The Financial Crimes Enforcement Network (FinCEN) has removed the requirement that U.S. companies and U.S. persons must report beneficial ownership information (BOI) to FinCEN under the Corporate Transparency Act.

The Financial Crimes Enforcement Network (FinCEN) has removed the requirement that U.S. companies and U.S. persons must report beneficial ownership information (BOI) to FinCEN under the Corporate Transparency Act. This interim final rule is consistent with the Treasury Department's recent announcement that it was suspending enforcement of the CTA against U.S. citizens, domestic reporting companies, and their beneficial owners, and that it would be narrowing the scope of the BOI reporting rule so that it applies only to foreign reporting companies.

The interim final rule amends the BOI regulations by:

• changing the definition of "reporting company" to mean only those entities that are formed under the law of a foreign country and that have registered to do business in any U.S. State or Tribal jurisdiction by filing of a document with a secretary of state or similar office (these entities had formerly been called "foreign reporting companies"), and
• exempting entities previously known as "domestic reporting companies" from BOI reporting requirements.

Under the revised rules, all entities created in the United States (including those previously called "domestic reporting companies") and their beneficial owners are exempt from the BOI reporting requirement, including the requirement to update or correct BOI previously reported to FinCEN. Foreign entities that meet the new definition of "reporting company" and do not qualify for a reporting exemption must report their BOI to FinCEN, but are not required to report any U.S. persons as beneficial owners. U.S. persons are not required to report BOI with respect to any such foreign entity for which they are a beneficial owner.

Reducing Regulatory Burden

On January 31, 2025, President Trump issued Executive Order 14192, which announced an administration policy "to significantly reduce the private expenditures required to comply with Federal regulations to secure America’s economic prosperity and national security and the highest possible quality of life for each citizen" and "to alleviate unnecessary regulatory burdens" on the American people.

Consistent with the executive order and with exemptive authority provided in the CTA, the Treasury Secretary (in concurrence with the Attorney General and the Homeland Security Secretary) determined that BOI reporting by domestic reporting companies and their beneficial owners "would not serve the public interest" and "would not be highly useful in national security, intelligence, and law enforcement agency efforts to detect, prevent, or prosecute money laundering, the financing of terrorism, proliferation finance, serious tax fraud, or other crimes."The preamble to the interim final rule notes that the Treasury Secretary has considered existing alternative information sources to mitigate risks. For example, under the U.S. anti-money laundering/countering the financing of terrorism regime, covered financial institutions still have a continuing requirement to collect a legal entity customer's BOI at the time of account opening (see 31 CFR 1010.230). This will serve to mitigate certain illicit finance risks associated with exempting domestic reporting companies from BOI reporting.

BOI reporting by foreign reporting companies is still required, because such companies present heightened national security and illicit finance risks and different concerns about regulatory burdens. Further, the preamble points out that the policy direction to minimize regulatory burdens on the American people can still be achieved by exempting foreign reporting companies from having to report the BOI of any U.S. persons who are beneficial owners of such companies.

Deadlines Extended for Foreign Companies

When the interim final rule is published in the Federal Register, the following reporting deadlines apply:

• Foreign entities that are registered to do business in the United States before the publication date of the interim final rule must file BOI reports no later than 30 days from that date.
• Foreign entities that are registered to do business in the United States on or after the publication date of the interim final rule have 30 calendar days to file an initial BOI report after receiving notice that their registration is effective.

Effective Date; Comments Requested

The interim final rule is effective on the date of its publication in the Federal Register.

FinCEN has requested comments on the interim final rule. In light of those comments, FinCEN intends to issue a final rule later in 2025.

Written comments must be received on or before the date that is 60 days after publication of the interim final rule in the Federal Register.

Interested parties can submit comments electronically via the Federal eRulemaking Portal at http://www.regulations.gov. Alternatively, comments may be mailed to Policy Division, Financial Crimes Enforcement Network, P.O. Box 39, Vienna, VA 22183. For both methods, refer to Docket Number FINCEN-2025-0001, OMB control number 1506-0076 and RIN 1506-AB49.

FinCEN Interim Final Rule RIN 1506-AB49

FinCEN News Release

Melanie Krause, the IRS’s Chief Operating Officer, has been named acting IRS Commissioner following the retirement of Doug O’Donnell. Treasury Secretary Scott Bessent acknowledged O’Donnell’s 38 years of service, commending his leadership and dedication to taxpayers.

Melanie Krause, the IRS’s Chief Operating Officer, has been named acting IRS Commissioner following the retirement of Doug O’Donnell. Treasury Secretary Scott Bessent acknowledged O’Donnell’s 38 years of service, commending his leadership and dedication to taxpayers. O’Donnell, who had been acting Commissioner since January, will retire on Friday, expressing confidence in Krause’s ability to guide the agency through tax season. Krause, who joined the IRS in 2021 as Chief Data & Analytics Officer, has since played a key role in modernizing operations and overseeing core agency functions. With experience in federal oversight and operational strategy, Krause previously worked at the Government Accountability Office and the Department of Veterans Affairs Office of Inspector General. She became Chief Operating Officer in 2024, managing finance, security, and procurement. Holding advanced degrees from the University of Wisconsin-Madison, Krause will lead the IRS until a permanent Commissioner is appointed.

A grant disbursement to a corporation to be used for rent payments following the September 11, 2001 terrorist attacks on the World Trade Center was not excluded from the corporation's gross income. Grants were made to affected businesses with funding provided by the U.S. Department of Housing and Urban Development. The corporation's grant agreement required the corporation to employ a certain number of people in New York City, with a portion of those people employed in lower Manhattan for a period of time. Pursuant to this agreement, the corporation requested a disbursement as reimbursement for rent expenses.

A grant disbursement to a corporation to be used for rent payments following the September 11, 2001 terrorist attacks on the World Trade Center was not excluded from the corporation's gross income. Grants were made to affected businesses with funding provided by the U.S. Department of Housing and Urban Development. The corporation's grant agreement required the corporation to employ a certain number of people in New York City, with a portion of those people employed in lower Manhattan for a period of time. Pursuant to this agreement, the corporation requested a disbursement as reimbursement for rent expenses.

Exclusions from Gross Income

Under the expansive definition of gross income, the grant proceeds were income unless specifically excluded. Payments are only excluded under Code Sec. 118(a) when a transferor intends to make a contribution to the permanent working capital of a corporation. The grant amount was not connected to capital improvements nor restricted for use in the acquisition of capital assets. The transferor intended to reimburse the corporation for rent expenses and not to make a capital contribution. As a result, the grant was intended to supplement income and defray current operating costs, and not to build up the corporation's working capital.

The grant proceeds were also not a gift under Code Sec. 102(a). The motive for providing the grant was not detached and disinterested generosity, but rather a long-term commitment from the company to create and maintain jobs. In addition, a review of the funding legislation and associated legislative history did not show that Congress possessed the requisite donative intent to consider the grant a gift. The program was intended to support the redevelopment of the area after the terrorist attacks. Finally, the grant was not excluded as a qualified disaster relief payment under Code Sec. 139(a) because that provision is only applicable to individuals.

