Seven new tax perks you don't want to miss when filing your '08 taxes
By Andrea Coombes, MarketWatch
Last update: 12:30 p.m. EST Jan. 29, 2009
SAN FRANCISCO (MarketWatch) -- In all the hoopla surrounding the current stimulus package, it's easy to forget that other stimulus bill -- the one in 2008 that resulted in a good-sized check for many U.S. taxpayers.
Forgetting about that earlier stimulus, and any of the other major tax changes in 2008, could mean missing out on some much-needed cash when you file your tax return this year418142.
There were six "pretty significant pieces of tax legislation" in 2008, said Mark Luscombe, a principal analyst with CCH Inc., a Riverwoods, Ill., tax publisher, including bills related to housing, farming, the military, pensions, and two on the economy.
Still, while all that tax tinkering affects most of us eventually, many of the changes last year were related to arcane rules -- and won't show up on our Form 1040s.
More noticeable for some taxpayers is that their bleaker financial situation may bring good news when they file. Small comfort it might be, but more people may be eligible for perks for which their formerly higher income made them ineligible, such as education-related credits or that stimulus payment from 2008.
"People's circumstances could change sufficiently that these deductions and credits are new for them," said Bob Scharin, New York-based senior tax analyst with Thomson Reuters' tax and accounting business.
Also, homeowners saw plenty of tax changes in recent years. For instance, those who don't itemize now have access to an extra standard deduction for property taxes paid, up to $500 for single filers and $1,000 for married-filing-joint filers. And homeowners who went through a foreclosure on their primary residence won't owe income tax on the forgiven mortgage-loan debt.
Here are seven more recent changes to consider:
1. Recovery rebate credit
You call it the "stimulus payment," but the IRS says "recovery rebate credit." If you weren't eligible for the full payment -- or any at all -- last year, you may get more money now if a layoff or investment losses slashed your income, because the stimulus checks sent in 2008 were based on 2007 returns. The credit starts phasing out with adjusted gross income over $75,000 for single filers and $150,000 for married-filing-jointly filers.
Also, if you had a baby in 2008 you may be eligible for the additional $300 stimulus payment per child. Or if your college-age child now supports herself, she might qualify for up to $600. Parents can't claim a payment for children older than 17 and a dependent can't claim it for him or herself, Scharin said. But "if the child graduated in 2008 and is no longer dependent, then that child could apply for it." See this IRS page for more on claiming recovery rebate credit.
2. Zero capital-gains rate
You might assume your income makes you ineligible for the zero rate on capital gains and qualified dividends in effect in 2008 for taxpayers in the 10% and 15% tax brackets. But don't forget those brackets refer to taxable income, not adjusted gross income.
While your AGI may be higher than the $65,100 which marks the start of the 25% tax bracket for married-filing jointly filers ($32,550 for single filers), deductions and other tax perks may bring your taxable income low enough to qualify for at least a portion of the zero rate.
"A family of four claiming the standard deduction could have adjusted gross income of $90,000 and that would translate to taxable income of $65,100 when you take the four personal exemptions plus the standard deduction," Scharin said. People who itemize may have even higher AGI yet still qualify for the zero rate, he said.
While plenty of people only wish they had gains in 2008, some might have sold long-held investments at a gain, Scharin said.
And, Luscombe said, "even if the gain itself moves you into the 25% bracket, there is still a portion of the gain that may be taxed at the zero percent rate."
3. AMT relief on incentive stock options
Taxpayers who've struggled to pay the alternative minimum tax owed on incentive stock options -- exercising an ISO can result in an unexpected AMT bill -- got some good news in 2008: You don't owe the tax.
"If you had an unpaid AMT liability resulting from an incentive stock option prior to 2008, it was basically abated by the law, so you don't have to pay it now," Luscombe said.
Also, Congress sped up the process by which taxpayers can take a credit against regular tax for previous AMT bills, among other provisions. See this IRS page for more information.
4. Perks for higher-income taxpayers
Even as some wonder whether Congress will allow the 2001 tax cuts to expire in 2010, some of those tax cuts are still going into effect.
Higher earners' ability to take itemized deductions and personal exemptions is limited -- those perks phase out at higher incomes. But thanks to the 2001 tax cuts, those phase outs themselves were slowly eliminated starting in 2006. (In 2010, higher-income taxpayers enjoy these perks with no reduction at all, but as with the other tax cuts, this one expires after 2010.)
In 2008, higher-income earners will find their itemized deductions and personal exemptions are cut by just one-third the amount in effect before the tax cuts.
The phase-out on deductions starts at adjusted gross income of about $159,950 for most filers and on exemptions at $159,950 for single filers and $239,950 for married-filing-jointly.
