Joseph A. Bellinghieri, Esquire
Nikolaos I. Tsouros, Esquire

"Today, it takes more brains and effort to make out the income tax form than it does to make the income." - Alfred E. Neuman

This time every year, we have the unpleasant duty of reminding our clients that in a relatively short time it will be tax season once again. As usual, we tell them that there are ways to lower next year's tax payments if they take action by December 31. By reviewing the following strategies, which includes both personal and business tax considerations, you may find several ways to lower your tax bill. And despite Alfred E. Neuman's opinion, it may be easier than you think.

1. Accelerate tax-deductible expenses. Try to make any tax-deductible expenses in the current year. You can accelerate expenses by making early payments of some investment expenses, mortgage interest, real estate taxes, state and local taxes, and charitable contributions. Please note that you must date these checks before the end of the year and mail them before January 1, 2006.
2. Defer recognition of income. Another way to take advantage of the scheduled tax rate reductions is to defer the recognition of income to years with lower tax rates. Some methods of deferring income include participating in employer deferred compensation programs and buying tax-deferred treasury securities like Series E bonds. There are also tax-deferred annuities that can be purchased. Additionally, if you are self-employed, delay year-end billing to clients so that payments will not be received in 2005.
3. Shift income to children. If your child is 14 or older, he or she will be taxed at his or her own tax rate, which now starts at 10 percent. It may be beneficial to transfer some income-producing assets to your child to take advantage of his or her lower income tax rates.
4. Maximize tax deductible contributions to Individual Retirement Accounts (IRAs).
   
   Traditional IRAs: Individuals who are not active participants in an employer pension plan may make deductible contributions to an IRA. The annual deductible contribution limit for an IRA for 2005 is $4,000. Individuals who are active participants in a plan may also make deductible contributions to an IRA but are limited in the amount deducted by his or her adjusted gross income (AGI). For 2005, the AGI phase-out range for deductibility of IRA contributions is between $50,000 and $60,000 of modified AGI for single persons (including heads of households), and between $70,000 and $80,000 of modified AGI for married couples filing jointly. Above these ranges, no deduction is allowed.
   
   For 2005, a $500 "catch-up" contribution deduction is allowed for taxpayers age 50 or older by the close of the taxable year who meet the other qualifications for IRA deductions. Thus, the total deductible limit for these individuals may be as high as $4,500.
   
   In addition, an individual will not be considered an "active participant" in an employer plan simply because the individual's spouse is an active participant for part of a plan year. Thus, you may be able to take the full deduction for an IRA contribution regardless of whether your spouse is covered by a plan at work, subject to a phase-out if your joint modified AGI is $150,000 to $160,000. Above this range, no deduction is allowed.
   
   Roth IRA: This type of IRA permits nondeductible contributions of up to $4,000 a year. Earnings grow tax-free, and distributions are tax-free provided no distributions are made until more than five years after the first contribution and the individual has reached age 59 and a half. Distributions may be made earlier on account of the individual's disability or death. The maximum contribution is phased out for persons with AGI above certain amounts: $150,000 to $160,000 for joint filers, and $95,000 to $110,000 for single filers (including heads of households). For 2005, a $500 catch-up contribution is allowed for taxpayers age 50 or older by the close of the taxable year, making the total limit $4,500 for these individuals.
   
   Roth IRA Conversion Rule: Funds in a traditional IRA may be rolled over into a Roth IRA. Such a rollover, however, is treated as a taxable event, and you will pay tax on the amount converted. No penalties will apply if all the requirements for such a transfer are satisfied. A taxpayer's AGI (whether married filing jointly or single) is limited to $100,000 to make such a conversion and the taxpayer must not be a married individual filing a separate return.
5. Maximize 401(k) contributions. In 2005, the amount that an individual can contribute to a 401(k) plan is increased to $14,000. Individuals are not taxed in the current year for any contributions that they make to their 401(k) plans. By the year 2006, the contribution limit will be $15,000 or $20,000 if you are over the age of 50.
   
   If your 401(k) plan has been amended to allow for catch-up contributions for 2005 and you will be 50 years old by December 31, 2005, you may contribute an additional $4,000 to your 401(k) account, for a total maximum contribution of $18,000 ($14,000 in regular contributions plus $4,000 in catch-up contributions).
6. Establish a Keogh or other self-employment retirement plan (SEP-IRA). If you are receiving consulting income, director's fees, or other types of self-employment income, you can establish and make tax-deductible contributions to a SEP-IRA or a Keogh plan. While these types of plans must be established by December 31, 2005, funding does not need to occur in some situations until April 15, 2006. Also, the IRS now allows self-employed individuals to establish Individual 401(k) Plans.
7. Save for education. Consider setting up a Section 529 plan or an educational IRA. The income earned in these plans will not be taxed so the assets in the plan can grow tax-free.
   
