side payroll tax cut along with a host of tax extenders and other expired provisions could be decided in coming weeks. A conference committee of House and Senate members is negotiating a full-year extension of the payroll tax cut and could add some or all of the tax extenders to a final package. Lawmakers also could extend the payroll tax cut without acting on any tax incentives.

Payroll tax cut

The Temporary Payroll Tax Cut Continuation Act of 2011 extended the employee-side OASDI tax cut through the end of February 2012. The employee-share of OASDI taxes is 4.2 percent for the two-month period, rather than 6.2 percent. The employer-share of OASDI taxes remains at 6.2 percent for the two month period. Self-employed individuals also benefit from a two percentage point reduction in OASDI taxes.

Unless extended, the employee-share of OASDI taxes is scheduled to revert to 6.2 percent after February 29, 2012. The White House and the leaders of the two parties in Congress agree that the payroll tax cut should be extended a full-year. They disagree, however, how to pay for the extension; even if it should be paid for at all.

Congress could extend the two-month payroll tax cut through the end of 2012 without paying for it. The 2011 payroll tax cut was unfunded. Congress appropriated to the Social Security trust funds amounts equal to the reduction in payroll tax revenues. The 2011 payroll tax cut was estimated by the Congressional Budget Office cost approximately $111 billion. Extending it through the end of 2012 is estimated to cost just as much if not more.

House Republicans reportedly have proposed a number of revenue raisers to offset the cost of extending the payroll tax cut through the end of 2012. One GOP proposal would extend the current pay freeze for employees of the federal government. Another GOP proposal would require higher-income individuals to pay increased Medicare premiums.

One possible revenue raiser, increasingly under discussion by Democrats, is a change in the taxation of so-called carried interest. Current law generally taxes carried interest as capital gains and not as ordinary income. Past efforts to change the tax treatment of carried interest have failed to pass Congress.

Extenders

The so-called tax extenders, popular but temporary tax provisions, expired at the end of 2011. Many taxpayers are surprised to learn that their particular tax break, whether it be the state or local sales tax deduction, the teachers’ classroom expense deduction, or the research tax credit, are temporary. The extenders have been routinely revived many times in the past. This year, however, could be different. Faced with record federal budget deficits, lawmakers may decide to extend only some of the expired provisions.

President Obama’s FY 2013 proposals

President Obama is expected to release his fiscal year (FY) 2013 federal budget proposals in early February, which will reignite debate over the Bush-era tax cuts. President Obama is expected to urge Congress to allow the Bush-era tax cuts to expire after 2012 for higher-income taxpayers, which President Obama defines as individuals earning more than $200,000 or families earning more than $250,000. In recent weeks, there has been speculation that President Obama may revisit those definitions in his FY 2013 budget, possibly raising the amounts.

Few Capitol Hill observers expect Congress to take any action on the Bush-era tax cuts before the November elections. Instead, Congress may take up some of President Obama’s other proposals. As in past budgets, President Obama will likely propose to extend some energy tax breaks for individuals and businesses, extend tax incentives for education and provide some targeted-tax breaks to businesses. President Obama has also promised to introduce proposals to encourage U.S. companies to “insource” jobs at home.

On some issues, such as energy and education, lawmakers may find common ground but negotiations are likely to go down to the wire. Our office will keep you posted of developments.

If you have any questions about the payroll tax cut, tax extenders or the various tax proposals under discussion, please contact our office.

The IRS reopened its offshore voluntary disclosure program in early 2012 in response to what the government described as strong interest among taxpayers. The reopened program, the third of its type in recent years, encourages taxpayers with unreported foreign accounts to make full disclosures in exchange for a reduced penalty framework. Like its predecessors, the terms and conditions of the reopened program are very complex. The IRS has promised to provide more details. In the meantime, the prior offshore disclosure programs are guides to how the IRS intends to implement the third, reopened program.

Previous disclosure programs

The IRS launched two previous offshore disclosure initiatives: one in 2009 and another in 2011. Both programs offered reduced penalties in exchange for full disclosure. In early 2012, the IRS reported it received 33,000 voluntary disclosures from the 2009 and 2011 offshore initiatives. The government has collected over $4.4 billion from the 2009 and 2011 programs. The IRS predicted it will collect more revenue as it continues to work cases.

Reopened program

The reopened program operates very similarly to the 2009 and 2011 programs but with some key differences. The previous programs were temporary. The 2011 program ended in mid-September 2011. The reopened program has no set end date. The IRS cautioned, however, that it could close the program at some future date. The decision to end the program is solely at the discretion of the IRS.

The reopened program requires taxpayers to file all original and amended tax returns and include payment for back-taxes and interest for up to eight years as well as pay accuracy-related and/or delinquency penalties. Additionally, taxpayers must pay a penalty of 27.5 percent of the highest aggregate balance in foreign bank accounts/entities or value of foreign assets during the eight full tax years prior to the disclosure. In comparison, the highest penalty in the 2011 program was 25 percent. IRS officials have said that the penalty was increased because the agency does not want to reward taxpayers who did not participate in the 2009 or 2011 disclosure programs because they anticipated that a future penalty would be lower.

In limited circumstances, taxpayers may qualify for a 12.5 percent penalty or a five percent penalty. Generally, taxpayers whose offshore accounts or assets did not surpass $75,000 in any calendar year may qualify for the 12.5 percent penalty.

The requirements for the five percent penalty are very narrow. The IRS has explained that taxpayers must meet four conditions: (1) The taxpayer did not open or cause the account to be opened; (2) the taxpayer exercised minimal, infrequent contact with the account, for example, to request the account balance, or update account holder information such as a change in address, contact person, or email address; (3) except for a withdrawal closing the account and transferring the funds to an account in the United States, the taxpayer did not withdraw more than $1,000 from the account in any year for which the taxpayer was non-compliant; and (4) the taxpayer can show that all applicable U.S. taxes have been paid on funds deposited to the account (only account earnings have escaped U.S. taxation).

The penalty amounts in the reopened program are not set in stone, the IRS cautioned. It may eventually increase penalties in the program for all or some taxpayers or defined classes of taxpayers.

Quiet disclosures

One goal of the three programs is to caution taxpayers against so-called “quiet disclosures.” A quiet disclosure occurs when a taxpayer files an amended return and pays any tax delinquency without making a formal voluntary disclosure. The IRS warned taxpayers making quiet disclosures that they risked being sanctioned to the fullest extent allowed by law.

Critics

The offshore disclosure programs were not without their critics. The National Taxpayer Advocate recently told Congress that the IRS should streamline what is a very complicated process. The National Taxpayer Advocate also reported that IRS examiners were assuming that all violations were willful unless a taxpayer presented evidence to the contrary. It is possible that the IRS may revisit some of the terms and conditions of the reopened program in light of the National Taxpayer Advocate’s report.

