6 Tax Tips from an Estate Plannner

1. Will You Owe a Gift Tax This Year?

The rules surrounding taxes on gifts often create confusion during tax season – or any other time. Below are some of the nuts and bolts of the gift tax, including when a gift tax form needs to be filed.

The annual gift tax exclusion for 2006 was $12,000. This means that any person who gave away $12,000 or less to any one individual (anyone other than their spouse) does not have to report the gift or gifts to the IRS; any person who gave away more than $12,000 to any one person, however, will have to file a Form 709, the gift tax return. But just because you file a Form 709 doesn't mean you necessarily have to pay taxes; this depends on your past gift-giving history.

The IRS allows you to give away a total of $1 million during your lifetime before a gift tax is owed. This $1 million exclusion means that even if you have to file a Form 709 because you gave away more than $12,000 to any one person last year, you will owe taxes only if you have given away more than a total of $1 million in the past. As a result, the filing of a Form 709 is only formality for most people. Keep in mind that any part of the $1 million credit that is reported on the gift return actually counts against your overall federal estate tax exclusion, which is $2 million this year. So that means if you give away $1 million during your lifetime, upon your death your estate may only exclude $1 million from taxes, not $2 million.

However, there are several ways to give away more than $1 million over a lifetime without owing taxes. Keep in mind that Form 709 is only required when you give away more than the annual exclusion. So a married couple with a married child can give away $48,000 in one year without having to report the gift: each parent gives the child and the child's spouse $12,000 each. If a couple did this for 25 years, they would have given away $1.2 million without even having to report the gifts, much less having them count against their lifetime $1 million exclusion. Also it would be possible for the couple to give away $96,000 within a short span of time -- $48,000 in December and $48,000 in January of the next calendar year. (Note that if both spouses have made gifts, each must file a separate Form 709.)

Another way for a gift to be exempted from reporting requirements – no matter the gift's size -- is to pay for someone else's medical care or educational tuition. It is important to note that the money must be paid directly to the school, university or health care provider to be exempt, and that pre-payments can often be made as soon as the person is admitted to the school (schools include not just colleges but nursery schools, private grade schools, or private high schools). However, if you contribute to someone else's 529 college savings plan, you are subject to the $12,000 gift exclusion rule. A special regulation in the tax code enables a donor to use up five years' worth of her exclusions and gift $60,000 to a 529 at one time

If you have given away property other than money, like stock, you have to report that on your gift return, too, if the value is more than $12,000. If the stock had gone up in value since you bought it, you report the value as of the date that you gave it away. You may want to inform the recipient that the basis, or the amount that you bought the stock for, becomes their basis. The basis is used when the property is sold to determine the profit or loss.

Finally, tax deductible gifts made to charities need not be reported on a gift tax return unless the donor retains some interest in the gifted property.

2. Deducting Medical Expenses from Your Taxes

Tax time is approaching, and if you have a large number of medical expenses, you may be able to deduct many of these from your taxes. Many types of medical expenses are deductible, from long-term care to hospital stays to hearing aids. To claim the deduction, your medical expenses have to be more than 7.5 percent of your adjusted gross income. In addition, you can only deduct medical expenses you paid during the year, regardless of when the services were provided, and medical expenses are not deductible if they are reimbursable by insurance.

What you can deduct:
You can deduct medical expenses for yourself, your spouse, and your dependents. The following are some of the items included in the definition of medical expenses:

• The cost of drugs that require a prescription. You can deduct insulin without a prescription.
• The cost of dental treatment, including x-rays, fillings, and dentures.
• The cost of travel to medical appointments.
• Premiums paid for insurance policies that cover medical care are deductible, unless the premiums are paid with pretax dollars. Generally, the payroll tax paid for Medicare Part A is not deductible, but Medicare Part B premiums are deductible.
• Payments made for nursing services. An actual nurse does not need to perform the services as long as they are the kind generally performed by a nurse.
• The cost of long-term care, including housing, food, and other personal costs, if you are chronically ill. Chronically ill means you are unable to perform (without substantial assistance) at least two activities of daily living, such as eating, toileting, transferring, bathing, and dressing for 90 days or you require substantial supervision due to a severe cognitive impairment.
• The cost of meals and lodging at a hospital or similar institution if a principal reason for being there is to receive medical care. The amount you include in medical expenses for lodging cannot be more than $50 for each night for each person.
• Costs for medical equipment installed in a house or improvements made to the home if the equipment or improvements are needed to for medical care. If you make an improvement, the deduction must be reduced by the increase in the value of your property.
• The portion of a lump-sum or “founders fee” payment to a retirement home that is for medical care. The agreement with the retirement home must require that you pay a specific fee as a condition for the home's promise to provide lifetime care that includes medical care.
• The cost of medical expenses for an immediate family member (including in-laws) or someone who has lived with you for a year. The family member must be a U.S. citizen or legal resident or resident of Canada or Mexico and you must provide more than half of that person's support for the year. Even if the taxpayer is not paying more than half family member's total support for the year, he may still be eligible for a deduction if a "multiple support agreement" is created. The taxpayer must pay more than 10 percent of an individual's total support for the year, and, with others who also support the resident, collectively contribute to more than half of the resident's support. All those supporting the individual must agree on and sign the applicable Multiple Support Declaration (Form 2120)

