Barry Gilbert, CPA, EA

New for 2008 and 2009, taxpayers who do not itemize can add to their standard deduction the cost of their real property taxes, not to exceed $500 ($1,000 for joint filing taxpayers). 

Those who stand to benefit from this provision are taxpayers who pay property taxes but whose itemized deductions are less than the standard deduction.  This most frequently will include retired taxpayers who have paid off their home loans and do not have any mortgage interest to deduct.  Note that to the extent any real estate taxes are related to business property, such as a home office, and deducted elsewhere on the tax return, they cannot be included in the added standard deduction.

Take, for example, a retired married couple, both over age 65, who paid $2,500 in property taxes and have no other significant itemized deductions.  Prior to this law change, their 2009 standard deduction would have been $13,000 (the $11,400 basic amount for joint filers plus $2,200 as an additional amount for married couples both over 65).  With the added real property tax deduction, the couple’s standard deduction is increased by the lesser of their property taxes or $1,000.  Therefore, for 2009 their standard deduction will be $14,600.  Assuming that they are in the 15% tax bracket, this will save them $150 of federal income tax.

In actual application, some taxpayers who are marginally itemizing their deductions may find it beneficial to take the standard deduction for 2008.   Please call this office if you have any questions.

With the advent of the home sale gain exclusion back in the 1990s, taxpayers have been using that provision of the law in a popular strategy to exclude gain not just from their primary residence but also from rentals and second homes as well.  

They do that by moving into and making the rental or second home their primary residence for two years, then selling it and excluding the gain, up to $250,000 ($500,000 for joint filers). 

To qualify for the exclusion each taxpayer must own and occupy the home as their primary residence for two of the five years prior to the sale and have not utilized the exclusion in the two years immediately preceding the sale.   Thus, with careful planning taxpayers could employ this technique on multiple properties.

Apparently this strategy became too popular and Congress included a provision in the recently enacted Housing Assistance Act of 2008 to curtail gain exclusion attributable to periods of ownership when the property was not the taxpayer’s primary residence.  The new law accomplishes this by prorating the home sale gain between qualified and nonqualifed use periods and allowing the home gain exclusion to apply only to gain from qualified periods.

Example: An individual taxpayer purchases a home on 1/1/09 and rents it.  Then on 1/1/11 he occupies the property as his primary residence and two years later on 1/1/13 he sells the home for a $200,000 gain.  Prior to this law change, the entire $200,000 could have been excluded. However, under the new law taking effect after 2008, the taxpayer would have to apportion the gain between the periods when it was a rental and when it was a personal residence.  In this example he owned it four years, of which time use for two years was nonqualified, so 50% of the gain ($100,000) would be attributable to a nonqualified use period and would not be excludable.  As a result the taxpayer would be able to exclude only $100,000 of the $200,000 gain.  Note that had the taxpayer used the home as a second home instead of a rental the results would have been the same.

The law does provide a pretty liberal definition of nonqualified use.  A period of nonqualified use means any period during which the property is not used by the taxpayer or the taxpayer's spouse or former spouse as a principal residence except as noted below.  For purposes of determining periods of nonqualified use do not include any period:

o Before January 1, 2009

o After the last date the property is used as the principal residence of the taxpayer or spouse (regardless of use during that period), and

o Not to exceed two years that the taxpayer is temporarily absent by reason of a change in place of employment, health, or, to the extent provided in regulations, unforeseen circumstances.

If your planning strategies include employing multiple sales, each qualifying for the home sale exclusion, you should carefully analyze the impact of this new law on your plans.  Please call this office if you have any questions.

First-time homebuyers who wish to take advantage of this new tax credit need to act before July 1, 2009.

Available for a limited time only, the credit:

• Applies to home purchases after April 8, 2008, and before July 1, 2009.

• Reduces a taxpayer's tax bill or increases his or her refund, dollar for dollar.

• Is fully refundable, meaning that the credit will be paid out to eligible taxpayers, even if no tax is owed or the credit is more than the tax that is owed.

However, the credit operates much like an interest-free loan, because it must be repaid over a 15-year period.  So, for example, an eligible taxpayer who buys a home and properly claims the maximum available credit of $7,500 on his or her 2008 federal income tax return must begin repaying the credit by including one-fifteenth of this amount, or $500, as an additional tax on his or her 2010 return.