5. First-time home buyer credit
If you're a first-time home buyer who bought a home after April 8, 2008, and before July 1, 2009, you may qualify for a credit of 10% of the purchase price up to $7,500 on your 2008 tax return. Even if you bought the home in 2009, you can take the credit on your 2008 return, Luscombe said.
But here's the rub: The credit is more like a loan and must be repaid over 15 years. The stimulus bill under consideration now may eliminate the repayment rule for homes bought in 2009, but what's not clear yet is -- if the new stimulus plan does eliminate the repayment rule -- will people who bought a home in 2009 but claimed the credit on their 2008 return be exempt from repaying the credit? (Those who take the credit on homes bought in 2008 will have to repay the credit, under current law.)
If you bought a home in 2009 (before the July 1 deadline), your best bet is to wait until the final bill gets signed into law to see whether to claim the credit on your 2008 return or to wait and claim it next year. See story on House OKs stimulus bill.
6. Donate land
For those who donate land for conservation by a land trust or other qualified recipient in 2008 and 2009, there's a generous new perk available.
"If you make a qualified conservation contribution like an easement over property or a remainder interest in property, instead of getting a charitable deduction for only up to 30% of adjusted gross income, it goes to 50% of AGI and instead of having a 5-year carryover period you have a 15-year carryover period," said Grace Allison, a tax strategist with Northern Trust in Chicago. "Lots of our clients and people we hear about are doing these qualified conservation contributions."
7. Harvest business loss for a gain
It's not a new perk but plenty of business owners may find themselves ready and eager to take advantage now of the loss carryback that allows them to use a net loss in 2008 to offset a profit from up to two years ago -- and collect a refund for the difference.
"You deduct the loss from your prior year's income and the differential in tax --with the loss and without the loss -- is what you would get refunded," said Maureen McGetrick, tax partner with BDO Seidman in New York. "You file Form 1045 and the IRS generally has to take action on that within 90 days."
Keep an eye on the new stimulus bill being discussed now: The loss carryback perk may get extended to five years, up from two years now.
Note that perks on your federal return may not apply to your state tax bill. For instance, California has frozen the benefit for businesses this year, said Stephen Kunkel, a Los Angeles-based certified public accountant and tax practice leader at CBIZ MHM.
"It continues to carry forward, they just kind of freeze it," he said.
Similarly, Kunkel said California doesn't allow businesses to take the full federal amount of the Section 179 expense deduction. The federal stimulus bill in 2008 increased the Section 179 expense deduction to $250,000 from $128,000. That law includes another perk: 50% bonus depreciation, allowing certain businesses to immediately write off one-half of the cost of a capital expense. Of course, few companies likely were making major purchases, especially toward year-end.
Also for business owners: The IRS raised the standard rate for deducting mileage to 58.5 cents per mile for July through December, up from 50.5 cents from January through June. That compares with 48.5 cents in 2007.
"The IRS on Jan. 1, 2009, dropped it back to 55 cents since gasoline has come down somewhat," Kunkel said. If gas prices decline further, "it may be that in mid-2009 they may adjust it downward again."
Andrea Coombes is an assistant personal finance editor for MarketWatch, based in San Francisco.
Thursday, January 29, 2009
Tuesday, January 27, 2009
The True Cost Of Debt
Most small and emerging businesses use debt as part of their financing structure. (The exceptions--and they have dwindled--are those high-potential ventures that can raise money through promises of potentially lucrative slices of equity.) The question: How much does that money cost?
The financial crisis is proof that too few people either 1) know how to perform these calculations or 2) bother to live by what the numbers are telling them. The first part is somewhat easily remedied; the second, sadly, is perhaps something only a painful recession can drive home.
If you borrow $100 for one year at a 10% annual rate, you owe $110 a year from now. This is the simplest way to calculate interest--but if you hadn't already guessed, hardly anything in life is so simple, especially when it comes to alternative financing schemes.
Consider the following:
Monthly payments of interest only. As I am sure you have noticed, lenders like to receive interest each month. (Bonds carry less frequent payments, with quarterly or semi-annual installments, but smaller businesses usually do not have access to the bond market.) Here's where things get tricky: Paying interest monthly effectively raises your interest rate.
Say the lender says it will lend to you at 12% per year, to be paid 1% per month. (On $100, that means you will pay $1 each month.) But by paying monthly, you have raised your effective rate, which takes into account the time value of money. Observed through that lens, your annual interest cost is 12.7%. The formula for effective rate can be duplicated quite easily on many financial calculators, or even a simple Excel spreadsheet.
Amortizing loans. Car and house loans often require an equal monthly payment that includes principal and interest. On these, the difference between the nominal rate and the effective rate can be significant.
