Helpful Tax Information


** You should always consult with a tax attorney and/or the IRS for updated tax information **

The gift tax is perhaps the most misunderstood of all taxes. When it comes into play, this tax is owed by the giver of the gift, not the recipient. You probably have never paid it and probably will never have to. The law completely ignores gifts of up to $12,000 per person, per year, that you give to any number of individuals. (You and your spouse together can give up to $24,000 per person, per year to any number of individuals.)

If you have 1,000 friends on whom you wish to bestow $12,000 each, you can give away $12 million a year without even having to fill out a federal gift-tax form. That $12 million would be out of your estate for good. But if you made the $12 million in bequests via your will, the money would be part of your taxable estate and would trigger an enormous tax bill. The $12,000 tax-free limit applies in 2008; the amount rises to $13,000 in 2009.

You can give up to $1 million in gifts that exceed the annual limit—total—in your lifetime, before you start owing the gift tax.

If you give $15,000 each to ten people in 2008, for example, you'd use up $30,000 of your $1 million lifetime tax-free limit.





Gift Planning

Gift planning can be an important part of estate planning. Start thinking about property transfers that may reduce or avoid estate taxes. Relatively small gifts can completely avoid gift tax because of the annual gift tax exclusion. Gifts to a spouse and certain gifts to pay educational or medical expenses are also not subject to the gift tax.

Gift tax generally does not have to be paid even on very substantial taxable gifts because the gift tax is offset by a tax credit that effectively exempts up to $1 million of lifetime taxable gifts from the tax. Gift tax is reported on Form 709.

There is an unlimited gift tax exclusion for payments of another person’s tuition or medical expenses. These exclusions apply only if you make the payment directly to the educational organization or care provider. The relationship between you and your donee does not matter as far as the medical and educational exclusions are concerned. The exclusion for directly paid educational expenses applies only to tuition. It does not apply to room and board, books, or supplies.

Contributions to a qualified tuition program (QTP) on behalf of a designated beneficiary do not qualify for the educational exclusion.

Gifts of a present interest to any particular donee during the calendar year are usually not subject to the gift tax unless the value of all the gifts to the donee during the calendar year exceeds $10,000.

While you're gifting to charities, you might also gift to family members or close associates. It won't decrease the 1999 tax bill but it will decrease the estate taxes when that day comes. Each donor can give $10,000 annually to each donee without gift tax. This means a married couple could give to a child and his/her spouse, a total of $40,000 with no tax implications.





Custodial Accounts for Minors

Since minors generally lack the ability to manage property, custodial accounts are set up for them. Custodial accounts are set up in a bank, mutual fund, or brokerage firm and can achieve income splitting.

Rules governing custodial accounts vary according to state. So, check with your local state to find out the requirements you need to follow. The differences between state laws, however, do not affect federal tax consequences regarding custodial accounts - in general. Purchase of securities through custodial accounts provides a practical method for making gifts of securities to a minor child, eliminating the need for a trust. The custodian may be a parent, child’s guardian, grandparent, brother, sister, uncle, or aunt. In some states, the custodian may be any adult, bank, or trust company.

The custodian has the right to sell securities in the account and collect sales proceeds plus investment income. The custodian can use the proceeds and investment income for the child’s benefit or reinvestment.


Social security taxes

Whether you owe taxes on your social security benefits depends entirely on your income level, and income types. If social security benefits have been your only form of income and will continue to be, you will most likely not need to pay taxes or file a Federal income tax return. However, before deciding to pay income taxes or not, it is probably a good idea to get a second opinion from a tax professional.


Do not forget your winnings

Some retired taxpayers get in to trouble with the IRS for having too much fun at the casino without telling Uncle Sam. Do not forget that gambling winnings are forms of taxable income. You will need to pay taxes on the winnings even if your next bet is a big loser.





Medical expenses

If you itemize your deductions, then the IRS will allow you to deduct dozens of medical expenses. The following items are all examples of qualified expenses.

In-patient care at a hospital or similar institution, including meals and lodging
Chiropractor fees
Ambulance or other transportation service
Laboratory fees and fees for X-rays
Artificial limbs, eyeglasses, contacts, hearing aid (including batteries), and artificial teeth
Prescription medicines and insulin
Medical supplies, such as bandages and crutches
Dental treatment, including fees for X-rays, fillings, braces, extractions, dentures, etc.
Eye examination fees or fees paid for eye surgery to treat defective vision, such as laser eye surgery or radial keratotomy
Cost of equipment and materials required for using contact lenses, such as saline solution and enzyme cleaner

But remember, the IRS only allows you to claim the medical expenses that exceed 7.5% of your adjusted gross income. Thus, make sure to keep track of all your expenses throughout the year to qualify for the largest deduction possible.


Volunteering deductions

If you do any volunteer work in your free time then you may be able to deduct any out-of-pocket expenses you incur. They must all be directly related to your volunteer activity, and the organization you volunteer for must be a qualified organization approved by the IRS.