Accuracy-Related Penalty

Because the corporation relied on Supreme Court decisions, statutory language, and regulations, there was substantial authority for its position that the grant proceeds were excluded from income. As a result, the accuracy-related penalty was not imposed.

CF Headquarters Corporation, 164 TC No. 5, Dec. 62,627

The parent corporation of two tiers of controlled foreign corporations (CFCs) with a domestic partnership interposed between the two tiers was not entitled to deemed paid foreign tax credits under Code Sec. 902 or Code Sec. 960 for taxes paid or accrued by the lower-tier CFCs owned by the domestic partnership. Code Sec. 902 did not apply because there was no dividend distribution. Code Sec. 960 did not apply because the Code Sec. 951(a) inclusions with respect to the lower-tier CFCs were not taken into account by the domestic corporation.

The parent corporation of two tiers of controlled foreign corporations (CFCs) with a domestic partnership interposed between the two tiers was not entitled to deemed paid foreign tax credits under Code Sec. 902 or Code Sec. 960 for taxes paid or accrued by the lower-tier CFCs owned by the domestic partnership. Code Sec. 902 did not apply because there was no dividend distribution. Code Sec. 960 did not apply because the Code Sec. 951(a) inclusions with respect to the lower-tier CFCs were not taken into account by the domestic corporation.

Background

The parent corporation owned three CFCs, which were upper-tier CFC partners in a domestic partnership. The domestic partnership was the sole U.S. shareholder of several lower-tier CFCs.

The parent corporation claimed that it was entitled to deemed paid foreign tax credits on taxes paid by the lower-tier CFCs on earnings and profits, which generated Code Sec. 951 inclusions for subpart F income and Code Sec. 956 amounts. The amounts increased the earnings and profits of the upper-tier CFC partners.

Deemed Paid Foreign Tax Credits Did Not Apply

Before 2018, Code Sec. 902 allowed deemed paid foreign tax credit for domestic corporations that owned 10 percent or more of the voting stock of a foreign corporation from which it received dividends, and for taxes paid by another group member, provided certain requirements were met.

The IRS argued that no dividends were paid and so the foreign income taxes paid by the lower-tier CFCs could not be deemed paid by the entities in the higher tiers.

The taxpayer agreed that Code Sec. 902 alone would not provide a credit, but argued that through Code Sec. 960, Code Sec. 951 inclusions carried deemed dividends up through a chain of ownership. Under Code Sec. 960(a), if a domestic corporation has a Code Sec. 951(a) inclusion with respect to the earnings and profits of a member of its qualified group, Code Sec. 902 applied as if the amount were included as a dividend paid by the foreign corporation.

In this case, the domestic corporation had no Code Sec. 951 inclusions with respect to the amounts generated by the lower-tier CFCs. Rather, the domestic partnerships had the inclusions. The upper- tier CFC partners, which were foreign corporations, included their share of the inclusions in gross income. Therefore, the hopscotch provision in which a domestic corporation with a Code Sec. 951 inclusion attributable to earnings and profits of an indirectly held CFC may claim deemed paid foreign tax credits based on a hypothetical dividend from the indirectly held CFC to the domestic corporation did not apply.

Eaton Corporation and Subsidiaries, 164 TC No. 4, Dec. 62,622

Other Reference:

• Code Sec. 960

An appeals court affirmed that payments made by an individual taxpayer to his ex-wife did not meet the statutory criteria for deductible alimony. The taxpayer claimed said payments were deductible alimony on his federal tax returns.

An appeals court affirmed that payments made by an individual taxpayer to his ex-wife did not meet the statutory criteria for deductible alimony. The taxpayer claimed said payments were deductible alimony on his federal tax returns.

The taxpayer’s payments were not deductible alimony because the governing divorce instruments contained multiple clear, explicit and express directions to that effect. The former couple’s settlement agreement stated an equitable division of marital property that was non-taxable to either party. The agreement had a separate clause obligating the taxpayer to pay a taxable sum as periodic alimony each month. The term “divorce or separation instrument” included both divorce and the written instruments incident to such decree.

Unpublished opinion affirming, per curiam, the Tax Court, Dec. 62,420(M), T.C. Memo. 2024-18.

J.A. Martino, CA-11

If you converted your traditional IRA to a Roth IRA earlier this year, incurred a significant amount of tax liability on the conversion, and then watched as the value of your Roth account plummeted amid the market turmoil, you may want to consider undoing the conversion. You can void or significantly lower your tax bill by recharacterizing the conversion, then reconverting your IRA back to a Roth at a later date. Careful timing in using the strategy, however, is essential.

What is a recharacterization?

"Recharacterization" is simply the term given to the transaction in which you undo your original conversion from a traditional IRA to the Roth. Even if you converted your entire account to a Roth, you do not need to recharacterize the entire amount that you converted from your traditional IRA to the Roth and can choose to only recharacterize a portion of the amount. To roll the money back and then forward into new Roth IRA, you must undo the original Roth conversion, wait at least 30 days (discussed in further detail, below) and then reconvert the IRA back to the Roth. This move may save you significant tax dollars since your IRA account is worth less due to the decline in market values.

Note. Roth IRAs are currently - but temporarily - restricted to taxpayers with adjusted gross incomes (AGI) that do not exceed certain amounts. For example, for 2008 Roth IRAs can be established by individuals with a maximum AGI of $116,000 ($169,000 for joint filers and heads of household). This restriction is completely lifted in 2010, when the AGI and filing status restrictions are eliminated.

Example. In June 2008, you converted your entire traditional IRA account balance of $200,000 to a Roth. However, the market has taken a toll on your account and it has declined in value and now in December is worth $100,000. Say you are in the 25 percent tax bracket -- the conversion would have left you with a $50,000 tax bill (since conversion amounts, in this case $200,000, are taxed at ordinary income tax rates). However, if you recharacterize and convert the $100,000 account back into a Roth after meeting the timing requirements, you will owe only $25,000 in taxes on the conversion.

Reasons for recharacterization

Recharacterizing a Roth conversion may be appropriate for many reasons, especially if your Roth account has lost significant value but you have a large tax bill for the conversion, which perhaps may even be more than the amount currently in your account. You might also want to consider undoing the conversion if you cannot afford the tax bill due, the conversion will propel you into a higher tax bracket, or subject you to the alternative minimum tax (AMT).

What is required

The recharacterization of a Roth conversion must meet certain requirements. The conversion must be completed by your tax filing deadline (typically April 15). If you converted an IRA in 2008, you have until October 15, 2009 to recharacterize the Roth conversion. However, you will then have to wait at least until the year after you originally converted the IRA to reconvert the account back to a Roth, or at least 30 days after the recharacterization (whichever is later). Essentially, if you converted your traditional IRA into a Roth in 2008 you will have to wait until 2009 to convert the funds back into a Roth account.

Notice

For the recharacterization to work, you will also have to provide notice to the financial institution(s) which is the trustee of your IRA accounts and the IRS before the date of the trustee to trustee transfer (a recharacterization is generally done in a trustee-to-trustee transfer). The notice generally includes information pertaining to the date of applicable transfers, type and amount of contribution being recharacterized, and will need to be attached to your tax return Form 8606, Nondeductible IRAs, with a statement explaining the recharacterization.

