RSM Resources

The spring tax-filing season may seem far off, but starting now toplan for your 2006 corporate and individual tax positions could provean effective strategy for reducing your overall tax bill. Effective taxplanning also can help increase your company’s cash flow and enhanceshareholder value.

Tax planning can be a year-long task, soit’s never too early to give your taxes a once-over, especiallyregarding two new provisions Congress passed and President Bushrecently signed: the Tax Increase Prevention and Reconciliation Act of2005 (TIPRA) and the Pension Protection Act of 2006 (PPA).

TIPRAaffects a broad cross-section of taxpayers. It extends thecontroversial dividend and capital-gains tax-rate cuts for two yearsbeyond 2008, gives taxpayers immediate relief from the alternativeminimum tax (AMT), extends small-business expensing thresholds, andgives high-income taxpayers the opportunity to convert retirementsavings to Roth individual retirement accounts (IRAs).

Lawmakersintended PPA to fix outdated pension laws that present risks totaxpayers, workers and retirees. It also encourages greaterparticipation in 401(k) and other defined-contribution retirement plansand makes permanent several other reforms to those plans that were setto expire over the next several years.

With the latest taxchanges in mind, tax professionals at RSM McGladrey suggest thefollowing tips for realizing your tax savings. For a more detailedaccount of recent tax changes and their effect on your business andpersonal tax liabilities, consult a tax advisor.

Business tax tips

Annual expensing election. Beforeclaiming your company’s tax depreciation, check to see if you can writeoff certain qualified fixed-asset purchases — such as furniture,equipment, computers and off-the-shelf software — under the Section 179annual expensing election rather than through depreciation over five orseven years. Since 2003, Congress has enhanced small-business expensingunder Section 179 several times to encourage business investment. TIPRAcontinues this special treatment. The maximum amount a taxpayer mayexpense is $100,000 of the cost of qualifying property, less the amountby which the cost of qualifying property exceeds $400,000. For 2006,the maximum qualifying expenses are indexed to $108,000 and $430,000,respectively. Without the extension, the expensing limit would havedropped to $25,000 on a $200,000 cap after 2007.

Cost-segregation study. Ifyou constructed, acquired, expanded or remodeled a building in recentyears, consider a cost-segregation study, which can identify possibletax savings. Businesses typically depreciate buildings over 39 years,but they can depreciate certain costs, including those associated withparking, landscaping, signs and equipment, over shorter periods. Thestudy will identify not only current-year costs you can depreciate overshorter periods but the depreciation you should have taken on assetsyou acquired in earlier years, with the cumulative adjustment allowedas a deduction in the current year. In one case — a $2.6 millionmanufacturing construction project — a business could depreciate morethan $1 million in costs early, resulting in a tax savings of $190,000.

Corporate status. When it comes to taxes, somecompanies, especially startups, may find it beneficial to convert to anS corporation. In general, an S corporation does not pay income taxes.Instead, the income, losses, deductions and credits pass through toshareholders. S corporations have other benefits as well. You maydeduct interest you incur in order to purchase S-corporation stock asan investment interest expense. When it comes to selling your Scorporation, your taxable gain on the sale may be less than it would beif the business had been a C corporation. For your business to qualifyas an S-corporation, it must be a U.S. company, offer just one class ofstock, and include no more than 100 shareholders who are all U.S.citizens or residents and are not partnerships or other corporations.

Telephone excise-tax repeal.Thanks to a series of court cases, tax refunds may result from a108-year-old tax on long-distance telephone service, originally createdto fund the Spanish-American War. In addition, the federal governmentwill refund about $13 billion in taxes collected on telephone billsover the past three years. The maximum refund taxpayers can claimwithout producing old telephone bills ranges from $30 for a singletaxpayer to $60 for a family of four. Businesses willing and able toproduce old telephone bills may be eligible for refunds worth hundredsof thousands of dollars.

