Tax Realty Consultant

The current uncertainty about tax laws makes year-end planning difficult for advisers and accountants. A number of tax initiatives are slated to sunset this year. Meanwhile, new provisions will take effect next year and several others remain in limbo while Congress decides whether to extend them. The fate of the alternative minimum tax (AMT) and qualified charitable distributions from an IRA are still undetermined.The AMT has become a huge problem for investors. Advisers said that even though a bill in Congress would offer taxpayer relief, there’s no certainty it will pass.

“Aren’t we trying to look forward into the future? How do you do that with the uncertainty that Congress is constantly changing the rules?” asked Susan Hartman, a lawyer who is a tax- and estate-planning consultant with Raymond James Financial Inc. of St. Petersburg, Fla.

Enacted in 1969, the AMT was supposed to level the playing field by targeting ultra-wealthy individuals who were getting significant tax breaks. But the tax now affects millions of middle-class Americans be-cause it was never indexed for inflation.

The AMT is a parallel tax system that requires taxpayers to recalculate their tax using different rules and rates, depending on their adjusted gross income. The AMT rules eliminate many deductions, such as those given for state and local taxes and for children.

On Nov. 9, the House of Representatives passed sweeping tax legislation that offers temporary relief for the AMT dilemma.

Introduced by House Ways and Means Committee Chairman Charles Rangel, D-N.Y., HR 3996 would extend for one year AMT relief for nonrefundable personal credits scheduled to expire at the end of 2007. The bill also increases the AMT exemption to $44,350 from $42,500 for individual filers and to $66,250 from $62,550 for joint filers.

It provides a one-year extension for a number of tax credits and deductions scheduled to expire at the end of the year. It would extend to 2008 deductions for state and local sales taxes, as well as allowing tax-free distributions from individual retirement accounts for charitable purposes.

The bill still needs to pass the Senate, and President Bush has threatened to veto it.

“There is a remote chance of a complete meltdown that will prevent any kind of [AMT] relief from going through,” said Kaye Thomas, a tax lawyer and consultant based in Lisle, Ill. “I like to think it’s a remote chance. If that were to happen, some people would owe thousands more in taxes,” he said. Mr. Thomas is the proprietor of Fairmark Press Inc. and writes books on taxes and investing.

One of the biggest problems with the AMT is that it’s misunderstood, said William Cass, senior vice president of retirement products and marketing for Putnam Investments of Boston.

“A lot of advisers think it’s an extra tax,” he said. “It’s a parallel tax system. The current problem is the uncertainty.”

The loss in AMT tax revenue is projected at $78.3 billion, and about 23 million people will be shielded from the AMT if the new bill becomes law. But there are revenue-generating provisions in the bill, such as raising tax rates on private equity managers, venture capitalists and some real estate investors.

One key provision of the current tax law that advisers hope will be extended into 2008 allows individuals 701/2 and older to make tax-free, qualified charitable donations up to $100,000 from their IRA.

Besides extending this provision, the bill also proposes cutting the age to 591/2.

For now, advisers say they’re working to help clients utilize the current provision before it expires, said Thom Hall, an adviser with Financial Strategies Institute LLC in Midvale, Utah.

“It sunsets at the end of this year, and the word to the wise is to get while the getting is good,” Mr. Hall said.

This strategy has worked for many of Kathy Longo’s clients. Ms. Longo is a certified financial planner with Accredited Investors Inc. in Edina, Minn.

Since it’s uncertain whether the provision will extend into 2008, she has advised some clients to donate significant amounts from their IRAs this year. “They might just do all of their gifts this year, and explain to the charity that: ‘This is my gift for this year and next year,’” Ms. Longo said.

With many clients who have hefty retirement assets but fewer personal assets, Ms. Longo sees an opportunity for them to preserve personal assets while using retirement assets for a charitable donation.

However, advisers have to be careful not to make a mistake, warned Seth Pearson, an adviser with Pearson Financial Services LLC in Dennis, Mass. For example, one of his clients withdrew funds from an IRA to make a charitable contribution rather than transferring the funds directly to the charity. This resulted in a taxable distribution.

This year marks the first time that individuals who inherited assets from a qualified retirement plan such as a 401(k) are allowed to roll over assets into a beneficiary IRA. Previously, non-spouse heirs were required to withdraw most of the assets and assumed all of the taxes at once.

Now, non-spouse beneficiaries can roll over the money as long as the company’s plan document permits it. The problem is that many plan documents do not include such language. However, starting in 2008, retirement plans will be required to change their documents to allow for such rollovers.

Ms. Longo said she has a client who inherited an IRA from her mother, but the plan did not contain the necessary language, so they’re waiting until January to roll over the assets.

Advisers are looking forward to a tax provision that has already been passed but doesn’t become effective until 2010, but they fear that Congress may strip it away before its effective date. This provision allows investors, regardless of income, to convert their traditional IRA to a Roth IRA in 2010. Some advisers and tax preparers are working with clients to prepare for this change. Others aren’t convinced that the provision will stick, and fear that Congress may repeal it.

Right now, anyone with modified adjusted gross income of $100,000 or more can’t convert an IRA to a Roth. But in 2010, there will be a one-time opportunity to eliminate the income cap.

Advisers are urging clients to prepare to convert in 2010 to take advantage of the opportunity.

The opportunity to convert is a major tax provision, Mr. Pearson said. “We think that it’s the absolute biggest tax advantage that we’ve seen in 30 years, to have that tax free,” he said.

Others, such as Ms. Hartman, are skeptical that this law will exist by 2010, and fear that lawmakers may cross it off the books.

“In view of what’s going on in the political arena, we may never get to 2010,” she said. “That’s not to say that we won’t, but how do you plan for that?”

Jaime J. Raskulinecz, chief executive of Entrust Northeast LLC in Verona, N.J., agrees that this is one of the biggest tax provisions, and hopes that it will stay on the books.

She even has encouraged clients to start IRAs now so that they can convert them in 2010.

“There’s not a whole lot of people talking about this particular section, and I happen to feel it’s one of the most important things we can be talking about right now,” Ms. Raskulinecz said.

Advisers are confident that a few key provisions, such as the “kiddie tax” and new rules on capital gains taxes, will not change.

Many parents may want to capitalize on current kiddie tax rules, which will change at the end of this year, Ms. Hartman said. The purpose of the tax is to prevent parents from taking advantage of their children’s low tax rate.

Currently, only children under the age of 18 fall under this tax provision, but starting next year, it will affect people through age 24.

Next year, a federal capital gains tax reduction will take effect. While some parents were hoping they could utilize that provision for college-age children, they won’t be able to do so, because the kiddie tax rules will become stricter.

Under the new provision, capital gains that are taxed at 15% will be taxed at 5%, while those taxed at 5% will not be taxed at all. The kiddie tax requires children to pay tax on unearned income over $1,700 at the same rate paid by their parents.