Summer 2008

Do You Have Debt Forgiveness?
You may not have to include it in income

When you are liable for a loan but can’t repay it, some lenders will forgive the debt. What many borrowers don’t realize is that this cancellation of debt (COD) often results in taxable COD income in the year of forgiveness. The lender usually will issue a Form 1099-C to report the cancelled debt. If you receive one, don’t ignore it. Be sure to give it to your tax preparer and discuss the circumstances surrounding the loan.

If you have cancelled debt but are bankrupt or insolvent, you may exclude the income on your tax return. To prove insolvency, you must show that your liabilities exceeded the fair market value of your assets immediately before the debt discharge. The amount of forgiven debt that can be excluded cannot be more than the amount your liabilities exceeded the value of your assets.

Congress passed the Mortgage Forgiveness Debt Relief Act in late 2007 to provide some relief for borrowers who can’t pay their mortgages. If you have forgiveness of debt on the mortgage of your qualified principal residence due to foreclosure or short sale, you may not have to include the COD income on your tax return. The maximum amount of debt forgiveness eligible for exclusion is $2 million. This relief is available for tax years 2007 through 2009.

Even with this special exclusion, many taxpayers are going to have to report taxable COD income, or taxable capital gain income, or both, as the result of residential foreclosures and short sales. Equity debt is going to be a common hang up, because only cancelled acquisition and improvement debt may be excluded from tax under the congressional relief act. Any borrowing done for other purposes (auto purchase, education, pay off credit cards, buy a second home or investment property, etc.) is considered equity debt. Expect cancelled equity debt to be taxable, except in cases of bankruptcy or insolvency.

California residents should expect to pay state income tax on COD income. Principal residence debt forgiveness will be excluded only if the legislature conforms to federal law by August 31.

Debt forgiveness is a complex topic and every situation is unique. If you are facing a possible foreclosure or short sale, consult your tax advisor to understand and prepare for the tax consequences.

Federal Housing Bill Passes
The Federal Housing Assistance Act of 2008
is no panacea, but it will help some

On July 30, 2008, President Bush signed into law a housing bill aimed at providing mortgage relief for more than 400,000 US homeowners facing foreclosure, primarily by allowing them to refinance high-interest, adjustable-rate mortgages, or ARMs, into less expensive fixed-rate loans backed by the Federal Housing Administration. Certain provisions will limit the number of homeowners who qualify, including a requirement that lenders write down loans to no more than 90 percent of a home's value. The program starts Oct. 1 and ends Sept. 30, 2011.

The Housing Assistance Tax Act of 2008 also includes these income tax provisions:

Credit for first-time home buyers, but it's really a loan

First-time home buyers are allowed a refundable tax credit of up to $7,500 for homes bought between April 9, 2008, and April 1, 2009. This is really an interest-free loan which is repaid ("recaptured") over 15 years. A taxpayer who is liable for the recapture tax must file an income tax return, even if not otherwise required to do so. The credit is phased out for taxpayers with adjusted gross income between $75,000 and $95,000 ($150,000 and $170,000 for joint filers). A “first-time home buyer” is an individual who had no present ownership interest in a principal residence during the three-year period ending on the date of the purchase of the principal residence to which the credit applies. If the individual is married, neither the individual nor his spouse may have had a present ownership interest in a principal residence during that three-year period. Taxpayers who purchase a residence after December 31, 2008, and before July 1, 2009, may elect to treat the purchase as made on December 31, 2008. Making this election allows the credit to be claimed on an original or amended 2008 tax return.

"Above the line" property tax deduction

For 2008 only, taxpayers who use the standard deduction can deduct an additional amount for state or local real property taxes. The additional deduction is limited to a maximum of $500 ($1,000 for joint filers).

New Rule Will Result in More Taxable Home Sales
Another change due to the federal housing bill

The federal housing bill just passed contains mostly provisions designed to help taxpayers. Here's one which does the opposite.

Currently, taxpayers are allowed to exclude up to $250,000 ($500,000 on a joint return) of gain from the sale of their principal residence. Generally, you must own and occupy the residence for at least two of the five years preceding the date of sale. A reduced exclusion is permitted for taxpayers who meet certain unforeseen circumstances.

Under the new law, taxpayers will not be allowed to exclude any gain attributable to a "nonqualified use." A period of nonqualified use is any period after January 1, 2009 during which the property is not used as the principal residence of the taxpayer, the taxpayer's spouse, or former spouse.

This rule will affect taxpayers who sell a principal residence which was previously a vacation home or rental property, for example. If there is a gain on the sale, they will owe some amount of tax, even if they meet the two-out-of-five years ownership and use tests. The amount of gain taxed will be based on a percentage arrived at by dividing the nonqualified use time by the total period of property ownership. (Note that for rental properties, tax will also be owed on the amount of allowable depreciation. This is prior tax law and remains unchanged.)

Since the definition of a period of nonqualified use doesn't include any period before January 1, 2009, a taxpayer can avoid this new rule if he moves into another residence he owns and makes it his principal residence before January 1, 2009.

[1] If you haven't yet filed a tax return to get your stimulus payment, you still have time to do so. You must file by Oct. 15 to get your payment this year. If you've already filed but have a question or issue, visit the IRS Stimulus Payment answer page.