Example: Say you borrow $100 for one year with equal monthly payments of principal and interest, and the lender says the annual rate is 12%. The normal practice is to calculate the monthly payment based on an amortization schedule, using a 1% rate per month. In that case, the effective annual rate is 12.7%.
Beware! Some unscrupulous lenders might calculate your monthly payment to be $112/12, or $9.33 per month. (Their nefarious logic: The interest payments are based on the initial principal, not the outstanding principal, which clearly diminishes over time.) Here, the effective rate is nearly double the nominal rate, or a whopping 23.5%.
Prepayment of interest. Some lenders will deduct the interest from the loan amount and lend the net figure, while still expecting repayment of the entire face value of the loan. Again, the stated interest rate undershoots reality. Say you borrowed $100 at a stated 10% rate for one year, but the bank only hands over $90. Your effective annual interest is $10 / $90, or 11.1%.
Compensating balances. This maneuver isn't used much anymore, but some lenders used to demand that borrowers keep a certain percentage of the loan in the bank, meaning that they would lend you the stated amount on their books but only hand over a portion. So, on that $100 loan, if the compensating balance is 20%, or $20, and the interest is $10 (or 10% of $100), then the effective loan amount is $80--boosting the effective rate to 12.5%.
A word about fees and penalties: Some lenders charge an upfront fee; others do not. If you are paying a fee of 2% of the principal amount, it is similar to borrowing $100 and having to repay $102 plus interest. You better believe those little fees can have a substantial impact over the long haul. Say you borrow $100,000 over 20 years at a stated rate of 7% and the upfront fee is 2%. Without the fee, that monthly payment is $775--with the fee, it is $790. Effective annual rate: 7.48%.
Note: Some lenders may charge low interest rates and fees but enforce strict terms. Fail to meet the terms of the loan, and you'll get whacked with a penalty.
Term loan versus line of credit. Really understand your needs before you strike a deal. If your business is seasonal, you may be in the market for a potentially cheaper line of credit, rather than a regular term loan.
Example: Suppose you only need $100 for six months. You could take out a one-year term loan at a stated 10% rate that also comes with stiff pre-payment penalty (that is, you pay back $100 in principal and $10 interest at year's end). Or, you could open a one-year "committed" line of credit (also called a revolver) at a 12% annual rate, on which you have to pay an annualized fee of 2% on any amount you didn't draw down during the year. Which to choose?
In the term-loan scenario, say you use the $100 for the first six months. Because you don't want to suffer a penalty for prepaying it before the full year is up, on the first day of the seventh month you put that $100 in a money-market fund yielding 4% per year, translating to $2 in earnings for the remainder of the year. Net financing cost: $10 - $2 = $8. (Note that some of the terms in this example may not seem realistic because you may just borrow the funds for six months--my point with a one-year, non-amortizing loan is to make a simple apples-to-apples comparison.)
Now look at a line of credit. Suppose you tapped that $100 line for the first six months, at the 12% annual rate, but repaid the principal and interest and didn't touch it for the last six months. That means that after six months you paid back the $100 along with $6 in interest. Now tack on that 2% fee for the unused funds--or 1% for six months. In that case, you paid $6 in interest in the first six months plus $1 for the commitment fee, for a total of $7.
What it all means: In this stylized example, you are more likely to benefit from the line of credit if the interest rate on the line is below 14%. That's because, at 14%, you will pay $7 in interest for the first six months, plus $1 for the unused amount during the remaining six months. So that 12% credit line a few paragraphs back is looking pretty good.
The math may be initially confusing, but the lesson here is simple. When it comes to borrowing money, do your own calculations and be sure to shop around. Even if you have to apply for a government-guaranteed loan, know that your lender can often sell off the guaranteed portion in the secondary market and earn handsome fees.
Don’t let lenders make you think they are doing you a favor if you are a sound credit. And if you aren't so sound, take steps to improve. For tips, check out Finance Any Business Intelligently, available at www.infinancing.com.
The financial crisis is proof that too few people either 1) know how to perform these calculations or 2) bother to live by what the numbers are telling them. The first part is somewhat easily remedied; the second, sadly, is perhaps something only a painful recession can drive home.
If you borrow $100 for one year at a 10% annual rate, you owe $110 a year from now. This is the simplest way to calculate interest--but if you hadn't already guessed, hardly anything in life is so simple, especially when it comes to alternative financing schemes.
Consider the following:
Monthly payments of interest only. As I am sure you have noticed, lenders like to receive interest each month. (Bonds carry less frequent payments, with quarterly or semi-annual installments, but smaller businesses usually do not have access to the bond market.) Here's where things get tricky: Paying interest monthly effectively raises your interest rate.