If you have any questions about the reopened offshore voluntary disclosure program, please contact our office.

Taxpayers with children should be aware of the numerous tax breaks for which they may qualify. Among them are: the dependency exemption, child tax credit, child care credit, and adoption credit. As they get older, education tax credits for higher education may be available; as is a new tax code requirement for employer-sponsored health care to cover young adults up to age 26. Employers of parents with young children may also qualify for the child care assistance credit.

Dependency Exemption

In addition to the personal exemption an individual taxpayer may take for him or herself to reduce taxable income (Line 42 on Form 1040), that taxpayer may also take an exemption for each qualifying dependent who has lived with the taxpayer for more than half of the tax year. A dependent may be a natural child, step-child, step-sibling, half-sibling, adopted child, eligible foster child, or grandchild, and generally must be under age 19, a full-time student under age 24, or have special needs. The amount of the exemption is the same as the taxpayer’s personal exemption, $3,700 for the 2011 tax year and $3,800 for the 2012 tax year.

Child Tax Credit

Parents of children who are under age 17 at the end of the tax year may qualify for a refundable $1,000 tax credit. The credit is a dollar-for-dollar reduction of tax liability, and may be listed on Line 51 of Form 1040. For every $1,000 of adjusted gross income above the threshold limit ($110,000 for married joint filers; $75,000 for single filers), the amount of the credit decreases by $50.

Child and Dependent Care Credit

If a taxpayer must pay for childcare for a child under age 13 in order to pursue or maintain gainful employment, he or she may claim up to $3,000 of his or her eligible expenses for dependent care. If one parent stays home full-time, however, no child care costs are eligible for the credit.

Adoption Credit

Taxpayers who have incurred qualified adoption expenses in 2011 may claim either a $13,360 credit against tax owed or a $13,360 income exclusion if the taxpayer has received payments or reimbursements from his or her employer for adoption expenses. For 2012, the amount of the credit will decrease to $12,650, and in 2013 to $5,000.

Higher Education Credits

There are two education-related credits available for 2012: the American Opportunity credit and the lifetime learning credit. The American Opportunity credit amount is the sum of 100 percent of the first $2,000 of qualified tuition and related expenses plus 25 percent of the next $2,000 of qualified tuition and related expenses, for a total maximum credit of $2,500 per eligible student per year. The credit is available for the first four years of a student's post-secondary education. The credit amount phases out ratably for taxpayers with modified AGI between $80,000 and $90,000 ($160,000 and $180,000 for joint filers). The lifetime learning credit is equal to 20 percent of the amount of qualified tuition expenses paid on the first $10,000 of tuition per family. The phaseout for 2012 ranges from $52,000 to $62,000 ($104,000 to $124,000 for joint filers). Parents also find tax relief in saving for college though Coverdell accounts, section 529 plans and specified U.S.. savings bonds.

Extended Health Care Coverage

Effective since September 23, 2010, the new health care law requires plans to provide coverage for children until they attain age 26. Further, effective on or after March 30, 2010, children under the age of 27 are considered dependents of a taxpayer for purposes of the general exclusion from income for reimbursements for medical care expenses of an employee, spouse, and dependents under an employer-provided accident or health plan. Therefore, a plan must provide coverage to a child who is still a dependent up to age 26; but can do so up to age 27 without income tax consequences. A child includes a son, daughter, stepson, or stepdaughter of the taxpayer; a foster child placed with the taxpayer by an authorized placement agency or by judgment, decree, or other order of any court of competent jurisdiction; and a legally adopted child of the taxpayer or a child who has been lawfully placed with the taxpayer for legal adoption.

Child Care Assistance Credit (for businesses)

Employers may take up to $150,000 of the eligible costs of providing employees with child care assistance as tax credit. These costs may include a portion of the costs of acquiring, constructing, improving, and operating a child care facility.

If you have any questions about these provisions and how they may benefit you, please contact our office.

The Treasury Department is authorized to offset a taxpayer’s tax refund to satisfy certain debts. A spouse who believes that his or her portion of the refund should not be used to offset the debt that the other spouse owes may request a refund from the IRS.

Offset

If an individual owes money to the federal government because of a delinquent debt, the Treasury Department’s Financial Management Service (FMS) can offset that individual's tax refund (and certain other federal payments) to satisfy the debt. The debtor will be notified in advance of the offset.

A taxpayer’s refund may be reduced by FMS and offset to pay:

• Past-due child support
• Federal agency non-tax debts
• State income tax obligations, or
• Certain unemployment compensation debts owed a state.

FMS advises taxpayers by written notice of an offset. FMS has explained that the notice will reflect the original refund amount, the taxpayer’s offset amount, the agency receiving the payment, and the address and telephone number of the agency. FMS will notify the IRS of the amount taken from your refund.

Form 8379

If a taxpayer filed a joint return and is not responsible for the debt of his or her spouse, the taxpayer may request his or her portion of the refund by filing Form 8379, Injured Spouse Allocation, with the IRS. Form 8379 may be filed with the original return or by itself after the taxpayer is aware of the offset.

The IRS has instructed taxpayers filing Form 8379 by itself to attach a copy of all Forms W-2 and W-2G for both spouses, and any Forms 1099 showing federal income tax withholding to Form 8379. Failure to attach these items may result in a delay in processing by the IRS.

The IRS has reported on its website that it generally processes Forms 8379 that are filed after a joint return has been filed in approximately eight weeks. The timeframe for processing a Form 8379 that is attached to a joint return is approximately 11 weeks (14 weeks if the joint return is filed on paper).

As an individual or business, it is your responsibility to be aware of and to meet your tax filing/reporting deadlines. This calendar summarizes important tax reporting and filing data for individuals, businesses and other taxpayers for the month of February 2012.

February 1

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates January 25–27.

February 3

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates January 28–31.

February 8

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 1–3.

February 10

Employees who work for tips. Employees who received $20 or more in tips during November must report them to their employer using Form 4070.

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 4–7.

February 15

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 8–10.

Monthly depositors. Monthly depositors must deposit employment taxes for payments in January.

February 17

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 11–14.

February 23

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 15–17.

February 24

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 18–21.

February 29

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 22–24.

March 2

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 25–28.

March 7

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 29–March 2.

The IRS is moving quickly to issue guidance on the many tax incentives for individuals and businesses in the American Recovery and Reinvestment Act of 2009 (2009 Recovery Act). Since Congress passed the multi-billion dollar stimulus package in February, the IRS has released guidance on the extended net operating loss (NOL) carryback for small businesses, the new Making Work Pay credit, the enhanced first-time homebuyer tax credit, the new COBRA subsidy, and the new sales tax deduction for motor vehicles.