[2] Keep separate track of business miles driven in the first half of 2008 and miles driven in the second half of the year. For business miles driven from Jan. 1 through June 30, 2008, the standard mileage rate for the use of a car (including vans, pickups, or panel trucks) is 50.5 cents per mile. The IRS raised the rate to 58.5 cents per mile effective July 1.

[3] Last year I wrote of the tax complications facing California Registered Domestic Partners, including the fact that they must file single federal tax returns and a joint state tax return. These same complications now apply to California same-sex married couples. Before marrying or registering a domestic partnership, I recommend that all couples receive competent legal and tax advice. This is especially true for same-sex couples, because lack of agreement between federal and state law creates many thorny issues.

[4] Are you planning on making any substantial gifts? Talk to your tax advisor first. Gifts with values exceeding $12,000 must be reported to the IRS.

[5] Not only will you save money at the pump if you buy a hybrid vehicle, you may be eligible for a credit on your income tax return. Note, however, that the credit is no longer available for certain vehicles, including the popular Toyota Prius. Check the IRS Alternative Motor Vehicle Credit page to see which vehicles still qualify.

ADP Pledges World Class Payroll Service
Three months free promotion through August 28

Many family child care providers and other small business owners have employees or are looking at hiring. Consider all your options when deciding how to handle paying employees, filing employment tax returns, and making tax payments. None of this is particularly hard, but it must be done correctly and on time to avoid some significant penalties.

If you are a business owner with your hands full, you probably want to use a full payroll service. My friendly representative at ADP asks that you consider working with him:

My name is Tim Wendling and I am the Regional Accountant Specialist for ADP. I work in the Small Business Division of ADP, specializing in providing services such as:
- Payroll
- Tax Filing and Depositing
- HR Compliance
- Workers Compensation

These services are tailored for the unique needs of each individual small business that I work with. By working with me, you are guaranteed world class service and preferred pricing thru your association with Alison T. Jacks, E.A.

We currently have a 3 MONTHS FREE Summer Promotion going through August 28. Please call me directly to ensure you receive this promotion and other preferred pricing offers at 925-251-5343 or email me at Tim_Wendling@adp.com.

Take Advantage of Tax Savings in a Down Market
Know when you have a deductible loss

Just because the stock market lost money doesn’t mean you have a deductible loss. As long as you hold on to an investment, you only have a loss on paper. It’s only when you actually sell the investment that you have a transaction to report on your tax return.

Fortunately, the tax law allows you to offset your capital gains by your capital losses. You can avoid or minimize taxable gain by selling two investments, one at a gain and the other at a loss.

However, an investment sold at a loss is not gone forever. If you believe it was a good long-term investment, you can buy it back. This strategy works very well if the price of the investment either stays the same or goes down even further. For example, let’s say you sold 100 shares of ACME stock, which you purchased for $3,000, and receive $2,500 in cash proceeds from the sale. You can use the $500 capital loss to offset capital gains or other income. Now, let’s assume you want to buy back the ACME stock because it’s a good long-term investment. If the price of 100 shares of ACME is $2,500 or less, you can use the proceeds from the first sale to buy the stock back without having to provide any additional money. Caution: You must wait at least 31 days after the sale to repurchase the stock, otherwise the loss is not allowed.

If you are an IRA owner over age 59½, you can take advantage of the down market by taking distributions (either voluntary or required) of actual investments from your IRA, instead of the cash. You’ll also escape the additional ten-percent premature distribution penalty. If there are investments within your IRA account that you want to hold long-term, but the value is currently down, you may want to consider having them distributed to you. Be aware that this is a taxable event and the fair market value of the investment must be reported on your tax return. However, any appreciation earned after the distribution will not be taxable until you sell the investment. This provides several advantages:

• If you sell the investment, it will be taxed at the lower capital gains rate, which may be less than the rate for your IRA distribution;
• It reduces your IRA account so your required minimum distributions may be smaller in future years; and
• You can gift that investment to a person or a charity at a later date.

As always, consult your investment and tax advisor prior to taking any actions.

Converting a Traditional IRA to a Roth?
You may want to wait

At some point, taxpayers who have a traditional IRA may wish to convert it to a Roth. Roth IRAs are more flexible in that there are no required minimum distributions when the owner reaches age 70½. In addition, qualified distributions from a Roth IRA are not taxable.

Under current tax law, in the year you convert a traditional IRA to a Roth IRA, you must recognize the amount converted as income on your tax return, with the exception of any basis that may be in the traditional IRA. Depending on the amount, this can significantly impact your tax return. It can even bump you up into a higher tax bracket.

New legislation may make it worthwhile to hold off converting your IRA. For conversions made in 2010 only, the income from these conversions may be included in income over the two-year period beginning in 2011. For example, let’s say you convert a traditional IRA worth $40,000 to a Roth during 2010. You won’t need to report the conversion on your 2010 return, unless you elect to. Your 2011 and 2012 returns will each include $20,000 of income from the conversion.

Generally, if your income is more than $100,000, you currently are not eligible to make a conversion. However, beginning in 2010, this restriction will be eliminated and you’ll be able to make conversions regardless of your income or filing status.

Spreading Roth conversion income over two years will be advantageous for most taxpayers. Keep in mind, however, that the income tax owed is based on the value of your traditional IRA account at the time of conversion. If your IRA is invested in market securities (i.e. stocks and bonds), you should consider the value of those securities when timing a Roth conversion. You will pay less tax if you convert when values are depressed.

Consider the timing of a Roth conversion carefully and seek professional advice, especially when considering large conversions.