Articles by Joyces Tax Services

The famous tax gap:

The Tax Gap is the difference between
taxes owed and taxes actually collected. The
IRS estimates the Tax Gap in 2001 was $345
billion. With roughly 71% of this “gap” attributed
to individual non-compliance and errors,
Congress is putting pressure on the IRS to find
ways to bring more individual taxpayers into
compliance and collect over $245 billion in
legally owed taxes, thus, increasing revenues
without raising taxes.

Congress demands answers
In April 2007, U.S. Treasury Secretary
Henry Paulson testified before Congress that
reducing the Tax Gap may not be possible
without “draconian and painful requirements
on all taxpayers.” Senators did not receive this
news well, with Senator Max Baucas expressing
his frustration that the IRS did not have, in
his opinion, a real plan to close the Tax Gap.
Baucas requested the Treasury revise its current
plan to include benchmarks, timetables
and goals by mid-July 2007.

In a July letter to Senator Baucas,
Paulson indicated the Treasury will have
such a plan to present in “the next few
weeks.” Senator Bacucas indicated he was
fine with the delay, saying, “I’d rather the
Treasury Department take the time necessary
to get it right than to provide the
committee with an incomplete plan.”
Responsibility for the gap

The IRS estimates the majority of noncompliant
returns belong to self-employed
individuals who do not report their businesses’
entire income. One IRS official has
estimated that cash-based businesses report
as little as 19% of their actual income. As a
result, the IRS has submitted a strategy to
Congress, focusing on small businesses and
individual taxpayers. Underreporting of business
income cost the Treasury $109 billion
in income tax in 2001. By comparison, IRS
figures show it lost just $14 billion to individuals
inflating their deductions.

IRS offers possible solutions
One interesting suggestion by the IRS is to
require credit card companies to report payments
to any sole proprietor of more than
$600 in a year, similar to the 1099 reporting
rules. Proprietors would be required to provide
their tax identification numbers to the
credit card companies or face the prospect of
being subject to backup withholding.

The IRS has also acknowledged that the
complexity of our tax code is the single biggest
factor affecting taxpayer compliance. One of
their recommendations does include simplifying
the tax code, but enforcement appears to be
the plan of attack in the mean time.

The IRS also has suggested that brokerages
and other third parties boost reporting on
individuals’ investments, and they would like to
make repeat offenders who willfully fail to file
their returns eligible for a felony charge rather
than a misdemeanor.

We have certainly not seen the end of this
debate, and as tax professionals, we should
make our clients aware of potential changes
coming in the near future. l

One of the best ways to minimize your income taxes is to maximize your pre-tax contributions to a retirement savings plan. The pre-tax contribution limits for 2007 are shown below. Try to maximize your contributions this year for the double benefit of lower income taxes and higher retirement savings balances.

2007 Retirement Savings Contribution Limits

High health care costs have taxpayers considering the itemized deduction for medical expenses with renewed interest. As you may know, the deduction is limited to the amount of all your unreimbursed medical expenses that, when combined, exceeds 7.5% of your adjusted gross income (AGI). For many individuals, surpassing the 7.5% of AGI floor is getting easier. Check the list below for some of the expenses you may be able to deduct.

1. Health insurance premiums.
2. Co-pays, deductibles, and other amounts paid out-of-pocket for hospital and nursing care, visits to doctors and dentists, and prescription medications.
3. Medically necessary home improvements.
4. Long-term care insurance premiums and services (within IRS limits).
5. Transportation to receive medical treatment, as well as food and lodging en route.

Tip: Taxpayers with medical expenses close to the 7.5% AGI hurdle may want to see if they can accelerate or decelerate incurring medical expenses to "bunch" them into a single tax year for higher deductions.

Remember to collect all receipts and proof of your charitable giving. New rules apply for 2007. When it comes to deductions for your charitable donations it is now important to practice:

Less Cash. Try to replace cash contributions with payments by check or credit card to create a record.

Receipts. If you give cash, ask for receipts from the charitable organization.

Qualified Organizations. Always make sure the charitable organization is an IRS qualified charity. If in doubt, ask the charity.

Non-cash Giving. Non-cash donations of household goods and clothing must now be in good or better condition for deductibility. Take pictures of your donated items and list them individually, then attach these to the receipt received from the charity.