CAUTION: Taxpayers are cautioned that this credit is a loan, and except under some special circumstances noted in this article, must be repaid.  You should not take this credit if you will be unable to meet the repayment requirements in the future.  The repayment is subject to the same penalties and interest and collection procedures as any other income tax when not paid on time.  In addition, your withholding or estimated payments may need to be adjusted to avoid the underpayment penalty.

Definition of a First-Time Homebuyer - A taxpayer is considered a first-time homebuyer if he (or spouse, if married) had no present ownership interest in a principal residence in the U.S. during the 3-year period before the purchase of the home to which the credit applies.  If the individual is married, neither the individual nor his spouse may have had a present ownership interest in a principal residence during that 3-year period, even if they file as married taxpayers filing separately.  Ownership of a home outside the U.S. during the three-year period will not disqualify the taxpayer.

When to Claim the Credit - If you make an eligible purchase in 2009, you can claim the first-time homebuyer credit on your 2008 or 2009 tax return.  If you decide to claim the credit on your 2008 return (you receive the money a year earlier) by including it on the original or amended 2008 return. 

Homes that Qualify - Only the purchase of a main home located in the United States qualifies.  Vacation homes and rental property are not eligible.  The home must be purchased after April 8, 2008 and before July 1, 2009.  For a home that is constructed, the purchase date is the first date the home is occupied.

Amount of the Credit - The credit is 10 percent of the purchase price of the home, with a maximum available credit of $7,500 for either a single taxpayer or a married couple filing jointly.  The limit is $3,750 for a married person filing a separate return. Unmarried taxpayers who purchase a home together are eligible to share the credit under an as-yet-to-be announced formula to be determined by the IRS.  In most cases, the full credit will be available for homes costing $75,000 or more.  Whatever the size of the credit a taxpayer receives, the credit must be repaid over a 15-year period.

Income Limits – The purpose of the credit is to assist lower-income individuals in acquiring their own home.  Thus, the credit is reduced or eliminated for higher-income taxpayers.  The credit is phased out based on the taxpayer’s modified adjusted gross income (MAGI).  MAGI is the adjusted gross income plus various amounts excluded from income - for example, certain foreign income.  For a married couple filing a joint return, the phase-out range is $150,000 to $170,000.  For other taxpayers, the phase-out range is $75,000 to $95,000.  This means that the full credit is available for married couples filing a joint return whose MAGI is $150,000 or less and for other taxpayers whose MAGI is $75,000 or less.

Who Cannot Take the Credit – In addition to the other qualifications and limitations discussed above, a taxpayer cannot take the credit if:

• The home is purchased from a close relative.  This includes a taxpayer’s spouse, parent, grandparent, child or grandchild.

• The home is no longer used as the main home.

• The home is sold before the end of the year in which it was purchased.

• He or she is a nonresident alien.

• He or she is, or was, eligible to claim the District of Columbia first-time homebuyer credit for any taxable year.

• The home financing comes from tax-exempt mortgage revenue bonds.

How and When is the Credit Repaid - The first-time homebuyer credit is similar to a 15-year interest-free loan.  Normally, it is repaid in 15 equal annual installments beginning with the second tax year after the year the credit is claimed.  The repayment amount is included as an additional tax on the taxpayer's income tax return for that year.  For example, if you properly claim a $7,500 first-time homebuyer credit on your 2008 return, you will begin paying it back on your 2010 tax return.  Normally, $500 will be due each year from 2010 to 2024.

A taxpayer may need to adjust his or her withholding or make quarterly estimated tax payments to ensure that he or she is not under-withheld.

However, some exceptions apply to the repayment rule. They include:

• Taxpayer’s Death - If the taxpayer dies, any remaining annual installments are not due.  If a joint return is filed by the taxpayer and he or she dies, the surviving spouse would be required to repay his or her half of the remaining repayment amount.

• Ceases Being Main Home - If the home is no longer used as the main home, all remaining annual installments become due on the return for the year that happens.  This includes situations where the main home becomes a vacation home or is converted to business or rental property.  There are special rules for involuntary conversions.  

• Home Sold - If the home is sold, all remaining annual installments become due on the return for the year of sale.  The repayment is limited to the amount of gain on the sale if the home is sold to an unrelated taxpayer.  If there is no gain or if there is a loss on the sale, the remaining annual installments may be reduced or even eliminated. For example, a home is purchased for $200,000 and a credit of $7,500 is claimed.  Assume that no improvements are made on the home and it is sold for $195,000 after repaying $500 of the credit.  The gain or loss would be measured for purposes of the accelerated credit recapture from $193,000 (the original cost of $200,000 less the $7,500 credit plus the $500 repayment).  In this case, there would be a gain of $2,000 on the sale ($195,000 - $193,000).  Thus, the taxpayer would only be liable for repaying $2,000 of the credit when the home is sold.  Had the home sold for $193,000 or less, there would be no repayment required.