Say the lender says it will lend to you at 12% per year, to be paid 1% per month. (On $100, that means you will pay $1 each month.) But by paying monthly, you have raised your effective rate, which takes into account the time value of money. Observed through that lens, your annual interest cost is 12.7%. The formula for effective rate can be duplicated quite easily on many financial calculators, or even a simple Excel spreadsheet.
Amortizing loans. Car and house loans often require an equal monthly payment that includes principal and interest. On these, the difference between the nominal rate and the effective rate can be significant.
Example: Say you borrow $100 for one year with equal monthly payments of principal and interest, and the lender says the annual rate is 12%. The normal practice is to calculate the monthly payment based on an amortization schedule, using a 1% rate per month. In that case, the effective annual rate is 12.7%.
Beware! Some unscrupulous lenders might calculate your monthly payment to be $112/12, or $9.33 per month. (Their nefarious logic: The interest payments are based on the initial principal, not the outstanding principal, which clearly diminishes over time.) Here, the effective rate is nearly double the nominal rate, or a whopping 23.5%.
Prepayment of interest. Some lenders will deduct the interest from the loan amount and lend the net figure, while still expecting repayment of the entire face value of the loan. Again, the stated interest rate undershoots reality. Say you borrowed $100 at a stated 10% rate for one year, but the bank only hands over $90. Your effective annual interest is $10 / $90, or 11.1%.
Compensating balances. This maneuver isn't used much anymore, but some lenders used to demand that borrowers keep a certain percentage of the loan in the bank, meaning that they would lend you the stated amount on their books but only hand over a portion. So, on that $100 loan, if the compensating balance is 20%, or $20, and the interest is $10 (or 10% of $100), then the effective loan amount is $80--boosting the effective rate to 12.5%.
A word about fees and penalties: Some lenders charge an upfront fee; others do not. If you are paying a fee of 2% of the principal amount, it is similar to borrowing $100 and having to repay $102 plus interest. You better believe those little fees can have a substantial impact over the long haul. Say you borrow $100,000 over 20 years at a stated rate of 7% and the upfront fee is 2%. Without the fee, that monthly payment is $775--with the fee, it is $790. Effective annual rate: 7.48%.
Note: Some lenders may charge low interest rates and fees but enforce strict terms. Fail to meet the terms of the loan, and you'll get whacked with a penalty.
Term loan versus line of credit. Really understand your needs before you strike a deal. If your business is seasonal, you may be in the market for a potentially cheaper line of credit, rather than a regular term loan.
Example: Suppose you only need $100 for six months. You could take out a one-year term loan at a stated 10% rate that also comes with stiff pre-payment penalty (that is, you pay back $100 in principal and $10 interest at year's end). Or, you could open a one-year "committed" line of credit (also called a revolver) at a 12% annual rate, on which you have to pay an annualized fee of 2% on any amount you didn't draw down during the year. Which to choose?
In the term-loan scenario, say you use the $100 for the first six months. Because you don't want to suffer a penalty for prepaying it before the full year is up, on the first day of the seventh month you put that $100 in a money-market fund yielding 4% per year, translating to $2 in earnings for the remainder of the year. Net financing cost: $10 - $2 = $8. (Note that some of the terms in this example may not seem realistic because you may just borrow the funds for six months--my point with a one-year, non-amortizing loan is to make a simple apples-to-apples comparison.)
Now look at a line of credit. Suppose you tapped that $100 line for the first six months, at the 12% annual rate, but repaid the principal and interest and didn't touch it for the last six months. That means that after six months you paid back the $100 along with $6 in interest. Now tack on that 2% fee for the unused funds--or 1% for six months. In that case, you paid $6 in interest in the first six months plus $1 for the commitment fee, for a total of $7.
What it all means: In this stylized example, you are more likely to benefit from the line of credit if the interest rate on the line is below 14%. That's because, at 14%, you will pay $7 in interest for the first six months, plus $1 for the unused amount during the remaining six months. So that 12% credit line a few paragraphs back is looking pretty good.
The math may be initially confusing, but the lesson here is simple. When it comes to borrowing money, do your own calculations and be sure to shop around. Even if you have to apply for a government-guaranteed loan, know that your lender can often sell off the guaranteed portion in the secondary market and earn handsome fees.
Don’t let lenders make you think they are doing you a favor if you are a sound credit. And if you aren't so sound, take steps to improve. For tips, check out Finance Any Business Intelligently, available at www.infinancing.com.
Article by Dileep Rao 01.26.09, 6:01 PM ET (originally published here at forbes.com)
Subscribe to:
Posts (Atom)