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Following is a summary which is intended to briefly review the federal and state income tax provisions that are most likely to be encountered by our clients over the next year. Tax Rates For 2008, the 28% tax rate applies to joint taxable income in excess of $131,450 and single taxable income in excess of $78,850. The 33% rate applies to joint taxable income in excess of $200,300 and single taxable income in excess of $164,550. The 35% rate applies to taxable income in excess of $357,700. For 2009, the 28% rate applies to joint taxable income in excess of $137,050 ($82,250 for a single taxpayer), the 33% rate applies to joint taxable income in excess of $208,850 ($171,550 for a single taxpayer) and the 35% rate applies to taxable income in excess of $372,950. The maximum tax rate for most California taxpayers remains 9.3%. This rate applies to joint taxable income over $94,110 in 2008. For a single taxpayer, the 2008 threshold amount is $47,055. Note that due to the passage of Proposition 63 in November, 2004, a California taxpayer pays an additional 1% surtax on taxable income in excess of $1,000,000. Each personal exemption is worth $3,500 in 2008 ($3,650 in 2009). Personal exemptions are phased out by 2% for each $2,500 or fraction thereof by which the taxpayer's adjusted gross income ("AGI") exceeds the "threshold amount" of $239,950 ($250,200 in 2009) for a joint return and $159,950 ($166,800 in 2009) for a single taxpayer. However, the maximum phase-out cannot exceed one-third of the exemption amount. Therefore, high-income taxpayers will be allowed a deduction of at least $2,333 for each exemption claimed in 2008, and $2,433 in 2009. Personal exemptions are not deductible for AMT. Taxpayers are eligible for a federal credit of $1,000 for each dependent child under 17. The credit is reduced at the rate of $50 for each $1,000 or fraction thereof by which AGI exceeds thresholds of $110,000 on a joint return and $75,000 for a single taxpayer. This credit can be used to offset AMT. Capital Gains For both regular and alternative minimum tax purposes the maximum tax rate on long term (held more than one year) capital gains is 15%. After 2010, the 15% rate is scheduled to increase to 20%. Long term capital gains from some assets, such as collectibles, are subject to a 28% maximum rate and the tax rate on depreciation recapture from the sale of rental property is 25%. California continues to tax all income at a maximum rate of 9.3% (or 10.3% for a taxpayer subject to the surtax on taxable income in excess of $1 million.) Dividends of Individuals Taxed at Capital Gain Rates All qualified dividends are taxed at a maximum 15% rate. In general, qualified dividend income includes a cash dividend received either from a domestic corporation or a qualified foreign corporation that is not a tax-exempt corporation. In addition, anti-abuse provisions require that the taxpayer hold the underlying stock for more than 60 days during the 120 day period beginning 60 days before the stock's "ex-dividend date." Alternative Minimum Tax (AMT) The base federal AMT rate is 26% and for federal AMT income in excess of $175,000 the rate increases to 28%. The California AMT rate is 7%. Real estate taxes, state income and sales taxes, miscellaneous itemized deductions, and certain home equity debt are not deductible for the AMT. The taxpayer pays the greater of the regular tax or the AMT. Therefore, a taxpayer with relatively large deductions for taxes, employee expenses or home equity debt may be subject to the AMT and lose the benefit of these deductions. For 2008, the federal AMT exemption amount is $69,950 for married filing joint status and $46,200 for a single taxpayer. The 2008 California AMT exemption amounts are $80,017 for joint filing status and $60,014 for a single filer. These AMT exemption amounts phase-out for high income taxpayers. The AMT exemption is reduced 25¢ for each dollar that AMT income exceeds a threshold amount of $150,000 for joint filing status and $112,500 for a single filer. The California threshold amounts are $300,065 for joint filing status and $225,050 for a single filer. Interest Expense Personal interest is not deductible. Interest expense incurred in connection with a trade or business continues to be fully deductible. Interest expense incurred to acquire and carry taxable investments is also generally deductible to the extent of "net investment income." Tracing interest expense to the use of the loan proceeds continues to be required for all loans except those for home equity debt. Home equity debt may be acquired for any purpose. However, home equity debt is not deductible for AMT. Acquisition debt is debt secured by your principal residence (including a second home) that is incurred to acquire, construct or improve the residence and that does not exceed $1,000,000. Such debt incurred prior to October 14, 1987, is treated as acquisition debt regardless of the amount. Home equity debt is debt secured by your principal residence (including a second home) that does not