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Tax Strategies for Families

Foreclosures No Longer Followed by a Big Tax Bite

Signed into law in December 2007, The Mortgage Forgiveness Debt Relief Act of 2007 protects American families from higher taxes when they refinance their homes. Under the previous tax law, if the value of your house declined and your bank or lender forgave a portion of your mortgage, the IRS could treat the amount forgiven as money that could be taxed.

The new law creates a temporary change to the tax code to eliminate any taxes home owners may face if a lender forgives a portion of outstanding mortgage debt (whether through a deficiency in foreclosure, or a loan modification/refinance). It increase the incentive for borrowers and lenders to work together to refinance loans and allow American families to secure lower mortgage payments without facing higher taxes. Learn more at

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Look After Your Parents?

Are you one of the millions of adult children who are looking after aging parents? If so, you could be eligible for a few tax breaks. If you and your parent meet IRS requirements, you'll be able to claim an added personal exemption on your income tax return. You may be able to reduce your taxable income by $3,200. To be deemed as a dependent for tax purposes, your parent must get more than half of his or her support from you. Learn more at

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Use a State 529 Plan to Pay for Tuition

A 529 plan, named for a section of the federal tax code, allows you to save for college in a tax-deferred investment. Your withdrawals are tax-free when used for tuition, room and board, and other qualified higher education expenses.

There are two types of 529 plans: college savings plans and prepaid college tuition plans. They differ in who chooses the investments and who assumes the risks.

  1. A college savings plan operates like a 401(k) retirement plan. You pick your investments and shoulder all of the investment risks. When it's time for college, you have whatever money is in your account.
  2. A prepaid college tuition plan operates more like a traditional pension. The funds you invest generally keep pace with increases in a state's resident undergraduate tuition. The state picks the investments and assumes all the investment risks.

All fifty states and the District of Columbia sponsor at least one type of 529 plan. In addition, a group of private colleges and universities sponsor a pre-paid tuition plan. Ask your investment advisor what's available in your state.

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Parents Can Get Credit for Sending Kids to Day Camp

Here's a tax break for the busy summer. Many working parents must arrange for care of their children under 13 years of age during the school vacation period. A popular solution with a tax benefit, is a day camp program.

The cost of day camp can count as an expense towards the child and dependent care credit. Expenses for overnight camps do not qualify. If your childcare provider is a sitter at your home, you'll get some tax benefit if you qualify for the credit.

The credit is generally 20% to 35% of non-reimbursed expenses; up to $3000 in expenses for one child and up to $6000 for two or more children. The actual credit is also based on your income.

You figure the credit on up to $3,000 of expenses for one child, $6,000 for two or more children. The credit rate ranges from 20% to 35% of expenses, depending on your income. The 35% rate applies if your income is under $15,000; the 20% rate, if your income is over $43,000.

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Roth & Spousal IRA Accounts

IRAs are well-known for providing taxpayers with tax benefits. Here are some easy suggestions to follow:

Roth IRA Set up and fund a ROTH IRA when you want to contribute a small amount of after-tax dollars to a retirement plan. A Roth IRA is a retirement plan that allows individuals to make contributions of $5,000, to the extent of their earned income. In other words, individuals can contribute either $5,000 or their income earned during the year, whichever is less. These contributions, and any growth in the value of the Roth IRA are tax-free forever. For individuals 50 and older, the contribution amount increased to $6000 per year.

The tax-free distributions of the Roth Ira make it a very popular tax saving device. The Roth IRA is a personal savings plan that offers tax advantages to set aside money for retirement. Once an individual has reached the age of 59-1/2 and has had their Roth IRA account longer than five years, all withdrawals are tax-free.

Spousal & Kids IRA If you own a business and want to receive some tax benefits from it, take advantage of the spousal and child IRA rules to include the rest of your family in your business’s retirement plan.

The spousal IRA allows a married person to make a self-directed IRA contribution for his or her spouse. A couple can contribute up to 100 percent of their combined earned incomes or $1,000 (whichever is less). And, an extra $5000 per person can be added under the catch-up provision if both spouses are over age 50 – bringing the total to $12,000.

If your spouse has income, or you file jointly, do not forget about having your spouse open a self-directed traditional or Roth IRA. Plus, your spouse is eligible to open a SEP, SIMPLE, or 40l(k) IRA if they have income from your business.

