When it comes to your taxes, good records are the best protection you can have if the government decides to audit your returns. But just as important as your effective recordkeeping are the measures you take to make certain that your records are kept safe. While it may cause a chuckle to picture a mythical taxpayer confessing to an IRS auditor that tax records were destroyed by the family pet, it probably wouldn’t be nearly as funny to give a similar response in a real audit of your own.

The Advantage of Good Records:

• A good set of records can help you cut your taxes. Detailed records reduce the chance that you will overlook deductible expenses when your tax return is prepared. After all, how many people remember the exact details of their expenditures months after the fact? Nothing is more frustrating than knowing you incurred deductions yet not being able to prove them. The ultimate consequence of poor recordkeeping is enforced payment of more tax than the law requires.
  
  
• Explicit records provide the best assurance of a favorable outcome if you are audited. Oral testimony alone is seldom enough to prove the deductions you claim on your tax return—auditors want to see a paper trail of receipts, logs, etc.
  
  
• When you’re missing adequate backup records, it can cost a great deal in time and effort to get duplicates. The unfortunate fact is that many businesses balk at hunting down receipts for past sales (you can’t really blame them since it raises their expenses). Your ongoing recordkeeping effort is your best remedy to counteract this problem.
  
  
• Good records help others who might have to handle your financial affairs in an emergency — e.g., an illness. The better your records are, the easier it could be for someone else to temporarily “step into your shoes” to handle your monetary transactions.
  
  For those with business phones, the actual amount of the excise tax must be determined for the rebate purpose. Thus, business returns (including Schedule C returns) must base their rebate on actual excise tax changes from the phone bills. And since the excise tax was originally deducted as a business expense (it was included in the phone expense deduction), the rebate will be taxable income in the subsequent year.

Tracking Income

How you track your income is largely dependent on the type of income you are receiving. For certain kinds of income, you will receive statements from the income payers to tell you the amount. These statements are called “information returns” by the IRS. Examples include:

Type of Income	Type of Information Return
Wages Pensions/IRAs Interest Dividends Stock Sales Real Property Sales Miscellaneous Income (e.g., rent, prizes, non-employee payments) Gambling Winnings Unemployment Comp Tax Refund Canceled Debts	Form W-2 Form 1099-R Form 1099-INT Form 1099-DIV Form 1099-B Form 1099-S Form 1099-MISC Form W-2G Form 1099-G Form 1099-G Form 1099-A, Form 1099-C

Be sure to keep information returns you receive in a safe place so that the amounts reported on them can be shown accurately on your tax return. Payers must submit the data to the government as well as to you. The IRS will compare what they have received with your return to see that your reporting and their data match. If there’s a mismatch, you will get a letter asking ‘Why?’ or assessing additional tax. Since the IRS may misinterpret return reporting, check carefully before paying any extra tax they try to assess!

Income from Other Sources

Income not traceable to information returns also needs to be reported on your tax return. It could include such items as:

• Receipts from a self-employed business,
• Rental income,
• Interest income on a personal loan.

Taxpayers who receive income from sources like these have a more complicated job in tracking it. It’s recommended that you record it in a separate ledger or through a computer spreadsheet program. In addition, you may want to deposit the funds in a separate bank account earmarked for that income alone.

Getting Organized

No one method is the only way to maintain your records. What’s important is to develop a system that is the most convenient and comprehensive for your situati n, and then to stick to it. The IRS estimates that a taxpayer who files a 1040 return with itemized deductions, dividend or interest income, and some stock sales will spend about eight hours doing recordkeeping. For a more complex return, such as one with rental properties or self-employment income, add at least another three to six hours. The following suggestions may help you organize your records, and also reduce the time you spend doing so.

Decide first if you will maintain your records manually or by computer.

• Bookkeeping software - Some taxpayers, even though they aren’t operating a business, choose computerized “bookkeeping” software that uses their check register data to track their income and expenses by category. Monthly and yearly reports conveniently recap the income and expenses, especially if the accounts (income and expense categories) are consistent with how the information is reported for tax purposes.
  
  
• Spreadsheet method - In lieu of purchasing bookkeeping software, a spreadsheet file (for example, in Excel) may be set up where you record your yearly income and expenses by tax return category. If you normally itemize your deductions, set up a separate sheet for each of the major deduction categories – medical, taxes, contributions, etc. – as found on Schedule A . For medical expenses, for example, record each expense by provider ’s name, type, date, amount paid, and payment method. Note medically related auto mileage at the same time. At year’s end, sort income and expenses of the same type together to get a yearly total. For income items, a cross-check from the spreadsheet to the 1099 forms for all bank interest or other income sources is an accurate way to verify that all needed 1099s have been received. If your tax advisor gives you a “tax organizer” to help you prepare for your appointment , you can quickly transfer the totals from your spreadsheet to the organizer, or, instead, you can provide your advisor with a copy of the spreadsheet.
  
  
• Manual lists - If you keep track of your records manually, the same type of system applies as for a spreadsheet, except you’ll set up a paper sheet for each category of income and expense that you normally have on your tax return. Write each payment you receive or expense you incur on the applicable list. At the end of the year, each list is ready to be totaled. If you make your entries no less frequently than monthly, you’ll find that the overall time you spend will be less, and the accuracy of the information will be greater, than if you wait until just before your tax appointment to put together the year’s lists.

Methods for retaining source documents - In addition to your lists of income and expenses, the receipts, canceled checks, credit card slips, income statements, etc., that back up the amounts need to be retained in case your tax return is audited. This is true whether you computerize or manually summarize your data. Choose from the following methods the one, or combination of methods, that suits you best:

• Envelopes – Using several blank envelopes, write the tax year and names of the income and expense categories that correspond to your spreadsheet or manual list of accounts. After you’ve recorded an item on your list, insert the corresponding receipt, canceled check, etc., into the envelope. By storing the source documents by category throughout the year, instead of throwing all of them in a box to get to “later,” you’ll not only save time but considerable frustration if you must search for a particular item. There is also less likelihood that a receipt or other document will be lost. Store the envelopes in a larger master envelope or box.
  
  
• File folders – Some taxpayers prefer to use file folders labeled by income and expense categories. These work well for manually maintained records, as the lists can go right in the folders along with the substantiating receipts, checks, credit card slips, etc. Small-sized receipts should be taped or stapled to a letter-sized sheet of paper to prevent them from falling out of the folder.
  
  
• Binders – A binder, set up with dividers labeled by income and expense categories, is also useful for keeping your lists and paper records. three-hole plastic sheet protectors are convenient for keeping source documents together by category in the binder(s). Binders are especially useful for filing monthly or quarterly brokerage or bank account statements.

Start now – If you aren’t already in the habit of keeping your records organized and maintaining them contemporaneously, start now! The effort will be worth it in time saved when you prepare for your next tax return preparation appointment. And most likely your records will be more accurate than they’ve ever been before.

Knowing When to Discard Records

Taxpayers often question how long records must be kept and how long the IRS has to audit a return after it is filed. ANSWER: It all depends on the circumstances! In many cases, the federal statute of limitations can be used to help you determine how long to keep records. With certain exceptions, the statute for assessing additional tax is 3 years from the return due date or the date the return was filed, whichever is later. However, the statute of limitations for many states is one year longer than the federal. The reason for this is that the IRS provides state taxing authorities with federal audit results. The extra time on the state statute gives states adequate time to assess tax based on any federal tax adjustments.