exceed $100,000. In the event that you have refinanced any real estate debt during 2008, please send us the settlement documents with respect to the new loan and indicate the use of the new loan proceeds. Please be aware that you must also trace the proceeds of any refinanced debt that is secured by business property that you hold directly or through a partnership. Therefore, if a partnership in which you are a partner refinances debt on a property and distributes the proceeds of the refinancing to you, it is your responsibility to trace the use of these funds and to the extent they are used for personal purposes, your share of the partnership's related interest expense will not be deductible. Taxpayers should reinvest their share of any refinancing proceeds from rental or other business property. Limitation on Itemized Deductions Itemized deductions otherwise deductible are limited by the amount that exceeds 3% of AGI in excess of $159,950 ($166,800 in 2009). However, the reduction amount itself is reduced to one-third of what it would otherwise be. Therefore, if 2008 AGI is $200,000, otherwise deductible itemized deductions will be reduced $401 ((3% x ($200,000-159,950)) x 1/3). Itemized deductions not subject to this limitation include medical expense, investment interest expense and casualty losses. Itemized deductions may not be reduced more than 80%. For California, a 6% reduction applies to itemized deductions, but the AGI thresholds are $326,379 for a joint return and $163,187 for a single filer. There is no limit on the California percentage reduction. Passive Losses Passive losses are generally only deductible to the extent of passive income. There remains a limited exception for rental real estate that is actively managed by the taxpayer. Under this exception, up to $25,000 of net passive losses are deductible. This exception begins to phase out for taxpayers whose AGI exceeds $100,000, at the rate of 50% of the amount of the excess. Therefore, the deduction is fully phased out for taxpayers whose AGI exceeds $150,000. An individual who spends more than 750 hours per year in real estate related activities may qualify as a "real estate professional" and avoid the passive loss limitations. California has not conformed to the rules for real estate professionals. Self-employment Tax Self-employed individuals may deduct one-half of their self-employment taxes for income tax purposes. The self-employment tax rate of 15.3% is a combination of the OASDI tax rate of 12.4% and the medicare tax rate of 2.9%. The OASDI tax applies to net self-employment income up to a limit of $102,000 for 2008 ($106,800 for 2009). There is no limit on earnings subject to the 2.9% medicare tax. Estimated Tax Payments Taxpayers could avoid penalties for underpayment of the 2008 estimated income tax by paying in equal, timely, quarterly installments an amount equal to the lesser of 90% of the 2008 tax or 100% of the 2007 tax. However, if 2007 AGI was more than $150,000, 110% of the 2007 tax had to be paid to avoid a 2008 underpayment penalty. These same rules apply in 2009 for federal purposes. For 2008, the California rules were the same as the federal rules. However, after 2008 California has added new rules intended to accelerate the payment of estimated taxes. 2009 quarterly estimated tax payments are required to be 30% for each of the first two quarters and 20% for each of the last two quarters. In addition, taxpayers whose 2009 adjusted gross income is equal to or greater than $1 million will not be protected by any safe harbor and must make the 2009 quarterly payments based on actual quarterly income. This will add substantial complexity to the determination of required payments for affected taxpayers. Finally, California will also require electronic payment of income tax payments once certain thresholds are met. Once a taxpayer has made a single estimated tax or extension payment greater than $20,000 for a taxable year beginning on or after January 1, 2009, all subsequent payments must be made electronically. Any such payment not made electronically will be subject to a 1% penalty. The penalty may be waived if there is reasonable cause. The Franchise Tax Board intends to notify affected taxpayers. These new California rules are very recent and were hastily enacted. They are obviously quite onerous and questions abound regarding their administration. We intend to update affected clients as any developments occur. But our clients should expect to pay 30% rather than the usual 25% for each of their first two 2009 quarterly estimated tax payments. Distributions from Qualified Pension Plans and IRA's Complex rules govern distributions from qualified pension plans and IRAs. Failure to meet the requirements can result in the assessment of significant excise taxes. Following is a summary of the most commonly encountered requirements: 1. Minimum distribution rules: a taxpayer is generally required to receive an annual minimum distribution from a qualified plan or IRA if the taxpayer is over 70-1/2 years old. Failure to do so will result in a 50% excise tax. If a taxpayer turned 70-1/2 during 2008, the taxpayer is required to take the first minimum distribution by April 1, 2009, and an additional distribution before the end of 2009. Recently enacted legislation has eliminated this requirement for 2009. Thus, no minimum distribution is required for 2009. California has conformed to this rule. Taxpayers other than 5% owners may delay distributions from qualified plans until their actual date of retirement, even if this is after a taxpayer has reached the age of 70-1/2. 