Tax law allows up to a $5,000 ($6,000 for 50+ individuals) spousal (nonworking) IRA contribution. This is in addition to your $5,000 regular IRA contribution, as long as your combined earned income and wages cover both contributions.

Your children can also have IRAs if they have earned income from your business.

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"Nanny Tax"

With so many households having two incomes, many employ someone to care for their children or other dependents in their home. Or, they hire someone to clean the house, cook, and/or provide other personal services in or around the home. If this is the case, families need to consider the necessity of paying and withholding Social Security and Medicare taxes (FICA) and federal unemployment taxes (FUTA). There are also other rules that need to be followed regarding the “Nanny Tax”.

First, the hired person (hereby known as a household employee) needs to be an employee of yours. An independent contractor (self-employed), or an employee of a cleaning agency do not qualify for the “nanny tax”. You need to control the household work that needs to be done, how it is done, when it is done, and provide the tools and cleaning supplies. In other words, you control the employee’s duties. It does not matter whether the worker provided part-time or full-time hours.

You are not allowed to employ an illegal alien. If you hire a household employee, an I-9 (Employment Eligibility Verification Form) must be filled out by both you and the employee. This is a U.S. Citizenship and Immigration Services Form providing verification for legally working in the U.S. You must keep a copy of the I-9 for your records.

You will also need to have the household worker complete a W-4 (Employee’s Withholding Allowance Certificate). This will include the employee’s name, address, and social security number. Keep this on file.

Check with your local state tax and labor departments. You may have to pay state unemployment tax on your household employee.

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Deferred Giving

A form of charitable contribution, deferred giving involves an irrevocable transfer to a charity whose ultimate use of the property is deferred to a future time. Deferred gifts have a tendency to provide a current charitable deduction, a retained income stream (or future property interest for your beneficiaries), a charitable contribution to your favorite organization, and a reduction in the donor’s taxable estate.

If this appears to your liking, consider establishing either a charitable lead trust or charitable remainder trust to accomplish some of the desired results mentioned above.

In a charitable lead trust, you donate property to a trust that guarantees to pay the charity a fixed amount. Or, it can pay a fixed percentage of the fair market value of the trust’s assets for a certain number of years. At the end of the trust term, remaining trust assets revert to you or to a designated beneficiary. A designated beneficiary could be a child or grandchild.

In a charitable remainder trust, you transfer property to a trust, and the trust guarantees to pay you or a designated non-charitable beneficiary a fixed amount. Or, it can pay a fixed percentage of the fair market value of the trust’s assets for life or a term of years (not longer than 20). At the end of the trust term, the remaining assets transfer to the charity.

In short and to summarize, the difference between a charitable lead trust and charitable remainder trust is– one transfers the trust’s assets to a designated beneficiary, while one transfers the trust’s assets to a charity.

The details and rules governing deferred giving and the involved trusts are very complex. Contact your tax advisor for more details.

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Dependents & Dependent Care Credit

According to the IRS, the definition of a dependent covers a wide range of individuals who depend financially upon taxpayers filing Form 1040. They depend on these taxpayers for their well-being, support, and housing. In order to claim a dependent on your tax return, certain tests must be met: 1) support; 2) joint return; 3) citizenship; 4) income; and 5) relationship.

The support test is known as the “over 50% rule”. This rule is met when you provide MORE THAN HALF OF his/her total support. Support is the key test for dependency qualifications.

The “joint return” test is basically to state that the dependent cannot file a joint return except for a refund. This means that a husband cannot claim his wife as a dependent. It also means that the wife cannot claim her husband as a dependent. “Common law” marriages are not recognized for joint return purposes.

Other qualifications for a “dependent” include U.S. citizenship (or U.S. residency). IRS Section 152 states that an individual is not considered a dependent if they are not a citizen or national of the U.S. unless such individual is a resident of the U.S. or a country contiguous to the U.S.

A qualified dependent must either have a very small or nonexistent income to meet the “income test”.

Age is not a qualifying factor in determining a dependent’s status. For instance, if a child is under the age of 24, but is a full-time student, they still qualify as a dependent if the taxpayer pays over 50% of their support.