Excess inventory. Tonail down a deduction for excess or slow-moving inventory, you mustdispose of it or hold it for sale at a substantially reduced pricewithin 30 days of year-end.

Skillful accounting. Accountingmethods deal with issues such as the recognition of income andexpenses, valuation of year-end inventory, capitalization of certainexpenses, treatment of prepaid expenses, and much more. By modifyingyour company’s accounting methods, you might find opportunities forsignificant tax deferrals and current-year tax reductions. Some methodchanges are automatic, while others require prior IRS approval.

The basics. If you have bad debt,write off those receivables to lower your income. If you have a Ccorporation with excess cash, consider making a dividend payment.Through 2010, the tax rate on dividends was lowered to 15 percent.

Tips for individual taxes

Standard versus itemized deductions. Compare your2006 standard deduction with your itemized deduction. If your itemizeddeductions exceed your standard deduction, you will save tax dollars byitemizing. If your itemized deductions are close to your standard,consider shifting some of them from one year to the next. For example,if you can’t itemize in 2006 but can in 2007, consider making yourannual charitable donation in January instead of December.

Protection from the alternative minimum tax. ThroughDec. 31, 2006, Congress lifted the curse of the alternative minimum tax(AMT) from some 15 million taxpayers, many of them middle class. TheAMT exemption amount increases to $62,550 from $58,000 for joint taxfilers and to $42,500 from $40,250 for single taxpayers. Additionally,the law also offers these taxpayers protection from the AMT if theyalso claim several nonrefundable personal credits, including thedependent-care credit, the credit for the elderly and disabled, thecredit for interest on certain home mortgages, the Hope credit forcertain college expenses, and the Lifetime Learning credit.

Reduced rates on long-term capital gains and qualified dividends. Long-termcapital gains and dividend income are taxed at a maximum rate of 15percent through 2008. For taxpayers in the 10 percent and 15 percenttax brackets, the tax rate is 5 percent through 2007 and zero in 2008.TIPRA extends the rates effective in 2008 through 2010. Without action,these rates would have increased after 2008.

Retirement plans.One way to effectively lower your taxable income is to contribute to oropen a retirement plan, such as a 401(k), 403(b), deductible IRA,SIMPLE IRA or simplified employee pension (SEP). Make contributions for2006 until Dec. 31, 2006, for 401(k)s and 403(b)s. With some plans, youhave until tax-filing day, April 17, 2007, to contribute, or later ifyou extend your return. Check with a tax professional to determine thebest move for you. The 2006 limits are: up to $15,000 for 401(k)s; upto $10,000 for SIMPLE IRAs; up to $5,000 for 401(k) catch-upcontributions (for those older than 50); up to $4,000 for traditionaland Roth IRAs; and up to $1,000 for traditional and Roth IRA catch-ups(for those older than 50).

You may be making elections nowfor your 2007 retirement savings. If you participate in a 401(k) plan,you should verify whether that plan provides for Roth 401(k) savings.If so, you need to decide whether you would be best served by makingpre-tax contributions that will be taxable upon withdrawal from atraditional 401(k) plan or after-tax contributions that you canwithdraw tax-free from a Roth 401(k).

Direct rollovers from retirement plans into Roth IRAs. Beginningin 2008, you can make a direct rollover from your retirement plan intoa Roth IRA. This new Roth conversion privilege will be available formoney coming out of qualified retirement plans, such as 401(k)s,Section 403(b) tax-sheltered annuity arrangements and governmentalSection 457 plans. Under the current Roth conversion rules (which willcontinue to apply through 2007), it takes a two-step procedure toconvert from a retirement plan to Roth status. You must first roll overthe funds into a traditional IRA. You then convert the traditionalaccount into a Roth account. Of course, you’ll have to pay any taxes onfunds you convert to Roth status — but that will be the last time youpay taxes on those Roth funds, assuming you follow the rules. Andthere’s another fly in the ointment: For 2008 and 2009, you’ll beineligible for the Roth conversion privilege if your modified adjustedgross income exceeds $100,000. Starting in 2010, however, the $100,000limitation is scheduled to disappear. So everyone will eventuallyqualify for Roth conversions, regardless of income.