• Divorce – If a taxpayer transfers his or her home to the spouse, or to a former spouse as part of a divorce settlement, that person is responsible for making all subsequent installment payments.

• Involuntary Conversion - If the home is involuntarily converted (e.g., it's destroyed in a storm), and the taxpayer buys a new principal residence within a 2-year period beginning on the date of the disposition or the date the home ceases to be the principal residence, the accelerated recapture rule does not apply.  However, the regular recapture rule applies to the replacement principal residence during the recapture period in the same way as if the replacement principal residence were the converted residence. 

Before making a home purchase, it may be appropriate to consult with this office if you or a family member are contemplating on utilizing this credit.  

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

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

AMT EXEMPTION PHASE OUT

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

AMT TAX RATES

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

Tax Rate 26% 28%

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

Every year, many of the various tax limitations, deductions, allowances, etc., are inflation adjusted. The following are the more commonly-encountered values that apply to 2009, along with the prior year's amounts. Click here for the table.

These are not the only items that are inflation adjusted. If you have questions regarding other limitations not listed here, please call this office.

A new law passed late in 2008 allows taxpayers age 70-½ and over and those who have inherited IRAs (beneficiaries) to forego their required minimum distribution (RMD) from 401(k) plans, IRAs, and similar retirement arrangements for 2009.  Thus, these individuals can take a distribution less than required, even none, and avoid the 50% RMD penalty. Keep in mind that this is for tax year 2009 only.  So if you turned 70-½ in 2008 and delayed the first distribution from your IRA to 2009, as permitted in the first RMD year, you will still be required to make that delayed distribution in 2009 and no later than April 1, 2009. On the other hand, if you turn 70-½ in 2009, your first distribution would normally be required by April 1, 2010, but due to the new law’s suspension provision, a distribution for 2009 is not required. However, you will be required to take your 2010 RMD by December 31, 2010.

Background: The reason for the RMD is to ensure that taxpayers take at least some taxable distributions from their retirement accounts over their lifetimes.  These distributions are based on the taxpayer’s age, and the percentage of the retirement account that must be distributed each succeeding year increases based upon annuity tables.  Each year’s distribution is based on the value of the retirement account on December 31 of the prior year.  

Problem: Most individuals have some, if not all, of their retirement funds invested in stocks or mutual funds. The decline in the stock market coupled with the requirement that the current year’s distribution be based on the prior year’s year-end value creates an unfavorable situation for withdrawals.  Because of the way in which RMDs are calculated (i.e., based on the previous year's closing value), the law would have forced those individuals taking distributions in 2009 to receive a disproportionately large portion of their remaining account balance.  And, to generate the cash required for the distributions, they would have been forced to sell stock or mutual fund shares at exceptionally depressed values.  Therefore, this new law gives the taxpayer the opportunity to forego a distribution without penalty for 2009.

What You Should Do:  Whether you should take a distribution, a reduced distribution, or no distribution at all for 2009 should be based on your unique financial and tax circumstances. Although this list by no means includes everything, here are some things to consider:

• If your taxable income for 2009 is low, you may wish to take a distribution anyway to take advantage of a zero or low tax rate.

• If you need to take a distribution to cover living expenses, you may still be able to minimize the distribution.

• If you are receiving Social Security and need to supplement your Social Security income with a distribution, keep in mind that the tax on the Social Security income is based on your total income, and by minimizing your distribution you might also reduce the tax on the Social Security income.

• If you can support your yearly living expenses with other funds, you can forego a distribution altogether for 2009.

• If your income is abnormally high for 2009 and you expect it to be lower in 2010, you might want to delay any distributions until 2010.

The foregoing is a summarization of the special rule for 2009. If you have questions or wish to optimize your 2009 distribution to suit your circumstances, please call.

The provision that permits taxpayers age 70½ and over to make direct distributions (up to $100,000) from their IRA account to a charity has been reinstated for 2008 and 2009.  The distribution is tax-free, but there is no charitable deduction.  This provision can be very beneficial to taxpayers who have social security income and/or do not itemize their deductions.

