Top Ten Tax Changes For 2008

There were a number of tax provisions that were buried in the two major legislative acts that were passed this year in response to the economic conditions. The Housing and Economic Recovery Act of 2008 (the Housing Bill) became law on July 30, 2008 and the Emergency Economic Stabilization Act of 2008 (the Bailout Bill) became law on October 3, 2008. Many of the tax changes dealt with extending prior tax breaks that had expired but a number of new tax provisions were also included. The following is a brief summary of the major changes that have significant tax and investment implications.

 We expect a number of additional tax changes to occur in the first part of 2009 as a result of additional economic stimulus legislation. However, we anticipate these tax changes to be effective starting in 2009 so stay tuned for our analysis next year. If you have any questions, please contact us at 407-629-6477.

1. ZERO Capital Gains and Dividend Tax Rates. For 2008 through 2010, the tax rate is 0% for capital gain and qualified dividend income for taxpayers in the 10% or 15% ordinary income tax bracket. For those in ordinary income tax brackets above 15%, the capital gains tax rate will stay at 15% until 2011. These lower tax rates provide a unique opportunity for reduced taxes for all investors, particularly if you own highly appreciated stock. However, the general expectation is that the top rate of 15% will most likely increase to 20% within the next year or so for individuals earning over $200,000 or couples earning over $250,000.

2. Additional Property Tax Deduction. The Housing Bill provides a one time benefit in 2008 to all homeowners who do not itemize their deductions. Under current law, property taxes are deductible only if a taxpayer itemizes their deductions on Schedule A of their tax return. The new provision allows a deduction for real estate taxes that is capped at $1,000 per couple or $500 per individual. This deduction is in addition to the standard deduction and cannot be used if a taxpayer itemizes.

3. Extension of Popular Tax Breaks. A number of tax breaks that expired in 2007 were extended to 2009 by the Bailout Bill. In particular, the option to deduct state and local sales tax as an alternative to state income tax is particularly valuable to those residents of states that have no income tax. This extension results in continued tax savings to all Floridians who itemize their deductions. In addition, educators can still deduct their out-of-pocket expenses for classroom supplies up to $250 regardless of whether they itemize their deductions. Another tax break that was extended involved the deduction for qualified education expenses regardless of whether one itemizes. This tuition deduction allows for a maximum deduction of $4,000 in tuition and fees for a married couple earning less than $130,000.

4. Higher Contribution Limits for IRAs/401(k)s/403(b)s. For 2008, the annual IRA contribution limit increased from $4,000 to $5,000 with a catch-up contribution of $1,000 allowed for those over age 50. The increased limit of $5,000 ($6,000 for those over 50) for 2008 is the first such increase in a few years. The higher contribution limits allow investors to continue to save even more for retirement while taking advantage of the tax benefits of a retirement account. The contribution limits for retirement plans also increased for 2009. The limit for 401(k)s and 403(b)s increases from $15,500 for 2008 to $16,500 for 2009. For those over 50, the additional catch-up contribution of $5,000 in 2008 also increased to $5,500 for 2009, allowing a maximum contribution of $22,000 for those over age 50. The limit for a Simple IRA increases from $10,500 for 2008 to $11,500 for 2009 with an extra $2,500 permitted for those over age 50.

5. Inflationary Adjustments Abound. The normal annual inflationary increases occurred for many tax related items such as tax brackets, personal exemptions and standard deduction. Of particular interest, the annual gift exclusion increased from $12,000 to $13,000 per person for 2009. In addition, the amount of income subject to social security tax also increased from $102,000 in 2008 to $106,800 for 2009. This increase of $4,800 represents the largest amount of an increase in history. The deductibility limits for IRA contributions also increased for those covered by a retirement plan at work. These limits start to phase out at income levels above $85,000 for joint filers and $53,000 for single filers. If only one spouse is covered by a retirement plan at work and the other spouse is either not covered or does not work, a tax deduction for an IRA contribution by the non-covered spouse now phases out as income rises between $159,000 and $169,000.