   Hope Credit and Lifetime Learning Credit: The maximum Hope credit is $1,500 (100 percent on the first $1,000, plus 50 percent of the next $1,000) for qualified tuition and fees paid on behalf of a student (i.e., the taxpayer, the taxpayer's spouse, or a dependent) who is enrolled on at least a half-time basis. The credit is available for only the first two years of the student's post-secondary education.
   
   The Lifetime Learning credit maximum in 2005 is $2,000 (20 percent of qualified tuition and fees up to $10,000). A student need not be enrolled on at least a half-time basis so long as he or she is taking post-secondary classes to acquire or improve job skills. As with the Hope credit, eligible students include the taxpayer, the taxpayer's spouse, or a dependent.
   
   For 2005, both the Hope credit and the Lifetime Learning credit are phased out at modified AGI levels between $87,000 and $107,000 for joint filers, and between $43,000 and $53,000 for single taxpayers.
   
   Coverdell Education Savings Account: Beginning in 2005, the aggregate annual contribution limit to a Coverdell education savings account is $2,000 per designated beneficiary of the account. This limit is phased out for individual contributors with modified AGI between $95,000 and $110,000 and joint filers with modified AGI between $190,000 and $220,000. The contributions to the account are nondeductible but the earnings grow tax-free.
   
   Student Loan Interest: You may be eligible for an above-the-line deduction for student loan interest paid on any "qualified education loan." The maximum deduction is $2,500. The deduction for 2005 is phased out at a modified AGI level between $105,000 and $135,000 for joint filers, and between $50,000 and $65,000 for individual taxpayers.
   
   Qualified Higher Education Expenses: For 2005, you also may be eligible to deduct qualified tuition and related expenses as an above-the-line deduction. In 2005, a taxpayer with modified AGI of not more than $65,000 ($130,000 for a married couple filing jointly) who is not claimed as a dependent on another person's return is entitled to a maximum deduction of $4,000. For taxpayers with modified AGI of $65,000 or more but not more than $80,000 ($130,000/$160,000 for a married couple filing jointly), the maximum deduction is $2,000. Note that, unless extended, 2005 is the last year for this deduction.
   
   Rules are in effect to coordinate education provisions, such as the qualified higher education expense deduction, the Hope and Lifetime Learning credits, Coverdell education savings accounts, and qualified tuition plans, to prevent double benefits.
8. Avoid underpayment of income taxes. You should double-check to make certain that you have fully paid your tax liability for the current year. Please note that the last estimated tax payment would be due by January 15, 2006 for the 2005 tax year. An income tax projection should be prepared to evaluate your potential exposure to underpayment penalties. However, you do not want to overpay because it would be similar to giving the government an interest-free loan.
9. Fund charitable gifts with long-term capital gains property. If you have capital assets that would generate long-term capital gains if sold, consider using these assets to fund your charitable commitments. This strategy will allow you to receive a charitable contribution deduction based upon the fair market value of the assets and avoid paying taxes on the accumulated gain.
   