In addition to lengthened state statutes clouding the recordkeeping issue, the federal 3-year rule has a number of exceptions:

• The assessment period is extended to 6 years instead of 3 if a taxpayer omits from gross income an amount that is more than 25 percent of the income reported on a tax return.
  
  
• The IRS can assess additional tax with no time limit if a taxpayer: (a) doesn’t file a return; (b) files a false or fraudulent return in order to evade tax, or (c) deliberately tries to evade tax in any other manner.
  
  
• The IRS gets an unlimited time to assess additional tax when a taxpayer files an unsigned return.

If no exception applies to you, for Federal purposes, you can probably discard most of your tax records that are more than 3 years old; add a year or so to that if you live in a state with a longer statute.

Examples:
Sue filed her 2004 tax return before the due date of April 15, 2005. She will be able to safely dispose of most of her records after April 15, 2008. On the other hand, Don filed his 2004 return on June 2, 2005. He needs to keep his records at least until June 12, 2008. In both cases, the taxpayers may opt to keep their records a year or two longer if their states have a statute of limitations longer than three years. Note: If a due date falls on a Saturday, Sunday or Holiday the due date becomes the next business day.

Important note:
Even if you discard backup records, never throw away your file copy of any tax return (including W- 2 s ). Often, the return itself provides data that can be used in future return calculations or to prove amounts related to property transactions, social security benefits, etc.

Records to Keep Longer than 3 Years

You should keep certain records for longer than 3 years. These records include:

• Stock acquisition data. If you own stock in a corporation, keep the purchase records for at least 4 years after the year you sell the stock. This data will be needed in order to prove the amount of profit (or loss) you had on the sale.
  
  
• Stock and mutual fund statements where you reinvest dividends. Many taxpayers use the dividends they receive from a stock or mutual fund to buy more shares of the same stock or fund. The reinvested amounts add to basis in the property and reduce gain when it is finally sold. Keep statements at least 4 years after final sale.
  
  
• Tangible property purchase and improvement records. Keep records of home, investment, rental property, or business property acquisitions AND related capital improvements for at least 4 years after the underlying property is sold.

Homeowners Receive Big Tax Breaks

Home ownership can provide you with several important tax benefits…

• Deductions for real estate taxes and home mortgage interest, and
  
  
• Gain exclusion if you meet certain occupancy and holding period requirements.

In fact, tax breaks are probably one of the biggest reasons you decided to buy your home in the first place. Unfortunately, some homeowners lose getting the most from their home’s tax advantages because they aren’t aware that certain limits apply. The purpose of this brochure is to highlight how you as a homeowner can best keep your home’s favorable tax edge.

Your Home's Basis

The amount of the gain exclusion permitted under current tax law tends to make most taxpayers forget about keeping track of their home improvements. Don’t forget, inflation will take its toll, and in a few years the exclusion limits may not be as significant as they are today or the law may change again. In either case, it may be appropriate to keep a record of the improvements on your home.

Once you buy a home, you need to begin keeping records related to your home’s “ basis,” i.e., the amount you have spent on the property. If you acquired your home through purchase, your basis is what you paid for it originally, including purchase expenses PLUS improvement costs you incur while you own it. Keeping track of basis is extremely important in order to accurately report gain or loss if you decide to sell.

For the purpose of computing basis, it’s important to distinguish between “improvements” and repairs; only improvement costs add to your basis. Minor repairs like replacing faucet washers, painting a bedroom or patching a hole in the roof don’t need to be tracked. In general, improvements are of a more permanent nature than repairs. They enhance the value of your home and are likely to last more than one year. If you make the same improvement more than once, only the most recent improvement adds to your basis.

You should log costs of items like the following in a home improvement record (be sure you keep your backup receipts and canceled checks):

Room additions New driveway Fence Sprinkler system Exterior lighting Intercom Storm windows/doors Central vacuum Central air Filtration system Wiring upgrade Soft water system Built-in appliances Bathroom upgrade Wall-to-wall carpet

Landscaping Walkways Retaining wall Swimming pool Satellite dish Security system Roof Heating system Furnace Light fixtures Water heater Insulation Kitchen upgrade Flooring

Whenever there’s doubt about whether an expenditure qualifies as an improvement, make a note of it in your record anyway. That way, the ultimate decision of qualification can be made later when (and if) you decide to sell.

Deductions Related to Your Home

Certainly not all costs related to your home are deductible. For example, unless you use your home for business (e.g., you have an office in your home), costs for insurance, repairs, utility costs, condo fees, etc., aren’t deductible.

However, you generally will be able to deduct:

• REAL ESTATE TAXES
• HOME MORTGAGE INTEREST

Keep in mind, however, that home mortgage interest deductions can be limited. Generally, you can deduct the interest from mortgages up to one million dollars on a combination of your first and second homes, provided they were the original loans. As the principal on these loans is paid down, the reduced loan amount becomes the new limitation. If you were to later refinance the home for more the remaining balance on the original loan, the excess would have be used for home improvements or qualify under the provisions that allow a taxpayer to borrow up to $100,000 in home equity. If not, a portion of the interest would not be deductible.

The additional $100,000 of home equity can be borrowed from the primary residence and a second home. When used wisely, the $100,000 equity loan can be used to finance other purchases where the interest expense would normally not be deductible. An example of this would be a personal vehicle.

Equity debt interest is not deductible for Alternative Minimum Tax (AMT) purposes, so taxpayers who are taxed by the Alternative Minimum Tax (AMT) should consider carefully whether or not to incur home equity debt.

Because of the current strict home mortgage deduction limits and the complicated tax rules associated with this tax deduction, be sure to review any home financing plans with your tax advisor before finalizing loan deals.

Points:

A question often comes up about the deduction for points on a home loan. Points are another name for prepaid interest – they may be called loan origination fees or some similar term. One point equals 1% of the loan amount. When points are paid for services a lender provides to set up a loan, the points aren’t deductible. However, when the points are paid as a charge for the use of money, the following rules apply:

• As a general rule, points are only deductible over the life of a loan. Say, for example, you paid $3,000 in points on a 30-year refinance loan. Your tax deduction would be limited to $100 a year ($3,000/30 years). If you decided to pay your loan off early, say after 15 years, you could write off the balance of the points ($1,500) in that year.
  
  
• An exception to the general rules lets you deduct in full, points you pay in connection with obtaining a mortgage to purchase, construct or improve your main home.
  
  
• Seller-paid points can even be deducted by a home buyer, but the amount deducted reduces the home’s basis.

Reporting Gains/Losses

Exclusion of Gain:

When you sell your principal home at a gain, you can exclude all (or a portion) of the gain if you meet certain occupancy and holding period requirements. To qualify for this exclusion, you must have owned and occupied the residence for two out of the prior five years. If you meet those qualifications and are filing a joint return with your spouse, you may exclude up to $500,000 ($250,000 for a single individual) of gain from the sale.

If you do not qualify for the exclusion, there is no deferral privilege and the gain is fully taxable.

NOTE: A second home, such as a mountain cabin or lake cottage, doesn’t qualify for the exclusion of gain.