6. First-time Homebuyer $7,500 Tax Credit. The Housing Bill provides taxpayers a tax credit of up to $7,500 for buying a home between April 8, 2008 and June 30, 2009 if they have not owned a primary residence in the previous three years. The credit phases out between $150,000 and $170,00 of adjusted gross income for married couples and $75,000 to $95,000 for single filers. If you purchase a house in 2009, you can elect to take the credit on your 2008 tax return. However, this tax credit must be repaid in its entirety over the next 15 years starting two years after the credit is claimed. So, if you claim a credit of $7,500 in 2008, you must pay an extra $500 in taxes in 2010 and the subsequent fourteen years. In effect, this tax credit is simply an interest free loan from the government for first-time homebuyers.

7. Alternative Minimum Tax (AMT) Partial Relief. In the Bailout Bill, Congress continued its annual ritual of increasing the exemption amount for AMT income in 2008 to $46,200 for individuals from $44,350 in 2007. For married couples, the exemption amount for 2008 increases to $69,950 from $66,250 in 2007. The exemption amounts are the amounts of AMT–taxable income taxpayers can earn before they may be subject to AMT. This legislative fix protects middle class taxpayers from having to pay nearly $62 billion more in alternative minimum taxes. While this extension is important, its effect is limited to 2008 and those taxpayers who were previously subject to AMT last year will most likely be subject to it again this year.

8. Modification to Rules for Excluding Gain on Sale of Primary Residence. Under prior rules, homeowners were able to exclude from taxes any gain on the sale of a primary residence up to $250,000 for a single person and $500,000 for a married couple if they used the house as their primary residence for at least two of the last five years. Under the revised rules set forth in the Housing Bill, any gain that occurs in the years that the home is not the primary residence are not excluded from taxes. For example, if a house is used as a vacation home for three years and as a primary residence for the next two years, the owner will have to pay capital gains tax on three-fifths of the gain – that portion of the gain that represents the three years the home isn’t a primary residence. Previously, the homeowner would have been able to avoid the entire capital gain subject the $500,000/$250,000 limits. In effect, the new rules allocate any gain over the five year period in an effort to restrict people from turning second homes into primary residences in order to avoid capital gain. These new rules take effect on January 1, 2009.

9. Energy Tax Credits. The Bailout Bill introduced a number of new energy tax credits and extended the popular residential energy credit through 2009. The residential energy credit allows a credit of up to $500 for purchasing and installing certain energy efficient products such as exterior windows and doors, insulation materials, electric heat pumps and central air conditioning. The credit is equal to 10% of the cost of qualifying materials. In addition, a tax credit equal to 30% of the cost of installing solar panels was extended and the previous maximum limit of $2,000 was removed. The Bailout Bill provided a new tax credit of up to $7,500 for purchasers of plug-in electric vehicles. This credit will start to phase out after 250,000 qualifying electric vehicles are sold in the United States.

10. Required Minimum Distributions to Charities Extended for 2008 and 2009. The Bailout Bill extended the previous opportunity to donate money directly from an IRA to a charity through 2009. The rules allow individuals who are 70 ½ and older to take tax-free withdrawals up to $100,000 so long as the distribution is from an IRA and payable directly to a charity. These withdrawals continue to count against an individual’s required minimum distribution. Under current law, IRA withdrawals are treated as part of taxable income. If an individual directs the money to charity they can deduct the contribution only if they itemize. Under these distribution provisions, if the IRA withdrawal is donated directly to charity, it is not included in taxable income. Consequently, this option will continue to benefit those taxpayers who typically do not itemize or those who may be subject to a phase out of their itemized deductions because of other income.

The legal and tax information contained herein is merely a summary of our understanding and interpretation of current tax laws as of December 15, 2008 and is not exhaustive. Where indicated, past performance is not a guarantee or indication of future performance. Nelson Investment Planning Services, Inc. offers securities through Nelson Ivest Brokerage Services, Inc., a member of FINRA, MSRB and SIPC.c., a member of FINRA, MSRB and SIPC.