Net operating losses

One of the most valuable tax breaks in the 2009 Recovery Act is the extended NOL carryback. Small businesses with an NOL in 2008 can offset this loss against income earned in up to five prior years. This special treatment will accelerate refunds and generate an immediate infusion of cash into a struggling business. The IRS expects record numbers of small businesses to be eligible for the carryback and has promised to expedite refunds.

To qualify for the new five-year carryback provision, a small business must have no greater than an average of $15 million in gross receipts over a three-year period ending with the tax year of the NOL. Businesses with more than $15 million in gross receipts can carry back their 2008 NOL for two years.

Generally small businesses that are not corporations (including sole proprietorships filing schedule C with their Form 1040) may accelerate a refund by using Form 1045, Application for Tentative Refund. Corporations with NOLs may accelerate a refund by using Form 1139, Corporation Application for Tentative Refund.

If your small business is in a loss position this year, the extended NOL carryback should not be overlooked. The requirements for the extended carryback are complex. Our office can help you elect this special treatment and maximize your refund.

Making Work Pay credit

Many employers have already implemented the new Making Work Pay credit. The credit reaches $400 for single individuals and $800 for married couples filing jointly. Like other incentives, the Making Work Pay credit phases out for higher income taxpayers (single individuals with modified AGI above $75,000 and married couples filing jointly with modified AGI above $150,000).

Taxpayers do not have to submit a new Form W-4 to their employers; the credit is automatic. However, an employee with multiple jobs or married couples whose combined incomes place them in a higher tax bracket may want to submit a revised W-4 to ensure sufficient withholding. Our office can determine if you need to adjust your withholding.

First-time homebuyer credit

The 2009 Recovery Act raised the maximum first-time homebuyer credit from $7,500 to $8,000 ($4,000 for married couples filing separately) for qualified homes purchased before December 1, 2009. Congress also removed the repayment requirement for homes purchased in 2009. Like other tax incentives, the first-time homebuyer credit has income restrictions. The credit begins to phase out for single individuals with modified AGI above $75,000 ($150,000 for married couples filing jointly).

The IRS recently announced that taxpayers can claim the $8,000 credit on their 2008 tax returns due April 15, 2009 or on their 2009 tax returns next year. Consequently, taxpayers have several filing options.

Taxpayers purchasing a home in the near future and who have already filed their 2008 returns may want to file an amended return. This will allow them to claim the credit almost immediately. However, some individuals may want to wait and take the credit in 2009.

Taxpayers purchasing a home who have not yet filed their 2008 returns may want to request a six-month extension (until October 15, 2009). Alternatively, they can file as planned and then file an amended return to take the credit.

If you are a first-time homebuyer in 2009, don't miss out on this valuable credit. Our office can recommend the best time to take the credit.

Economic recovery payment

Social Security recipients, disabled veterans and retired government employees may be eligible for one-time economic recovery payments of $250. These payments are in lieu of the Making Work Pay credit. However, the economic recovery payment will be a reduction to any Making Work Pay credit for which the recipient qualifies.

The IRS will not be distributing the economic recovery payments. Individuals will receive them from the Social Security Administration, Department of Veterans Affairs, or other agency. The SSA expects to start making the payments in May.

COBRA subsidy

Individuals who are involuntarily terminated from employment between September 1, 2008 and December 31, 2009 may qualify for a 65 percent COBRA premium subsidy for up to nine months. Family members may also be eligible for the subsidy. Eligible individuals will pay 35 percent of the COBRA premium and employers will pay the remaining 65 percent. The COBRA subsidy, however, phases out for individuals whose modified AGI exceeds $125,000 ($250,000 for married couples filing jointly). Individuals with modified AGI exceeding $145,000 ($290,000 for married couples filing jointly) do not qualify for the subsidy.

Employers will recover their share through a payroll tax credit. The IRS has instructed employers to use Form 941, Employer's Quarterly Federal Tax Return, to report their COBRA premium assistance payments. In some cases, such as multi-employer plans, the plan provides the subsidy and will be reimbursed by taking a credit on Form 941.

Sales tax deduction for vehicle purchases

Congress created a temporary deduction in the 2009 Recovery Act for state and local sales and excise taxes paid on the purchase of new motor vehicles. Cars, light trucks, motor homes, and motorcycles are eligible for the deduction. The deduction is limited to the tax on up to $49,500 of the purchase price of an eligible motor vehicle. Because this is an above-the-line deduction, taxpayers who do not itemize their deductions can also take advantage of it.

Similar to other incentives, there are income limitations. The deduction phase out for single individuals with modified AGI between $125,000 and $135,000 and married couples with modified AGI between $250,000 and $260,000.

We've covered a lot of material in a short time. As always, please contact our office if you have any questions about these valuable tax incentives.

If you have completed your tax return and you owe more money than you can afford to pay in full, do not worry, you have many options. While it is in your best interest to pay off as much of your tax liability as you can, there are many payment options you can utilize to help pay off your outstanding debt to Uncle Sam. This article discusses a few of your payment options.

Pay Uncle Sam as much as you can

First and foremost, if you cannot pay the full amount of taxes due, you should nevertheless file your return by the April 15 deadline. Moreover, you should send in as much money as you can with your return. The IRS assesses failure-to-file penalties so you should file your return despite being unable to pay the full amount with the return. As such, it's to your benefit to file your return by its due date and pay off any outstanding balance as soon as you can in order to minimize interest and penalties.

Payment options

If you are not able to pay the full amount of tax you owe, you have options. While you can obtain an automatic six-month extension of time to file, the IRS will still assess interest on the outstanding unpaid tax liability. To do so, you must file Form 4868, Application for Automatic Extension of Time To File U.S. Income Tax Return, by the due date for filing your calendar year return (typically April 15) or fiscal year return. However, an extension of time to file is not an extension of the time to pay your taxes. Penalties and interest continue to accrue during the extension.

Second, consider paying some or all of your tax liability by credit card or obtaining a cash advance on your credit card. The interest rate your credit card or bank charges (plus applicable fees) may be lower than the total amount of interest and penalties imposed by the IRS under the Tax Code.

You may also be eligible to take advantage of the IRS's monthly installment agreement option. This option allows eligible taxpayers to pay off their tax bill over a period of time - in monthly installments - to the IRS. However, if you have entered into an installment agreement during the preceding 5 years you cannot use this option. Additionally, even while you are making payments through an installment agreement, penalties and interest continue on the unpaid portion of that debt. To request an installment plan, you can use Form 9465, Request For Installment Agreement. Or, you can use the Online Payment Agreement (OPA) application.

There are many options for paying off your tax debt. Our office can discuss the payment options that will work best in your specific circumstances. Please don't hesitate to call our office with questions.

The American Recovery and Reinvestment Tax Act of 2009 (ARRTA) provides more than $75 billion worth of tax benefits for business for 2009 and 2010, in addition to numerous individual tax breaks. This article highlights some of the valuable tax breaks for businesses in the new law.

