2007 Tax Law Changes Affecting Individuals 

By E. Lynn Nichols, CPA

Some tax changes were passed in May, some will be passed before year-end, some are routine inflation adjustments, and others just speculative.  This article lists what’s likely to pass within the next 30 days and what’s already passed (in May of 2007) that will affect 2007 returns and 2008 planning for individual taxpayers.  As you browse through the lists below, ask yourself at each item “How will this affect my clients?” and “Is there a way to gain an advantage for my client as a result of this change?”  For sure, we don’t want to miss even the smallest benefit . . . the $250 deduction for a schoolteacher’s supplies . . . for example.

Nor will we want to ignore the larger opportunities, such as a tax free distribution of up to $100,000 from an IRA account of an individual over 70 ½ to a 501(c)(3) organization.

Legislation in process in late October offers the promise of continued limited relief from the Alternative Minimum Tax, and extension of many credits and tax incentives offers planning opportunities for future years.

One statement about the 2007 tax rules that is absolutely true is “They are different from 2006.”  Another true statement is “There are many things that can be done before December 31, 2007 that can significantly reduce the tax bills of many individuals and businesses.”  See how many good ideas you can generate from the information that follows.

Late Changes in 2007 Will Affect 2007 Returns and Year-end Planning

Ways and Means Chairman, Charles Rangel, is determined to “simplify” the tax code, but in the meanwhile, it’s politics as usual and these are our best thoughts on “open items” in late October that are likely to become law in time to affect 2007 tax obligations.

* AMT exemption amounts will be increased, to $66,250 for joint filers and $44,350 for individual filers

* Virtually every provision that was scheduled to expire during 2007 or as of 1/1/08 will be extended . . . at least through the end of 2008 . . . including . . .

    o     Deduction for State and local general sales taxes
    o     Above the line deduction for qualified educational expenses
    o     Special capital gain rules for conservation easements
    o     Tax free distributions from IRA accounts for charitable purposes
    o     The $250 deduction for teacher’s supplies
    o     Election to include combat pay in earned income for earned income credit
    o     The deduction for mortgage insurance premiums

* Energy conservation credits will be expanded, and additional credits may be added

* The refundable child tax credit limitation will be reduced, thereby increasing the benefit of the credit.

* Relief from tax on up to $2 million of debt forgiveness will be available to homeowners who lose their principal residence to foreclosure.

Now, let’s go over the certain changes and what that means to you and your tax clients.

Individual changes and special provisions for 2007 that we’re sure of

* Beginning in 2008, the age threshold to escape the ‘Kiddie Tax” increases to 19. That means 2007 is the last year an 18 year old can use the individual tax brackets for investment income, unless at least 50 percent of their future income will be “earned income.”  If you have business clients with children approaching these age limits, who have significant investment income and plan to continue their education, you should consider arranging employment for the child in order to avoid higher taxes on the investment income all the way to age 24.

* Beginning in 2007, unused AMT credits can be used ratably over a 5 year period.  The benefit phases out, however, when Adjusted Gross Income exceeds $234,600 in a joint return, $156,400 in an individual return.  Individuals who got stuck by falling value of stock acquired by exercising incentive stock options are prime prospects to benefit from this provision.

* Mortgage insurance premiums are eligible for a special deduction in 2007

* A number of favorable provisions were extended for 2007 . . .

    o     The deduction for State Sales Taxes in lieu of State Income Taxes
    o     The $250 deduction for teacher’s supplies
    o     The deduction for Tuition and Fees for lower income taxpayers

* The personal exemption increases to $3,400, but phases out when Adjusted Gross Income exceeds $234,600 in a joint return, $156,400 single, and $195,500 Head of Household.

* The Standard Deduction increases to $5,350 for individuals, $10,700 married filing jointly, and $7,850 for Head of Household.

* Phaseout of itemized deductions begins when Adjusted Gross Income exceeds $156,000.

* The Adoption Tax Credit increases to $11,390.

* Starting in 2007, retired Public Safety Officers (police, firefighters, and EMS) can exclude up to $3,000 of amounts received from pension plans that are used for health or long-term care insurance if payments are made directly from the plan to the insurance carrier. This allows those who qualify to provide important benefits on a tax favored basis.

* Phaseout of the Hope Scholarship Credit and Lifetime Learning Credit begins at taxable income of $94,000 for joint filers, $47,000 for singles.  That means more individuals can benefit from these two important education subsidies.

* Phaseout of the Student Loan Interest Deduction begins at Adjusted Gross income of $110,000 in a joint return, $55,000 for singles.

* Limits on deductions for health related payments are all increased for 2007 . . .

    o     Deductible long-term-care premiums for taxpayers 71 and older increase to $3,680 per year and the maximum tax free benefit increases to $260 per day.  Other long-term-care limits increase as well.

    o     Deductible contributions to Health Savings Accounts (HSA) increase to $5,650 for family coverage, $2,950 for an individual, with an additional $800 allowed for persons 55 or older.  If you haven’t taken a hard look at how these plans work, you should do so as soon as possible.  Most of the initial confusion about how such plans would work has been solved and there are many excellent options for both the high-deductible health plans at the heart of the HSA plan and for HSAs themselves.

    o     A one time transfer of funds from an IRA to a health savings account is permitted for 2007 up the maximum annual HSA limit.

* Limits on contributions to retirement plans are all increased for 2007 . . .

    o     IRA contribution can be $4,000 plus $1,000 for persons over 50.  Whether deductible or not, it’s wise to make that IRA contribution as early as possible to begin earning a tax free return.

    o     The phaseout range when Adjusted Gross Income begins to limit a deductible IRA contribution by an “active participant” in an employer plan increases to $83,000 for a couple and $52,000 for a single person.

    o    Roth IRA contributions of singles are limited when Adjusted Gross Income exceeds $99,000, marrieds filing jointly hit the limitation when AGI exceeds $156,000.

    o    Some non-spousal heirs may be able to roll inherited amounts from qualified plans into IRA accounts, thereby avoiding current income tax or a 5 year distribution scheme.

There is something in this list for everyone on your client list.  Be proactive, contact them with your ideas about how to benefit from the tax law developments in this list.