Year-end Income Tax Planning for Individuals

We are sending you this letter to bring you up-to-date on these and other new tax planning opportunities provided by this new legislation, and to remind you of several traditional year-end tax planning strategies. Please keep in mind that many of the provisions contained in the new tax legislation are first effective in 2006, while others won’t be available until 2007, or later years. Consequently, pay careful attention to the effective date of each new provision which we highlight prominently in each segment.

Be Careful! Moving income from one tax year to another may reduce your personal exemptions and itemized deductions. Moreover, strategies suggested in this letter may subject you to the alternative minimum tax (AMT). For example, you might trigger AMT if you exercise incentive stock options, take large capital gains, have a large family, live in a state with high income or property taxes, or incur significant unreimbursed employee business expenses. Consequently, you should not adopt any tax planning strategy offered in this letter without first computing the impact of the strategy on your overall tax liability, including your AMT liability, for 2006 and 2007. Therefore, we suggest that you call our firm before implementing any tax planning technique discussed in this letter. You cannot properly evaluate a particular planning strategy without calculating your overall tax with and without that strategy.

Planning Alert! At the time we completed this letter, Congress had not extended several popular tax breaks that expired on December 31, 2005, including: the $250 deduction for teacher’s classroom expenses, the deduction for state and local sales taxes, the deduction for higher education expenses, and the election to treat tax-exempt combat pay as earned income for earned income tax credit purposes. However, it is possible that Congress will retroactively extend these provisions before the 2006 tax filing season. Please call our firm if you need a status report.

HIGHLIGHTS OF THE PENSION PROTECTION ACT OF 2006
On August 17, 2006, President Bush signed the landmark Pension Protection Act of 2006 (PPA 2006), a more than 900 page bill that not only makes dramatic changes to qualified retirement plans, but also reforms major portions of the charitable contribution rules. The following summary highlights selected provisions of the Act impacting individuals.

Trustee-To-Trustee Transfer Allowed From Deceased Individual’s Retirement Account To IRA Naming Non-Spouse Beneficiary. Effective for distributions after 2006, PPA 2006 allows a tax-free trustee-to-trustee transfer from a qualified retirement plan (e.g., a §401(k) plan, a profit-sharing plan) to an IRA for the benefit of a non-spouse beneficiary. This option is currently available for IRA distributions, but not for distributions from qualified plans. Under PPA 2006, the transferee IRA will be treated as an "inherited IRA," and the beneficiary will be subject to the same minimum required distribution rules as apply to any non-spouse beneficiary. Tax Tip. Many qualified plans (e.g., profit-sharing plans and pension plans) require the distribution of amounts in an employee’s account within a certain period after the employee’s death. For example, some plans require a lump-sum distribution and others require distributions over 5 years. The new law does not allow a non-spouse beneficiary who receives a distribution from a decedent’s plan to roll it into an IRA. However, beginning in 2007, the non-spouse beneficiary may defer the tax by having the qualified plan trustee transfer the distribution directly to an IRA for the benefit of the non-spouse beneficiary, using a trustee-to-trustee transfer. In most cases, this will allow the beneficiary to distribute and pay tax on his or her share of the decedent’s account balance over the beneficiary’s life expectancy. Planning Alert! The rules for taxing distributions from IRAs and other retirement plans are extremely complex. Please call us before the distribution is made so we can help you determine your options.

Tax Refund May Be Paid Directly To Your IRA. PPA 2006 provides that you may direct the IRS to deposit all or a portion of your tax refund directly into your traditional or Roth IRA beginning with your 2006 Federal tax refund. To be deductible on your 2006 return, your IRA contribution must be deposited by April 16^th of 2007. Therefore, you need to file your 2006 return early enough so that your refund will be deposited into your IRA account by the IRS no later than April 16, 2007. In addition, you must establish the IRA at a bank or other financial institution before you request the direct deposit and you must notify the IRA custodian that the direct deposit is to be treated as a 2006 contribution.