Bonus Depreciation. The ARRTA extends bonus depreciation under the 2008 Economic Stimulus Act, allowing businesses to immediately write-off an additional 50-percent of the cost of qualifying depreciable property placed in service before 2010. The additional 50-percent first-year bonus depreciation applies retroactively to capital expenses incurred on or after January 1, 2009. Qualified property includes most types of new property, including equipment, computers, tractors, wind turbines and solar panels.

The ARRTA also extends through 2010 additional first-year bonus depreciation for property with a recovery period of 10 years or longer, for transportation property (for example, tangible personal property used to transport people or property, and for certain aircraft).

Note. Effective January 1, 2009, the ARRTA law also increases the regular dollar caps for new passenger vehicles placed in service after 2008 and before 2010 by $8,000 when bonus depreciation is claimed.

Code Sec. 179 Expensing. For 2009, the ARRTA extends the Code Sec. 179 expensing amounts, which had been increased by the 2008 Economic Stimulus Act. For 2009, the Code Sec. 179 expensing amount is $250,000 and the investment ceiling is $800,000.

Five-Year NOL Carryback. The ARRTA allows certain small businesses to elect a five-year carryback of net operating losses (NOLs) arising in 2008. Only qualified small businesses with average gross receipts of $15 million or less qualify for the longer carryback. Eligible businesses can elect to carryback 2008 NOLs three, four or five years. The new carryback treatment applies only to NOLs arising in tax years beginning or ending in 2008. Quick refunds apply if your business qualifies.

AMT/R&D Credits Election. Through 2009, the ARRTA temporarily extends the ability of businesses to accelerate the recognition of a portion of their accumulated AMT and research and development (R&D) credits instead of taking bonus depreciation. In effect, this allows an immediate cash refund for these credits.

Work Opportunity Tax Credit. Businesses can claim a Work Opportunity Tax Credit (WOTC) generally equal to 40 percent of the first $6,000 of wages paid to employees who are in one of nine targeted groups. The ARRTA adds (1) unemployed veterans and (2) disconnected youth to the list of targeted groups. The new categories apply to individuals who are hired and begin work in 2009 or 2010.

Cancellation of Debt Income. Under the ARRTA, eligible businesses can make an (irrevocable) election to recognize certain cancellation of debt income (CODI) ratably over a five-year period, beginning in 2014. The election applies to certain types of business debt repurchased by the business during 2009 and 2010.

S Corp Built-In Gain Period. Current law provides that if a C corporation converts to an S corporation the conversion is not a taxable event. However, the S corporation usually must hold its assets for 10 years after the conversion in order to avoid being taxed on any built-in gains that existed at the time of the conversion. For S corp sales of their C corp assets  in 2009 and 2010, however, the ARRTA temporarily shortens the holding period, from 10 to seven years, for sales of assets subject to the built-in gains tax imposed after such a conversion.

Qualified Small Business Stock. Pre-ARRTA law allowed noncorporate investors to exclude 50 percent of the gain from the sale of certain qualified small business stock (QSBS) held for more than five years. The ARRTA increases the exclusion to 75 percent for QSBS acquired after February 17, 2009 and before 2011. A "qualified small business" is one that does not have more than $50 million in assets and conducts an active trade or business.

Estimated Tax Payments. For individual taxpayers with income from small businesses, the ARRTA temporarily reduces 2009 required estimated tax payments for certain small businesses. Under the new law, 2009 quarterly estimated tax payments may now be based on 90 percent - instead of 100 percent - of the taxpayer's 2008 returns. For purposes of the new provision, a "small business" is one that does not employ more than an average of 500 people, and the individual's adjusted gross income is less than $500,000. The individual also must certify that at least 50 percent of the gross income shown on his or her return for the preceding tax year was income from a "small trade or business."

Energy Incentives. A number of the energy tax incentives in the ARRTA are targeted to businesses. The ARRTA:

• Extends and modifies the Code Sec. 45 renewable production tax credit.
• Expands the Code Sec. 48 energy investment credit to include qualified small wind energy property.
• Allows the Code Sec. 48 investment tax credit to be claimed in lieu of the Code Sec. 45 production tax credit.
• Removes the individual dollar limits on certain energy tax credits for qualified small wind energy property, qualified solar water heating property, and qualified geothermal heat pumps.

If you have any questions about the business incentives in the ARRTA, please contact our office.

The American Recovery and Reinvestment Tax Act of 2009 (ARRTA) is loaded with various tax incentives for individuals for 2009 and 2010. Among the individual tax breaks in the new law are incentives for homeownership, help for the unemployed and employed, as well as education assistance and tax breaks for taxpayers with children. This article provides an overview of the major individual tax incentives provided by the ARRTA.

Making Work Pay Credit. The Making Work Pay credit is a new but temporary refundable credit. Qualified taxpayers will either take the credit through a reduction in the amount of income tax withheld from their paycheck by allowing a credit against income tax in an amount equal to the lesser of 6.2 percent of the individual's earned income or $400 ($800 for married couples filing jointly), or in a lump sum when filing their income tax return for the tax year.

Note. Individuals who are self-employed may qualify for the credit as well, to the extent earnings from self-employment are taken into account in computing taxable income.

The credit applies retroactively to the start of 2009 and extends through 2010. Up to the maximum $400/$800 credit amount is allowed for each year.  The credit begins to phase out for individuals with modified adjusted gross income (MAGI) exceeding $75,000 ($150,000 in the case of married couples filing jointly). The credit will be phased out at a rate of 2 percent above the MAGI limits.

$250 Economic Recovery Payment. The ARRTA also provides a one-time payment of $250 to individuals on a fixed income, including railroad retirement beneficiaries, Social Security recipients, disabled veterans, as well as retired government workers who are not eligible for Social Security benefits. The $250 payment will reduce the individual's otherwise allowable Making Work Pay credit to which they may be entitled. This payment will only be made in 2009, likely around mid-year.

New Car Deduction. Both itemizers and non-itemizers can take advantage of a new but temporary above-the-line deduction for state and local sales taxes or excise taxes paid on the purchase of a new (qualifying) motor vehicle. Both domestic and foreign vehicles qualify as well as motor homes, SUVs, light trucks and motorcycles weighing no more than 8,500 gross pounds.

The deduction is allowed in computing AMT, but is not available to taxpayers who elect to deduct state and local sales and use taxes in lieu of income taxes as an itemized deduction. The deduction begins to phase-out for taxpayers with adjusted gross income (AGI) exceeding $125,000 ($250,000 for joint filers). Additionally, deductible sales/excise taxes cannot exceed the portion of tax attributable to the first $49,500 of the purchase price.