Previously Postponed Gain:

Under prior tax law (generally pre-98), gain from the sale of a principal residence could be deferred into your replacement residence. Those gains were accumulated from home to home as long as each replacement home cost more than the adjusted selling price (i.e., sales price less expenses of sale and pre-sale “ fix-up” costs) of the previous home. Although gain deferral from a principal residence is no longer permitted under current law, the gains deferred under prior law into a home currently being sold must be accounted for.

Sales at a Loss:

Losses from the sales of business or investment properties are normally tax-deductible. However, a loss from the sale of your main home is considered personal in nature and therefore, unless the law changes, it is not allowed as a deduction. This rule also applies to second homes.

Reporting the Sale:

You need to report a home sale even if there is no tax due on the transaction. You will probably receive Form 1099-S showing the gross proceeds from the sale. The IRS will also receive this information and will match the amount to what’s on your return. If there’s a mismatch, you could receive a letter from the IRS asking why there’s a difference.

Exclusion Qualifications

Under prior law. . . (generally pre-98), individuals were entitled to a once-in-a-lifetime exclusion of gain from the sale of their principal residence. To qualify for that exclusion, the taxpayer or spouse must have reached the age of 55 prior to the sale and they must have resided in the home for 3 of the prior 5 years. Having exercised that exclusion does not bar a taxpayer from qualifying for the current law exclusion.

Under current law… there is no age requirement associated with the exclusion. The period of time the home must be owned and occupied as a principal residence has been reduced to 2 out of the past five years. In addition, the exclusion amount has been raised to $500,000 for couples filing jointly and $250,000 for other individuals. The once-in-a-lifetime limitation has been deleted, thus permitting taxpayers to exclude a gain every two years if they meet all of the other conditions.

CAUTION: Prior law included a provision for the deferral of gain allowing taxpayers to avoid taxation on a gain that was not excludable if their replacement residence met certain qualifications. The new law contains no deferral provisions, thus any gain not excludable is immediately taxable.

CAUTION - FIVE-YEAR HOLDING PERIOD: If you originally acquired the home you intend to sell by means of a tax-deferred exchange (sometimes referred to as a 1031 exchange), the required ownership period to qualify for the home sale exclusion becomes five years as opposed to the normal two years.

SPECIAL MILITARY RULES: Generally, the five-year qualification period for the 2-out-of-5-year use test can be suspended for up to 10 years for persons on qualified extended duty in the U.S. Armed Services or the Foreign Service. Please call this office for more details.

Tax Planning and Your Home

The information outlined here is only a brief overview of the tax rules involving home ownership. Since the rules are complicated, if you’re thinking of buying or selling your home, or refinancing a home loan, it’s best to discuss the plans with your tax advisor to interpret closing documents and to make absolutely certain the transaction meets the necessary qualifications.

Employment Tax Responsibilities for Employers of Household Workers

Household employees are workers you hire for “ domestic services,” i.e., those services performed in and about your home. Duties of cooks, butlers, housekeepers, governesses ,maids, valets, babysitters, caretakers, gardeners, janitors, or personal chauffeurs all can qualify as “domestic services.”

Not everyone you hire for work at your home is considered a household employee, though. For example, a self-employed gardener may take care of your lawn and several others in your neighborhood, providing all his own tools and job assistants and setting his own work schedule. That gardener probably won’t be considered your household employee because he is running an independent operation over which you have no “say-so.”

You see, a worker at your home becomes an employee when you control what work that person is to do AND how and when the work is to be done. If you qualify as a household employer, you may have to pay certain federal payroll taxes, including social security and Medicare taxes and unemployment taxes. You withhold some of these taxes from your employee’s wages; others you must pay from your own funds. (Some states require certain taxes too, so be sure to check with the state employment department in your area.)

Taxes You Withhold from Wages

Social Security and Medicare Taxes:

If you pay cash wages in excess of a specified threshold amount during the year to a given employee, you must withhold social security and Medicare taxes from the employee’s wages. This threshold amount ($1,500 in 2006) will vary from year to year and applies to each separate household employee you hire.

Example: This year, Jane hired Louise, a housekeeper, and Rose, a babysitter. She withheld social security and Medicare taxes from their wages. Over the course of the entire year, however, she paid Louise only $500 and Rose $800. Since neither worker’s yearly wage equaled the threshold amount, Jane owes no social security or Medicare tax for them. That being the case, she must repay to the workers the taxes she already had withheld from their wages.

Federal Income Tax:

Household employees may also ask you to withhold income tax from their wages; you aren’t required to agree to the request. If you choose to withhold, however, you must collect the income tax from the employee’s wages (the IRS publishes tables to let you know how much to withhold) and you pay the amount withheld to the government.

Additional Taxes You Must Pay

Employer’s Share of Social Security and Medicare Taxes:

As an employer, you must match the amount of social security and Medicare tax you withhold from your employee’s wages. For instance, if you withheld $50 in social security from your housekeeper’s wages, you would be required to pay to the government $100 (the $50 withheld from your employee, plus another $50 from your own funds).

Federal Unemployment Tax (FUTA):

You are also responsible for FUTA taxes if you paid a total of $1,000 or more in household employee wages during any calendar quarter of the current year or the previous year. FUTA tax isn’t a withholding tax but is paid by you alone on behalf of your employees. (Certain states also assess unemployment taxes – check with the appropriate agency in your area.)

Paying the Tax

You report and pay the required payroll taxes for your household employees along with your regular individual income tax return. Schedule H, Household Employment Taxes, is used to figure the amount of the tax that you owe.

Reporting Wages to Employees

You need to give your household employees Form W- 2 ,Wage and Tax Statement, to report wages and tax withholding for the year. The W-2 is due to the employee by Jan. 31 of the year following the year in which you paid the wages . You must also file a copy of the W-2 with the Social Security Administration (usually by the end of February).

To accurately prepare W-2s, you need certain information from your employee, including his/her name, address, and social security number. So that you have all the necessary information available for timely filing, you may want to have your workers fill out Form W-9, Request for Taxpayer Identification Number and Certification, when you hire them. That way you will have data on file to complete W-2s when the time comes.

Other Paperwork Chores

Form SS-4:

If you have household employees, you will need to obtain an employer identification number for yourself. This number is not the same as your Social Security Number. You get the number by filling out and mailing Form SS-4, Application for Employer Identification Number, to the IRS (it's also possible to have the number assigned by telephone – the SS-4 instructions explain how to do this).

Employee Form W–4:

If you agree to withhold income tax for an employee, ask him/her to complete Form W-4, Employee’s Withholding Allowance Certificate. The information on this form will help you determine the correct amount of income tax to withhold.

Payroll Journal:

You should record in a journal each payday the wages and withholding of household employees. Set up a separate record for each employee with room for the following information:

• Payment date
• Check number
• Gross wages (before withholding
• Social security tax withheld
• Medicare tax withheld
• Federal withholding, if any
• State withholding amounts (establish a column for each separate kind of tax withheld)

For computer users, an inexpensive payroll program may simplify the recordkeeping job.

Keep employment tax records for at least four years after the later of: the due date of the return on which you report the taxes, or the date you pay the taxes.

If You Have Other Employees

If, in addition to your household employees, you have employees in a sole proprietorship, you can choose whether to pay the employment taxes of your household workers with your personal tax return or along with your business payroll returns. If you choose the latter option, you file W-2s for you household employees along with those of all your business employees.

Have You Forgotten Anything?

