Tax News & Tips
Two New Tax Laws

Simplify Your Record Keeping

Two New Tax Laws

Two new tax laws were signed in May. I've read them carefully and need to pass along the information.

Kiddie Tax Headache.
In its search for extra tax revenue, the Congress has targeted an unlikely group - teenagers. They raised the threshold age for the "kiddie tax" from 14 to 18.

What is "Kiddie Tax"? To catch parents trying to move some of their income into a child's lower bracket, tax law has special rules. The child's investment income over $1,700 is taxed at the higher of the tax rate of the child or the parent. For simplicity, parents may perform the calculation on their own return but only if all the child's income is from investments.

Who's Affected? Not many families can afford to provide this much income to youngsters. But, the change opens new tax problems for those who can. Tax forms are easy when the child has only this one type of income. But, teenagers often have income from part-time jobs. Now they can't file the simplest tax forms. Investment income over $1,700 needs extra calculations to determine whether the youngster or the parent has the higher tax rate. If the parents are divorced, special rules are used to tell which parent is looked at. The parent's information must be given on the youngster's return.

Worse, parents who planned under older law may have set up college accounts that now are the property ofthe teenager. They expected the income to be taxed at the youngster's low rates. Whoops!

With the new law parents might choose investments which avoid the "kiddie tax". Government bonds, tax-free municipal bonds, and growth-oriented investments are a few possibilities. Tax-favored college savings plans look more attractive. But, parents who made plans based on prior law may be very unhappy with the outcome.

Low Capital Gain Rates Extended.
Long-term capital gains are taxed at special low rates. Gains falling into the 15% or lower brackets are taxed at 5%. Gains falling in the 25% or higher brackets are taxed at 15%. This is referred to as a 5%/15% rate. The rate was set to go 10%/20% in 2009. The increase is pushed back two years to 2011. Some 25 years ago President Ronald Reagan proved that lowering tax rates can actually produce an increase in tax revenues. Congress believes this reduction will have that special behavior.

Qualified Dividends, Too.
Dividends from U.S. corporations have been taxed at the same rates as capital gains. This is also extended through 2010.

Roth IRA Conversions.
In a "conversion" you cash a regular IRA (and pay the tax), but "roll over" the funds to a Roth IRA. If no withdrawals are made for 5 tax years, all income in the account is tax-free once you reach age 59Vz. The "wealth" catch - you can't do a conversion if your income exceeds $100,000. The new law removes the income ceiling in 2010. If income is too high for conversion now you can wait until 2010. Depending on your age (and your tax bracket) you might like the trade-off: pay tax now, and get tax-free earnings in the future. Age matters, because it takes a few years to recoup the money spent on tax you could have deferred.

Winning Strategy.
If you have no IRA funds at present, you could make deposits into a nondeductible IRA for 2006, 2007,2008, and 2009. In 2010, you convert the funds to a Roth IRA. You will be taxed on the growth from these four years, but not on your original contributions. You could deposit $4,000 in 2006 and 2007, and $5,000 in 2008 and 2009. (Limits are $1,000 higher each year if you are age 50 or higher.) With luck, you'll have earnings of a few thousand dollars by 2010. Do the conversion, and 5 years later you have a completely tax-free account! Only the earnings are taxed, and the tax is spread over your 2010 and 2011 returns. This is clearly a wise strategy for anyone under age 60, and even for older folks ifthe investment is right.

AMT - A Band-Aid.
AMT" stands for the "Alternative Minimum Tax". It was originally enacted to prevent wealthy Americans from using too many tax "goodies". In recent years it has been affecting more and more folks. Currently about 5% of tax returns include an AMT. An allowance or "exclusion" from AMT was set to drop in 2006, returning to the levels from year 2000. Rather than attack the tax itself, Congress gave us a one-year increase in the exclusion.

Simplify Your Record Keeping

Have you ever tried to apply the theory of Constructive Laziness to Life's Major Pains?

Keeping tax records is a chore. But, life is full of distasteful chores. Ask yourself how you can do the least work and still do a good job. You know you'd save money if your records were in better shape. That is - you'll be paid to do this chore.

Routines. It's all about "routines". Try to add to something you already do. Records involve receipts, little slips of paper, and writing things down - so you're looking for a routine that uses these, or can have these things added.

Do you keep a desk calendar? Or even one on your refrigerator? When and where do you pay bills? Do you constantly place things in a particular drawer or shelf? You can add a small routine to this and keep records with minimum hassle. It can happen over the morning paper, or while you're trying to decide what you need to do each day. The trick here is - don't try to teach yourself a whole new regimen, just add a little to an existing routine.

"Locked Envelope" System. Here's a simple trick to keep things arranged with the least amount of work. Remember - it's Constructive Laziness. Get a few large envelopes, preferably 9Xl2-inch ones. You'll need one for each major area of records. They might be marked "household", "job expense", "rental", "investment" and "home improve". They will be used to keep the notes and records. Most folks need only 4 or 5 envelopes. But here's the trick:

"Locked" means you can't open the envelope to put something inside until you write the information on the outside of the envelope.

Regular Usage. For best results you should do this daily. I've heard clients say they do this before the morning paper can be opened, or over the morning coffee, or before evening television. One salesman client felt a need to brush his shoes each morning and kept the tax records in the drawer with the shoe polish! On most days it takes all of about 3 seconds to realize "I didn't do anything yesterday that affects my taxes."

It's OK to toss the little receipts and notes into the basket or drawer when you're in a hurry, but now you'll need 5-10 minutes on a Saturday to straighten the mess.

Some Notes. As you get used to the "locked envelope" system, some questions will arise:

Lost Receipts. Truth is - you don't need receipts for amounts up to $75 if your record system amounts to a "diary". Write it on the envelope!

Check Registers should always be used. Make a habit of marking a "T" (for "tax") next to items you'll need for taxes. Don't forget to write it on the envelope!

Investment Records. Do you get tired of the monthly statements from the broker? Maybe you don't even open the envelopes any more. Watch for the special statement in January. It's your "consolidated" statement. It shows your entire year of activity. Keep it, and discard those unopened monthly statements.

"Permanent" Envelopes. Some records continue after yearend. Your "Home Improvements" envelope may take years to fill up. The others will call for a new envelope each year.

Try It! A valid trial must go until the year ends. You'll be surprised how thorough your records can be. And, remember - your being paid!

Would you like to read a past issue. Please check out one of these issues:
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