Enhanced First-Time Homebuyer Tax Credit. The ARRTA raises the maximum amount of the first-time homebuyer tax credit to $8,000 (up from $7,500) and extends the credit through December 1, 2009. The ARRTA also completely eliminates any repayment requirement for purchases made after January 1, 2009 if the taxpayer does not sell or otherwise dispose of the property within 36 months from the date of purchase. However, if the taxpayer does dispose of the residence within this time, pre-ARRTA rules for recapture apply, requiring the homebuyer to repay any credit amount received to the government over 15 years in equal installments. Purchases on or after April 9, 2008 and before January 1, 2009 are still governed by the original first-time homebuyer tax credit rules enacted last year in the Housing and Economic Recovery Act of 2008.

Education Credit. The ARRTA temporarily enhances and expands the Hope education tax credit (renaming it the American Opportunity education tax credit) for 2009 and 2010. The credit is increased in amount, to a maximum of $2,500 per year and extended to all four years of college education. Additionally, the credit is subject to more generous phase-out levels of $80,000 of AGI for individuals and $160,000 for joint filers. For 2009 and 2010, up to 40 percent of the American Opportunity credit is refundable.

Qualified Tuition Programs ("529 plans"). Distributions from qualified tuition programs (also known as "529 plans") used to pay a beneficiary's qualified higher education expenses are tax-free. For 2009 and 2010, ARRTA allows beneficiaries to use distributions from QTPs to pay for computers, laptops and computer technology, including internet access.

Child Tax Credit. The ARRTA increases the refundable portion of the child tax credit for both 2009 and 2010. For 2009 and 2010, the child tax credit is refundable to the extent of 15 percent of the taxpayer's earned income in excess of $3,000.

Enhanced Earned Income Tax Credit. For 2009 and 2010, the ARRTA temporarily increases the Earned Income Tax Credit (EITC) for working families with three or more children. The new law (1) increases the credit to 45 percent of a family's first $12,570 of earned income for families with three or more children and (2) adjusts the start of the EITC phase-out range upwards by $1,880 for joint filers, regardless of the number of children.

AMT Patch. The ARRTA boosts alternative minimum tax (AMT) exemption amounts for 2009. The new amounts are slightly higher than last year's exemptions but much higher than the amounts they had been set to revert to had this remedial provision not been passed.

The 2009 exemption amounts are:

• $46,700 for individuals and heads of household; and
• $70,950 for joint filers and surviving spouses.

The new law also provides that for 2009 nonrefundable personal credits may offset both regular tax and the AMT.

Partial Exclusion of Unemployment Benefits. The ARRTA temporarily excludes up to $2,400 of unemployment compensation from a recipient's gross income for 2009. Unemployment benefits are otherwise includible in a recipient's gross income for tax purposes. As such, any unemployment benefits over $2,400 in 2009 will be subject to federal income tax.

Increased Transit Benefits For Workers. Beginning in March 2009, and effective for 2009 and 2010, the ARRTA increases the income exclusion for transit passes and van pooling to $230 per month.

Energy Incentives. Code Sec. 25C provides a tax credit for energy efficient improvements made to a taxpayer's home. The ARRTA increases the Code Sec. 25C residential energy property credit to 30 percent (up from 10 percent), raises the maximum cap to a $1,500 aggregate amount for 2009 and 2010 installations, eliminates the pre-2008 $500 lifetime cap, and makes other modifications to the credit. Taxpayers can use the credit for insulation materials, exterior windows and doors, skylights, central air conditioning, and hot water boilers, among many other energy efficient improvements.

The ARRTA also removes the individual dollar caps under the Code Sec. 25D residential energy efficient property credit for solar hot water property, wind energy property and geothermal heat pumps. Moreover, if you are interested in an environmentally-friendly car, the ARRTA modifies the credit for plug-in electric vehicles, although they are not yet on the market.

If you have any questions about the individual tax incentives in the ARRTA, please contact our office.

The flagging state of the economy has left many individuals and families to cope with rising gas prices and food costs, struggle with their mortgage and rent payments, and manage credit card debt and other common monthly bills. Whether individuals are contemplating how to pay off their credit card or obtain a mortgage amid the "credit crunch" and "economic downturn," many people may be considering alternative sources of financing to reach their goals, including the tapping of a retirement account.

You can generally withdraw funds from your 401(k) three ways: through regular distributions, hardship withdrawals or plan loans. Many employers have adopted 401(k) plan provisions that allow employees to borrow money from their retirement account. Although borrowing from your 401(k) may be an option, there are several important considerations you should take into account before tapping your retirement fund.

The basics of borrowing from your 401(k) plan

The amount that you can borrow from a 401(k) plan is limited to 50 percent of the value of your vested benefit or $50,000, whichever amount is less. However, you can take a loan up to $10,000 even if it is more than one-half of the present value of your vested accrued benefit. Interest on a 401(k) plan loan is not deductible. Despite withdrawing funds from your 401(k) through a plan loan, you will remain vested in your account, subject to your obligation to repay the loan.

If certain requirements are not met, a loan from your 401(k) plan will be treated as a premature distribution for tax purposes, subjecting you to current income tax at ordinary rates plus a 10 percent early withdrawal penalty on the amount distributed, certain requirements must be met. You must repay a loan from your 401(k) within five years, subject to only one exception for a loan used to make a first-time home purchase (a principal residence, not a vacation or secondary home). This "residence exception" allows for a loan term as long as 30 years.

Loan repayments must be made at least every quarter, and are generally automatically deducted from your paycheck. If you are unable to repay the loan and default, the IRS treats the outstanding loan balance as a premature distribution from your 401(k), subject to income tax and the 10 percent early withdrawal penalty. Additionally, most plan terms require that you repay the loan within 60 days if you leave or lose your job.

Drawbacks to borrowing from your 401(k)

Before you dip into your 401(k), you need to be aware of the many disadvantages to taking money from your retirement savings. First, and foremost, many plans contain provisions that prohibit you, and your employer, from making contributions to your 401(k) until you repay the loan or for up to 12 months after the distribution. This is a critical disadvantage to borrowing money from your 401(k) because you are not saving for retirement during the time you are repaying the loan, which may take up to five years, or for the year in which contributions are prohibited. This not only means that you are not saving for retirement for a substantial period, you are also not earning a return on the money you could have contributed albeit for the suspension.

It is imperative that you consider the effects of suspended contributions and the lost earnings and tax-free compounding you could have earned on the money you borrowed from your 401(k). And, as previously discussed, if you default and are unable to pay the loan balance, the outstanding amount is treated by the IRS as a premature distribution and subject to income tax at your ordinary tax rate as well as a 10 percent early withdrawal penalty. Additionally, the maximum contribution you will be allowed to make in the year following the suspension will be reduced by the amount contributed in the prior year.

