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Save Tax on Savings Bond Interest
U.S. Savings Bonds are unlikely to ever be the stars
of the investment world. However, they come with a special tax benefit
that has helped make them attractive to a generation of savers. You can
purchase the bonds and then basically ignore them for years if you like
because unless you elect otherwise, the interest they earn isn't taxable
until the bonds mature, or are redeemed for cash. Because of this feature,
and the fact that they're considered by many to be one of the safest investments
around, millions of taxpayers have savings bonds tucked away somewhere.
However, at the bondholder's
death, one of the downsides to these bonds comes into play. Stock or mutual
fund investments are "stepped up" (or down) to their value at
the decedent's date of death so that, if the beneficiary immediately sells
the inherited asset, there is no gain or loss. However, U.S. Savings Bonds
are inherited by the beneficiary at the decedent's original cost basis
unless the decedent previously elected to include the bonds' interest
as income in the years it accrued, which is unlikely. Thus, if you cash
in a significant amount of inherited U.S. Savings Bonds, there's likely
to be substantial interest income that's going to be taxable to you at
your marginal tax rate. That's obviously not good news.
A recent Tax Court decision
explains a potential solution to this problem. The decedent's executor
can elect to include the accrued interest to the date of death in the
decedent's final return. In situations where the decedent had little
or no other taxable income in the year of death, this can substantially
lower the tax on the interest income. This option is even available in
situations where, after including the accrued interest from the bonds,
the decedent still owes no income tax on the final return, but has to
file the return to report the interest income (the return just won't show
a balance due).
Please
call us if you have any questions about how this planning opportunity
might work in your situation or about any other personal or business tax issues.
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Tax Calendar
April 17
-Besides
being the last day to file (or extend) your 2006 personal return and pay
any tax that is due, 2007 first quarter estimated tax payments for individuals,
trusts, and calendar-year corporations are due today. So are 2006 returns
for trusts and calendar-year estates, partnerships, and LLCs, plus any
final contribution you plan to make to an IRA or Education Savings Account
for 2006. SEP and Keogh contributions are also due today if your return
is not being extended.
-If
you need to file a 2006 gift tax return, it also must be filed or extended
by this date.
-If
you paid cash wages of $1,500 or more in 2006 to a household employee,
you must file Schedule H by this date, unless it is included with an extended
Form 1040. You may also have to report any federal unemployment tax paid
and any income tax you withheld for your household employees.
April 30
-If
you have employees, a federal unemployment tax (FUTA) deposit is due if
the FUTA liability through March 31 exceeds $500.
-The
first quarter Form 941 (Employer's Quarterly Federal Tax Return) is also
due today (except that you have until May 10 to file if you deposited
all taxes for the quarter when they were due).
June 15
-Second quarter estimated tax payments for individuals, trusts, and calendar year corporations are due today.
Hybrid Vehicle Credit Phase-out Continues for Toyota Brands
Sales
of Toyota (including Lexus) hybrid vehicles were brisk throughout 2006,
totaling 212,073 vehicles for the year. As a manufacturer's sales of qualifying
vehicles passes a 60,000-unit threshold, the Alternative Vehicle Credit
begins a phase-out process. The credit for Toyota brands was reduced to
50% of the original amount on October 1, 2006, and subsequently to 25%
of the original amount on April 1, 2007. The credit is completely phased
out for vehicles purchased after September 30, 2007.
The
phase-out's effect can be seen by reviewing the credit available on the
popular Toyota Prius. The original credit of $3,150 was reduced to $1,575
on October 1, 2006 and subsequently to $787.50 on April 1, 2007. No credit
will be available on the Prius after September 30, 2007 when the credit
is completely phased-out.
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Merck Settles with IRS for $2.3 Billion
Drug
maker Merck will
pay the IRS $2.3 billion to resolve several tax disputes. The settlement covers taxes, interest,
and penalties related to tax years 1993 through 2001. The primary dispute
related to a tax-saving partnership with a British bank based in Bermuda.
The
resolution is one of the largest achieved in recent years by the IRS and
a taxpayer through the examination process.
Although
large, the recent settlement with Merck was not the largest with a major drug manufacturer. Last September,
Glaxo SmithKline Holdings (Americas) Inc. & Subsidiaries agreed to
pay the IRS $3.4 billion in what was the largest tax settlement ever with
a major drug manufacturer.
Basics of the Dependent Care Credit
Many
taxpayers are eligible for the Dependent Care Tax Credit. This credit
has been in an evolutionary state for more than two decades, being tweaked
over the years by various pieces of legislation. So, we thought it might
be a good time to review some of the basics of this beneficial credit.
Depending
on the taxpayer's income, the credit ranges from 20% to 35% of the dependent
care expenses (limitations apply) paid and incurred while the taxpayer
and spouse, if married, are gainfully employed. The care must be for a
qualifying individual.