To qualify as a dependent, the “relationship test” must be met. This is a vague area. One thing in common is the fact, in general, that a blood relationship exists. Qualifying dependents such as sons, daughters, stepson, stepdaughter, brother, sister, stepbrother, stepsister, father, mother, ancestor, niece, nephew, in laws – are all defined by the IRS as blood relatives. If a blood relationship does not exist between you and your claimed dependent, the IRS addresses this as a “member of the household”. The IRS describes a dependent as being a member of the taxpayer’s household in which they maintained their principal place of residence for the taxable year.

What is important about claiming dependents is the fact you can claim an exemption for each. Section 151 of the Internal Revenue Code is titled ‘Allowance of Deductions for Personal Exemptions’. A personal exemption is a deductible amount used during the computation of your taxable income on Form 1040. You can see how each exemption is a wonderfully valuable tax-saving device. You claim your exemptions on Page 1 near the top.

Knowing that you have qualified dependents helps in claiming a dependent care credit on your tax return. The dependent care credit is meant to help two-income earner families while they pursue their earning potential.

If you are gainfully employed, use Form 2441 (Child and Dependent Care Expenses) to claim any minor children or disabled adults you support. A dependent care credit or a dependent care exclusion is allowed. You must use this form to list the amount paid and name of each care provider, their address, and tax number. Keep track of all your expenses incurred in taking care of your qualifying individual such as food, shelter, utilities, instructional toys, handicap aids, and other expenses necessary to enable the taxpayer to be gainfully employed.

If you file jointly and one spouse is not gainfully employed, there is no dependent care credit allowed. You get no tax credit when not taxably employed, but you can incur the expenses.

The dependent care credit can be a complex area. Consult a tax professional for more help.

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Education Tax Benefits

There are a variety of ways to ease your tax burden through educational incentives. Here is a listing of some:

Qualified tuition program (QTP).
There are no income limits on the amount of large gift, tax-free contributions made to a qualified tuition program. These plans allow you to either:

  1. Prepay a designated beneficiary’s future qualified higher education expense; or
  2. Establish a savings plan from which educational expenses can be paid. States can sponsor savings plans and prepayment plans. Qualified costs for higher education include books, supplies, tuition, fees, and eligible room and board expenses. Contributions are not deductible on federal tax returns, however. Contributions are eligible for the annual gift tax exclusion regarding federal taxes. Distributions from a qualified tuition program are generally tax-free to the extent of qualified expenses. The qualified higher education expenses paid during the year must be reduced by any tax-free assistance such as scholarships, Pell grants, employer-paid expenses, and veterans’ assistance. This figure will give you the adjusted higher education expenses. Consult your tax professional for details.

Coverdell Education Savings Accounts. Each child is allowed one $2,000 contribution per year. These are tax-free distributions for education. They can be used for kindergarten through post-graduate school. It also includes school-related computer equipment purchase, room and board. There is, however, an income phase-out. Check with your tax advisor.

Education savings bond exclusion. The interest is tax-free on redemption for higher-education expenses. This does not include room and board, however. Proceeds can be transferred to a Coverdell ESA (mentioned above) or another qualified tuition plan. The child cannot own the bonds. There is an income exclusion phase out.

Student loan interest deduction. Up to $2,500 of student loan interest deductible, even by non-itemizers. The interest cannot be claimed by the tax dependent. There is a maximum deduction phase out for singles with a modified AGI of $75,000; for joint filers it is $150,000.

Education-assistance plan. Up to $5,250 of employer-provided education assistance is tax-free. It does not have to be job-related education. It also includes graduate study. There are no income limitations.

Roth IRA distributions for higher-education expenses. These distributions are tax-free after the age of 59-1/2 only if the plan was established within the past five years. Another stipulation includes having these distributions tax-free and penalty-free up to the amount of the contribution. What is nice about Roth IRA distributions is the fact they are exempt from premature distribution penalties. There are no income limitations.

Traditional IRA distributions for higher-education expenses. These are taxable to the same extent as any other IRA distribution. They are, however, exempt from the 10% premature distribution penalty. There are no income limitations.

Higher education tax credits. Education tax credits can help offset the costs of higher education for yourself or a dependent. The Hope Credit and the Lifetime Learning Credit are two education credits available which may benefit you. You may be able to subtract them in full from your federal income tax, rather than just deducting from your taxable income.

