Year-End Tax Planning
 
December 20, 2006
 
Todd Schneider - Chicago

As the year draws to a close, there are several pending changes in the tax laws that may affect you. In addition, there are several traditional year-end tax planning strategies that may minimize your tax bill in 2007.

Inflation Adjusted Figures for 2007

The Internal Revenue Service recently released Revenue Procedure 2006-53, which contains inflation-adjusted figures for 2007. Several of those changes are described below.

Income Tax Changes

Standard Income Tax Deduction. In 2007, the standard deduction amounts under are as follows:

Filing Status	Standard Deduction
Married individuals filing joint returns and surviving spouses	$10,700
Heads of households	$7,850
Unmarried individuals (other than surviving spouses and heads of households)	$5,350
Married individuals filing separate returns	$5,350

Dependent. The standard deduction amount for an individual who may be claimed as a dependent by another taxpayer is $850.

Aged or blind. The additional standard deduction amount for the aged or the blind is $1,050 ($1,300 if the individual is also unmarried and not a surviving spouse).

Overall Limitation on Itemized Deductions. Itemized deductions are reduced for those with adjusted gross incomes of $156,400 (or $78,200 for a separate return filed by a married individual).

Personal Exemption. For 2007, the personal exemption amount is $3,400 ($1,133 for taxpayers with adjusted gross income in excess of the maximum phase-out amount).

Phase-Out of Personal Exemptions. The personal exemption amount begins to phase out at, and reaches the maximum phase-out amount after, the following adjusted gross income amounts:

Filing Status	AGI - Beginning	AGI - Maximum of Phaseout Phaseout
Married individuals filing joint returns and surviving spouses	$234,600	$357,100
Heads of households	$195,500	$318,000
Unmarried individuals (other than surviving spouses and heads of households)	$156,400	$278,900
Married individuals filing separate returns	$117,300	$178,550

“Kiddie Tax.” The net unearned income of a child under 18 will generally be taxed at the parents’ highest marginal tax rate. In 2007, the first $850 of a minor’s income is generally exempt from this rule.

Adoption Credit. Beginning in 2007, the credit allowed for an adoption of a child is $11,390. The available adoption credit begins to phase out for taxpayers with modified adjusted gross income in excess of $170,820 and is completely phased out for taxpayers with modified adjusted gross income of $210,820 or more.

Child Tax Credit. The maximum credit for each qualifying child is $11,750. This amount is reduced for taxpayers with modified adjusted gross income in excess of $75,000 ($110,000 for a joint return).

Hope and Lifetime Learning Credits. The maximum Hope Scholarship Credit is $1,650. The available credit begins to phase out for taxpayers with modified adjusted gross income in excess of $47,000 ($94,000 for a joint return).

Periodic Payments Received Under Qualified Long-Term Care Insurance Contracts or Under Certain Life Insurance Contracts. The per diem limitation for periodic payments received under a qualified long-term care insurance contract, or periodic payments received under a life insurance contract that are treated as paid by reason of the death of a chronically ill individual, is $260.

Roth IRAs. Contributions to Roth IRAs are subject to the same contribution limits as traditional IRAs. In 2007 the contribution limit is $4,000 (with a $1,000 “catch-up” allowance for taxpayers who are at least 50 years of age). In 2007, taxpayers with adjusted gross incomes over $114,000 cannot contribute to a Roth IRA ($171,000 for married taxpayers filing jointly). Married taxpayers filing separately cannot contribute to a Roth IRA. The contribution amount begins to phase out at $99,000 ($156,000 for married taxpayers filing jointly).

Expatriation to Avoid Tax. An individual with “average annual net income tax” of more than $136,000 for the five taxable years ending before he or she gave up United States citizenship is subject to tax.

Foreign Earned Income Exclusion. For taxable years beginning in 2007, the foreign earned income exclusion amount is $85,700.

Transfer Tax Changes

Estate Tax Exclusion. The Applicable Exclusion Amount remains at $2 million per individual in 2007. Under current law, the Exclusion is scheduled to increase to $3.5 million in 2009 and will be unlimited in 2010.

Generation Skipping Transfer (GST) Tax Exemption. The GST Exemption will also remain at $2 million per individual in 2007. It is also scheduled to increase to $3.5 in 2009.

Annual Exclusion for Gifts. The first $12,000 of gifts to any person (other than gifts of future interests in property) are not included in the total amount of taxable gifts made during that year. This Exclusion remains unchanged from 2006.