Here’s a quick checklist of issues you should make sure you have considered when you hire and pay household employees:

• Legality of worker’s employment in the United States
• Applicability of state employment taxes and state return filing requirements
• Applicability of withholding social security and Medicare taxes
• Income tax withholding agreements with employees
• Recordkeeping system
• Employer identification number application
• W-2 filing with employees and Social Security Administration
• Return filing and payment deadlines

Are the Payroll Taxes you Pay Deductible?

In most cases, the payroll taxes you pay in connection with your household workers’ wages are not deductible on your individual tax return. The IRS considers these taxes, and the wages on which they are based, to be personal, nondeductible expenses. However, there are a couple of circumstances when you may be eligible for a tax benefit for the payroll taxes you pay:

• Child Care Credit – If you are eligible to claim a Child or Dependent Care Credit based on wages you pay a household employee who cares for your child, other dependent, or spouse, the payroll taxes you pay on the wages are counted as part of your eligible expenses when figuring the credit.
  
  
• Medical Care Providers – The wages and associated payroll taxes you pay to a household worker who provides nursing services for you, your spouse, or your dependent are medical expenses that may be deductible on your return if you itemize your deductions. (Note that the same expense can’t be used both as a medical deduction and for the Dependent Care Credit.

In these two situations, the payroll taxes that you include are the FUTA tax, state unemployment tax, and your portion of the Social Security and Medicare taxes that you have actually paid during your tax year. For example, if you paid $56 FUTA tax in January 2006 for medically deductible wages that you paid to a nurse in 2005, you would include $56 as part of your medical expenses on your 2006 return. (The wages paid in 2005 are deductible on your 2005 return.) Do not include the Social Security and Medicare taxes, federal and state income taxes, or other state or local taxes you’ve withheld from the employee’s wages, since these amounts are already part of the gross wages for which you are claiming the credit or deduction.

Your Charitable Gifts Make a Difference for Others AND for Your Taxes

When you give away cash or goods to qualified nonprofit organizations, you will probably be able to take a tax deduction as partial reward for your generosity. However, the IRS rules for deducting charitable contributions aren’t as simple as many people might think. For example, deduction limits can apply, and certain gifts require timely written acknowledgment from the recipient organizations.

Qualified Charitable Organizations

In order for donations to be deductible, it must be given to a “qualified U.S. organization.” Not all nonprofit organizations qualify, but the IRS regularly publishes a list of the ones that do. In general, the qualifying groups can be categorized as:

• governmental bodies;
• nonprofit groups organized for religious, educational, scientific, or literary purposes;
• war veterans’ groups;
• fraternal societies and lodges; and
• certain nonprofit cemetery companies.

Typical examples of qualified organizations include churches, nonprofit hospitals, colleges and universities, school booster clubs, libraries, public parks and recreation facilities, etc.

When gifts are made to fraternal organizations and lodges, only the part of the gift that those organizations give away to other qualified charities is deductible. In addition, gifts to a cemetery company can’t be deducted if they are earmarked for the care of a specific cemetery lot.

Limits on Charitable Deductions

In general, deductions for charitable gifts are limited to 50% of a taxpayer's adjusted gross income. However, depending on the kind of organization and the type of property being given, that limit can dip as low as 20%. And if the individual's income is high enough, the partial benefit of his or her charitable deductions can be lost due to an overall limit the IRS imposes on itemized deductions.

Gifts That Return a Benefit to You

If a taxpayer is audited on his or her contributions, the IRS looks to see whether voluntary donations were made intentionally or whether it was just payment for services provided by a charitable organization. For example, payments to a parochial school for a child’s tuition or to a church for a family wedding give the taxpayer a benefit and don’t qualify as contributions. Payments to charities for raffle tickets, lotteries, or bingo also fall in this category and aren’t deductible - with these one is really purchasing the chance to win that new TV, trip to Hawaii, etc.

In certain situations, only a partial benefit may be received for what is given. In that case, one can generally deduct the amount of the gift that is over and above the value of what is received. Say you paid $50 to attend a fundraising dinner at your church.The church determines that the value of the dinner and program is $15. Your deductible charitable contribution is $35, i.e., the amount of your payment that exceeds $15.

Giving Your Time

Although you may volunteer many hours working for a charitable organization, the value of your time is not deductible. However, if you incur expenses (e.g., travel costs to and from the charity’s location) related to volunteer work, those costs are deductible. Other out-of-pocket costs incurred on behalf of the charity may be deductible as well.

Travel Away From Home For Charity

A charitable deduction can be taken for travel expenses (including meals and lodging) incurred while performing services for a charity in an out-of-town location. However, two important criteria need to be met in order to get this deduction:

1 . You must perform services for the organization in an official capacity while you’re away from home.

2 . No “significant element of personal pleasure” must be connected with the travel. Does this mean your trip can’t be enjoyable? No, but it does mean that the primary purpose of your travel must be related to your charitable duties and not be a personal vacation.

Noncash Donations

Donations don’t always have to be in cash. One can also deduct the “fair market value” (FMV) of donated items like used clothing, furniture, and appliances (FMV is the price goods are likely to sell for on the open market).

Valuing Your Donation:

Perhaps the most difficult part of making noncash donations is determining the value of the goods being given away. The decision about value is left to you and, unfortunately, there aren’t any cast-in-concrete formulas to give you the “right” answer.

Here are a few general guidelines that may help:

• Consider the condition of each item being given away. Compare the style of your donation with current styles. Outdated and/or damaged property may have little or no market value. Categorize each item being given by its condition (e.g., poor, good, excellent, new, etc.)
  
  
• Do a little detective work to find out what the item you are donating would sell for in the current market. A visit to the local thrift shop, a quick glance through newspaper classified ads, or a stop at a neighborhood garage sale should provide you with a pretty good idea of the prices of goods like yours.
  
  
• If your donation includes equipment or machinery, consult with publications of commercial firms or trade organizations to find out your property’s value. Many of these organizations regularly publish information about going sales prices for cars, boats, airplanes, etc. Caution: When donating used vehicles to charity, special rules apply. See paragraph on "Donating Vehicles to Charity."

Your research will probably show that most used merchandise has a value that is considerably less than your property’s original cost!

However, some items you give away may have actually gone up in value (e.g., antiques, jewelry, or artwork). To determine the value of these, hire a qualified appraiser. Regardless of whether the value of a donated item has gone up or down, if its current value is more than $5,000, a professional appraisal is mandatory (exception: most publicly-traded securities do not require an appraisal). Check with your tax advisor about the details that must be included in the appraisal and the IRS-required form.

Donating Used Vehicles to Charity:

Beginning in 2005, Congress has imposed some tough new rules that will substantially limit the deduction for the popular charitable car donation. Past rules generally allowed taxpayers to deduct the fair market value (FMV) of the vehicle. Under the changes taking effect in 2005, if the deduction exceeds $500, the deduction will generally be limited to the gross proceeds from the charity’s sale of the vehicle. In addition, a written acknowledgement from the charity is required and must contain the name of the donor, donor’s tax ID number and the vehicle identification number (or similar number) of the vehicle. The IRS has provided Form 1098-C for this purpose. There is an exception to the new rules for donated vehicles that the charity retains for its own use “to substantially further the organization's regularly conducted activities.” Please call this office for more information.

Record of Noncash Donations:

Keep a list of the donated items and include a description of the property, its cost and FMV and when and how it was acquired. If the property has appreciated in value, be sure to get an appraiser’s report (since special rules apply to appreciated property, check with your tax advisor before you make your contribution). Request a receipt at the time of the donation and make sure it includes the date and the organization's name and address.