Certain Military Personnel Granted New Relief From Early Withdrawal Penalty. PPA 2006 provides that a "qualified reservist" called to active duty after September 11, 2001 and before December 31, 2007 may take a taxable distribution from an IRA, §401(k) plan, or §403(b) annuity without paying the 10% early distribution penalty. To qualify, you must be a reservist or a National Guardsman called to active duty for a period in excess of 179 days or for an indefinite period. In addition, the distribution must occur during the period beginning on the date of your active duty order and ending on the close of that active duty period. Tax Tip. Please call our firm if you think you qualify for a refund of the 10% penalty paid with respect to qualifying distributions made after September 11, 2001. The new law extends the time for obtaining a refund of the 10% penalty until one year following August 17, 2006 (i.e., August 16, 2007).

Temporary Tax-Free IRA Payments To Charities. Effective for 2006 and 2007, if you have reached age 70½, you may have your IRA trustee contribute up to $100,000 each year from your IRA directly to a qualified charity and exclude the distribution from your income. The payment to the charity is not included in your income, however, you receive no charitable contribution deduction for the payment. This distribution to charity also counts toward any "minimum required distribution" that you would otherwise be required to take during the year of the contribution. This new rule only applies to the "taxable portion" of the IRA. Furthermore, to qualify, the contribution must be made by the IRA trustee "directly" to a qualifying 50% charity. Planning Alert! Contributions to "donor-advised funds" and certain "supporting organizations" do not qualify. In addition, this special rule does not apply to distributions from SEP or SIMPLE IRAs. Tax Tip. You should compare various options before disbursing IRA funds to charity. For example, you may benefit more from a contribution of substantially appreciated capital gain property since 1) the appreciation (gain) is not included in income, and 2) a charitable contribution deduction is allowed for the full fair market value of the property. Please call our firm before you transfer any IRA funds to a charity.

New Restrictions On Charitable Contributions Of Clothing And Household Items. Effective for contributions made after August 17, 2006, no deduction will be allowed for charitable contributions of clothing or household items, unless the items are in "good used condition or better." The term "household items" includes furniture, furnishings, electronics, appliances, linens, and other similar items. It does not include food, paintings, antiques, and other objects of art, jewelry, gems or collections. Congress has instructed the IRS to issue guidance as to what constitutes "good used condition or better." Tax Tip. You should consider contributing your clothing and household items to charitable thrift shops that have a policy of accepting only items that are in good condition.

New Recordkeeping Requirements For Contributions Made In Cash Or Check. Effective for contributions made in tax years beginning after August 17, 2006, in order to deduct a charitable contribution made in cash, check, or other monetary means, the contribution must be supported by 1) a bank record (e.g., a cancelled check), or 2) a receipt, letter or other written communication from the charity showing the name of the donee organization, the date of the contribution, and the amount of the contribution.

If the contribution is for $250 or more, you will also need a written receipt as required under current law, including a statement indicating whether or not goods or services were received in return for the contribution.

TAX INCREASE PREVENTION AND RECONCILIATION ACT OF 2005
On May 17, 2006, President Bush signed the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA). This $70 billion tax cut bill not only extends tax breaks that were scheduled to expire, but also creates several new tax relief provisions. The following is a summary of selected TIPRA provisions:

Kiddie Tax Now Applies To Children Under Age 18 (Rather Than Age 14). Prior to 2006, children who had not reached age 14 by the end of the tax year were taxed on their unearned income (e.g., interest, capital gains, and dividends) at their parents’ marginal tax rates, if the unearned income exceeded a threshold amount ($1,600 for 2005; $1,700 for 2006). Effective for tax years beginning after 2005, TIPRA increases the age of children subject to this tax to those under age 18. Tax Tip. Since "earned" income is exempt from the kiddie tax, paying reasonable wages to children under age 18 from a family business becomes an even more valuable tax strategy.