3. Claiming a Parent As a Dependent

If you are caring for your mother or father, you may be able to claim your parent as a dependent on your income taxes. This would allow you to get an exemption ($3,300 in 2006) for him or her.
There are five tests to determine whether you can claim a parent as a dependent:

• The person you are claiming as a dependent must be related to you. This shouldn't be a problem if you are claiming a parent (in-laws are also allowed). Keep in mind, however, that foster parents do not count as a relative. To claim a foster parent, he or she must live with you for a year as a member of your household.
• Your parent must be a citizen or resident of the United States or a resident of Canada or Mexico.
• Your parent must not file a joint return. If your parent is married, he or she must file separately. There is an exception if your parent is filing jointly, but has no tax liability. If your parent files a joint tax return solely to get a refund, you can claim him or her as a dependent.
• Your parent must not have a gross income of $3,300 (in 2006) a year or more. Gross income does not include Social Security payments or other tax-exempt income. (For those with incomes above $25,000, some portion of Social Security income may be includable in gross income.)
• You must provide more than half of the support for your parent during the year. Support includes amounts spent to provide food, lodging, clothing, education, medical and dental care, recreation, transportation, and similar necessities. Even if you do not pay more than half your parent's total support for the year, you may still be able to claim your parent as a dependent if you pay more than 10 percent of your parent's support for the year, and, with others, collectively contribute to more than half of your parent's support. To receive the exemption, all those supporting your parent must agree on and sign the applicable Multiple Support Declaration (Form 2021).

4. The Tax Deductibility of Long-Term Care Insurance Premiums

Qualified long-term care insurance policies receive special tax treatment. To be "qualified," policies must adhere to regulations established by the National Association of Insurance Commissioners. Among the requirements are that the policy must offer the consumer the options of "inflation" and "nonforfeiture" protection, although the consumer can choose not to purchase these features.

The policies must also offer both activities of daily living (ADL) and cognitive impairment triggers, but may not offer a medical necessity trigger. "Triggers" are conditions that must be present for a policy to be activated. Under the ADL trigger, benefits may begin only when the beneficiary needs assistance with at least two of six ADLs. The ADLs are: eating, toileting, transferring, bathing, dressing or continence. In addition, a licensed health care practitioner must certify that the need for assistance with the ADLs is reasonably expected to continue for at least 90 days. Under a cognitive impairment trigger, coverage begins when the individual has been certified to require substantial supervision to protect him or her from threats to health and safety due to cognitive impairment.

Policies purchased before January 1, 1997, are grandfathered and treated as "qualified" as long as they have been approved by the insurance commissioner of the state in which they are sold. Most individual policies must receive approval from the insurance commission in the state in which they are sold, while most group policies do not require this approval. To determine whether a particular policy will be grandfathered, policyholders should check with their insurance broker or with their state's insurance commission.

Premiums for "qualified" long-term care policies will be treated as a medical expense and will be deductible to the extent that they, along with other unreimbursed medical expenses (including "Medigap" insurance premiums), exceed 7.5 percent of the insured's adjusted gross income. If you are self-employed, the rules are a little different. You can take the amount of the premium as a deduction as long as you made a net profit--your medical expenses do not have to exceed 7.5 percent of your income.

The deductibility of premiums is limited by the age of the taxpayer at the end of the year, as follows (the limits will be adjusted annually with inflation):

5. Taxation of Social Security Benefits

Although Social Security benefits are generally not taxable, people with substantial income in addition to their Social Security may pay taxes on their benefits. If you file a federal tax return as an individual and your "combined income," including Social Security benefits and nontaxable interest income is between $25,000 and $34,000, 50 percent of your Social Security benefits will be considered taxable. If your combined income is above $34,000, 85 percent of your Social Security benefits is subject to income tax. If you file a joint return and you and your spouse have a combined income between $32,000 and $44,000, 50 percent of your benefits will be subject to tax. If your combined income is more than $44,000, 85 percent of your Social Security benefits is subject to income tax.

For more information on the taxation of Social Security benefits, call the Internal Revenue Service's toll-free telephone number, 1-800-829-3676, and ask for Publication 554, Tax Information for Older Americans, and Publication 915, Social Security Benefits and Equivalent Railroad Retirement Benefits. You can also access these publications on the IRS Web site. Calculating the taxes you owe on your Social Security benefits is also explained in the instruction booklet accompanying your Form 1040 federal tax return.


 

6. New Tax Break Helps Surviving Spouses

Widows and widowers who don't want to sell their house right away will get a tax break under a new law. The law gives surviving spouses two years to sell their house and receive the full $500,000 capital gains exclusion that married couples are entitled to.

Couples who are married and file taxes jointly can sell their main residence and exclude up to $500,000 of the gain from the sale from their gross income. Single individuals can exclude only $250,000. Under the previous law, if a spouse died, the surviving spouse could file jointly -- and therefore get the full $500,000 exclusion -- only for the year in which the spouse died. The new law allows surviving spouses to get the full $500,000 exclusion if they sell their house within two years of the date of the spouse's death and other ownership and use requirements have been met. The result is that widows or widowers who sell within two years may not have to pay any capital gains tax on the sale of the home.

The change is contained in the Mortgage Forgiveness Debt Relief Act of 2007, signed into law Dec. 20, 2007. For more on the bill, go to: http://www.govtrack.us/congress/bill.xpd?bill=h110-3648

For a Wall Street Journal article on the change, click here.