Recordkeeping for Cash Donations

For cash gifts, you should have a canceled check or a receipt from the donee. In addition, for each gift of $250 or more, a timely acknowledgment of the gift must be obtained from the donee organization; otherwise, a deduction is not allowed.

While many organizations may take the responsibility of providing a receipt, the tax law actually places this responsibility of getting acknowledgment on the gift donor. “This provision does not impose an information requirement upon charities; rather it places the responsibility upon taxpayers who claim an itemized deduction of $250 or more to request (and maintain in their records) substantiation from the charity.”

The charity’s acknowledgment must contain the following:

• The amount of money and a description of the value of other property, if any, contributed.
  
  
• Whether the charity provided any goods or services in return for the gift.
  
  
• A description and reasonable estimate of the value of the goods or services provided.

Saving Money to Ensure Your Future

The Smiths are college graduates with two healthy children, good jobs, a home worth about $160,000 and two relatively new cars. To the casual observer, they’re doing well. Yet anyone taking a close-up view would find a few flaws in their situation, especially when it comes to their finances . . .

You see, the Smiths have:

• Virtually no savings;
  
  
• Retirement plans available through employers but with contributions at a bare minimum;
  
  
• A portfolio of several hundred shares of stock bought as a result of a tip from a friend - the investment has gone sour; and
  
  
• Large debts on their home, cars and credit cards.

Obviously, Mr. and Mrs. Smith could benefit from a course in financial fitness. Their greatest need is to take a long, objective look at their financial picture AND make some rather radical adjustments!

Unfortunately, the hypothetical Smiths aren’t a lot different from many Americans today. Statistics indicate that a large number are saving less than 5 percent of their disposable household income, far less than citizens in other countries. For example, Canadians and Germans save about 10 and 12 percent respectively.* In addition, American workers (similar to the Smiths) aren’t taking full advantage of their employer’s retirement plans, most making pension contributions of only about $2,700 each year.

Perhaps most ominous, however, is the amount of personal debt Americans have been incurring. Statistics show that there has been a $256 billion increase in consumer spending in recent years. And 44% of it is being paid for using installment plans!

Improve Your Own Financial Future

The Smith scenario and previously cited statistics paint a gloomy picture, but there are steps you and your family can take to prevent similar results. Achievement of financial security comes from adjusting your current financial picture in light of future goals. Far from being easy, the whole process requires a good amount of self sacrifice and more than a few trade-offs along the way.

Check Your Spending Habits

The only way to objectively view your finances is to set down on paper what you’re currently spending. No one enjoys this job, but it’s necessary if you’re serious about a plan to ensure financial well-being.

Keep a log of what you spend your money on for a while (account for every cent, including all cash, check and credit purchases). Write down everything from house payments to dinners out, grocery purchases, haircuts, parking fees, entertainment expenses, doctor visits, etc. Try to list each item by category - e.g., amounts spent on movies out, video rentals, and cable TV could all be listed under a category called Entertainment Costs.

At the end of the period, total each expense category and get ready for a huge surprise - you’ll probably find that those “ little” extra miscellaneous items have made a sizable dent in your pocketbook. After you examine the totals carefully, you’ll begin to see a trend. It’s then that you need to ask yourself, “Where can I cut down?”

Once you have a feel for the expense side of the ledger, concentrate on your income - salaries, pensions and annuities, interest, dividends,etc.

Total everything you received for a given period (e.g., a month, a quarter, or a year) and subtract from it the grand total of all your expenditures for that same period. If your answer is positive, you’ve done all right - there’s a profit. If your answer is negative, you could be faced with a problem.

Debt Could Be the Culprit

One reason many people can’t seem to get ahead financially is that they have a lot of debt - mortgages, credit cards, etc. And it’s difficult to reduce debt unless spending habits change. Probably the best place to start cutting back is with the credit cards. Most people have a huge pile of them (the average is nine for most Americans).

Credit card spending is expensive. Assume, for example, that the balance on your Megabank card is $1,000 on which you’re charged an annual interest rate of 20 percent. If you pay the minimum $20 per month on your account, your total yearly payments will be $240 ($20 x 12). Yet by the end of one year, you will have only reduced your debt balance by $44, as shown in the following chart:

Month	Interest	Principal	Balance
1 2 3 4 5 6 7 8 9 10 11 12	$16.67 16.61 16.55 16.50 16.44 16.38 16.32 16.26 16.20 16.13 16.07 16.00	$3.33 3.39 3.45 3.50 3.56 3.62 3.68 3.74 3.80 3.87 3.93 4.00	$996.67 993.28 989.83 986.33 982.77 979.15 975.47 971.72 967.92 964.05 960.12 956.12

And what if you have eight other credit cards with balances similar to the Megabank card? You see how easy it is for debt to escalate?

To get and keep the upperhand on all that plastic, you may need to:

1. Quit making purchases by credit card. If the cash isn’t available,don’t make the purchase.

2. Carry only one card for emergencies and get rid of those with the highest balances.

3. Begin the search for a credit card with a low interest rate - there are some available, but it may take a little detective work to find them.

4. See if you can consolidate your credit card debt into the card carrying the lowest interest rate.

5. Start making the largest payment you can each month to pay off the debt. Once you’ve established an amount, keep at it EVERY month. You will be able to get it paid off faster than you think if you work at it consistently!

Home Equity - Savior or Trap?

Your home equity is a tempting source for money. Just keep in mind that you will never own the home if you continuously tap into that equity. Your reasons for using the equity may be legitimate, but were they necessary and paid back in a timely manner?

Using home equity loans is an often touted means of avoiding higher interest rates on consumer loans for automobiles, major appliances, etc. It also provides a way to convert nondeductible consumer interest to deductible interest, since the interest on home equity debt (up to $100,000) is deductible as home mortgage interest.This is a good strategy if you plan to pay off the equity debt in the same period of time the consumer debt would have been paid off. Trap#1: People tend to roll their equity debt into their long-term home debt and end up paying on that consumer purchase for years, long after the car or appliance has been carried off to the recycle yard. Trap#2: Interest on equity debt is not deductible for Alternative Minimum Tax (AMT) purposes. Thus, if you are being taxed by the AMT, your benefit from the equity debt interest deduction will be reduced or eliminated.

Savior: If used wisely, a home equity loan can provide you with a fresh start. If you are heavily burdened with consumer debt and have sufficient equity in your home, you can consolidate your debts into a new home loan and substantially reduce your monthly outlay. With the extra monthly cash from the reduced debt, begin saving for future cash purchases, children’s education and retirement. Trap: After restructuring your debt, you continue to run up additional consumer debt and could potentially overextend yourself again.The cycle repeats itself and leaves you with no equity in your home and a heavy mortgage debt at retirement.

Saving For the Future

After you’ve taken stock of your inflow and outgo and instituted measures to reduce debts, the next step is to begin developing a savings plan. Here again, consistency is the key. For instance, look at what happens when you put away $25 a week at an annual compounded interest rate of only 5 percent:

Term 10 years 20 years 30 years

Ending Balance $16,768 44,081 88,571

In addition to regular savings, if you participate in a retirement plan, either through an employer or your own self-employed plan, begin using it to the fullest. Contribute as much as you can! After all, most pension plans allow you to build savings and defer paying taxes on income until you begin making withdrawals. It’s hard to find a better deal than this anywhere.