As
the taxpayer's income increases, the nonrefundable credit is gradually
reduced from 35%
to 20% of the lesser of the qualifying expenses or earned income of the taxpayer and spouse,
if married. There is also an overall limitation of $3,000 for one qualifying
person or $6,000 for two or more qualifying persons. A qualifying individual
is either a qualifying child under age 13, or a dependent or spouse who
is physically or mentally incapable of self-care and has the same principal
place of abode as the taxpayer for at least half of the year. The credit
is allowed to married taxpayers only if they file a joint return.
To
claim the credit, child and dependent care expenses provided for the well-being
and protection of a qualifying individual must be incurred to enable the
taxpayer (and spouse, if married) to work. This means if the expenses
were for household services, part of the services must have been for
the care of a qualifying individual. Thus, expenses for ordinary household
services (such as a housekeeper, maid, or cook that are necessary to run
the home qualify for the credit if part of the expenses relate to the
care of a qualifying individual.
Example:
Danielle, a single parent, pays Bea (who is over age 18 and not a relative)
to care for her child, age 10, after school in her home while she is at
work. The entire amount paid enables her to work, and thus is eligible
for the credit, even though Bea performs household services in addition
to child care. As Bea's employer, Danielle is liable for the employer's
portion of FICA if she pays wages of $1,500 or more.
Expenses
for care outside the taxpayer's home qualify for the credit if incurred
to allow the taxpayer(s) to work, and the main reasons for the expenses
are the well-being and protection of the qualifying person.
Example:
Jack places his five-year-old son in a daycare center each workday. The
center provides breakfast and lunch, as well as various educational
activities. While amounts paid for food and education generally are not
considered work-related expenses, services that are incidental to and
cannot be separated from the cost of caring for a qualifying person are
not excluded from the credit computation. Costs for care outside the home
are eligible if the qualifying individual regularly spends eight hours
or more per day in the taxpayer's household. Jack's son meets this requirement.
The
cost of a day camp or similar programs may be for the care of a qualifying
individual and an employment-related expense, even if the day camp specializes
in a particular activity.
Example:
For two weeks during the summer, Jack puts his son into a day camp sponsored
by his church. If all other requirements are met (as discussed in the
previous example), the cost of the day camp should qualify as a dependent
care expense. On the other hand, if Jack's son stays overnight at the
camp during the two-week period, the cost does not qualify as a dependent
care expense.
One
final point: a tax credit offsets your tax liability on a dollar-for-dollar
basis. So, we want to ensure that you benefit from this and any other
available credit. Please call us with any questions you might have on
the Dependent Care Tax Credit or any other individual or business tax
issue.
Potential Double Benefit from a Tax Deduction
For
most taxpayers, the amount of federal income tax they pay each year often
depends upon where they fall in the federal income tax brackets and on
the breakdown of their taxable income between ordinary (e.g., wages) and
capital gains from the sale of assets (e.g., common stock).
Taxpayers
eligible for the lower federal income tax brackets (those under 25%) on
their ordinary income can generally expect to be taxed at a rate of, only
5% (exceptions apply) on their long-term capital gains. Taxpayers finding
themselves in the 25% or higher federal income tax brackets can generally
expect to be taxed at a 15% rate (again, exceptions apply) on at least
a portion of their long-term capital gains.
So,
if it is inevitable that as our federal taxable income increases the
rate of tax we pay on at least a portion of that income also increases,
the converse should and does apply. That is, as our federal taxable income
decreases the rate of tax we pay on at least a portion of that income
will decrease. In addition, if a taxpayer has a long-term capital gain
that, after considering ordinary income, is partially taxed at the 15%
rate, any additional deduction that decreases ordinary income will simultaneously
diminish the taxation of a comparable amount of long-term capital gain
from the 15% bracket to the 5% bracket. This has the effect of producing a double benefit for that deduction as shown in the example below.
Example:
Jeff and Jani, filing jointly for 2007, have net ordinary income of $50,000
and a long-term capital gain from the sale of stock of $40,000. For 2007,
the joint rates applicable to ordinary income change from 15% to 25% at
$63,700. Accordingly, $13,700 ($63,700 - $50,000) of their long-term capital
gain will be taxed at 5% and the balance of $26,300 ($40,000 - $13,700)
is taxable at 15%. In this example, all income, both capital and ordinary,
is taxed at a rate of 15% or less.
If
Jeff and Jani contribute $8,000 to their deductible IRAs ($4,000
each for 2007), they will receive a 25% tax rate savings, even though
their highest tax bracket is 15%. The $8,000 IRA deduction reduces ordinary
income at the 15% ordinary federal tax rate, but also has the effect of
shifting $8,000 of capital gain taxation from the 15% to the 5% bracket,
for another 10% savings. This produces a total tax benefit of 25% on the
$8,000 reduction.
A
similar impact would occur for any expenditure or deduction that reduced
ordinary income (e.g., Section 179 bonus depreciation, additional interest expense,
etc.).
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