IMPORTANT! If you are over 70½, you must act quickly to take advantage of this provision for 2008.  This provision can substantially benefit low-income taxpayers, as well as the more wealthy individuals.  Please call if you are contemplating a cash charitable contribution between now and the end of the year to see if it would benefit you to make a direct contribution from your IRA.

The key benefits of this provision lie in the fact that the distribution;

(1) Is not included in the taxpayer’s income for the year,

(2) Counts toward the taxpayer’s minimum required distribution for the year, and

(3) Does count as a charitable contribution for the year.  This is of no importance for 2009 distributions since they are suspended for 2009. However, it would count as the RMD for taxpayers who turned 70½ in 2008 and delayed their RMD until 2009.

How does a taxpayer benefit from this provision?

• By making a contribution directly from the IRA, taxpayers are able to exclude the amount that was contributed from their income for the year, which is essentially the same as deducting the contribution without itemizing their deductions.

• This technique also lowers a taxpayer’s adjusted gross income (AGI) for other tax breaks pegged at various AGI levels, such as medical expenses, passive losses, etc., allowing them greater benefits from the AGI limited deductions.

• For taxpayers receiving Social Security (SS), the taxability of the SS is also based on income.  Thus, excluding the portion of the IRA distribution directly distributed to the charity can reduce the taxable portion of the SS.

• Taxpayers who wish to make very large contributions (up to the 100,000 limit) can do so with IRA funds that would have otherwise been taxable to them.

Example: Retired couple (both over 70½) file a joint return.  Their income consists primarily of RMD from their IRA accounts totaling $35,500, both of their SS incomes totaling $28,000, and $2,000 of investment income.  They are very active with their church and make a $14,000 contribution each year. They have no other income or deductions.  Compare the 2006 results with and without a qualified charitable distribution:

 

In this example, instead of making a charitable contribution, the taxpayer made a qualified charitable distribution of $14,000, lowering their AGI, reducing their taxable SS, and then using the standard deduction.  Result: Tax savings of $2,936. 

Caution – It is important to stress that a qualified charitable IRA contribution must be directly distributed to the qualified charity. Otherwise, the distribution is taxable as income and the charitable deduction would be taken on the taxpayer’s itemized deductions subject to all the normal limitations.  Please call this office before attempting to execute this strategy.

The Economic Stability Legislation that was passed into law on October 3, 2008 included several individual bills that Congress had before them.  One of the bills was the 2008 Extenders Act that reinstated and extended several popular tax benefits.  Among those items were the following three popular deductions, which have been reinstated and extended for 2009.

• Deduction for State and Local Sales Taxes – With this provision, a taxpayer may elect to claim an itemized deduction for state and local general sales taxes instead of  deducting state and local income taxes.  It primarily benefits taxpayers in states with no income tax.  However, this deduction can also be beneficial to taxpayers whose sales tax deduction exceeds their state and local income tax deduction.  The sales tax deduction can be based on actual receipts OR the amount from the IRS income-based table PLUS sales tax paid when purchasing motor vehicles, boats, aircrafts, homes (including mobile and prefabricated homes), and materials to build a home.  When using the IRS income-based tables, the income is based upon spendable income which includes income that is not included in the adjusted gross income such as; worker’s compensation, public assistance payments, tax exempt military compensation tax-exempt interest, nontaxable portions of Social Security, railroad, or veterans retirement benefits, etc.

• Deduction of Qualified Tuition & Related Expenses - This above-the-line deduction (can be claimed without itemizing) allows a taxpayer to claim a deduction for qualified tuition and related expenses for higher (post-secondary) education.  The maximum deduction is $4,000 for an individual whose adjusted gross income (AGI) for the tax year does not exceed $65,000 ($130,000 in the case of a joint return), or $2,000 for other individuals whose AGI does not exceed $80,000 ($160,000 in the case of a joint return).  No deduction is allowed for an individual whose AGI exceeds the relevant AGI limits, for a married individual who does not file a joint return, or for an individual whose personal exemption deduction may be claimed by another taxpayer for the tax year.

• Educator Above-the-Line Expenses - The above-the-line deduction for educators (kindergarten through 12th grade) permits eligible educators to claim an above-the-line deduction for up to $250 annually for expenses paid or incurred for books, supplies (other than nonathletic supplies for courses of instruction in health or physical education), computer equipment (including related software and services) and other equipment, and supplementary materials used by the eligible educator in the classroom.  To be eligible for this deduction, the expenses must be otherwise deductible as a trade or business expense.  Generally, an eligible educator includes a teacher, instructor, counselor, principal, or aide who works in a school for at least 900 hours during a school year.