Income Limitation For Traditional-To-Roth IRA Conversions Eliminated After 2009. Currently, whether you file joint or single, you are not allowed to convert (rollover) your traditional IRA into a Roth IRA unless your modified adjusted gross income is $100,000 or less. In addition, if you are married, you must file a joint return with your spouse. Effective for tax years beginning after 2009, TIPRA removes this income threshold and the joint return requirement. Thus, you will be able to convert your regular IRA to a Roth IRA after 2009, without regard to your income or your filing status. If you convert in 2010, unless you elect out, you will report the income triggered by the conversion pro rata in 2011 and 2012. This two-year spread is not available for conversions after 2010. Tax Tip. Regardless of your income level, you can currently contribute to a traditional nondeductible IRA, and convert that nondeductible IRA to a Roth IRA after 2009. You could continue making nondeductible IRA contributions after 2009 and rolling them over into a Roth IRA periodically. However, if you convert a nondeductible IRA to a Roth, the earnings are taxed. Caution! If you contribute to a nondeductible IRA and then convert the nondeductible to a Roth after 2009, you must pay tax on the taxable portion of the distribution. The amount of the distribution that is taxable is calculated by aggregating all of your IRAs except Roth IRAs. Traditional deductible IRAs, nondeductible IRAs, SEP IRAs, and SIMPLE IRAs are treated as one IRA in determining the "taxable amount" upon the conversion of an IRA to a Roth.

OTHER RECENT DEVELOPMENTS

Uniform Definition Of Child For Tax Purposes. There are several common tax benefits that are potentially available to taxpayers with children: the dependency exemption; the child tax credit; the earned income credit; the child care credit; the exclusion for employer-provided child care; and head-of-household filing status. Recent tax legislation establishes a uniform definition of a "qualifying child" for purposes of qualifying for the above-listed tax benefits. Tax Tip. For divorced or separated parents, the child is treated as the qualifying child of the parent who has custody for the greater portion of the year. However, the child may be treated as the qualifying child of the noncustodial parent for purposes of the personal exemption deduction and the child tax credit, if the custodial parent releases the claim to the exemption to the noncustodial parent in a written declaration (typically by properly executing Form 8332) that the noncustodial parent attaches to the noncustodial parent's tax return. In that event, the child is still the qualifying child of the custodial parent for purposes of the earned income credit, the child care credit, the exclusion for employer-provided child care, and for claiming head-of-household status.

IRS Announces Telephone Excise Tax Refund. The IRS recently announced that anyone who paid the 3% Federal telephone excise tax on long-distance telephone service after February 28, 2003 and before August 1, 2006, is entitled to a refund of the tax. Tax Tip. If you are an individual taxpayer, you may avoid the complicated task of computing the amount of federal telephone excise tax that you’ve paid since February 28, 2003, by simply electing to claim a standard refund amount allowed by the IRS on your 2006 income tax return. The standard amounts are: $30 if you claim one personal exemption, $40 if you claim two exemptions, $50 if you claim three exemptions, and $60 if you claim four or more exemptions. If you are not required to file an individual income tax return, a special Form 1040EZ-T must be filed in order to claim your refund.

TRADITIONAL YEAR-END TAX PLANNING TECHNIQUES

Watch Out For Incentive Stock Options And AMT. If you exercised an incentive stock option (ISO) in 2006, the exercise could trigger the alternative minimum tax (AMT) on your 2006 return. Your AMT income includes the excess of the fair market value of the stock acquired upon the exercise of the option over the exercise price even though this excess is not included in regular taxable income upon the exercise of the options. Tax Tip. If you exercised an ISO in 2006 and the stock you acquired has declined in value since the date of exercise, it may be possible to eliminate or reduce your AMT tax liability if you sell the stock on or before December 31, 2006. Please check with us if you have exercised incentive stock options during 2006 and the price of the stock has fallen since the date of exercise. A sale of the stock after December 31, 2006 will not affect your AMT liability for 2006. So, we must act timely for a sale to reduce 2006 taxes! Planning Alert! For this strategy to eliminate the AMT liability, you may not purchase the same or similar stock within 30 days before or 30 days after the sale.

Year-End Considerations For Capital Assets. Timing your year-end sales of stocks, bonds, or other securities may save you taxes. After fully evaluating the economic factors, the following are several year-end tax planning ideas for sales of capital assets. Caution! Always consider the economics of a sale or exchange first!