Vehicle Donation. If you donate a vehicle be sure you know what the charity will do with it. If they sell it without using it or fixing it you may only deduct the amount they receive for the vehicle. You may use the "fair market value" of your vehicle if the charity uses the vehicle to serve the charity’s purpose or substantially improves the vehicle and then sells it.

Donate Your IRA. If you are over 70 1/2 and have to make a minimum distribution from your IRA you may want to consider donating some or all of the distribution depending on your needs. For 2007, IRA distributions directly to a qualified charity are tax free and will not be counted as income on your return which may lower your taxes even more. You won’t be able to deduct the contribution, however.

Mileage. Keep a log of any driving you do in connection with charitable and volunteer work. You can deduct either your actual expenses or $0.14 per mile plus parking and toll charges.

The income brackets for each tax rate are:

Listed here for your reference are key deduction rates for 2007.

Personal Exemptions

The personal exemption for each qualifying dependent increases by $100 for 2007.

The exemption phases out by 2% for each $2,500 ($1,250 for married filing separately) by which your income is over:

2007 Alert: This phaseout amount is now reduced by 1/3 in 2007.

Standard Deductions

Standard deductions for those who do not itemize are as follows:

If 65 or over and/or blind add:

Itemized Deduction Phaseout

Deductions are reduced by 3% of every dollar of Adjusted Gross Income (AGI) over $156,400 ($78,200 if married filing separately) up to a maximum phaseout of 80% of your itemized deductions. Your medical expenses, investment interest, casualty losses and gambling losses are excluded.

2007 Alert: The phaseout amount noted above is now reduced by 1/3 in 2007.

Standard Mileage Rates

The standard mileage rates for 2007 are:

In addition to the preprogrammed changes discussed and charted to the right, three federal tax laws passed in 2006 could result in substantially more tax savings when your 2007 tax return is filed. Here is a summary of some important changes for 2007 that apply to many clients:

Income Limits Up for Student Loan Interest Deduction.

For 2007, up to $2,500 of interest you pay on qualified higher education loans may be deductible. The amount of the student loan interest deduction is phased out if your modified adjusted gross income (MAGI) is between %55,000 and $70,000 (between$110,000 and $140,000 if married filing jointly).

Income Limits Up for Hope and Lifetime Learning Credits.

In 2007, the amount of your hope ($1,650) or Lifetime Learning ($2,000) credit is phased out (gradually reduced) if your modified adjusted gross income (MAGI) is between $47,000 and $57,000 ($94,000 and $114,000 if you file a joint return). Married filing separately may not qualify for these credits.

Adoption Benefits Increased.

The maximum adoption credit for 2007 has increased to $11,390. Also, the maximum exclusion from income for benefits under your employer’s adoption assistance program has increased to $11,390. These amounts are phased out if your modified adjusted gross income is between $170,820 and $210,820. You cannot claim the credit or exclusion if your income is $210,820 or more.

Increase in Deductible Limit for Long-Term Care Premiums.

For 2007, the maximum amount of qualified long-term care premiums you can include as medical expenses, up to the amounts charted here:

Long Term Care Premium Deductibility

*note: The limit is for each person.

Mortgage Insurance Premiums.

For 2007 you may deduct mortgage insurance premiums you pay during the year if they are related to taking out a new mortgage loan in 2007 to either finance or refinance the purchase of your home. The amount you can deduct is reduced by 10% for every $1,000 ($500 if your filing status is married filing separately) by which your adjusted gross income exceeds $100,000 ($50,000 if your filing status is married filing separately).

Two major Federal Tax Bills were signed into law during 2006 - The Tax Increase Prevention and Reconciliation Act (TIPRA) and The Pension Protection Act (PPA). Together with other scheduled 2006 changes, these bills will result in billions of dollars of tax provisions for individuals and corporations. The key laws that could impact are:

Kiddie-Tax Expands. Until recently, the Kiddie tax meant some of a chile’s unearned income got taxed at the parent’s higher rate until they reached 14 years old. But the rule now applies to children’s unearned income until they hit 18 and although the change was enacted in May, the law is retroactive to January 1, 2006.