Net Income Attributable (NIA) to the conversion

A recharacterization must also include the transfer of any net income attributable (NIA) to the contribution amount. NIA is generally any earnings or losses attributable to the converted amounts in the account. If the Roth IRA that you are recharacterizing consists only of the amounts originally converted from the traditional IRA, there is generally no need to compute NIA. Generally, NIA must be computed when less than the entire account balance is being recharacterized, your Roth includes amounts from other transaction such as a Roth IRA contribution (made after the conversion to the Roth), or the Roth includes funding from another Roth IRA conversion. The financial institution that has custody of your Roth may offer a service to help you compute your NIA, or talk with your tax advisor for help.

If you would like further information on Roth conversions or reconversions, please feel free to contact this office. As explained, there are time periods and deadlines that must be met, so procrastination may prove expensive in some situations.

If you are finally ready to part with those old gold coins, baseball cards, artwork, or jewelry your grandmother gave you, and want to sell the item, you may be wondering what the tax consequences will be on the disposition of the item (or items). This article explains some of the basic tax consequences of the sale of a collectible, such as that antique vase or gold coin collection.

If you are finally ready to part with those old gold coins, baseball cards, artwork, or jewelry your grandmother gave you, and want to sell the item, you may be wondering what the tax consequences will be on the disposition of the item (or items). This article explains some of the basic tax consequences of the sale of a collectible, such as that antique vase or gold coin collection.

Collectibles

You must pay tax on any gain you realize from the sale of a collectible item (or the entire collection), such as a gold watch or other jewelry, antique coins, artwork, figurines, and even baseball cards. Capital gains on collectibles are taxed at a rate of 28 percent, rather than the regular long-term capital gains rate, currently at 15 percent (zero for those in the 10 or 15 percent income tax brackets). Gain on collectibles is reported on Schedule D of Form 1040. To calculate capital gains on the sale or other disposition you need to determine what your basis in the item is.

If you purchased the item, your basis is generally what you paid for the item as well as certain expenses related to the purchase. Fees related to the sale itself should also be included, such as a broker's or auctioneer's fee or an appraisal or authentication fee.

If you inherited the item, then your basis is the item's fair market value (FMV) at the time you inherited it. There are two principal methods for determining FMV: an appraisal, such as used for estate purposes, or valuing the item based on contemporaneous sales of comparable items. However, this can be tricky because the condition of a collectible item plays significantly into its value.

If the item was a gift, then your basis is the same as the basis of the person who gave you the item.

If you buy and sell collectibles on a regular basis, devote a substantial amount of time and effort to the activity and have developed a degree of skill in identifying profitable transactions, you may be engaged in a trade or business. In this case, you may be engaged in a trade or business in the eyes of the IRS, and therefore your stock of collectibles may be "inventory" and your profits taxable as ordinary income.

Precious metals

Gold and silver, like stamps and coins, are treated by the IRS as capital assets except when they are held for sale by a dealer. Any gain or loss from their sale or exchange is generally a capital gain or loss. If you are a dealer, the amount received from the sale is ordinary business income. However, metals like gold and silver are classified by the Internal Revenue Code as collectibles, and gain recognized from the sale of gold or silver held for more than one year - whether or not in the form of jewelry or sold simply for its market content - is taxed at the maximum rate of 28 percent.

For all sales of more than $600, an information return generally must be filed with the IRS.

790

With the economic downturn taking its toll on almost all facets of everyday living, from employment to personal and business expenditures, your business may be losing money as well. As a result, your business may have a net operating loss (NOL). Although no business wants to suffer losses, there are tax benefits to having an NOL for tax purposes. Your business can use the NOL in future years to offset its taxable income. Your business can also use an NOL to offset income from the prior two years; in this type of "carryback" situation, it can mean an immediate tax refund to help with current operating expenses.

NOLs, generally

A trade or business has an NOL when its allowable deductions exceed its gross income for the tax year. A business can have an NOL whether it is a corporation, partnership or sole proprietorship. For example, NOLs can be generated if you operate a trade or business as a sole proprietorship that is taxed to the individual.

Note. The American Reinvestment and Recovery Act of 2009 (2009 Recovery Act) temporarily increases the carryback period to five years for small businesses (defined by the new law as businesses with average gross receipts of $15 million or less). These businesses can elect to carryback NOLs three, four or five years. However, this treatment applies only to NOLs beginning or ending in 2008. Businesses that qualify can apply for an immediate refund of taxes paid during the extended carryback period. Forms 1045, Application for Tentative Refund, and Form 1139, Corporate Application for Tentative Refund, must generally be filed within one year after the end of the tax year of the NOL.

Deductible expenses for computing NOLs

Generally, business deductions are those deductions related to a taxpayer's trade or business or employment. For this purpose, the following types of losses are considered business deductions that can be used to compute an NOL:

• Losses from the sale or exchange of depreciable or real property used in the taxpayer's trade or business, including Code Sec. 1231 property;
• Losses attributable to rental property;
• Losses incurred from the sale of stock in a small business corporation or from the sale or exchange of stock in a small business investment company, to the extent that these types of losses qualify as ordinary losses;
• Losses on the sale of accounts receivable (but only if the taxpayer uses the accrual method of accounting); and
• Business losses from a partnership or S corporation.

In addition, the following expenses are considered business deductions for purposes of computing an NOL:

• Personal casualty and theft losses and nonbusiness casualty and theft losses from a transaction entered into for profit;
• Moving expenses;
• State income tax on business profits;
• Litigation expenses and interest on state and federal income taxes related to a taxpayer's business income;
• The deductible portion of employee expenses, such as travel, transportation, uniforms, and union dues;
• Payments by a federal employee to buy back sick leave used in an earlier year;
• Unrecovered investment in a pension or annuity claimed on a decedent's final return; and
• Deduction for one-half of the self-employment tax.

Carryback and carryforward rules

Generally, an NOL must be carried back and deducted against taxable income in the two tax years before the NOL year before it can be carried forward and applied against taxable income, up to 20 years after the NOL year. An NOL must be used in the earliest year available; however, you can waive the use of the carryback period and immediately carry the NOL forward. To claim an NOL carryback, an individual or a corporation must file an amended return within three years of the year the NOL was incurred.

Generally, the carryback and carryforward periods cannot be extended. Any NOL remaining after the 20-year carryforward period will be lost. However, you may be able to use an expiring NOL in the final year by accelerating the recognition of income.

Comment. There are certain exceptions to the two-year carryback period. The carryback period is three years for an NOL from a casualty or theft, and also three years for losses from a Presidentially-declared disaster affecting a small business or a farmer. A "farming loss" can be carried back five years and a 10-year period is available for product liability losses and environmental claims.

Partnerships and S corporations

If your business operates as a partnership or an S corporation, the NOL flows through to the partners or shareholders who can use the NOL to offset other business and personal income. The partnership or S corporation itself cannot use the NOL.