• Taking Capital Losses To The Extent Of Capital Gains Plus $3,000. If you have already recognized capital gains in 2006, you should consider selling securities that have declined in value prior to January 1, 2007. These losses will be deductible on your 2006 return to the extent of your recognized capital gains, plus $3,000. Net capital losses in excess of $3,000 are carried forward and offset capital gains for future years. These losses may have the added benefit of reducing your income to a level that you qualify for other tax breaks (e.g., the child credit, the HOPE credit, and IRA contributions). Planning Alert! If within 30 days before or after the sale of loss securities, you acquire the same securities, the loss will not be allowed currently because of the wash sale rules.

• Making The Most Of Capital Losses. If your stock sales to date have created a net capital loss exceeding $3,000, consider selling enough appreciated securities before year end to decrease the net capital loss to $3,000. Stocks that you think have reached their peak would be good candidates. All else being equal, you should sell the short-term gain (held 12 months or less) securities first. This will allow your short-term capital gain to absorb your net capital loss (in excess of $3,000), while preserving your favorable long-term capital gain treatment for later years. Tax Tip. Net short-term capital gains could also be used to free up a deduction for any "investment interest" you have incurred (e.g., interest you have paid on your margin account).

Postponing Taxable Income. Generally, it’s a good idea to defer as much income into 2007 as possible if you believe that your marginal tax rate for 2007 will be equal to or less than your 2006 marginal tax rate. Deferring income into 2007 could also increase various credits and deductions for 2006 that are being phased out as your adjusted gross income increases. If you believe that deferring taxable income into 2007 will save you taxes, consider the following strategies:

• Self-Employed Business Income. If you are self-employed and use the cash method of accounting, consider delaying year-end billings to defer income until 2007. Planning Alert! If you have already received the check in 2006, deferring the deposit does not defer the income. Also, you may not want to defer billing if you believe this will increase your risk of not getting paid.

• Required Distributions From Retirement Plans After 70½ Or Death. If you want to postpone the distributions (and therefore the taxation) of amounts in your traditional IRA or in a qualified retirement plan as long as possible, there are many technical steps you need to consider, including:

Naming A Proper Beneficiary. It is critical that you name the appropriate beneficiaries. You should generally name an individual or a "qualified trust" as the beneficiary. Planning Alert! If your estate is the beneficiary of your IRA or qualified plan account, your heirs will generally miss out on substantial tax deferral opportunities after your death. In addition to naming an individual or individuals as your beneficiary, you should also name a "contingent beneficiary" in case your primary beneficiary dies before you. Planning Alert! The rules for maximizing the tax deferral possibilities for IRAs and qualified plan accounts are complicated. We will gladly review your beneficiary designations and offer planning suggestions.

Attaining Age 70½ During 2006. If you reach age 70½ at any time during 2006, you must begin distributions from a traditional IRA account no later than April 1, 2007. A 50% penalty applies to the excess of the required minimum distribution over the amount actually distributed. If you wait until 2007 to make the first distribution, then two distributions must be made for 2007 (one by April 1, 2007 for the 2006 year and one by December 31, 2007 for the 2007 year). If you are in this situation, please call our firm and we will help you determine whether it will be to your tax advantage to defer the required distribution for 2006 until 2007, or make the 2006 distribution on or before December 31, 2006.

Accelerating Deductions Into 2006. If you are a cash method taxpayer, you can generally accelerate a 2007 deduction into 2006 by "paying" it in 2006. Accelerating an "above-the-line" deduction, such as the IRA deduction, qualified student loan interest deduction, and deductible alimony into 2006 may allow you to reduce your "adjusted gross income" below the thresholds needed to qualify for many tax benefits. Remember, however, that itemized deductions do not reduce your "adjusted gross income" and, therefore, will not affect your 2006 deductions and credits that are reduced as your income increases. Itemized deductions include charitable contributions, state and local taxes, medical expenses, unreimbursed employee travel expenses, and home mortgage interest. Tax Tip. "Payment" typically occurs in 2006 if a check is delivered to the post office, if your electronic payment is debited to your account, or if an item is charged on a third party credit card in 2006. Planning Alert! The IRS says that prepayments of expenses applicable to periods beyond 12 months will not be deductible in 2006.