Caution: Parents who transfer appreciated stock to their 14-year-old this year anticipating lower tax rates on gains could be facing a tax hit three times higher (15% versus 5%) than expected.

Split Refund Deposits. You may now have your federal tax refund directly deposited into as many as three accounts. Simply provide deposit instructions with your tax filing information.

Charitable Contributions. The IRS is cracking down on frivolous charitable deductions. All cash contributions will now require a cancelled check or receipt from the qualified charity.

Non cash donations of clothing and household items must now be in good or better condition.

But there is some good news as well. Retirees over 70 1/2 can contribute funds to public charities directly from their IRAs in 2006 and 2007 (avoiding some ordinary income tax).

Federal Long Distance Excise Tax Credit. Based on the repeal of the 3% excise tax on long distance telephone calls retroactive to February 28, 2003, you will receive a standard credit depending on the number of personal exemptions claimed on your return from $30 to $60. You may claim a higher credit if you can provide telephone receipts showing the actual excise tax paid.

Energy Credits. There are two new residential energy credits and a new alternative fuel vehicle credit in 2006. If you installed new energy efficient property (AC, water heater, air circulatory fans, furnace, solar system, window or doors) OR purchased a new hybrid vehicle you may be entitled to a credit on your return this year.

Military. Reservists may now take penalty free withdrawls from retirement plans if called to active duty for 180 days or more. Combat pay may be considered income for purposes of making IRA contributions. This change is provided retroactively to 2004. Contributions via amended return filing could yield refunds.

Retirement Plans. All of the higher contribution levels for retirement plans such as IRA’s, Roth IRA’s, Roth 401(k), 401(k), 403(b), 457, SIMPLE, including the "catch-up" contribution for age 50 and over are permanent.

Qualified Tuition Plans (529 Plans). This temporary college savings plan is now permanent and won’t expire in 2010 as scheduled.

Higher AMT Exemptions. The Alternative Minimum Tax income exemption amounts are raised to $62,550 for married joint filers and $42,500 for singles in 2006.

Lower Capital Gain and Dividend Rates Extended. The soon-to-expire reduced tax rates of 5% and 15% for capital gains and dividends are extended through 2010.

Each year taxpayers claim a variety of tax credits for which they are eligible. Tax credits are valuable because they are a dollar-for-dollar reduction of taxes owed.

1) The Earned Income Tax Credit is a refundable credit for low-income working individuals and families.

2) The Child and Dependent Care Credit is for expenses paid for the care of children under age 13, or for a disabled spouse or dependent.

3) The Child Tax Credit is for people who have a qualifying child. The maximum amount of the credit is $1,000 for each qualifying child in 2006.

4) The Adoption Credit is a tax credit of up to $10,960 in 2006 for qualifying expenses paid to adopt a child.

5) The Credit for the Elderly or the Disabled is a credit available to individuals who are either age 65 and retired on permanent and total disability.

While the numerous credits make filing taxes complex, rest assured a full review will ensure you receive all the "credits" you deserve.

Most tax deductible expenses are incurred and deducted against your income in a single tax year. There are several deductions, however, that you can carry from one year to the next. Capital Losses, Business Losses and Charitable Contributions are three common examples.

Capital Losses: You can carry forward a capital loss from the sale of stocks or other securities until they are used up or until the day you die. Capital losses can be used to offset any capital gains you may have in the current year. You can then use up to $3,000 of a capital loss each year to offset regular income. If your capital losses are greater than your capital gains plus $3,000 of income, you can carry forward what remains to offset gains and income in future years.

Business Losses: These losses usually apply to self-employed clients. Business losses can be carried back two years or forward for twenty years. One of the reasons for the generous carry back and carry forward deductibility is the recognition a self-employed person who has a net loss for the year may need cash fast. That person can file amended returns and secure a quick refund for taxes paid in the prior two years. Then any remaining losses can offset income in the current year and future years until exhausted.

Charitable Contributions: Your annual charitable contributions may only be deducted up to an amount equal to a percentage (20-50%) of your adjusted gross income. Should your contributions ever exceed this level you will be able to carry the remainder of the contributions forward to offset taxable income over the next five years. If you think you have a carry forward or carry back deduction, please call to discuss your situation and appropriate next steps.