Note. Shareholders may not deduct a C corporation's NOLs. Moreover, because a corporation is a separate taxpayer, NOLs do not automatically flow between the corporation and another entity that takes over the corporation.

Individuals

Individuals may have an NOL not only from business losses but from other expenses, although this is less common. In addition to business losses, an individual includes in his or her NOL computation the following deductions:

• Employee business expenses;
• Casualty and theft;
• Moving expenses for a job relocation; and
• Expenses of rental property held for the production of income.

If you would like to discuss whether you have an NOL and how you might use it, please contact our office.

You have carefully considered the multitude of complex tax and financial factors, run the numbers, meet the eligibility requirements, and are ready to convert your traditional IRA to a Roth IRA. The question now remains, however, how do you convert your IRA?

Conversion basics

A conversion is a penalty-free taxable transfer of amounts from a traditional IRA to a Roth IRA. You can convert part or all of the money in your regular IRA to a Roth. When you convert your traditional IRA to a Roth, you will have to pay income tax on the amount converted. However, a traditional IRA may be converted (or rolled over) penalty-free to a Roth IRA as long as you meet the requirements for conversion, including adjusted gross income (AGI) limits in effect until 2010. You should have funds outside the IRA to pay the income tax due on the conversion, rather than taking a withdrawal from your traditional IRA to pay for it - those withdrawals are subject to an early withdrawal penalty and they cannot be put back at a later time to continue to accumulate in the tax-free environment of an IRA.

Big news for 2010 and beyond

Beginning in 2010, you can convert from a traditional to a Roth IRA with no income level or filing status restrictions. For 2008, Roth IRAs are available for individuals with a maximum adjusted gross income of $116,000 ($169,000 for joint filers and heads of household). These income limits have prevented many individuals from establishing or converting to a Roth IRA. Not only is the income limitation eliminated after 2009, taxpayers who convert to a Roth IRA in 2010 can recognize the conversion amount in adjusted gross income (AGI) ratably over two years, in 2011 and 2012.

Example. You have $14,000 in a traditional IRA, which consists of deductible contributions and earnings. In 2010, you convert the entire amount to a Roth IRA. You do not take any distributions in 2010. As a result of the conversion, you have $14,000 in gross income. Unless you elect otherwise, $7,000 of the income is included in income in 2011 and $7,000 is included in income in 2012.

Conversion methods

There are three ways to convert your traditional IRA to a Roth. Generally, the conversion is treated as a rollover, regardless of the conversion method used. Any converted amount is treated as a distribution from the traditional IRA and a qualified rollover contribution to the Roth IRA, even if the conversion is accomplished by means of a trustee-to-trustee transfer or a transfer between IRAs of the same trustee.

1. Rollover conversion. Amounts distributed from a traditional IRA may be contributed (i.e. rolled over) to a Roth IRA within 60 days after the distribution.

2. Trustee-to-trustee transfer. Amounts in a traditional IRA may be transferred in a trustee-to-trustee transfer from the trustee of the traditional IRA to the trustee of the Roth IRA. The financial institution holding your traditional IRA assets will provide directions on how to transfer those assets to a Roth IRA that is maintained with another financial institution.

3. Internal conversions. Amounts in a traditional IRA may be transferred to a Roth IRA maintained by the same trustee. Conversions made with the same trustee can be made by redesignating the traditional IRA as a Roth IRA, in lieu of opening a new account or issuing a new contract. As with the trustee-to-trustee transfer, the financial institution holding the traditional IRA assets will provide instructions on how to transfer those assets to a Roth IRA. The transaction may be simpler in this instance because the transfer occurs within the same financial institution.

Failed conversions

A failed conversion has significant negative tax consequences, and generally occurs when you do not meet the Roth IRA eligibility or statutory requirements; for example, your AGI exceeds the limit in the year of conversion or you are married filing separately (note: as mentioned, the AGI limit for Roth IRAs will no longer be applicable beginning in 2010).

A failed conversion is treated as a distribution from your traditional IRA and an improper contribution to a Roth IRA. Not only will the amount of the distribution be subject to ordinary income tax in the year of the failed conversion, it will also be subject to the 10 percent early withdrawal penalty for individuals under age 59 1/2, (unless an exception applies). Moreover, the Tax Code imposes an additional 6 percent excise tax each year on the excess contribution amount made to a Roth IRA until the excess is withdrawn.

Caution - financial institutions make mistakes

The brokerage firm, bank, or other financial institution that will process your IRA to Roth IRA conversion can make mistakes, and their administrative errors will generally cost you. It is imperative that you understand the process, the paperwork, and what is required of you and your financial institution to ensure the conversion of your IRA properly and timely. Our office can apprise you of what to look out for and what to require of the financial institutions you will deal with during the process.

Determining whether to convert your traditional IRA to a Roth IRA can be a complicated decision to make, as it raises a host of tax and financial questions. Our office can help you determine not only whether conversion is right for you, but what method is best for you, too.

It is a common decision you may make every tax season: whether to take the standard deduction or itemize deductions. Most taxpayers have the choice of itemizing deductions or taking the applicable standard deduction amount, the choice resting on which figure will result in a higher deduction. Once you have determined the standard deduction amount that applies to you, the next step is calculating the amount of your allowable itemized deductions; not always a simple task.

Standard deduction basics

Nearly two out of three taxpayers take the standard deduction rather than itemizing deductions, according to the IRS. Moreover, favorable changes to the tax laws made in 2008 may make the standard deduction even more attractive to non-itemizers. Not all taxpayers can take the standard deduction, however. For example, a married taxpayer filing a separate return whose spouse elects to itemize his or her deductions can not take the standard deduction that year. And those who are dependents of another cannot take the full standard deduction.

The standard deduction amounts have increased for 2009 as a result of inflation adjustments. Additionally, marriage penalty relief continues to allow joint filers to take double the deduction amount as single filers. However, this benefit for married couples sunsets for tax years after December 31, 2010, unless Congress acts to extend marriage penalty relief.

The standard deduction amounts for the 2009 tax year are:

• $11,400 for married couples filing a joint return (and surviving spouses);
• $5,700 for singles and married individuals filing separately; and
• $8,350 for heads of household.

Standard property tax deduction for non-itemizers. Non-itemizers can also increase their standard deduction for 2009 by the lesser of (1) the amount otherwise allowable to the individual as a deduction for state and local property taxes, or (2) $500 ($1,000 in the case of married individuals filing jointly).

Additional deduction for age and blindness. Taxpayers who are age 65 or older or who are blind receive an additional standard deduction amount that is added to the basic standard deduction (above). The additional amounts for 2009 are $1,400 for single filers and head of household, and $1,100 each, for married individuals (filing jointly or separately) and surviving spouses. Two additional standard deduction amounts can be taken by a taxpayer who is both over 65 and blind.

Itemizing deductions

A significant consideration when deciding whether to itemize your deductions is that total itemized deductions will be reduced if your adjusted gross income (AGI) is too high. For 2009, the itemized deductions of higher-income taxpayers are reduced by the lesser of:

• 3 percent of a taxpayer's AGI over $166,800 ($83,400 for married taxpayers filing separately); or
• 80 percent of the amount of the itemized deductions subject to the reduction, which are otherwise allowable for the tax year.