"Bunching" Itemized Deductions. If your itemized deductions fail to exceed your standard deduction in most years, you are not receiving maximum benefit for your itemized deductions. You could possibly reduce your taxes over the long term by bunching the payment of your itemized deductions in alternate tax years. This may produce tax savings by allowing you to itemize deductions in the years when your expenses are bunched, and using the standard deduction in other years. Tax Tip. The easiest deductions to shift between tax years are charitable contributions, state and local taxes, and your January home mortgage interest payment. For 2006, the standard deduction is $10,300 on a joint return and $5,150 for single individuals. If you are blind or age 65, you get an additional standard deduction of $1,000 if you’re married ($1,250 if single). Planning Alert! For 2006, most itemized deductions are reduced by 2% (3% in 2005) of your adjusted gross income in excess of $150,500 ($75,250 for married individuals filing separately). This cut back rule began phasing out in 2006, and is eliminated altogether by 2010.

If we have previously advised you to pay one property tax payment in odd years and three payments in even years (or vice versa) in order to maximize or bunch your deductions, you should continue to do so.

Charitable Contributions. If you are considering a significant 2006 contribution to a public charity (e.g., church, synagogue, or college), it will generally save you taxes if you contribute appreciated long-term capital gain property, rather than selling the property and contributing the cash proceeds to charity. By contributing capital gain property held more than one year (e.g., appreciated stock, real estate, etc.), a deduction is generally allowed for the full value of the property, but no tax is due on the appreciation. Planning Alert! Generally, this rule does not apply to contributions to private foundations. Tax Tip. A charitable contribution deduction is allowed for 2006 if the check is mailed on or before December 31, 2006, or the contribution is made by a credit card charge in 2006. However, if you give a note or a pledge to a charity, no deduction is allowed until you pay off the note or pledge.

Maximizing Home Mortgage Interest Deduction. If you are looking to maximize your 2006 deductions, you can increase your home mortgage interest deduction by paying your January, 2007 payment on or before December 31, 2006. Typically, the January mortgage payment includes interest that was accrued in December and, therefore, is deductible if paid in December. Planning Alert! Mortgage interest paid on a home equity loan or line of credit may be subject to certain limitations. Generally, interest paid on up to $100,000 of qualified home equity indebtedness is deductible, regardless of the use of the proceeds. However, the interest is not deductible for AMT purposes unless the proceeds are used to buy, build or substantially improve your principal residence or a second home that is a qualified dwelling. Additionally, there are potential deduction limitations related to home acquisition indebtedness. Please contact us if you contemplating refinancing your existing mortgage, paying off your mortgage early or purchasing a principal residence in which you are planning on using equity from another property that you own.

Tax-Wise Payment of State and Local Taxes. If you anticipate deducting your state and local income taxes, consider paying them (fourth quarter estimate and balance due for 2006) and property taxes for 2006 prior to January 1, 2007 if your tax rate for 2006 is higher than or the same as your projected 2007 tax rate. This will allow a deduction for 2006 (a year early) and possibly against income taxed at a higher rate. Planning Alert! You should not employ this tactic without carefully calculating the alternative minimum tax impact. Also, "overpayment" of your 2006 state and local income taxes is generally not advisable since a refund in 2007 from a 2006 overpayment may be taxed at a higher rate than the 2006 deduction rate because of the phase-out rules for itemized deductions. Please consult us before you overpay state or local income taxes!

Penalty for Under-Withholding or Under-Estimating. One way to avoid a penalty for failing to pay or withhold sufficient income taxes for a tax year is to pay 100% of your prior year’s tax liability in quarterly estimated payments or through income tax withholding. Planning Alert! If your 2005 AGI was over $150,000, you must pay in 110% of your 2005 tax liability to qualify for this safe harbor in 2006. Tax Tip. If you have not paid sufficient estimates to avoid an underpayment penalty for 2006, you may have additional amounts withheld from your wages, year-end bonuses, or IRA distributions on or before December 31, 2006. Any withholding for 2006 is deemed paid equally on each quarterly installment date for estimated tax purposes, even if the withholding occurs in December.