2. Premature distribution rules: there is a 10% excise tax on premature withdrawals from qualified plans or IRAs. Generally, a premature withdrawal is one taken prior to age 59-1/2. Significant exemptions to the penalty tax include premature withdrawals due to death or disability or that are used to pay some medical expenses, certain qualified higher education expenses, certain expenses associated with purchasing a principal residence and for certain premature withdrawals by unemployed individuals. IRA Contributions and Deductions An individual can contribute the lesser of $5,000 or earned income to a deductible IRA. However, if an individual is an active participant in a pension plan, the deduction is phased out when AGI is greater than $105,000 ($109,000 in 2009) on a joint return or $63,000 ($65,000 in 2009) on a single return. A non-working spouse can contribute up to $5,000 to an IRA. However, if the other spouse is an active participant in a pension plan, the deduction for the non-working spouse is completely phased-out when AGI is greater than $169,000 ($176,000 in 2009) on the joint return. A taxpayer age 50 or older can make an additional "catch-up" contribution of $1,000, for a total individual annual contribution limit of $6,000. The "Roth IRA" allows non-deductible contributions, but qualified withdrawals are received tax-free. The contribution limit is coordinated with the limit for all other IRAs. The contribution limit for Roth IRAs fully phases out for joint taxpayers with AGI in excess of $169,000 ($176,000 in 2009) and for a single taxpayer with AGI in excess of $116,000 ($120,000 in 2009). Education Deductions and Credits An "above the line" deduction up to $2,500 may be claimed for interest paid on qualified education loans. The deduction is phased out for joint taxpayers with AGI in excess of $145,000 ($150,000 in 2009) and for a single taxpayer with AGI in excess of $70,000 ($75,000 in 2009). The student must be enrolled at least half-time in a degree program. Only the person liable for the debt may claim the deduction. The HOPE scholarship credit provides a maximum allowable credit of $1,800 per student for costs incurred for tuition for each of the first two years of post-secondary education. The student can be the taxpayer or a dependent and must be enrolled on at least a half time basis. The Lifetime Learning credit allows a 20% credit for qualified tuition expenses for any year that the HOPE credit is not claimed. The maximum annual Lifetime Learning credit is $2,000. A student need not be enrolled on at least a half-time basis so long as the student is taking post-secondary classes to acquire or improve job skills. Both credits phase out completely for joint taxpayers whose AGI exceeds $116,000 ($120,000 in 2009) and for a single taxpayer whose AGI exceeds $58,000 ($60,000 in 2009). Taxpayers may take a deduction up to $4,000 for qualified tuition and related expenses if no credit is claimed. The deduction phases out for joint taxpayers whose AGI is more than $130,000 and for a single taxpayer whose AGI is more than $65,000. A $2,000 deduction is available for joint taxpayers with AGI up to $160,000 and for a single taxpayer with AGI up to $80,000. California does not allow any of these deductions or credits. Non-deductible contributions can be made to a Coverdell Education Savings Account up to $2,000 per beneficiary under age 18. The $2,000 annual contribution limit is phased out for joint contributors with AGI in excess of $220,000 and for a single contributor with AGI in excess of $110,000. The fund may be used to pay for elementary or secondary education expenses, in addition to higher education expenses. The elementary or secondary education expenses may be for a public, private or religious school. California's Scholarshare Program became effective in 1999. Any person may open an account for a beneficiary. At any time, the beneficiary can be changed to another family member of the original beneficiary. The trust may make distributions on behalf of the beneficiary for most college expenses. Any funds remaining can be transferred to the account of another beneficiary or refunded subject to a penalty. Income earned on the money deposited into the trust will be federal and state tax deferred. Any amounts disbursed for education expenses will be exempt from tax. Contributions to the trust are gifts subject to gift tax, but are eligible for the annual gift exclusion ($12,000 in 2008 and $13,000 in 2009). An election can be made to spread a contribution over five years in order to use each