• Additional Standard Deduction for State and Local Property Taxes – Although this deduction is new for 2008, it was also extended through 2009.  This tax provision allows taxpayers who claim the standard deduction, instead of itemizing deductions, to claim an additional standard deduction for state and local property taxes paid.  The deduction cannot exceed the lesser of state and local property taxes actually paid or $500 ($1,000 for joint return filers).  No taxes deductible in computing adjusted gross income are taken into account in computing the increased standard deduction.  Taxpayers who marginally itemize their deductions may find it more beneficial to use the standard deduction with the added standard for property taxes.

If you have questions related to these deductions, please give this office a call.

Over the past several months, Congress has been enacting legislation to stabilize the economy.  At the urging of the incoming administration, Congress is working on yet another stimulus plan.  As they make temporary changes to the tax code and extend expiring provisions, and with the phase-in phase-out provisions of earlier legislation, it becomes more difficult to keep track of what does and does not apply for the 2009 year.  The following are highlights of the provisions affecting small to medium-sized businesses for 2009:

• The FUTA (Federal Unemployment Tax Act) tax rate had been scheduled to drop to 6% after 2008, but under the new law, it will remain at 6.2% through 2009 and will drop to 6% for 2010 and later.

• Section 179 Expense Deduction – This deduction dropped substantially for 2009.  The maximum Sec. 179 deduction for 2009 is $133,000 ($66,500 if married filing separately).  This is down from the $250,000 allowance in 2008.  For 2009, if more than $530,000 is invested in Sec. 179 property, the maximum deduction is reduced. It is quite likely that the incoming Congress will revise this deduction again in its stimulus plan.  

• 50% Bonus Depreciation – The special 50% first-year bonus depreciation for equipment purchased during the year was NOT extended past 2008.  This is another area where the new Congress might make a change for 2009.

• Food & Book Inventory Contributions - A two-year extension through 2009 of enhanced charitable contribution deduction rules for gifts of certain types of food inventory, and corporate gifts of book inventory or computer equipment to schools was enacted.

• Environmental Remediation Expenses - The tax break that allows expensing of qualified environmental remediation expenses, namely cleanup of hazardous substances (including petroleum products) at qualified contaminated sites, was extended two years, through 2009.

• Energy-Efficient Commercial Building - The deduction for energy-efficient commercial building property has been extended so that it applies through 2013.

• Electric Drive Motor Vehicles - For purchases after 2008 and before 2015, taxpayers will be able to claim a tax credit for electric drive motor vehicles.

• Bicycle Commuting Fringe Benefit - After 2008, companies will be able to give employees who commute by bicycle a $20 per month tax-free reimbursement for reasonable bicycle-related expenses.

• Disaster Area Clean Up - Through 2010, qualified disaster expenses, such as clean up (removal of debris, demolition of structures) and repairs, may be expensed.

• Disaster Loss Carryback - A 5-year net operating loss (NOL) carryback applies for losses resulting from a casualty within a disaster area instead of the usual 2- or 3-year carryback periods available for other types of business losses. This provision is valid through 2010.

• Section 179 Expense Increased in Disaster Areas – Through 2010, the otherwise maximum amount of machinery and equipment that may be expensed under Section 179 is increased by up to $100,000 for qualifying assets, and the investment-based phase-out of the expensing deduction is increased by $600,000.

• Through 2010 - A 50% first-year bonus depreciation allowance applies to most types of machinery and equipment bought to rehabilitate or replace damaged property.  A number of conditions must be met, and certain types of property are excluded (including property eligible for the more widely applicable 50% first-year bonus depreciation allowance enacted as part of the Economic Stimulus Act of 2008).

• Farming – There is a 5-year quick depreciation write-off for most farm machinery and equipment placed in service after 2008 and before 2010.

• Real Estate, Retailers and Restaurants - The 15-year depreciation write-off for qualifying leasehold improvements and qualifying restaurant property has been extended through 2009.  What's more, for property placed in service after 2008 and before 2010, (a) buildings as well as building improvements may qualify for the quick write-off for restaurant property; and (b) the 15–year depreciation write-off also applies to qualifying retail improvement property.

• Construction Companies - The $2,000 tax credit for building energy-efficient homes ($1,000 for manufactured homes) has been extended to apply to homes acquired through 2009.  Note that construction companies also may benefit indirectly from the extended and enhanced tax breaks for real estate, restaurants and retailers.