Annual Exclusion for Gifts to a Non-Citizen Spouse. The first $125,000 of gifts to a spouse who is not a citizen of the United States (other than gifts of future interests in property) are not included in the total amount of taxable gifts made during that year. This is an increase from $120,000 in 2006.

Lifetime Gift Tax Exclusion. The lifetime exclusion remains frozen at $1 million. There is no pending legislation to increase this amount.

Estate and Gift Tax Rate. In 2007 the top estate and gift tax rate will drop from 46 percent to 45 percent. For all practical purposes, this results in a flat tax of 45 percent on the value of assets included in a decedent’s estate over $2 million.

Valuation of Qualified Real Property in Decedent’s Gross Estate. For an estate of a decedent dying in calendar year 2007, if the executor elects to use the special use valuation method under § 2032A for qualified real property, the aggregate decrease in the value of qualified real property resulting from electing to use § 2032A for purposes of the estate tax cannot exceed $940,000.

Notice of Large Gifts Received from Foreign Persons. Recipients of gifts from certain foreign persons may be required to report these gifts if the aggregate value of gifts received in a taxable year exceeds $13,258.

Other Things to Consider as the Year Draws to a Close

If your estate is large enough to be subject to estate tax, you should consider making gifts that qualify for the various federal gift tax exclusions prior to the end of the year.

Annual Exclusion Gifts. In 2006 and 2007, you can transfer assets worth as much as $12,000 to any individual, without federal gift tax consequences ($24,000 for married couples who elect to split the gift). Annual exclusion gifts can substantially reduce your potential estate tax liability. For example, each $24,000 gift that you make before the end of the year may eventually save your family at least $10,800 in estate tax.

Education/Medical Exclusion. In addition to the annual gift tax exclusion, each person has an unlimited exclusion for direct payments of tuition or medical expenses. The only caveat is that the payments must be made directly to the provider of the medical care or the student’s school. They cannot be given to the person who incurred the expenses.

Lifetime Exclusion Gifts. Each person is also entitled to transfer assets worth as much as $1 million to any individual during the transferor’s lifetime without incurring any gift tax liability. This amount is $2 million for married couples if they elect to split the gift.

529 College Savings Plans. If you have a child, grandchild or other family member who may attend college in the future, you should consider funding a 529 College Savings Plan for that person. Under present law, a taxpayer may contribute up to $60,000 (or $120,000 for a consenting married couple) to a 529 College Savings Plan for any individual in one year, free of gift tax as long as the donor does not make any other gifts to the same beneficiary for the next five years. Contributions to 529 Plans are generally removed from the donor’s taxable estate, even though the account owner usually retains the right to change the beneficiary to another member of his or her family and even to take back funds in the beneficiary’s account. Distributions from such accounts are completely free from federal income tax if they are used to pay for qualified college expenses, such as tuition, books, room and board. In addition, 529 Plans do not impair the student’s eligibility for federal financial aid because they are not considered the student’s asset, unlike trust funds and custodial accounts.

Coverdell Education Savings Accounts (ESAs). You should also consider contributing $2,000 to a Coverdell ESA if your adjusted gross income is less than $190,000 (married filing jointly) or $95,000 (if single). The amount that can be contributed to Coverdell ESAs phases out for taxpayers that have adjusted gross incomes between $95,000 and $110,000 ($190,000 to $220,000 for married couples).

Contributions of IRA Benefits to Charity. Under the Pension Protection Act of 2006, an IRA owner who is at least 70-1/2 can transfer up to $100,000, tax-free, directly to an eligible charitable organization. Eligible IRA owners can take advantage of this provision in 2006 and 2007, whether or not they itemize their deductions. To qualify, the funds must be contributed directly by the IRA trustee to a public charity. Not all charities are eligible recipients. For example, contributions cannot be made directly from an IRA to a donor-advised fund, a supporting organization or a private foundation. Transferred amounts are counted in determining whether the owner has met the IRA’s required minimum distribution rules.

Conclusion

We will continue to monitor changes in the federal tax system and will keep you apprised of developments through our newsletters. Based on all the pending changes, if you have not recently reviewed your estate plan with your attorney, it would most likely be beneficial to do so in the near future. n

For more information, e-mail Todd J. Schneider at todd.schneider@hklaw.com or call toll free, 1-888-688-8500.