Note. There is no required reduction for deductions of medical expenses, investment interest, and casualty, theft or wagering losses. You may want to take steps to decrease your AGI this year, such as by deferring income or accelerating the deductions to a low AGI year.

Some itemized deductions may only be claimed if they exceed a certain percentage of your AGI (2% for miscellaneous itemized deductions, 7.5% for medical expenses, and 10% for casualty losses). Any increase in your AGI will reduce AGI-based itemized deductions leaving you with fewer deductions to offset your total income.

Common itemized deductions you may want to consider are:

• Medical expenses;
• Charitable contributions;
• Sales taxes (in lieu of state and local income taxes);
• State and local income taxes;
• State and local property taxes;
• Mortgage interest on a principal and secondary residence;
• Investment interest;
• Personal casualty losses;
• Gambling losses of a nonprofessional gambler not in excess of winnings; and
• "Miscellaneous" deductions.

Commonly claimed miscellaneous expenses (subject to the 2% AGI limit) include:

• Expenses connected with managing your investment or income producing property
• Tax advice and preparation fees
• Appraisal fees connected to charitable contributions or casualty losses
• Job hunting and moving expenses
• Professional journal subscriptions
• Home office expenses
• Union or professional dues, and
• Employee's unreimbursed expenses.

Planning tip. Those who are close to the cut off amount for being better off itemizing than taking the standard deduction might want to consider using a year-end planning technique that incorporates alternating between the standard deduction and itemizing deductions each year. The strategy is to accelerate or defer expenses that can boost itemized deductions all into a one year, then take the standard deduction for the other tax year.

Caution. To complicate matters, some deductions either are not permitted or are allowed only in a lower amount if you are subject to alternative minimum tax (AMT).

If you have questions about preparing your return, give our office a call. We can discuss your tax situation and help you navigate the complex maze of tax laws.

In a period of declining stock prices, tax benefits may not be foremost in your mind. Nevertheless, you may be able to salvage some benefits from the drop in values. Not only can you reduce your taxable income, but you may be able to move out of unfavorable investments and shift your portfolio to investments that you are more comfortable with.

First, you should keep in mind that gain and loss on a sale of stock or mutual fund shares depends on the fair market value of the shares when sold or disposed of, compared to the cost basis of the stock. Your investments may have lost substantial value over recent periods. Nevertheless, if the stock's value when sold is higher than the basis, you still have a gain.

Example. You purchased X Corp stock in 2004, when it cost $5. At the end of 2007, the stock is worth $12. In November, 2008, you sell the stock when its value is $8 a share. Even though your investment has declined in value by 33 percent, you have a gain of $3 a share on the sale ($8 sales price less $5 cost).

The same tax-basis situation that may cause capital gain on the sale of shares that have dropped significantly in value over the past year also is causing many owners of mutual funds that have declined in value to be surprised with a capital gains distribution notice from their fund managers. If you own the mutual fund shares at the time of the capital gain distribution date, you must recognize the gain. Of course, that gain may be netted against your losses from stock or other capital asset sales.

If you realize a profit on a stock sale, the long-term capital gains tax is a maximum of 15 percent, while taxes on wages and other ordinary income can be taxed as high as 35 percent. For taxpayers in the 10 or 15 percent rate brackets, there is no capital gains tax. These reduced capital gains rates are scheduled to expire after 2010. Short-term capital gains (investments held for one year or less) are taxed at ordinary income rates up to 35 percent.

Capital losses can offset capital gains and ordinary income dollar for dollar. Capital gains can be offset in full, whether short-term or long-term. Ordinary income can be offset up to $3,000. If net capital losses (capital losses minus capital gains) exceed $3,000, the excess can be carried forward without limit and can offset capital gains and $3,000 of ordinary income in each subsequent year.

Because a capital loss can offset income taxed at the 35 percent rate, it can be advantageous to sell stock that yields capital gains in one year, while delaying the realization of capital losses until the following year.

Example. Mary has two assets. One asset would yield a $6,000 long-term capital loss when sold. The other would yield a $6,000 long-term capital gain. If Mary sells both assets in the same year, she has a net capital gain of zero. If she realizes the gain in 2008 and the loss in 2009 (by selling the assets in different years), she will increase her 2008 taxes by a maximum of $900 ($6,000 X 15 percent), but will reduce her taxes in 2009 and 2010 by a maximum of $2,100 ($3,000 X 35 percent X 2 years). She will reduce her taxes by $1,200 merely by shifting the timing of the sales.

Worthless securities. You can write off the cost of totally worthless securities as a capital loss, but cannot take a deduction for securities that have lost most of their value from stock market fluctuations or other causes if you still own them and they still have a recognizable value. You do not have to sell, abandon or dispose of the security to take a worthless stock deduction, but worthlessness must be evidenced by an identifiable event. An event includes cessation of the corporation's business, commencement of liquidation, actual foreclosure and bankruptcy. Securities become worthless if the corporation becomes worthless, even if the corporation has not dissolved, liquidated or ceased doing business.

If you would like to discuss these issues, please contact our office. We can help you consider your options.

The high cost of energy has nearly everyone looking for ways to conserve and save money, especially with colder weather coming to many parts of the country. One surprising place to find help is in the financial markets rescue package (the Emergency Economic Stabilization Act of 2008) recently passed by Congress. Overshadowed by the financial provisions are some very important energy tax incentives that could save you money at home and in your business.

While the energy tax incentives in the new law are generous, they are also complex. The names of the tax credits and deductions themselves can be daunting. Don't be put off by all the complex rules. Our office can help you navigate them and take advantage of their benefits.

Individuals

Improvements. If you are thinking of installing insulation or new energy-efficient windows and doors, you may be eligible for the residential energy property credit. This credit (also known as the Code Sec. 25C credit) gives eligible taxpayers a lifetime credit of up to $500 for making energy-efficient improvements to their residences. Up to $200 of the credit can be taken for the cost of windows. Besides insulation and energy-efficient windows and doors, some electric heat pump water heaters, natural gas, propane and oil furnaces, and other items qualify. The credit limits and energy-efficiency ratings are very complex so please contact our office before you make a purchase. We don't want you to miss out on a potentially valuable tax break. However, because of a quirk in the new law, the residential energy property credit is not available for 2008. However, you can take advantage of it in 2009.

Alternative energy. This credit (also known as the Code Sec. 25D credit) sounds a lot like the credit for energy efficient property but it is different. The key word in the title of the credit is "alternative." This credit rewards individuals who install certain types of alternative energy systems in their homes, particularly systems that utilize solar power and wind energy. These include solar electric, solar water heating, small wind energy, and geothermal heat pump property. Generally you must install the property before the end of 2016.

Businesses

Solar and wind power. Businesses are also eligible for some valuable energy tax breaks. Businesses that install solar energy and small wind energy property can take advantage of special tax credits that can reach as high as 30 percent. Generally, the solar or wind energy property must be used to generate electricity that heats, cools or lights a building.