Review Your Strategy and Adjust For Changes

Remember, you need to continually review the savings strategy you establish in light of your overall goals - someday you will retire, in 20 years the children will be going to college, eventually you may want a bigger house, etc. Your strategy shouldn’t simply take into account those KNOWNs; your plan must create a cushion to handle the UNKNOWNs as well.

Change is a certainty, and because of this, no plan for meeting financial objectives can remain static. As you go along, you’ll no doubt have to do a little “adjusting” here and there. Events like marriage, divorce, birth, death, retirement, job relocation, etc., can all complicate and force reevaluation of your original plan. Because of all the technicalities involved, you’ll probably want some outside help. It’s advisable to consult professional tax, legal and financial advisors before embarking on or changing your course of action.

* According to statistics from the Organization for Economic Cooperation and Development

Planning Ahead for Your Finances

With the number of savings strategies being publicized these days, you’d think that planning ahead for retirement would be a fairly simple job. To the contrary, however, many investors are finding themselves uncertain that they will be able to find a strategy that will allow them to build adequately to meet long-term financial goals.

In the “good old days” the picture seemed simpler - people ended their 30-year career with assurance that a pension and social security were waiting to provide them with a fairly comfortable retirement. Contrast this with today, when people are faced with reports of a wobbly future for the social security system and pessimistic stories about the stability of retirement plans (both privately funded and employer-sponsored plans).

Planning for your financial future doesn’t have to be surrounded by mystery and perplexity. Accepting the planning challenge with realistic expectations and taking an overall long-term approach to finding investment solutions can help you immensely as you move toward attaining financial goals. This brochure highlights a few of the general principles and strategies which have traditionally been the foundation of sound financial planning; they are designed to help you weather the ups and downs of a changing economic climate.

Building Blocks of Financial Planning

Start Saving –– the Sooner the Better!

Start investing and earning interest on your money as early in life as possible - the results are amazing. The classic example is the 25-year old who invests $250 a month in an account at 8.5%, compounded monthly. By the time that 25-year old reaches age 65, savings have mounted up to a million dollars! The key to that savings success was “regularity,” investment of a specific amount on a specific schedule. Such discipline was rewarded with a good-sized nest egg!

But don’t make the mistake of not beginning a savings program just because you’re already over age 25. Start one no matter what your stage is in life, and you’ll be pleasantly surprised to see how your efforts can pay off after a just a few years of compound interest. It’s never too late to start saving!

Watch Your Investment Mix

Planning involves finding the right blend of investment choices - a concept called “asset allocation.” Your blend should depend not only on the financial goals you have chosen but on your stage of life and your tolerance for risk. For example, a young person just starting out may consider investing a large portion of funds aggressively to get a higher return. As that person reaches retirement age, however, he/she would probably want to shift a bigger portion to something that offers greater security, like bonds or government-insured savings.

Always Diversify

Diversification can help keep your portfolio on an even keel. It means spreading your investments over a broad range of investment media. Diversifying is wise no matter how much you invest - it adds balance to a portfolio by opening up the opportunity for stability for a gain in one market to counteract a downturn in another.

Remember Inflation Will Take a Toll

Plan your investment strategy with inflation in mind. Even when the inflation rate is low, it causes savings to lose purchasing power over a period of time.When you factor inflation into some so-called “safe” investments (which are usually low - yield), you may find that, over the long haul, the ones you thought were doing all right are really costing you more than you’re gaining on them.

Consider Taxes

Don’t forget tax planning as you look at investment strategies. Most invested funds will eventually lead to payment of taxes - e.g., those tax-deferred annuities, IRAs, etc., will eventually be withdrawn and become taxable. But even a small amount of planning can help you find every legal way possible to lower Uncle Sam’s bite from your hard-earned money!

What's Your Risk Tolerance?

It’s a fact of life that some investments are much more risky than others. When you begin your financial planning, you need to come to terms with your risk comfort level. Naturally, you don’t want your investments to keep you awake nights while you worry about what ’s going to happen to them tomorrow. If you’re worried about risk, your goal should be finding that “comfort zone” that will allow growth without a high degree of volatility.

Some people, for example, aren’t comfortable with stock funds where values can fluctuate quite widely in the short-term - yet these funds may offer a good deal of potential for growth over time.

The Plan Should Be Adjustable

Changing circumstances are also a certainty! Your financial plan may need to be adjusted somewhat when your situation is changed by events like:

• Marriage;
• Divorce;
• A birth or death in the family;
• A job change;
• Entry into a new business;
• A home purchase or sale; or
• Retirement.

Beware of locking up funds permanently - leave room in any plan for some flexibility that allows you to maneuver and switch investment vehicles if necessary.

Long-Range Planning Can Help Meet Future Needs

There are certain areas in tax and financial planning where long-term planning can make a significant contribution to your future financial well-being.

Consider the following areas:

• College Educational Funds for Your Children - There are tax-favored plans that allow you to fund a child’s future education. Keep in mind that the benefits are greatest for those who plan early in the child’s life.
  
  
• Planning for Your Retirement - With a variety of different retirement plans available, it is important to find the right one for you. There are many factors to consider. Will the plan give you a tax deduction? Is it tax-free or will it impact other income when you reach retirement? Early planning can maximize your tax benefits now and minimize your taxable income at retirement.
  
  
• Gift and Estate Planning - Passing your wealth on to your heirs while minimizing the government’s take is an important long-range planning issue for everyone.
  
  
• Selling Real Estate - To minimize your tax liability when selling real estate, pre-planning can employ a variety of strategies such as tax-free exchanges, installment sales and home gain exclusion.
  
  
• Business Exit Strategies - Whether you are retiring, passing a business on to family members, or just moving on to other ventures, long-range planning is needed to insure the transaction is smooth, orderly and meets your financial expectations.

Give Your Plan a Regular Tune-Up

For a financial plan to accomplish what you intend, it needs attention and care. Checking up on investment performance goes hand-in-hand with the flexibility issue raised by changing circumstances. Regardless of whether circumstances have changed, the plan needs regular “health” check-ups every few months to make sure it’s on track.

Getting Help with Financial Planning

With all the intricacies of financial markets, you may want to consider getting advice from a professional before launching out on a plan. The professionals in our office are well-qualified to help. We’re trained to help find answers to questions like:

Is there a best way to look for high returns on your investments?

How can you manage risk?

How should you divide your portfolio between stocks, bonds, and cash savings?

What are the best ways to handle inflation?

Is there any way to reduce taxes on investment income?

How long should you stick with a particular investment?

Please don’t hesitate to call with your own questions and to find out about the many services we offer!

Your IRA Contribution Options

For years, individuals have been able to set up personal retirement plans called individual retirement accounts (IRAs). Nearly everyone who receives “compensation,” either as an employee or as a self-employed individual, can contribute to an IRA. You can choose from a variety of different types; some give you a tax deduction,while others don’t. This brochure highlights in general terms the IRA options available under current law and points out some of the advantages of each. For more details about which IRAs fit best with your specific situation, be sure to check with your tax advisor.

Setting up an IRA:

To select the best type of IRA to meet your current income level and your long-term investment goals generally requires the advice of a professional. You are strongly advised to seek the advice of your tax advisor or financial planner before selecting a specific type of IRA and the investment vehicle for your IRA. Although others, not fully cognizant of your current tax planning objectives or your long-range financial and estate planning needs will be eager to assist you, prudent planning may be more appropriate.