Another point to consider: the money you borrow will only earn the interest you pay on the loan. Typically, on a 401(k) plan loan, administrators use an interest rate of one to two percentage points above prime interest rates. While paying a lower interest rate to yourself may be more favorable then paying a higher interest rate to a bank, you aren't necessarily earning money, especially considering that the interest you pay on the loan could be significantly lower than the potential earnings you could be making if the money remained in your account.

Potential double taxation

In fact, the interest you pay on the loan is money taken from your paycheck, after-taxes. While it is not an additional cost you'd be paying to a bank, but paying yourself, it is money you may essentially be paying tax on twice. That is because the money you pay yourself interest with is taxed in your paycheck currently, then later when it is distributed to you from the plan in retirement as ordinary income.

Falling interest rates and the current slowdown in the U.S. economy are having a widespread affect on today's economy and individuals' financial resources, from savings accounts to personal loans and credit card debt. The drop in interest rates that has occurred over the course of the last few months has also produced strategic tax planning opportunities for individuals contemplating certain types of asset transfers.

Lower interest rates affect the income, estate and gift tax consequences of making certain asset transfers and utilizing various estate planning tools, reducing or eliminating altogether transfer tax costs. On the other hand, low interest rates make some types of transfers and tax planning techniques unappealing. Here are some examples.

Private annuity arrangements

Private annuities, like life estates, term interests, remainders, and reversions are valued for estate, gift and tax purposes using actuarial tables issued under Code Sec. 7520 by the IRS. The applicable interest rate, which the IRS calls the "Applicable Federal Rate" (or AFR), fluctuates based on current market interest rates and is published on a monthly basis by the IRS. For example, the Code Sec. 7520 interest rate for March 2008 was 3.6 percent. The interest rate hit a historical low of 3 percent in July 2003, and has been as high as 11.6 percent.

In a typical private annuity arrangement, a parent transfers assets to his or her child or children in exchange for the transferee's promise to pay a fixed, periodic income payment for the parent's life. To escape gift tax, the value of the annuity payments is based on the IRS's published interest rates and life expectancy schedules. If the fair market value of the assets that are transferred under the arrangement equal the value given to the annuity under the IRS's valuation tables, no gift tax will result from the transaction. The lower the interest rates when the private annuity arrangement is entered into, the lower the annual annuity payments that will have to be made to the parent, resulting in lower, or no, gift tax costs.

Grantor retained annuity trust

A grantor retained annuity trust (GRAT) is an attractive estate-planning tool, especially when interest rates are low. A GRAT is an irrevocable trust in which the grantor transfers assets to the trust but retains the right to receive fixed annuity payments for a specified period of years. When the trust's term expires, the trust terminates and the remaining trust assets are distributed to non-charitable beneficiaries, such as the grantor's children.

The value of the remainder interest in a GRAT is determined according to the IRS's Code Sec. 7520 interest rate; the assumption is that the assets placed in the trust will appreciate at this rate. Therefore, the lower the interest rate in the month that a GRAT is set up, the lower the value of the remainder interest in the trust and therefore the less in gift tax will be paid. A GRAT is especially useful for transferring income-producing assets or property expected to increase in value over the course of the years because all future appreciation not only is removed from the grantor's estate, but appreciation that exceeds the Code Sec. 7520 interest rate passes free of gift tax to the beneficiaries.

Charitable lead annuity trust

A charitable lead annuity trust (CLAT) is like a GRAT, except that the annuity payments are distributed to charities, not the grantor, with the remainder passing to noncharitable beneficiaries, such as children. Gift tax is not due on the value of the charitable interest. A low interest rate in the month that the CLAT is established creates two important benefits: an increase in the present value of the charity's lead interest, which translates into a larger charitable income tax deduction and a lower gift tax on the remainder interest that passes to family members.

Charitable remainder interests in a personal residence

Lower interest rates also produce tax savings for individuals who transfer a remainder interest in their home, but retain a life interest in the property. The individual takes an income tax deduction for the gift of the remainder interest in the home that passes to the charitable organization. As interest rates decrease, the value of the remainder interest and, thus, the charitable deduction increases.

Importantly, low interest rates are not always beneficial in tax planning. Although there are tax benefits to the following planning tools, lower interest rates make these tax planning "techniques" unattractive:

Grantor retained income trusts

A grantor retained income trust (GRIT) operates like a GRAT, except that the grantor retains an income interest in the trust for a specified period instead of an annuity interest. A decrease in interest rates operates to reduce the value of the grantor's retained income interest, thereby increasing the value of the remainder interest to the beneficiaries, and thus increasing the gift tax.

Charitable remainder annuity trusts

A charitable remainder annuity trust (CRAT) also operates like a GRAT except that the remainder interest in the trust passes to one or more charitable beneficiaries, as opposed to family members. The grantor takes a current income tax deduction for the present value of the charity's remainder interest, therefore the grantor wants the trust's remainder interest to be as large as possible so that he or she can maximize the deduction. The lower the interest rate when the CRAT is established, the lower the value of the remainder interest that passes to charity, and therefore the lower the charitable tax deduction.

Charitable remainder unitrusts

A CRUT is similar to a CRAT - but the grantor receives a fixed percent of the trust's value each year, with the remainder interest passing to charity. And like a CRAT, a change in interest rates will not generally affect the size of the income tax deductions or the gift taxes associated with charitable remainder unitrusts (CRUTs). For example, the value of the charitable interest is calculated based on today's values, and thus a lower interest rate will result in a lower value of the charitable interest and thus a lower current tax deduction.

Qualified personal residence trust

A qualified personal residence trust (QPRT) is similar to a GRAT, except the grantor retains the right to live in the home, instead of receiving annuity payments, with the remainder interest passing to his or her beneficiaries. The lower the interest rate, the larger the remainder interest subject to gift tax, and therefore the larger the transfer tax.

If you would like to talk about the tax benefits and consequences of these or other tax planning tools, please call our office. We would be glad to discuss how these and other strategies fit in to your personal financial and tax situation.

Taxpayers who do not meet the requirements for the home sale exclusion may still qualify for a partial home sale exclusion if they are able to prove that the sale was a result of an unforeseen circumstance. Recent rulings indicate that the IRS is flexible in qualifying occurrences as unforeseen events and allowing a partial home sale exclusion.

Generally, single taxpayers may exclude from gross income up to $250,000 of gain on sale or exchange of a principal residence and married taxpayers filing jointly may exclude up to $500,000. The exclusion can only be used once every two years.

To qualify for this exclusion, taxpayers must own and use the property as their principal residence for periods totaling two out of five years before sale. The five-year period can be suspended for up to 10 years for absences due to service in the military or the foreign service.

Partial exclusions are available when the ownership and use test or two-year test is not met but the taxpayer sells due to change of employment, health or unforeseen circumstances. Without these mitigating circumstances, all gain on the sale of a residence before the two years are up is taxed.