Improvements. There is also a special tax deduction for energy efficient improvements made to commercial buildings. Generally, the improvements to heating, cooling, ventilation, lighting, and other qualifying systems must significantly reduce annual energy costs. Many of the new heating, cooling and lighting systems currently on the market meet these standards. If you recently installed new heating, cooling or lighting systems, you may have qualified for a tax break without even knowing it.

Manufacturers and builders. Manufacturers of energy efficient appliances, such as washing machines and refrigerators, are eligible for special tax credits. Additionally, contractors that build energy efficient homes can take advantage of tax breaks.

Transportation

In the not too distant future, you may be able to purchase a plug-in electric vehicle. In anticipation of that day, Congress created a new plug-in electric vehicle tax credit. The credit is available to everyone: individuals and businesses. Electric plug-in vehicles could be on the market as soon as 2010 so keep this tax break in mind if you shop for one.

These are just the highlights of some of the many energy tax incentives in the new law. Please contact our office for more details.

Nonbusiness creditors may deduct bad debts when they become totally worthless (i.e. there is no chance of its repayment). The proper year for the deduction can generally be established by showing that an insolvent debtor has not timely serviced a debt and has either refused to pay any part of the debt in the future, gone through bankruptcy, or disappeared. Thus, if you have loaned money to a friend or family member that you are unable to collect, you may have a bad debt that is deductible on your personal income tax return.

The fact that the debtor is a family member or other related interest does not preclude you from taking a bad debt deduction, provided that the debt was bona fide and that worthlessness has been established. A direct or indirect transfer of money between family members may create a bona fide debt eligible for the bad debt deduction. However, these transactions are closely scrutinized to determine whether the transfer is a bona fide debt or a gift.

Bona-fide debt and other requirements for deductibility

You may only take a bad debt deduction for bona-fide debts. A bona-fide debt is a debt arising from a debtor-creditor relationship based on a valid and enforceable obligation to repay a fixed or determinable sum of money. You must also have the present intention to seek repayment of the debt. Additionally, for a bad debt you must also show that you had the intent to make a loan, and not a gift, at the time the money was transferred. Thus, there must be a true creditor-debtor relationship.

Moreover, nonbusiness bad debts are only deductible in the year they become totally worthless (partially worthless nonbusiness bad debts are not deductible).

To deduct a bad debt, you must also have a basis in it, which means that you must have already included the amount in your income or loaned out your cash (for example, if your spouse has not paid court-ordered child support, you can not claim a bad debt deduction for the amount owed as this amount was not previously included in your gross income).

Reporting bad debts

You can deduct nonbusiness bad debts as short-term capital losses on Schedule D of your Form 1040. On Schedule D, Part I, Line 1, enter the debtor's name and "statement attached" in column (a). Enter the amount of the bad debt in parentheses in column (f). If you are reporting multiple bad debts, use a separate line for each bad debt. For each bad debt, attach a statement to your return containing the following:

•  A description of the debt, including the amount and date it became due;
• The name of the debtor, and any business or family relationship between you and the debtor:
• The efforts you made to collect the debt; and
• An explanation of why you decided the debt was worthless (for example, you can show the debtor has declared bankruptcy or is insolvent, or that collection efforts such as through legal action will not likely result in the debt being paid).

If you did not deduct a bad debt on your original income tax return for the year it became worthless, you can file a refund claim or a claim for a credit due to the bad debt. You must use Form 1040X to amend your return for the year the debt became worthless. It must be filed with 7 years from the date your original return for that year had to be filed, or 2 years from the date you paid the tax, whichever is later.

Note. If you deduct a bad debt and in a later year collect all or part of the money owed, you may have to include this amount in your gross income. However, you can exclude from your gross income the amount recovered up to the amount of the deduction that did not reduce your tax in the year you deducted the debt.

With the U.S. and world financial markets in turmoil, many individual investors may be watching the value of their stock seesaw, or have seen it plummet in value. If the value of your shares are trading at very low prices, or have no value at all, you may be wondering if you can claim a worthless securities deduction for the stock on your 2008 tax return.

Capital or ordinary loss treatment

When stock you own in a corporation becomes totally worthless during the tax year, you may be able to report a loss in the stock equal to its tax basis. Generally, a worthless stock loss is characterized as a capital loss because securities like stock that become worthless are usually treated as capital assets. When a security that is not a capital asset becomes wholly worthless, the loss is deductible as an ordinary loss. For example, if worthless stock is Code Sec. 1244 stock, ordinary loss treatment applies. Worthless stock is treated as if it was sold on the last day of the tax year.

Note. You may only deduct a loss on worthless securities if the loss is incurred in a trade or business, in a transaction entered into for profit, or as the result of a fire, storm, shipwreck, another casualty, or theft. It is generally assumed that an individual acquires securities for profit (although this assumption may be refuted).

Your stock is trading at $1.08 a share: Is it "worthlessness?"

A worthless stock deduction may only be taken when your securities have become totally worthless. You can not take the deduction for stock that has become only partially worthless. The Internal Revenue Code, however, does not define "worthlessness." Nonetheless, in the IRS's eyes, a company's stock is not going to be automatically considered worthless simply because the stock or security has plummeted in value and is now trading at mere dollars and cents.

With the current market turmoil, many stocks have taken big hits and dropped significantly in value, perhaps even trading for a $1.08 per share, but are nonetheless still alive and trading on an exchange. Therefore, you can not take a worthless stock deduction for a mere decline in value of stock caused by a fluctuation in market price or other similar cause, no matter how steep the decline, if your stock has any recognizable value on the date you claim as the date of loss. Even if a company in which you have stock files for bankruptcy, or lawsuits are filed against it, does not automatically qualify the stock or securities as worthlessness.

More hurdles to overcome

Even if you can establish that the stock you own has become totally worthless, the loss must be (1) evidenced by a closed and completed transaction, (2) fixed by identifiable events and (3) actually sustained during the tax year. First, you may only claim the deduction on your return for the tax year in which the stock has become completely worthless, and you must be able to show that the year in which you are claiming the loss is the appropriate tax year.

Generally, a worthless stock loss deduction can be taken in the year in which you abandon the stock. To abandon a security, you must permanently surrender and relinquish all rights in the security and receive no consideration in exchange for the security. But, whether the transaction qualifies as abandonment, and not an actual sale or exchange, is a facts and circumstances test.

If you would like to know whether the stock or other securities you own have become worthless, please contact our office. We can help you navigate these complex rules.

Individuals with $400 or more of net earnings from self-employment must pay self-employment tax, in addition to any income tax imposed on the same income. This article can help you estimate any self-employment tax liability that you may owe for 2008.

Self-employment tax

The self-employment tax consists of two taxes: a tax used to fund Social Security benefits and a tax used to fund Medicare benefits. The Social Security tax rate is 12.4 percent, and the Medicare tax rate is 2.9 percent. The combined tax rate is 15.3 percent.