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Family Tax Planning Suggestions

Want to help manage your year-end taxes? Here are some tax-saving planning tips:

  • Donate to your favorite charity. Charitable contributions are an excellent way to decrease your taxable income. Plus, they help others. Do you have an older vehicle sitting around that nobody uses? Donate it. Older clothes, etc. Be certain you receive a receipt (written acknowledgement) containing the dollar amount of your donation. This will be needed for tax purposes. The IRS does not consider a cancelled check alone as sufficient proof of a donation of $250 or more.
  • Buy U.S. Savings Bonds. These investments are tax-free until the date they are cashed. In other words, the income is deferred until the day you cash them.
  • Hire Your children. If you own a business, consider hiring your children to shift some taxable dollars to them. By hiring your own kids to work in your business, you lower your taxable income and the kids receive tax-free income. If they are too young to perform easy tasks such as washing the company car, include their picture in your company literature. Older children can perform tasks such as filing and answering the phones.
  • Stock Option Trust. Consider putting some or all of your nonqualified stock options in trust for your children. Although you must pay income tax on the value of the options when they are exercised, you could save quite a lot of estate and gift tax. Most option plans may need to be amended to allow this type of transfer. Consult with your financial planner for more details.
  • Life insurance proceeds. Another way of transferring money to other members of your family is via life insurance. The face value of the policy is not taxable to the recipient if such amounts are paid by reason of the death of the insured. Life insurance is considered a form of trust, whereby the insuring company is the trustee. Interest received from the policy is taxable to the recipient, however. Distribution amounts (income) will be shown on Form 1099-R.
  • Gifts. Consider giving gifts of either property or cash to help reduce your tax liability. Excluded from gross income are the following:
    1. each taxpayer is allowed one annual exclusion of up to $12,000 as a donee, there is no limit to the number of donees;
    2. cumulative gifts to minors up to age 21, only when held in a custodial account until that age;
    3. direct payments to educational institutions and medical care facilities on behalf of ANY family or nonfamily member;
    4. one-time lifetime/deathtime exclusion of around $2,000,000 (actual amount varies according to year of gift).
Using any of these tax-saving suggestions will benefit you, your family, and your pocketbook.

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Health Savings Accounts

A popular way for families to save on taxes is by contributing to a Health Savings Account. By establishing and funding a Health Savings Account, taxpayers can make health-related expenditures tax deductible. This also helps taxpayers save for the medical expenses that occur unexpectedly.

Individuals under age 65 may establish an HSA (Health Savings Account) which allows them to save for qualified medical and retiree health expenses on a tax-free basis. These accounts are custodial in nature. One of the requirements of an HSA is the fact that the individual covered (known as an account beneficiary) must also be covered under a high-deductible health plan (HDHP). Any eligible individual can establish an HSA.

For HSA purposes, an “eligible individual” must meet the following requirements:

  • covered under a high-deducible health plan (HDHP) on the first day of applicable month;
  • NOT covered by any other health plan that is not an HDHP;
  • NOT entitled to benefits under Medicare;
  • NOT claimed as a dependent on another person’s tax return.

Contributions made by individuals and family members are tax deductible for the account beneficiary – even if the account beneficiary does not itemize. The account beneficiary does not lose his or her unused HSA dollars at year end. This means that the account contributions are NOT on a use-or-lose basis. This is beneficial to the beneficiary.

Employer contributions are made on a pretax basis and are NOT taxable to the employee. Employers will be allowed to offer HSAs through a cafeteria plan. However, these employer contributions must be made available on a comparable basis to all participating employees.

HSA distributions are tax-free if they are used to pay qualified medical expenses. Some of these medical expenses include:
  • Prescription drugs
  • Diagnosis, cure, treatment, mitigation, or prevention of disease costs
  • Continuation coverage required by federal law
  • Qualified long-term care services
  • Qualified long-term care insurance
  • Health insurance for the unemployed
  • Medicare expenses (not Medigap)
  • Retiree health expenses for individuals age 65 or older

Distributions made for any other purpose taxable and have a 10 percent penalty. This 10 percent penalty is waived for distributions made by individuals age 65 or older.

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