The IRS offers several "safe harbors," that is, events that will be considered to be unforeseen circumstances. These include the involuntary conversion of the taxpayer's residence, casualty to the residence caused by natural or man-made disasters or terrorism, death of a qualified individual, unemployment, divorce or legal separation, and multiple births from the same pregnancy.

If a taxpayer does not qualify for any of the safe harbors, the IRS can determine if a sale is the result of unforeseen circumstances by applying a facts and circumstances test. Some of the factors looked at by the IRS are proximity in time of sale and claimed unforeseen event, suitability of the property as the taxpayer's principal residence materially changes, whether the taxpayer's financial ability to maintain the property is materially impaired, whether the taxpayer used the property as a personal residence and whether the unforeseen circumstances were foreseeable when the taxpayer bought and used the property as a personal residence.

Recently, the IRS has decided that several non-safe harbor events were unforeseen circumstances. These include sales because of fear of criminal retaliation, the adoption of a child, a neighbor assaulting the homeowners and threatening their child, and a move to an assisted living facility followed by a move to a hospice.

If you think you may be eligible for a reduced home sale exclusion because of an unforeseen circumstance, give our office a call.

You should beware of fancy footwork when it comes to estimating, filing, and paying federal taxes. One misstep can lead to harsh penalties. Willful or fraudulent mistakes can generate criminal sanctions as well.

Failure to pay tax

If you don't pay your taxes when due, the IRS may impose a penalty in addition to the tax. The addition to tax is one-half of one percent of the amount not paid, for each month (or part of a month) it remains unpaid, up to a maximum of 25 percent.

Delinquent returns

Failure to file on time may result in an "addition to tax" (the formal name that the IRS gives to its late-payment fee). This penalty is five percent for each month that no return is filed, up to 25 percent. If the return is not filed within 60 days of the due date (including extensions), the penalty will be at least $100 or 100 percent of the tax due on the return, whichever is less.

The penalty doesn't apply if you can show a reasonable cause for not filing. However, a "reasonable cause" for failure to file does not include (1) reliance on the advice of an agent; (2) reliance on the accountant to do the filing; or (3) misjudging the extension date.

Understatement of tax

If you substantially understate taxes due, the IRS can impose a 20 percent accuracy-related penalty. A "substantial understatement" occurs if the amount is (1) 10 percent of the tax required to be shown on the return (including self-employment tax) or (2) $5,000, which ever is greater.

You may be able to avoid this penalty if:

-- You acted in good faith and there was reasonable cause for the understatement;

-- The understatement was based on substantial authority; or

-- There was a reasonable basis for the tax treatment and the relevant facts were adequately disclosed.

Negligence, fraud, and criminal acts

If underpayment is due to negligent, reckless or intentional disregard of the tax laws, the IRS may impose a 20 percent accuracy-related penalty. Negligence includes failure to reasonably comply with the tax laws, to exercise reasonable care in preparing a tax return, to keep adequate books and records, or to properly substantiate items.

Fraud is punished more harshly. A penalty may be imposed on 75 percent of the underpayment due to fraud. The fraud penalty will not apply, however, if no return is filed, other than a return prepared by the IRS when a person fails to file a return. Criminal sanctions also are likely.

Frivolous returns

If you file a frivolous return, you risk a $500 penalty. A return is "frivolous" if it omits necessary information, shows a substantially incorrect tax, is based on a frivolous position, or is filed in an attempt to avoid tax collection. Changing or crossing-out the "penalty of perjury" language above the signature line on a return is treated as filing a frivolous return.

During uncertain economic times, it's easy to feel pessimism and react hastily amid media reports about growing unemployment rates and stock market downturns. However, such actions can wreak havoc on your long-term personal and financial goals. Taking some time out now to put the uncertain future into perspective can help minimize the impact that many external forces can have on your personal and financial life.

During uncertain economic times, it's easy to feel pessimism and react hastily amid media reports about growing unemployment rates and stock market downturns. However, such actions can wreak havoc on your long-term personal and financial goals. Taking some time out now to put the uncertain future into perspective can help minimize the impact that many external forces can have on your personal and financial life.

Prepare for the unexpected. "Always be prepared" is a good motto to live by in order to position yourself, your family, and/or your business to survive and thrive in uncertain economic times. Getting your personal and financial houses in order can result in a viable fallback plan as well as peace of mind.

• Build an emergency fund. We've all heard the sage financial advice to keep 3-6 months of expenses in cash on hand - and many of us have quickly rejected this advice. How much sense does it make to have tens of thousands of dollars sitting around when there are credit card balances to pay off and children's college funds to contribute to? Well, just ask anyone who has unexpectedly lost their job or been faced with a devastating personal tragedy - cash is king. Make your emergency fund priority number one and if 3-6 months of cash seems unreachable to you, consider getting a home equity loan. Low interest rates coupled with high home values can get you into a home equity loan that will cost you little or nothing to maintain each year - an instant emergency fund. And don't procrastinate here - any kind of loan is tough to qualify for when you are unemployed or buried in debt.
• Keep your networking ties fresh. Keeping in touch with peers in your industry can cushion the blow of a job loss as you utilize this network to discover potential job openings. Since people are so mobile in the workplace these days, it's important that you make the effort to stay connected with those who may someday provide you with valuable leads and/or referrals. Remember, networking is a two-way street -- make sure these peers know that they can come to you for the same type of assistance should their careers hit a road bump.

Revisit your portfolio. Call it returning to the scene of the crime - your perhaps battered portfolio probably needs some attention. Revisiting your investment portfolio periodically to make adjustments to take into consideration current economic factors can help you feel a bit more in control of events outside of your control.

• Diversify, diversify, diversify. Diversification is key. It's worth taking the time to ascertain that your portfolio is properly allocated among many different investment vehicles in order to buffer it from potential market downturns or other uncontrollable financial events.
• Keep things in perspective. The stock market moves in a cycle with historically good times as well as bad. Keep your eye on your long-term goals and make sure that any short-term anxiety you may have doesn't knock your portfolio off track and keep you from maximizing your long-term average return.
• Be proactive, not reactive. Certain events - both major and minor - have the ability to send the financial markets on a white-knuckle roller coaster ride. Knee-jerk reactions to daily events unfortunately add more fuel to the fire and can result in an unstable investing environment. On a smaller scale, this same type of reaction can seriously affect your personal investment portfolio as long-term goals are derailed by short-term reactions. This is not to say you should turn a blind eye to current events - on the contrary, it is important to consider these events and their potential impact on your portfolio. However, any changes to your portfolio should be made in a proactive - not reactive - manner, and should take into consideration historical performance as well as possible future trends.

Relax and breathe. Dealing with uncertainty - whether related to your job, investments, health, etc., is never easy and can cause a certain level of anxiety and stress. However, how a person uses this new energy (positively or negatively) can determine their ability to not only survive through the bad times but to thrive as they open themselves up to new opportunities - to get their financial house in order or to prepare themselves to seek out another more fulfilling or secure job or career.