year's annual gift exclusion. Grandparents and others may contribute to an account setup by the parents or can set up accounts of their own. However, the total of all the accounts may not exceed the cap set for the prospective student. The cap amount is provided by the state and is partly a function of the age of the prospective student . See www.scholarshare.com for more information. California Use Tax You may now pay use tax with your personal income tax return, rather than on a separate use tax form filed with the Board of Equalization. You may have reportable use tax if you purchased goods outside of California (e.g. over the internet) for use, storage, or consumption in California and did not pay California sales tax on the purchase. If you need to report your use tax on your personal tax return, please provide us with an itemized list of items purchased, the purchase price of each item and the amount of sales tax paid to any other state on each item. State Sales Tax Deduction 2004 federal tax legislation enacted a new deduction for state sales tax that may be taken instead of the deduction for state income taxes. The deduction will typically be taken from a table published by IRS. The sales tax paid on certain enumerated large purchases (e.g. auto purchase) can be added to the table amounts. This deduction is intended to benefit taxpayers in states that do not have an income tax. Federal Energy Credits There is an "alternative motor vehicle credit" for the purchase of a hybrid, fuel cell, advanced lean burn, or other alternative power vehicle. The dollar amount of this credit depends on the power plant, the fuel savings and the weight of the vehicle. As a result, the credit amount may vary greatly from vehicle to vehicle. There is a new credit for new plug-in electric cars and trucks for years after 2008. The credit equals $2,500 plus $417 for each kilowatt hour of traction battery capacity in excess for four kilowatt hours. The credit can be as much as $7,500 for a vehicle with a gross weight rating of 10,000 pounds or less. There is a 30% credit for the purchase price of qualifying residential energy efficient property including solar water heating property, solar electric equipment, small wind energy property, fuel cell power plants and geothermal heat pump property. Generally, the maximum credit is $2,000 per year for each category of solar equipment (there is no limit on the solar electric property credit after 2008). The limit for small wind energy property expenditures is $500 for each half kilowatt of capacity not to exceed $4,000 and for fuel cell property expenditures it is $500 for each half kilowatt of capacity. The property purchased cannot be used to heat a swimming pool or hot tub. These credits can now be used to offset AMT. Health Savings Accounts (HSAs) Following is a brief summary of the HSA rules. Note that California does not conform to these provisions. For more information, www.hsainsider.com. Coverage must be provided under a "high deductible" health insurance policy. The annual deductible must be at least $1,100 ($1,150 in 2009) for individual coverage or $2,200 ($2,300 for 2009) for family coverage. For all practical purposes, this is the only permitted coverage. HSA contributions are deductible as an adjustment to gross income. Thus, medical expenses paid from the HSA avoid the 7.5% of AGI threshold that applies when medical expenses are taken as an itemized deduction. Earnings on funds deposited into the HSA are not taxed; distributions from the fund are not taxed so long as they are used to pay for qualified medical expenses. For 2008 the maximum income tax deduction for contributions to an HSA is $5,800 ($5,950 in 2009) for a family plan and $2,900 ($3,000 in 2009) for an individual plan. If coverage includes an individual age 55 or older, an additional $900 can be deducted ($1,000 in 2009). HSAs are not available to individuals eligible for Medicare. Charitable Contribution Deductions Recent legislation has tightened the record keeping requirements for all charitable contributions made in cash or property subsequent to August 17, 2006. The IRS may now deny any deduction for which the taxpayer does not maintain a bank record or a receipt, or other written communication from the donee organization indicating the name of the donee as well as the date and amount of the contribution. For contributions of clothing and household items, a deduction will only be permitted if the item is in "good used condition or better." The IRS may deny a deduction if the item donated has minimal monetary value. Donations of clothing or household items that are not "in good used condition or better" will be allowed only if a deduction of more than $500 is claimed for the single item and a qualified appraisal for that item is attached to the return. For a contribution of appreciated tangible personal property, if the value of the property exceeds $5,000, the charitable organization must certify that it will use the property in relation to the organization's exempt purpose or function until such intended use becomes impossible or infeasible to implement. If this certification is not obtained, the taxpayer's deduction will be limited to the cost basis of the property if the donee organization disposes of the property within three years of the contribution. Taxpayers are still required to maintain a contemporaneous written acknowledgment from the donee organization for all charitable contributions of $250 or more. A canceled check alone is no longer sufficient documentation to support such a charitable deduction. Taxpayers are required to obtain a qualified written appraisal for donated property (other than marketable securities) with a value in excess of $5,000. Failure to obtain a qualified appraisal will result in loss of the deduction. 