• Reuse & Recycling Equipment - For property placed in service after August 31, 2008, the new law permits 50% first-year bonus depreciation for qualified reuse and recycling property.  In general, this is machinery and equipment (not including buildings or real estate), along with associated property, including software necessary to operate the equipment, which is used exclusively to collect, distribute, or recycle qualified reuse and recyclable materials.  This break is not limited to businesses in the recycling industry.

• Film and TV - The option to expense up to $15 million of qualifying film and TV productions ($20 million if produced in certain low-income areas) is extended so that it applies for productions beginning before 2010; also, the qualified domestic production activities deduction has been liberalized in several ways for this industry, effective for tax years beginning after 2007.

• Motorsports Racing - The short 7-year write-off for land improvements and support facilities at motorsports entertainment complexes has been extended to apply for property placed in service before 2010.

• Oil and Gas —There are three significant changes:

(1) The otherwise available domestic production activities deduction for companies that have oil-related income will be reduced after 2009 (a complex reduction formula will apply);

(2) The rule providing that percentage depletion from marginal oil and gas wells isn't limited to 100% of income from these properties is extended though 2009; and

(3) The rules relating to foreign tax credits for the oil and gas industry have been revised for tax years beginning after 2008.

Please keep in mind that the foregoing are only highlights of changes affecting businesses in 2009.  If you would like more details, please call at your convenience.

If the decline in the real estate market or the nation’s economic downturn has caused you to lose your home by foreclosure or short sale, or you voluntarily signed the deed over to the lienholder, you will probably be faced with debt relief income. You can also have debt relief income if you had a credit card, an automobile loan, or other debt forgiven in a settlement with a credit card company or other lender. 
 
Normally, debt forgiveness results in taxable income.  But there are several provisions of the tax code that allow individuals to exclude debt relief income and thereby avoid taxes on the forgiven income.  The two exclusions that will most often apply this year are:

• Insolvent Taxpayer Exclusion — An insolvent taxpayer is one whose debts (liabilities) exceed his assets.  Tax law generally allows taxpayers to exclude debt relief income to the extent their liabilities exceed their assets.  In addition, when adding up the assets, a taxpayer does not need to include assets excluded under state bankruptcy law.  Although the concept is rather simple, inventorying and appraising assets and liabilities can be a tedious and time-consuming job.  Yet, it should be accomplished as soon as possible since valuations are based upon the assets’ values and the amount of the liabilities immediately before the debt is relieved.

• Home Mortgage Debt Relief — Under a special rule that applies to years 2007 through 2012, taxpayers can exclude from taxation up to $2 million ($1 million for an unmarried person filing separately) of home “acquisition” debt forgiven on their principal residence.  Debt forgiven on second homes, rental property, business property, credit cards, or car loans do not qualify for this special tax-relief provision. 

Whenever your debt is reduced or eliminated, you will receive a year-end statement (Form 1099-C) from your lender.  By law, this form must show the amount of debt forgiven, and if the debt relief involves a foreclosure or repossession, Form 1099-C will generally include the fair market value of the property taken back by the lender.

The information included on the 1099-C is not always correct, and it may be necessary to notify the lender immediately if any of the information shown is in error.  

If you have had debt or mortgage relief during the year, you are encouraged to contact this office right away, while more time is available, so we can determine the impact on your tax liability and explore any mitigating options before the year ends.  

The Internal Revenue Service has acknowledged the certifications by manufacturers that certain advanced lean-burn technology vehicles qualify for the alternative motor vehicle tax credit.

Before, only hybrid vehicles, fuel cell vehicles and alternative fuel vehicles had been certified, but now certain advanced lean-burn technology vehicles, which generally run on diesel fuel have been certified.  These vehicles are passenger cars or light trucks with an internal combustion engine designed to operate primarily using more air than is necessary for complete combustion of the fuel.  The vehicles also must incorporate direct fuel injection technology and achieve at least 125 percent of the 2002 model year city fuel economy rating.

Available credit amounts may vary and include a base credit amount based on fuel economy compared to the 2002 model year city fuel economy rating and an additional amount based on the vehicle’s lifetime fuel savings.  For a taxpayer to claim the credit, the original use of the vehicle must begin with the taxpayer, and the vehicle must be acquired for use or lease by the taxpayer and not for resale.

There is a limitation on the number of qualified hybrid and advanced lean-burn technology vehicles eligible for credit.  The phase-out period begins when a manufacturer sells 60,000 qualified hybrid and advanced lean-burn technology vehicles.