   Hurricane Katrina Relief: For qualified charitable contributions made by individuals between August 28, 2005, and December 31, 2005, for Katrina relief efforts, the percentage limitations under §170(b) and the carryover provisions of §170(d) are suspended. Although enacted under the guise of Hurricane Katrina relief, this provision applies to qualified contributions made for any purpose, not just those for relief efforts related to Katrina, but the recipient organizations are limited to those described in §170(b)(1)(A) (other than a §509(a)(3) supporting organization). Also, individual taxpayers may claim a $500 deduction against taxable income for each "Hurricane Katrina displaced individual" that the taxpayer houses for free in the taxpayer's principal residence for a period of at least 60 days that ends in the taxable year. The deduction is available only in 2005 and 2006. The aggregate total for both years cannot exceed $2,000.
10. Evaluate your exposure to alternative minimum tax (AMT). Before you make any tax moves, check your status under the alternative minimum tax (AMT). Because the AMT brackets have not been widened like the regular tax brackets by inflation indexing, many upper and middle-income taxpayers are finding themselves subject to AMT. There has been some limited relief under the new Act. However, if you have exercised and held incentive stock options, have non-traditional investments that generate AMT preference, or anticipate that long-term capital gains will be a substantial portion of your total income, evaluate your exposure to AMT. Proper advance planning can minimize or eliminate the adverse impact of the alternative minimum tax.
11. Consider establishing a flexible savings account or cafeteria plan. This would allow you to set aside tax-free dollars with your employer to pay for any medical or independent care expenses. The benefit of this is that all monies used to pay for such medical or dependent care expenses are effectively tax-deductible since they will not be considered income to you. However, please note that these are "use it" or "lose it" accounts and any dollars not spent by December 31 are lost forever.
12. Offset capital gains. If you have any realized capital gains for the year, review your portfolio for any loser stocks to unload to offset your realized capital gains. Furthermore, you are also allowed to use capital losses to offset up to $3,000 of ordinary income in each year. However, be careful to avoid a wash sale, which is selling and buying the same security within a 30-day period. 
13. Investigate energy incentives.
    Alternative Motor Vehicle Credit: Although not available until tax year 2006, if you are planning to purchase a motor vehicle powered by certain alternative fuels, you may need to act in a hurry. A credit, dependent on fuel savings and weight of the vehicle, is available for vehicles placed in service after December 31, 2005. The most popular vehicles subject to the credit are hybrids. However, when a particular manufacturer sells its 60,000th of the particular hybrid in the United States, a phase-out period begins. The phase-out will reduce the credit from fully available to unavailable. The phase-out begins in the second calendar quarter following the calendar quarter when the manufacturer sold its 60,000th hybrid vehicle following December 31, 2005. Credits are also available for lean-burn technology vehicles (subject to the same phase-out), qualified fuel cell motor vehicles, and qualified alternative fuel motor vehicles.
    
    Residential Energy Efficient Property Credit: If you plan on installing certain energy efficient property, such as photovoltaic, solar water heating or fuel cell property, it will be worthwhile to wait until 2006. Beginning in 2006, a credit is available for the expenditures incurred for such property up to a specific dollar limitation. The property purchased cannot be used to heat swimming pools or hot tubs. The credit is set to expire for property placed in service after 2007.
    
    Non-business Energy Property Credit: If you plan on remodeling your home and you plan on incorporating specific energy efficient property, it will be worthwhile to wait until 2006. Beginning in 2006, a credit is allowed for the purchase of qualified energy efficiency improvements. Such property includes advanced main air circulating fans, natural gas, propane, oil furnace or hot water boiler, windows, insulation material, exterior doors, etc. that meet certain energy efficiency standards. The credit is capped in dollar amounts per item of property. The credit is set to expire for property placed in service after 2007.

Business Tax Planning
There are also certain things that can be done to lower business taxes as well. These include the following:

1. Deduct 100 percent of technology and equipment purchased in 2005. Small businesses may take a big deduction for all or part of their computers, furniture, office equipment and other so called personal property purchased through the end of 2005. You can deduct up to $105,000 worth of computer hardware, software and other business purchases in 2005. This deduction is allowed under Internal Revenue Code Section 179.
2. Consider establishing a health savings account program. Health savings accounts allow employees to set aside a savings account that can be used for non-reimbursed health care expenses as part of a high deductible health insurance plan.
   
   Self-Employed Health Insurance Premiums: Self-employed individuals are allowed to claim 100 percent of the amount paid during the taxable year for insurance that constitutes medical care for themselves, their spouses and dependents as an above-the-line deduction, without regard to the 7.5 percent of AGI floor.
3. Set up an employee pension plan. There is a 50 percent credit for up to $1,000 spent by an eligible small employer to set up or administer a new pension plan. This means you can knock $500 off your tax bill. You can get the credit in the year the plan is started as well as the following two years.
4. Set up a dependent care assistance program. The dependent care assistance program is a program that allows employees to place $5,000 in a dependent care assistance fund. Employees do not pay income taxes on this income and the employer does not pay payroll taxes.
   
   Employer-Provided Child Care Credit: For 2005, employers may claim a credit of up to $150,000 for supporting employee childcare or childcare resource and referral services. The credit is allowed for a percentage of "qualified childcare expenditures" including for property to be used as part of a qualified childcare facility, for operating costs of a qualified childcare facility, and for resource and referral expenditures.
5. Apply current net operating losses to previous tax periods. If your business suffers net operating losses in 2005, you may apply those losses against taxable income for the past two tax years. Thus, for example, the loss could be used to reduce taxable income--and thus generate tax refunds--for tax years as far back as 2003.

To make the most of these and other benefits created under the Internal Revenue Code, contact Joseph A. Bellinghieri, Esq., CPA or Nikolaos I. Tsouros, Esq. at MacElree Harvey, Ltd. to help you tailor a tax strategy for you and your business. 

MacElree Harvey
17 West Miner Street
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West Chester, PA 19381–0660
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