As illustrated above, preparation and perspective are two very important elements need to survive and thrive in an uncertain economy. If you find you need any assistance, do not hesitate to contact the office for additional guidance.

Ask someone whether they've created a long-term financial plan and they are likely to answer, "Not me...I'm not rich enough, old enough, etc..." While most people realize the importance of financial planning, there still exist several misconceptions about who it can benefit and how to get the most out of it.

Ask someone whether they've created a long-term financial plan and they are likely to answer, "Not me...I'm not rich enough, old enough, etc..." While most people realize the importance of financial planning, there still exist several misconceptions about who it can benefit and how to get the most out of it.

Myth #1: Only wealthy people should develop financial plans. Financial planning is for anyone who wants to achieve either short-term or long-term financial goals, such as retiring, attending college, buying a home or leasing a car.

Myth #2: Financial planning is just about investing. While investing your money as you strive to reach your financial goals makes good sense, keep in mind that financial planning also involves the proper handling of your taxes, insurance, retirement, budgeting, estate planning, and life goals. A comprehensive financial plan should coordinate often competing financial aspects of your life while developing strategies and objectives that enable these aspects to work together effectively to meet your goals.

Myth #3: Financial planning is for older people. If you want to meet your financial goals, you need to start now, no matter what your age. Waiting until you are older limits your financial opportunities and your ability to bear some risk. For example, every ten years you wait to save towards retirement, you must save three times as much per month in order to reach the same size retirement account. If you wait too long, many financial strategies will become useless or less effective for you.

Myth #4: You only need to create a financial plan once. While implementing a financial plan is important, just as important is the maintenance of your plan. Financial planning is a life long process. Every time your financial situation changes, such as getting married, moving or having children, you must review and update your financial plan. Changing markets and personal needs may dictate an adjustment of your financial plan. Changing tax laws may also require additional adjustments.

A little planning now for your financial goals will save a lot of grief and panic in the future. If you are interested in finding out more about how you can benefit from financial planning, please contact our office.

The benefits of owning a vacation home can go beyond rest and relaxation. Understanding the special rules related to the tax treatment of vacation homes can not only help you with your tax planning, but may also help you plan your vacation.

The benefits of owning a vacation home can go beyond rest and relaxation. Understanding the special rules related to the tax treatment of vacation homes cannot only help you with your tax planning, but may also help you plan your vacation.

For tax purposes, vacation homes are treated as either rental properties or personal residences. How your vacation home is treated depends on many factors, such as how often you use the home yourself, how often you rent it out and how long it sits vacant. Here are some general guidelines related to the tax treatment of vacation homes.

Treated as Rental Property

Your home will fall under the tax rules for rental properties rather than for personal residences if you rent it out for more than 14 days a year, and if your personal use doesn't exceed (1) 14 days or (2) 10% of the rental days, whichever is greater.

Example - You rent your beach cottage for 240 days and vacation 23 days. Your home will be treated as a rental property. If you had vacationed for 1 more day (for a total of 24 days), though, your home would be back under the personal residence rules.

Income: Generally, rental income should be fully included in gross income. However, there is an exception. If the property qualifies as a residence and is rented for fewer than 15 days during the year, the rental income does not need to be included in your gross income.

Expenses: Interest, property taxes and operating expenses should all be allocated based on the total number of days the house was used. The taxes and interest allocated to personal use are not deductible as a direct offset against rental income. In the example above, the total number of days used is 263, so the split would be 23/263 for personal use and 240/263 for rental.

Any net loss generated will be subject to the passive activity loss rules. In general, passive losses are deductible only to the extent of passive income from other sources (such as rental properties that produce income) but if your modified adjusted gross income falls below a certain amount, you may write off up to $25,000 of passive-rental real estate losses if you "actively participate". "Active participation" can be achieved by simply making the day-to-day property management decisions. Unused passive losses may be carried over to future years

Planning Note: If your personal use does exceed the greater of (1) 14 days, or (2) 10% of rental days, the special vacation home rules apply. This means you drop back into the personal residence treatment, which allows you to deduct the interest and taxes and usually wipe out your rental income with deductible operating expenses. This is explained in greater detail below.

Treated as Personal Residence

If you use your vacation home for both rental and a significant amount of personal purposes, you generally must divide your total expenses between the rental use and the personal use based on the number of days used for each purpose. Remember that personal use includes use by family members and others paying less than market rental rates. Days you spend working substantially full time repairing and maintaining your property are not counted as personal use days, even if family members use the property for recreational purposes on those days.

Rented 15 days or more. If you rent out your home more than 14 days a year and have personal use of more than (1) 14 days or (2) 10% of the rental days, whichever is greater, your home will be treated as a personal residence.

Income: You must include all of your rental receipts in your gross income. Again, however, if the property qualifies as a residence and is rented for fewer than 15 days, the rental income does not need to be included in your gross income.

Expenses:

Interest and Taxes: Mortgage interest and property taxes must be allocated between rental and personal use. Personal use for this allocation includes days the home was left vacant.

Example: You rent your mountain cabin for 4 months, have personal use for 3 months, and it sits empty for 5 months. The amount of interest and taxes allocated to rental use would be 33% (4 months/12 months) and since vacant time is considered personal use, you would allocate 67% (8 months/12 months) to personal use. The rental portion of interest and taxes would be included on Schedule E and the personal part would be claimed as itemized deductions on Schedule A.

Operating Expenses: Rental income should first be reduced by the interest and tax expenses allocated to the rental portion (33% in our example above). After that allocation is made, you can deduct a percentage of operating expenses (maintenance, utilities, association fees, insurance and depreciation) to the extent of any rental income remaining. When calculating the allocation percentage for operating expenses, vacancy days are not included. Any disallowed rental expenses are carried forward to future years.

Planning Note: It would be wise to try to balance rental and personal use so that rental income is "zeroed" out since, even though losses may be carried forward, they still risk going used. Mortgage interest should be fully deductible on Schedule A as a second residence. If more than two homes are owned, choose the vacation home with the biggest loan as the second residence. Property taxes are always deductible no matter how many homes are owned.

Rented fewer than 15 days. If you have the opportunity to rent your home out for a short period of time (< 15 days), you will not have to worry about the tax consequences. This rental period is "ignored" for tax purposes and the house would be treated purely like a personal residence with no tricky allocation methods required.

Income: You do not include any of the rental income in gross income.

Expenses: Interest and taxes are claimed on Schedule A. You can not write off any operating expenses (maintenance, utilities, etc...) attributable to the rental period.

Planning Note: Take advantage of this "tax-free" income if you get the chance. Short-term rentals during major events (such as the Olympics) can be a windfall.