The first $102,000 (for 2008) of net income from self-employment (reduced by any wages received by the individual) is subject to a 15.3 percent tax (which includes the Social Security and Medicare health insurance taxes). Income above that amount is only subject to a 2.9 percent Medicare tax. Taxpayers use Schedule C or C-EZ (Form 1040) to figure net earnings from self-employment (self-employment income). Schedule SE (Form 1040) is used to figure and report self-employment taxes.

Calculating self-employment tax liability

Step1. Determine your net income from self-employment (from Schedule C or C-EZ for sole proprietors; from Schedule E for self-employed businesses treated as a partnership; or Schedule F for farmers). Generally, net income is your total business receipts minus your total business deductions.

Step 2. Multiply your net income from self-employment by 0.9235 (or 92.35 percent). This is your net earnings from self-employment (self-employment income). If this number is less than $400, you do not owe self-employment tax.

Step 3. Multiply by 0.153 (or 15.3 percent) the amount of your net earnings up to an amount equal to $102,000 reduced by any wages received (for which there has already been withholding). Additionally, if applicable, multiply any net earnings over $102,000 by 0.029 (or 2.9 percent). Add these two numbers together. This is your estimated self-employment tax liability.

Step 4. Report your self-employment tax liability on Schedule SE of Form 1040.

Example. Your Schedule C shows net business income of $225,000. Your net earnings from self-employment (self-employment income) is $207,787.50 ($225,000 x 0.9235 = $207,787.50). The first $102,000 (assuming no wage income) gets taxed at a maximum rate of 15.3 percent ($102,000 x .153 = $15,606). The remaining $105,787.50 is taxed at 2.9 percent ($105,787.50 x .029 percent = $3,067.84). Your total self-employment tax liability is an estimated $18,673.84 ($15,606 + $3,067.84= $18,673.84).

Contributions to political campaigns are nondeductible. Nondeductible campaign contributions include, for example, contributions to pay for campaign expenses as well as contributions to pay for a candidate's personal expenses while the candidate is campaigning. The line sometimes gets gray, however, when a contribution is being made for a charitable purpose that is being sponsored by a political candidate or is being made to a charity that also appears to be endorsing a political candidate as opposed to a particular position within the public discourse.

Nondeductible contributions and expenses

Admission prices to political dinners and inaugural events, such as balls, galas, parades or concerts, as well as advertising in convention programs and other publications may be nondeductible if the proceeds "inure to the benefit" of a political party or candidate. Proceeds "inure to the benefit" of a political party when the party has the ability to spend any part of the money on the types of expenses enumerated above, or the ability to spend any part of the proceeds even if the money is restricted to a particular purpose that is unrelated to the election of a specific candidate. Proceeds "inure to the benefit" of a candidate if the money can be used, directly or indirectly, to further the selection, nomination or election of the candidate to office. It doesn't matter in that case that the expense (for example, advertising in a dinner program) also furthers the business of the contributor.

Example. The Libertarian Party holds a dinner to raise money for a voter registration drive and a voter education program. Even though the proceeds of the dinner cannot be used for any purpose that is related to the election of specific candidates to public office, the proceeds still inure to the benefit of the Libertarian Party and a taxpayer cannot deduct the costs of any tickets to the dinner that the taxpayer purchases.

Deductible nonpartisan or impartial election expenses

On the other hand, expenses that support certain nonpartisan and impartial election campaign programs may be deductible. Expenses that are paid or incurred by a taxpayer engaged in a trade or business for contributions that support certain nonpartisan or impartial election programs are deductible. Examples of expenses a taxpayer may deduct include:

• Expenses incurred in supporting a debate that gives all candidates for the same public office an equal opportunity to present themselves to the public, provided the expenses are related to a taxpayer's expected future patronage and other otherwise deductible trade or business expenses;
• Expenses incurred in holding an impartial debate for candidates for public office sponsored by the taxpayer and wherein the taxpayer's name is read before and after the debate;
• Expenses in connection with a voter registration drive, even though polls indicate that those who are registered in the drive would more likely support a particular candidate.

Move over hybrids - buyers of Volkswagen and Mercedes diesel vehicles now qualify for the valuable alternative motor vehicle tax credit. Previously, the credit had gone only to hybrid vehicles. Now, the IRS has qualified certain VW and Mercedes diesels as "clean" as a hybrid.

Qualifying vehicles

The IRS has designated the following diesel-powered vehicles as advanced lean-burning technology motor vehicles that qualify for the alternative motor vehicle tax credit:

• The 2009 VW Jetta TDI sedan and TDI sportwagen models; and
• The 2009 Mercedes-Benz GL320, R320 and ML320 Bluetec models.

 The credit amounts vary depending on the vehicle's fuel economy. The credit amounts for each vehicle are as follows:

• 2009 VW Jetta TDI sedan and TDI sportwagen: $1,300 credit;
• 2009 Mercedes ML320 Bluetec: $900;
• 2009 Mercedes R320 Bluetec: $1,550; and
• 2009 GL320 Bluetec: $1,800.

VW's diesels went on sale in August, while the Mercedes Bluetec models are expected to go on sale beginning this October.

The alternative motor vehicle tax credit, generally

The alternative motor vehicle tax credit is a lucrative tax credit for purchasers of qualifying automobiles. But, just as the situation is with hybrids, the full amount of the credit for each vehicle is available only during a limited period. The dollar value of the tax credit will begin to be reduced once the manufacturer sells 60,000 vehicles that qualify for the tax credit. Additionally, the credit is available only to the original purchaser of a new, qualifying vehicle. As such individuals who lease the vehicle are not eligible for the credit - the credit is allowed only to the vehicle's owner, such as the leasing company.

Taxpayers may claim the full amount of the allowable credit up to the end of the first calendar quarter after the quarter in which the manufacturer records its sale of the 60,000th advance lean burn technology motor vehicle or hybrid passenger automobile or light truck. For the second and third calendar quarters after the quarter in which the 60,000th vehicle is sold, taxpayers may claim 50 percent of the credit. For the fourth and fifth calendar quarters, taxpayers may claim 25 percent of the credit. No credit is allowed after the fifth quarter.

The credit - as Congress has allotted so far - may only be taken for qualified vehicles purchased before the end of 2010.

Education continues to become increasingly expensive. The Tax Code provides a variety of significant tax breaks to help pay for the rising costs of education, from elementary and secondary school to college. Some people are surprised at what is available these days, as the dust settles on tax rules that have been in transition now for a number of years. A good place to start educating yourself on these education-related tax incentives - to help yourself or a member of your family better tackle the rising expense of education - is right here.

Education continues to become increasingly expensive. The Tax Code provides a variety of significant tax breaks to help pay for the rising costs of education, from elementary and secondary school to college. Some people are surprised at what is available these days, as the dust settles on tax rules that have been in transition now for a number of years. A good place to start educating yourself on these education-related tax incentives - to help yourself or a member of your family better tackle the rising expense of education - is right here.

Hope scholarship and Lifetime Learning credits

The Hope (temporarily enhanced and renamed the "American Opportunity Tax Credit" for 2009 and 2010 by the American Recovery and Reinvestment Act of 2009) and Lifetime Learning credits can be claimed for qualified tuition and fees paid by an individual for his or her (or a spouse's or dependent's) enrollment or attendance at any college, university, vocational school or postgraduate school. The American Opportunity Tax Credit, just like the Hope credit, and Lifetime Learning credit can not both be taken for the same student in the same year.