Types of Investments:

Examples of typical IRA investment vehicles include insurance annuities, stocks, bonds, mutual funds and cash (in savings institutions).

Definition of Compensation:

You can open an IRA only if you receive “compensation.” Compensation includes wages, salaries, tips, professional fees, commissions, self-employment income and alimony. Compensation does not include rental income, interest or dividend income, pensions or annuities, deferred compensation, or amounts you exclude from income.

IRA Penalties

Remember that various penalties can apply to most IRAs. When you contribute more than the IRA limits allow, withdraw from the account too early, or don’t take sufficient distributions when required, penalties can apply. Under certain circumstances, penalties can be avoided for premature IRA withdrawals. Exceptions apply, for example, when withdrawal is due to disability, for paying certain first-time home purchase expenses, and for paying educational costs. Be sure to check with your tax advisor concerning the exact rules on penalties to ensure against receiving unwelcome “ surprises” when you file your tax return.

Traditional IRAs

With a Traditional IRA , if you’re under age 70-1/2, you can contribute up to the annual limit to your IRA account. However, if your taxable compensation is less than the annual limit in a given year, your contribution will be limited to the amount of your compensation.

Traditional IRA contributions are generally deductible on your tax return. However, one can designate that they be nondeductible. If this choice is made, you build up a basis in your IRA so that when you begin to withdraw from the account, part of each withdrawal is nontaxable. However, the choice not to deduct an IRA contribution should be made with caution in light of your particular tax situation. This is especially true since recent law changes involving IRAs allow only nondeductible contributions to certain types of accounts (see more under Roth and Education IRAs).

If you’re married, file jointly, and your spouse has little or no compensation, a Traditional IRA may be set up as a spousal IRA, allowing your spouse to make IRA contributions based upon your compensation. However, neither spouse can deposit more than the annual limit to his/her individual account.

Participation in Other Plans:

One complication of Traditional IRAs affects taxpayers who actively participate in other pension plans - e.g., an employer plan, a Keogh or SEP, etc. When you are covered by another pension plan, your IRA deduction “phases out” (i.e., gradually reduces to zero) depending on your filing status and your income level. Phase out begins at income levels according to the following schedule:

Threshold Level
Tax Year 2000 2001 2002 2003 2004 2005 2006 2007 and after	Single* 32,000 33,000 34,000 40,000 45,000 50,000 50,000 50,000	Joint 52,000 53,000 54,000 60,000 65,000 70,000 75,000 80,000

*The Single threshold applies to taxpayers other than those filing joint, except Married Separate taxpayers who have a threshold of $ -0- .

Through 2006, if a taxpayer's income exceeds the above thresholds by less than $10,000, his or her IRA deduction will be limited; if it exceeds the threshold by $10,000 or more, there is no IRA deduction. After 2006, $20,000 will be substituted for the $10,000 amount for taxpayers filing married joint.

Break for Spouse of an Active Participant:

The limits on deductible IRA contributions no longer apply to the spouse of an active participant. Instead, the maximum deductible IRA contributions for an individual who is not an active participant but whose spouse is an active participant, is phased out for the nonactive individual if the couple’s combined AGI is between $150,000 and $160,000.

Example: A wife is an active participant in a retirement plan, but her husband is not. The couple’s combined AGI is $200,000. Neither spouse can take an IRA deduction, because their AGI is over $160,000.

But assume the couple’s combined AGI was only $125,000. Since the husband isn’t an active participant in another plan, he can make a deductible IRA contribution. However, his wife can’t make one, because the combined AGI is over the threshold for joint filers (see chart for annual threshold amount).

Due Date for Making Traditional IRA Contributions:

Traditional IRA contributions (whether deductible or nondeductible) must be made by the due date (without extensions) of the return for the year to which they apply.

Roth IRAs

You may be able to open a Roth IRA, a type of IRA that allows only nondeductible contributions. Distributions from these IRAs, including earnings on them, are tax-free if a holding period and other requirements are met. Like the Traditional IRA, annual contributions are limited to the smaller of your compensation or the annual limit. However, if you have other IRAs - for example, a Traditional IRA - your combined annual contributions to all of them (including the Roth IRAs) can’t be more than the annual contribution limit. Roth IRAs allow contributions even after you turn age 70-1/2, and spousal Roth IRAs are also allowed. The due date for making your contributions to a Roth IRA is the same as for Traditional IRAs.

Contributions to Roth IRAs phase out if income is between $150,000 and $160,000 for joint filers and between $95,000 and $110,000 for individuals (special phase-out rules apply to married separate filers). The phase out applies regardless of whether the taxpayer (or spouse, if married) is an active participant in another plan.

Rollovers:

Regular IRAs may be rolled over or converted to Roth IRAs by taxpayers whose AGI isn’t more than $100,000 in the rollover year. Married separate taxpayers can’t roll or convert a regular IRA to a Roth IRA.

When you roll over or convert to a Roth IRA, you must pay tax on the income from the regular IRA that would have been taxed if you had not converted it to a Roth IRA.

Comparing Results of Traditional and Roth IRAs:

Determining whether a Traditional IRA or a Roth IRA best suits for you depends upon your unique circumstances, both now and in the future. You are encouraged to seek assistance from your tax or financial advisor to assist you with this decision.

Deemed IRAs

For years after 2001, where a "qualified employer plan" elects to allow employees to make voluntary employee contributions into a separate account or annuity in a "qualified employer plan," it will be considered a “Deemed IRA.” Deemed IRAs are treated in the same manner as an individual retirement account or annuity. This gives the employees participating in their employer’s qualified plan the option to designate their voluntary contribution into a separate Traditional or Roth IRA.

However, all of the normal IRA income and AGI limitations will apply to "Deemed IRA" contributions. This can create problems if an individual also contributes to a Regular IRA and the combination of the Regular IRA and the Deemed IRA exceed the annual limitation. Another trap exists when a taxpayer designates the Deemed IRA as a Roth IRA and later discovers their income disqualifies them from having a Roth IRA. If you are not sure of the implications of Deemed IRA designations for your specific circumstances, consult with your tax or financial advisor.

Annual Contribution Limits

The IRA contribution annual limit is slowly increasing over the years. In addition, taxpayers age 50 and older are allowed to make "catch-up" contributions allowing them larger contributions in their later years to fund their approaching retirement needs. The table below illustrates the annual contribution limit applicable to each year by age.

	Contribution Limits
Year Through 2001 2002 through 2004 2005 2006 through 2007 2008 2009 and after	Under Age 50 2,000 3,000 4,000 4,000 5,000 Inflation Adjusted	Age 50 and Over 2,000 3,500 4,500 5,000 6,000 Inflation Adjusted

 

 

 

Saver’s Credit:

The Retirement Savings Contribution Credit, frequently referred to as the Saver’s Credit,was established to encourage low to moderate income taxpayers to put funds away for their retirement.