Taxpayers may claim the full amount of the allowable credit up to the end of the first calendar quarter after the quarter in which the manufacturer records its sale of the 60,000th hybrid passenger automobile or light truck or advanced lean-burn technology motor vehicle. For the second and third calendar quarters after the quarter in which the 60,000th vehicle is sold, taxpayers may claim 50 percent of the credit.  For the fourth and fifth calendar quarters, taxpayers may claim 25 percent of the credit.  No credit is allowed after the fifth quarter.

Neither of the manufacturers listed below have reached the phase-our periods and full credit is still available. The qualifying vehicles and their credit amounts are:

• 2009 Volkswagen Jetta 2.0L TDI Sedan manual or automatic - $1,300
• 2009 Volkswagen Jetta 2.0L TDI SportWagen manual or automatic - $1,300
• Mercedes GL 320 Blue TEC - $1,800
• Mercedes R 320 Blue TEC - $1,550
• Mercedes ML 320 Blue TEC - $900

The residential energy improvement credit has been reinstated for one year only, 2009 (this credit was last available in 2007).  In addition, the tax credit for residential solar and fuel cell equipment has been extended and expanded through 2016.  This gives taxpayers who want to “go green” a chance to offset some of the cost of going green with tax credits.  

These are two distinctly different credits with different requirements and limitations.  Because of these limitations, there are circumstances where you may not benefit from the credits.  The following is an overview of these credits.  However, before entering into any contractual arrangements to install any of these energy items, you are strongly urged to contact this office to first verify what your tax benefit might be.

• Tax Credit for Residential Energy Improvements - Energy improvements to a principal residence located in the United States and placed in service during 2009 qualify for the residential energy improvements credit.  This credit also was previously available in tax years 2006 and 2007.  Generally, the credit is the cost (up to certain limits) for qualifying heat pumps, boilers, water heaters and fans meeting specific energy-efficient standards certified by the manufacturer.

In addition, you may qualify for a credit of 10% of the cost of qualifying insulation, exterior windows including skylights, exterior doors, metal roofs coated with heat-reduction pigments and asphalt roofing with appropriate cooling granules. 

However, the total lifetime credit is limited to $500, of which no more than $200 can be for window components, $50 for an advanced main air circulating fan, $150 for a qualified furnace or hot water boiler, or $300 for any qualified central air conditioner, heat pump, or water heater.  Installation expenses do not count as part of the cost for determining the credit.

• Tax Credit for Residential Solar and Fuel Cell Equipment

o Residential Solar Equipment - For property placed in service before the end of 2016, a credit is allowed for 30% of the cost of qualifying solar water heaters, up to $2,000 per year, and a credit subject to the same limits also applies for photovoltaic (electricity-generating) solar panels but the $2,000 per year limit no longer applies after 2008.  The foregoing applies to the taxpayer’s first or second homes.

o Fuel Cell Equipment - In addition, a credit of 30% of the cost is allowed for fuel cell property, up to a maximum credit of $500 for each half-kilowatt of capacity installed per year on the taxpayer’s principal residence.

o Wind & Geothermal Energy Equipment - A 30%-of-cost credit is allowed for qualified systems placed into service before 2016.  The credit is limited to $500 for each half-kilowatt of capacity (maximum $4,000 for wind turbines and $2,000 for geothermal heat pumps).

Labor costs for onsite installation and for piping and wiring connections are qualifying costs for these credits.   However, the credits do not apply to equipment used to heat swimming pools or hot tubs. 

Credit Limitations – Although these credits can be used to offset both the regular tax and AMT, they are nonrefundable personal credits that can only reduce a taxpayer’s tax to zero, and any remaining balance is not refundable.  If the amount of the credit for the residential energy-efficient property credit (i.e., the credit for residential solar and fuel cell equipment and wind/geothermal energy equipment) exceeds the taxpayer’s tax after subtracting other nonrefundable personal credits, the excess can be carried to the next tax year and is added to that year’s allowable credit.

Check with this office first to verify the tax benefits before signing on with a contractor or salesperson.  That way your tax benefits can be determined based on your particular tax situation before you obligate yourself. 

The extended due dates for returns of calendar-year trusts and estates (1041), partnerships (1065), and certain other returns that generate form K-1s have historically been the same as for individual returns (1040).  Since these returns generally include information that is required to complete the individual returns of beneficiaries or partners, having the same extended due dates does not always give the beneficiary or the partner the ability to timely meet their filing obligation.  This can lead to a variety of penalties on the individual 1040 returns. 