If you pay the qualified education expenses of more than one student in the same year, however, you can choose to take the credits on a per-student for that year. Expenses that do not count towards the Lifetime Learning credit are those incurred to purchase books, supplies and other equipment, and charges and fees associated with meals and lodging. However, the American Opportunity Tax Credit can be claimed for course materials for 2009 and 2010 only.

Moreover, the American Opportunity Tax Credit (unlike the Hope credit) is available for expenses incurred during all four years of college, as provided under the 2009 Recovery Act. The Hope credit is only available for the first two years of college). However, the Lifetime Learning credit can be claimed for all years of postsecondary school (as well as for courses to acquire or improve job skills). In effect, the Lifetime Learning credit can pick up where the Hope credit left off.

The maximum American Opportunity Credit that can be claimed in 2009 and 2010 is $2,500 (previously $1,800 under the Hope credit) of qualified education expenses per student. Under the new credit, the maximum $2,500 per year would be allowed on $4,000 in qualifying payments (100 percent of the first $2,000 and 25 percent of the next $2,000).

For 2009 and 2010, the American Opportunity Tax Credit begins to phase-out when modified adjusted gross income (MAGI) reaches $80,000 for individuals (and $160,00 for joint filers). For 2009, the amount of the Lifetime learning credit phases out for individuals when MAGI reaches $50,000 for individuals and $100,00 for joint filers.

Coverdell Education Savings accounts

Individuals can contribute up to $2,000 a year to a Coverdell Education Savings account, which is established to help pay for the costs of education of an account beneficiary. A beneficiary is someone who is under age 18 or with special needs.

Although contributions to a Coverdell account are not deductible, earnings grow tax-free, and distributions are also tax free if used for qualified education expenses, including tuition and fees, required books, supplies and equipment, as well as qualified expenses for room and board. The account can help pay for the costs of attending an elementary or secondary school, whether public, private or religious, as well as a college or university.

As with the education credits, there are contribution limits based on the taxpayer/contributor's modified AGI.  

Student loan interest

Eligible individuals can take an above-the-line deduction for up to $2,500 of interest paid on student loans used to pay for the cost of attending any college, university, vocational school, or graduate school. A student loan, for purposes of the deduction, is a loan you took out and is designated solely to pay your (or your spouse's or dependent's) qualified education expenses. For example, if you take out a home equity loan to pay for college tuition, the interest may be deductible as mortgage interest, but it is not considered above-the-line interest for a student loan since the lender did not specifically restrict the proceeds to education expenses.

Good news on student loan interest, however, is that qualified education expenses in this case include not only tuition and fees, but also room and board, books, supplies and equipment, and other necessary expenses such as transportation. Interest paid on a loan that is made to you by a related person, such as parents or grandparents, or from a qualified employer plan do not qualify for the deduction.

The deduction is available regardless of whether or not you itemize. For 2009, the amount of the deduction begins to phase out when an individual's modified AGI exceeds $60,000 a year (or $120,000 for married couples filing jointly). The deduction is completely eliminated once an individual's modified AGI reaches $75,000 (or $150,000 for joint filers). For all other taxpayers, the deduction phases out when AGI reaches $60,000 (and is eliminated completely at AGI of $75,000). If you are claimed as a dependent on another's tax return, you can not take the deduction, however.

IRA and 401(k) withdrawals for education expenses

Generally, if you take a distribution from your IRA before you reach age 59 1/2, you must pay a 10 percent additional tax on the early distribution, as well as income tax on the amount distributed. This applies to any IRA you own, whether it is a traditional IRA, a Roth IRA or a SIMPLE IRA. However, you can take a distribution from your IRA before you reach age 59 1/2 and not be subject to the 10 percent additional tax, if the distribution is used to pay the qualified education expenses for:

• Yourself;
• Your spouse; or
• Your or your spouse's child, grandchild or foster child.

Qualified education expenses include tuition, fees, books, supplies, and equipment required for enrollment or attendance at any college, university, vocational school or other post-secondary educational institution. In addition, if the student is at least a part-time student, room and board are generally qualified education expenses, subject to certain limitation.

If you have a 401(k) plan that allows "hardship withdrawals" to be taken to pay for certain higher education expenses, such as tuition and other education expenses, you may consider taking such a distribution to pay for the education expenses for yourself, or your spouse or your children.  

Section 529 college savings plans

An often touted way to pay for college is through a state college savings plan (aka Section 529 plans, or qualified tuition plans). Section 529 plans allow you to save money, tax-free, to pay for qualified education expenses for college. Although contributions are not deductible for federal tax purposes, many states allow residents to deduct contributions on their state return. Moreover, distributions from a 529 plan are tax-free unless the amount distributed is greater than the account beneficiary's adjusted qualified education expenses. Qualified education expenses include amounts paid for tuition, fees, books, supplies and equipment, as well as reasonable costs of room and board for individuals are at least part-time students.

For 2009 and 2010, beneficiaries of qualified tuition plans can use tax-free distributions to pay for computers and computer technology, including internet access. This is courtesy of the American Recovery and Reinvestment Act of 2009.

Special needs education

The cost for a mentally or physically handicapped individual to attend a special school may be deductible as a medical expense if the principal reason for the individual attending the school is to help overcome or alleviate his or her disability. To qualify for the deduction, the individual does not have to attend a "special school." According to the IRS, the costs of a special education program at any school may be deductible if the program is primarily targeted to the individual's disability. Other deductible medical expenses may include the costs of transportation for the special education, summer school, tutoring, and meals and lodging at the school.

However, remember that medical expenses are only deductible to the extent they exceed 7.5 percent of your income, as an itemized deduction. Individuals with special needs children might also consider Coverdell Education Savings accounts as a vehicle for saving and paying for their children's special education expenses.

Private secondary and nursery school expenses

Private secondary expenses are generally not deductible. Furthermore, the IRS has ruled that any expenses allocated to high school tuition related to advance-placement college credit courses are still considered secondary tuition expenses and will not be counted toward the Hope or Lifetime learning credits.

"After-school" or "extended-day" programs, however, may be deductible if taken toward the child and dependent care credit for a child under age 13 to enable both spouses to work.  Expenses incurred to send a child to nursery school, pre-school or similar programs for children below the kindergarten level qualify fully for the child and dependent care credit without any requirement to separate by time or otherwise the educational portion of the expenses from the child care expenses.

The child and dependent care tax credit is a popular credit that, in part, enables you and your spouse (if married) to reduce your taxes by the cost of certain qualifying expenses you incur to have someone care for your child or childrenwho are under the age of 13 so that you can work or look for work. For 2009, you can generally claim up to $3,000 of expenses paid in the year for one qualifying individual, or $6,000 for two or more qualifying individuals, under the dependent and child care credit. Additional income and eligibility limitations apply.

If you have any questions on how these rules apply to your education expenses, please do not hesitate to call our offices.