Up to $2,000 per taxpayer of contributions to an IRA (Traditional or Roth) or other retirement plans, such as a 401(k), may be eligible for a nonrefundable tax credit that ranges from 10% to 50% of the contribution, depending on the taxpayer’s income. The maximum credit per person is $1,000. The contribution amount on which the credit is based is reduced if the taxpayer (or spouse if filing jointly) received a taxable retirement plan distribution for the year for which the credit is claimed (including up to the return due date in the following year) or in the prior two years. If modified AGI exceeds $25,000 (single), $50,000 (married joint) or $37,500 (head of household), no credit is allowed. An individual who is under age 18, a full-time student, or a dependent of someone else is ineligible. The credit, which applies for tax years 2002 through 2006, is in addition to any deduction allowed for traditional IRA contributions.

Education IRAs:

Now referred to as Coverdell Education Savings Accounts (CESA), the CESA is really a nondeductible education savings account. The investment earnings from these accounts accrue and are withdrawn tax-free, provided the proceeds are used to pay qualified education expenses of the beneficiary. These accounts first became available in 1998, and nondeductible contributions of up to $500 were permitted per year for the benefit of the designated beneficiary. Beginning in 2002, the allowable nondeductible contribution has been increased to $2,000 per year per beneficiary. Contributions are only allowed for designated beneficiaries under the age of 18.

The annual contribution limit is gradually reduced if the contributing taxpayer’s “modified AGI ” is within the phase-out range and eliminated for taxpayers above the range. Beginning in 2002, the phase-out limits for married taxpayers has been increased to $190,000 - $220,000 while remaining at $95,000 - $110,000 for single taxpayers. If the AGI limits the contribution, the funds can be gifted to someone else whose contribution would not be AGI limited, even the beneficiary.

Tax law includes several tax breaks for students and their parents. Those benefits, combined with other benefits in existence at the time, provided taxpayers with a large number of options for tax-favored financing of their education and the education of their family members. This brochure highlights the various education benefits included within the U.S. income tax system.

• Coverdell Education Savings Account
• Qualified State Tuition Program
• Hope Scholarship Program
• Lifetime Learning Credit
• Penalty-Free IRA Withdrawals for Education Purposes
• Deduction for Education Loan Interest
• Tax-Free Savings Bond Interest

Student aid is available from the Department of Education for students of limited means.The aid can include educational grants such as a “Pell”grant or various types of student and parent educational loans.  Planning and saving for future education can limit or eliminate potential student aid, because these resources will be taken into consideration at the time the need for student aid is determined.

Understanding the tax terms: You will encounter several tax terms in this brochure that may be unfamiliar to you. Understanding their full meaning will help give you a better picture of the limits, qualifications and restrictions that apply to the benefits for education.

Phase Out: Instead of just eliminating certain deductions and credits, the tax law often decreases them gradually to zero (“phases them out”) over a specific income range. For example, say a hypothetical $1,000 deduction is allowed, but “phases out” when a taxpayer’s “modified adjusted gross income (AGI)” is between $40,000 and $60,000. A taxpayer with a modified AGI of $40,000 or less will be allowed the full $1,000 deduction, while the taxpayer with a modified AGI of $60,000 or more would get no deduction. For modified AGIs between $40,000 and $60,000, the taxpayer would be allowed a pro-rated deduction amount.

Regular AGI and Modified AGI: AGI is the abbreviation for “adjusted gross income.” “Regular AGI” is the total of all income, allowable losses and adjustments before subtracting itemized or standard deductions and personal exemptions. However, several tax benefits described in this brochure are limited or not available to taxpayers whose so-called “modified AGI ” is too high. Generally, the modified AGI for educational benefits adds back certain income from foreign, U.S. Possession and Puerto Rican sources that is excluded from income.

Qualified Educational Institutions: These institutions are generally accredited, post-secondary educational institutions that offer credit toward a bachelor’s degree, an associate’s degree, or some other recognized post-secondary credential. Certain proprietary institutions and post-secondary vocational institutions also qualify if they are eligible to participate in Department of Education student aid programs.

Coverdell Education Savings Account

The Coverdell Education Savings Account is really a nondeductible education savings account. The investment earnings from this account accrue and are withdrawn tax-free. The proceeds are used to pay qualified education expenses of the account beneficiary. Contributions are only allowed for designated beneficiaries under the age of 18.

The annual contribution limit is gradually reduced if the contributing taxpayer’s “modified AGI” is within the phase-out range and eliminated for taxpayers above the range. The phase-out range for single taxpayers is $95,000 - $110,000 and $190,000 - $220,000 for married taxpayers. Anyone is allowed to make the contribution, provided the total contribution for the under 18 beneficiary does not exceed the annual contribution limit and the contributing taxpayer’s AGI is within limits. If the contribution is limited or not allowed because of the AGI limits, the funds can be gifted to someone else whose contribution would not be AGI-limited, even the beneficiary. Subsequently, that person can make the contribution.

Distributions from the Coverdell Education Savings Account are tax-and penalty-free (including interest on the account) if they are used to pay for qualified education expenses of the designated beneficiary or a member of the beneficiary’s family.

In addition to education expenses for higher education, the definition of qualified expenses includes elementary or secondary education, kindergarten through grade 12. Contribution to these accounts can be made up to April 15 of the following tax year.

Additional rules apply for dealing with rollovers, changes in designated beneficiaries, death of taxpayer or beneficiary, excess contributions, special needs beneficiaries and unauthorized use of distributions.

Qualified State Tuition Programs

A qualified state tuition program is one generally set up by a state or state instrumentality that lets individuals make contributions to an account established for a designated beneficiary’s higher education. Unlike the Coverdell Education Savings Account, there is no limit on the annual contributions to Qualified State Tuition programs.

However, contributions to these plans are considered gifts to the beneficiary, making the annual gift exclusion amount the practical annual limit per contributor. The long-standing annual gift exclusion amount of $10,000 ($12,000 for 2006) is now inflation-adjusted; please call this office for the limit for other years. A special rule allows a donor who makes total contributions exceeding the annual gift limit to elect to take the contributions into account ratably over a five-year period, starting with the year of the contribution. This allows a donor to contribute as much as $50,000 adjusted for inflation ($60,000 for 2006) in one year, while avoiding the gift tax implications. The donor must file a gift tax return for the year of the contribution, and a five-year election must be made on the return. Care should be exercised in determining the total contributed to any individual’s account to avoid nonqualified distributions if the amount exceeds the educational needs.

Virtually all of the states now have these programs, which are professionally managed and tailor the investments and risk potential to the potential student’s current age. Individuals are not restricted to using the program established in their home state but instead can pick and choose among the programs of any of the states that have established programs.

The benefit of these programs was significantly enhanced for years after 2003 when the distributions of earnings from the programs can be excluded from income if used for qualified expenses.This is a big change from prior rules where the earnings from the accounts were taxable to the beneficiary when withdrawn. This puts the Qualified State Tuition Programs on par with Coverdell Education Savings Accounts, but without the annual contribution limit. Additional rules apply for designated beneficiaries,death of taxpayer or beneficiary, and unauthorized use of distributions.

Penalty-Free IRA Withdrawals

Generally, when funds are withdrawn from an IRA before a taxpayer reaches age 59-1/2, a 10% early withdrawal penalty applies to the distribution. Penalty-free withdrawals are permitted if the funds are used to pay qualified higher education expenses. The withdrawals will still be subject to regular income tax.

Qualified “higher education expenses” include tuition at a qualified educational institution, as well as related room, board, fees, books, supplies, and equipment. The expenses can be for the taxpayer, spouse, or taxpayer’s or spouse’s children and grandchildren.