MISCELLANEOUS CONNECTICUT PROVISIONS

Withholding Tax – Employees in a Civil Union. An employee who is a party to a civil union recognized under Connecticut law should complete a new Form CT-W4.  By choosing the filing status of civil union filing jointly or civil union filing separately, the employee will have the correct amount of Connecticut income tax withheld from his or her wages.  The wages subject to Connecticut income tax withholding are the same as the wages subject to federal income tax withholding, determined as if the employee were married. For example:

1. An employer provides health insurance coverage for employees and their families. For federal income tax withholding purposes, the coverage for an employee’s spouse is a nontaxable fringe benefit, but the cost of coverage for an employee’s civil union partner is taxable income to the employee. For Connecticut income tax withholding purposes, the benefit for the civil union partner is treated in the same manner as a benefit for a spouse; therefore the coverage for the civil union partner is not taxable.

2. An employer provides a "cafeteria plan" package which allows employees to use pre-tax income for health insurance payments.  For federal income tax withholding purposes, the premiums for an employee’s spouse are a pre-tax salary reduction, but the premiums for a civil union partner are not a pre-tax salary reduction.  However, for Connecticut income tax withholding purposes, the premiums for a civil union partner are a pre-tax salary reduction.  

Out-of-state same-sex marriages (as opposed to civil unions) have no legal significance and are not recognized for any purpose in Connecticut, including Connecticut income tax purposes.  

Connecticut Higher Education Trust (CHET). Any individual required to file a 2006 Connecticut income tax return is eligible to claim a deduction for contributions to a CHET account or accounts during taxable year 2006, whether or not the individual is a CHET account owner. An individual whose filing status for Connecticut income tax purposes is "single," "head of household," "married filing separately," or "civil union filing separately" may claim a deduction up to $5,000 of the contributions to a CHET account or accounts during taxable year 2006.  Individuals whose filing status for Connecticut income tax purposes is "married filing jointly," "civil union filing jointly", or "qualifying widow(er) with dependent child" may claim a deduction up to $10,000 of the contributions to a CHET account or accounts during taxable year 2006. 

If the contributions to a CHET account or accounts during taxable year 2006 exceed the $5,000 or $10,000 limits, the excess is carried over to the five taxable years following taxable year 2006.  The maximum deduction allowed for each of the five succeeding taxable years still can not exceed the $5,000 or $10,000 limit.

There is no per-beneficiary limit. It does not matter whether contributions are to one CHET account or to multiple CHET accounts. The $5,000 and $10,000 limits are overall limits and not per-beneficiary or per CHET account limits. The contributor is eligible to claim a deduction whether or not the beneficiary of the CHET account is a resident or nonresident of Connecticut and whether or not the contributor is a resident or nonresident of Connecticut, as long as the contributor is required to file a Connecticut income tax return.

The contributions must have been made on or after January 1, 2006 and prior to January 1, 2007. Electronic payments must be made on or before the last business day of taxable year 2006 (December 29, 2006).

FINAL COMMENTS
Please call us if you are interested in a tax topic that we did not discuss. Tax law constantly changes due to new legislation, cases, regulations, and IRS rulings. Our firm closely monitors these changes and we will be glad to discuss any current tax developments and planning ideas with you. Please contact us before implementing any planning ideas discussed in this letter, or if you need more information.

Note: The information contained in this material represents a general overview of tax developments and should not be relied upon without an independent, professional analysis of how any of these provisions may apply to a specific situation.

Circular 230 Disclaimer: Any tax advice contained in the body of this material was not intended or written to be used, and cannot be used, by the recipient for the purpose of 1) avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions, or 2) promoting, marketing, or recommending to another party any transaction or matter addressed herein.