Donations directly out of IRAs for seniors. Ifyou’re 70 1/2 or older, you can contribute otherwise taxable amountsyou withdraw from a traditional IRA or Roth IRA directly to tax-exemptcharities. These "qualified charitable distributions" are free fromfederal income tax. However, since tax-free treatment equates to a 100percent write-off, you can’t claim any itemized deduction for aqualified charitable distribution. A qualified charitable distributionmeans your IRA trustee makes a payment directly to a qualified publiccharity; the money cannot pass through your hands. The new rule appliesfor 2006 and 2007, but you cannot donate more than $100,000 in one year.

Direct deposit of tax refund into IRA. Startingwith 2007 Form 1040, you can directly deposit all or part of yourfederal income-tax refund into your IRA, or your spouse’s IRA if youfile jointly.

Charitable contributions. Peoplewho wish to make a charitable donation and who own stock that has risenin value should consider donating appreciated property rather thancash. The full fair-market value of the stock will be deductible as acharitable contribution on Schedule A. In addition to enjoying theimproved cash flow and tax deduction, you will avoid paying tax on theunrealized stock gain. Another bonus: Donating clothing and householdgoods to charities before Jan. 1, 2007, is not just a good deed, it’salso deductible on your 2006 return. Be sure to get a receipt from theorganization you’re supporting, and keep in mind that deductions arelimited to the items’ current fair-market value.

Documentation of cash donations. In2007, you’ll no longer be allowed to write off contributions of cash,checks or other monetary gifts without a bank record (for example, acanceled check) or a written statement from the charity. The existingrule that requires you to obtain receipts for cash donations of $250 ormore remains in force. Smaller cash donations will fall under the newrule. Once the new rule takes effect, you won’t get any write-offs forundocumented cash contributions (such as money placed in churchcollection plates and cash dropped into Salvation Army pots).

Planned wealth transfer. It’salso recommended that you plan well in advance how you intend todistribute your assets to your children, grandchildren or others.Current law allows individuals to make annual giftsup to $12,000 to each individual recipient without being subject togift tax. A husband and wife can transfer up to $24,000 per recipient.To be eligible for this annual exclusion, the gift must constitute apresent interest in an asset. An unlimited exemption is available foreducation or medical expenses paid on behalf of an individual — as longas the payments are made directly to the service provider. This allowsyou to minimize your taxable estate without incurring gift taxes. Youcould also consider establishing tax-free savings accounts, also knownas qualified tuition programs or state-sponsored Section 529 plans, tosave for the college expenses of your children or grandchildren. Yourcontribution can qualify for the $12,000 annual gift-tax exclusion($24,000 for gifts by married couples).

Taxpayer-friendly rules for Section 529 plans. Thetaxpayer-friendly federal tax rules for Section 529 plans were enactedin 2001, but they were scheduled to expire after 2010. PPA makes theexisting rules permanent, including federal-income-tax-free treatmentfor qualified Section 529 plan distributions. However, the new law alsogives the IRS authority to issue "anti-abuse" rules to preventtaxpayers from using Section 529 plans in tax-saving strategies that gobeyond what Congress intended. For example, the government doesn’t likethat taxpayers use Section 529 accounts to avoid estate taxes whileretaining control over how they use the funds.

"Kiddie" tax.Under current law, children are taxed on their unearned income (such asinterest, dividends and capital gains) at their parent’s tax rate,which is usually higher than what they would pay based solely on theirincome. The kiddie tax applies if the child is younger than 4, thechild has net unearned income greater than $1,700 and the parent canclaim the child as a dependent. TIPRA raises the age limit 17.