Should I Roll Over My 401(k)? In short, yes. Rolling over your 401(k) almost always makes a ton of sense. After all, why would you want your former employer overseeing your account? Taking control of that money will open up a world of investment options.

Your plan probably has at most 20 mutual funds to pick from. A rollover IRA will give you thousands of choices. I assume, since you're ready to retire early, that you have a brokerage account. So if you're happy with that firm, you could just roll over your account there.

Of course, if you want some of that money immediately and you're over age 55 (but younger than 59 1/2) take the money out first and then roll over the rest of the account. Thanks to a handy penalty exception for those who quit or retire between those ages, you can take payouts from company-sponsored qualified retirement plan accounts and successfully dodge a 10% early withdrawal penalty. The amount will be taxed to be sure, but it's better than rolling the money into an IRA and then trying to access it.





When Not to Roll Over: Company Stock

A rollover may not be the best option when your qualified retirement-plan account has a bunch of low-cost stock from your former company. If the current market value of the company shares is high in relation to their cost, you should strongly consider withdrawing the shares now and paying the resulting taxes.

The reason is because your tax bill will be based on the (low) cost of the shares, rather than their (high) market value. If you're under age 55, you'll also owe the 10% penalty. But since the cost of the stock is low, the tax hit will probably be manageable even after the penalty. Why follow this strategy? Because it positions you to pay only the 20% capital-gains tax on the difference between the cost of your company shares and the eventual selling price. Here's an example of how cashing in your company stock could benefit you:

Say you decide to bail out of your job at the ripe old age of 52. Your company 401(k) account is worth $500,000. Of that, $200,000 is invested in company shares that cost only $25,000. If you follow my sage advice, you'll roll over $300,000 tax-free into your IRA. So far, so good. Now withdraw all the company stock and put the shares into a taxable account with your favorite brokerage firm. You'll owe income taxes on $25,000, which is the cost of the stock. Plus you'll owe the 10% penalty (because you're not age 55 or older) on the $25,000. Let's say the total tax hit, including the penalty, is 41% or $10,250 (.41 x $25,000). That's the bad news.

The good news is your company stock now qualifies as a capital asset. So if you sell immediately for $200,000, you'll only owe the 20% capital-gains tax on your $175,000 profit. In contrast, if you roll the shares over into your IRA, your profit will be taxed at your regular rates (up to 39.6%) when you start taking IRA withdrawals.

Things will work out even better if you hang onto the shares for over a year and they continue to appreciate. Now any additional profit will also qualify for that nice, low 20% capital-gains rate. Say you hold the shares for 10 years and then sell out for a cool $600,000. You'll pay only 20% on your $575,000 profit. In this example, the future tax savings from not rolling your shares over could be as much as $112,700 ($575,000 profit taxed at only 20% instead of 39.6%).

One word of caution: To be eligible for the favorable tax treatment I just explained, your company stock must be received as part of a lump-sum distribution from the qualified retirement plan or plans in which you participate. Check with your employee-benefits department to make sure your retirement-plan payout qualifies as a lump-sum distribution. You can then roll over the remaining amount into an IRA.





Tapping your IRA

Unlike a company-sponsored plan, there's no special treatment when it comes to IRAs for people between the ages of 55 and 59 1/2. So if you tap your IRA before official retirement age, you usually get hit with the 10% early withdrawal penalty. There are some penalty exemptions we've listed them here but as you'll see, some are decidedly less appealing than others:

Annuity-like withdrawals taken over your life expectancy. The withdrawals must be taken at least annually for a minimum of five years or until you turn 59 1/2, whichever is later. To figure how much you could withdraw penalty-free under this exception, call us as there are many methods and our recommendation depends upon age, marital status and investment return assumptions.
Withdrawals to pay qualified higher-education expenses. This could be for youâ but more likely it could be used for your kids.
Withdrawals to pay deductible medical expenses (the amount in excess of 7.5% of your adjusted gross income).
Withdrawals to help pay for a qualified home purchase (there's a $10,000 lifetime limit on this exception). Again, this could be given to a family member.
Withdrawals after death or disability.


Tapping Your Roth

The great thing about Roth IRAs is your earnings can be withdrawn totally tax-free. But that's only true if: (1) the account has been open at least five years, and (2) you are at least age 59 1/2, dead, disabled or use the money for higher education or to make a qualified home purchase ($10,000 limit). If you don't pass both parts of the test, the earnings are taxed when withdrawn.

For withdrawals before age 59 1/2, you'll also owe the 10% penalty on those withdrawn earnings, unless one of the penalty exceptions listed earlier applies. That penalty will also apply if you withdraw "conversion contributions" within five years of the conversion. Conversion contributions are those you made by converting a traditional IRA into a Roth and paying the resulting tax hit.

On the other hand, you generally can withdraw Roth contributions tax-free and penalty-free. Even so, you shouldn't do it. Why? Because taking withdrawals mean you'll have that much less to continue investing on a tax-free basis. And think of it this way: If you need the money so badly that you need to immediately tap your original contribution, you probably ought to keep working for a few more years.









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