New IRS regulations designed to ease this problem have shortened the extended due date for 1041 and 1065 returns by one month.  Thus, beginning in 2009, the extension period for these returns has been reduced to five months (previously six months) while the extension period for individual 1040 returns remains at six months.  This provides the 1040 filer with one additional month to complete and file individual 1040 returns.

The change will be effective for extension requests for returns due on or after January 1, 2009 and applies to any business entity filing any of the following forms:

• Form 1065 (U.S. Return of Partnership Income);
• Form 1041 (U.S. Income Tax Return for Estates and Trusts);
• Form 8804 (Annual Return for Partnership Withholding Tax)

The IRS is eliminating the same-day deadline for these returns and 1040 returns, which causes needless hardship and puts the individual taxpayer in an awkward position.  Thus, under the new rule, a calendar-year partnership’s or trust’s extended return will be due on September 15, while the partner’s or beneficiary’s extended individual return will be due on October 15.

If you feel you are unable to have the information needed to file the income tax return of a trust, estate, or partnership return on time, please contact this office to arrange for filing of extensions for both the pass-through return and your individual return.  Please keep in mind the extension is an extension to file but not an extension to pay.  Thus, the late payment penalty and interest will apply to any balance due on the individual return that isn’t paid by the original due date.  Therefore, it is important to complete the returns as quickly as possible when on extension.

Beginning in 2010, the new legislation:

(1) Eliminates the $100,000 modified AGI limit on conversions of traditional IRAs to Roth IRAs, and

(2) Permits married taxpayers filing a separate return to convert amounts in a traditional IRA into a Roth IRA. Under prior law, married taxpayers who filed separate returns were restricted from making conversions.

In addition, for conversions made in 2010, the taxpayer can choose to elect to:

a. Include the income in the 2010 return, or
b. Include one-half of the conversion income in 2011 and one-half in 2012.

Note: 2010 is the last year for the current “low” tax rates unless Congress extends them in future legislation. Thus, using the option to include the income in 2011 and 2012 may not be a good option for taxpayers that may be subject to the increased tax rates after 2010.

Planning Ahead for Roth 2010 Rollover Strategies - Looking ahead, there are some interesting strategies a taxpayer can employ to convert nondeductible traditional IRA contributions to a Roth IRA, thereby funding the more favorable Roth IRA.

• Strategy - Taxpayers who have employer plans and are restricted from making deductible traditional IRA contributions because of income level can make nondeductible traditional IRA contributions in the tax years leading up to 2010, and then convert those nondeductible traditional IRAs to Roth IRAs with virtually no tax since they were nondeductible. Only the earnings would be taxable. Taxpayers who are prohibited from making Roth IRA contributions because their income exceeds the limit may also benefit from this strategy.

• Strategy - Using the same strategy above, even a taxpayer who can make a deductible contribution can elect to make it nondeductible, providing the same result as above.

• Strategy – Generally, rollovers are thought of as transfers from a qualified plan to an IRA or from one IRA to another IRA. However, beginning in 2002, the law has allowed an IRA to be rolled (or transferred) to other qualified plans including 401(k) plans, 403(a) and 403(b) annuities and 457 governmental retirement plans (assuming the plan will accept the IRA funds). In addition, the law only allows the taxable portion of the IRA to be moved to qualified plans. For taxpayers who have mixed IRAs (including both deductible and nondeductible contributions), this provides a means to segregating the taxable and nontaxable amounts and then later converting the nontaxable portion without paying any conversion tax (except on any interim earnings). Thus, the taxable portion can be rolled into a qualified plan, leaving the nontaxable portion in the IRA where it can be converted to the Roth IRA.

• Strategy - More aggressive taxpayers with the financial resources to pay the rollover tax might also consider rolling (or transferring) the funds from a qualified plan into a traditional IRA and then converting the traditional IRA to a Roth IRA.

The amount of tax imposed on a Roth conversion will depend on a number of issues including the taxpayer’s marginal tax bracket, intended conversion amount and whether or not the conversion is made in one or multiple years. Also a factor is whether the taxpayer made deductible IRA contributions in earlier years in addition to the nondeductible contributions intended for rollover to the Roth. All of the taxpayer’s regular, SEP and SIMPLE IRAs have to be combined when determining the amount that is taxable upon conversion, so there could be unintended taxable consequences. Minimizing the conversion tax requires careful planning and strict adherence to the conversion rules.