2004 tax legislation significantly changed the rules for donations of automobiles beginning January 1, 2005. Generally, the new rules limit the deduction to the amount for which the automobile is subsequently sold by the charity. A table for values of clothing and household goods contributed to charity can be found at the Salvation Army website: www.satruck.com. Sale of a Personal Residence For the sale of a personal residence, a taxpayer can exclude up to $250,000 ($500,000 for married sellers filing jointly) of any gain. To qualify, a taxpayer must have used the home for at least two of the five years before the sale. There is no limit on the number of times that a taxpayer can exclude gain from the sale of a personal residence, however the gain exclusion cannot be used more often than once in a two year period. Surviving spouses can qualify for the $500,000 exclusion if the sale occurs within two years of the date of death. Beginning with sales after 2008, gain from the sale of a taxpayer's principal residence allocable to nonqualified use (not used as a principal residence) is not excluded. The excluded gain is calculated using a ratio based on the aggregate periods of qualified use to the total period of ownership. There are exceptions for non-qualified use after the last time the residence was used as a principal residence and certain temporary absences (not to exceed two years) due to changes in employment, health and unforeseen circumstances. Other 85% of Social Security benefits are taxed for those taxpayers whose provisional income exceeds $44,000 for a joint return and $34,000 for a single taxpayer. 50% of Social Security benefits may be taxed for those taxpayers whose provisional income exceeds $32,000 for a joint return and $25,000 for a single taxpayer. Provisional income generally equals adjusted gross income plus tax exempt income plus one-half of the Social Security benefits received. California does not tax Social Security benefits. Self-employed persons can deduct 100% of their qualified health insurance premiums. The federal expense deduction for the cost of depreciable assets used in a trade or business (Section 179) is $250,000 for 2008 and $133,000 for 2009. The limit for California remains $25,000. For 2008 and 2009, there is a federal tax deduction available to elementary and secondary school teachers for out-of -pocket classroom expenses. The maximum deduction is $250. The annual gift tax exclusion amount is $12,000 for 2008 and $13,000 for 2009. The estate tax exclusion amount is $2,000,000 for 2008 and $3,500,000 for 2009. The applicable lifetime credit amount for gift tax remains $1,000,000 and does not increase like the estate tax exclusion amount. The standard automobile mileage rate for business related auto use is 50.5¢ per mile for the period from January 1 to June 30, 2008. From July 1 to December 31, 2008, the rate is 58.5¢ per mile. For 2009 the rate is 55¢ per mile. The standard mileage rate for charitable use is 14¢ per mile for 2008 and 2009. The standard mileage rate for medical use from January 1 to June 30, 2008 is 19¢ per mile. From July 1, to December 31, 2008 the rate is 27¢ per mile. For 2009 the rate is 24¢ per mile. The maximum elective deferral to a Sec. 401(k) plan is $15,500 in 2008 and $16,500 in 2009. For a taxpayer age 50 or older an additional "catch-up" contribution of $5,000 can be made for 2008 and $5,500 for 2009. The gross income threshold that triggers the "kiddie tax" for a child under age 19 is unearned income of $1,800 for 2008 and $1,900 for 2009. The tax may also apply to children between the ages of 19 and 23 if they are full time students. The California limit remains age 14. Payroll tax returns are required when wages of $1,600 ($1,700 in 2009) in any year or $1,000 in any quarter are paid to a household worker. Payments to the taxpayer's parents or children under age 21 are exempt. Pursuant to new federal legislation, consumers are now entitled to a free annual credit report. Go to www.annualcreditreport.com. We hope you find this summary information helpful in preparing your 2006 tax returns and planning for your 2009 taxes. We wish you the best in this new year and please do not hesitate to contact us if you have any questions or need any assistance. Hines & Jones Certified Public Accountants
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